1. 3/19/2014 1 CopyrightFraudResourceNet LLC How to Use Data Analytics to Expose Fixed Asset and Inventory Fraudsters Special Guest Presenter: Stefan Davis, TopCAATs March 19, 2014 CopyrightFraudResourceNet LLC About Jim Kaplan, MSc, CIA, CFE President and Founder of AuditNet, the global resource for auditors (now available on Apple and Android devices) Auditor, Web Site Guru, Internet for Auditors Pioneer Recipient of the IIAs 2007 Bradford Cadmus Memorial Award. Author of The Auditors Guide to Internet Resources 2nd Edition

2. 3/19/2014 2 CopyrightFraudResourceNet LLC President and Founder of White Collar Crime 101 Publisher of White-Collar Crime Fighter Developer of FraudAware Anti-Fraud Training Monthly Columnist, The Fraud Examiner, ACFE Newsletter Member of Editorial Advisory Board, ACFE Author of Fraud in the Markets Explains how fraud fueled the financial crisis. About Peter Goldmann, MSc., CFE CopyrightFraudResourceNet LLC About Stefan Davis, MEng, MBA Director at Reinvent Data Former Big-4 Auditor and Consultant Co-developer of TopCAATs, an Excel based CAATs package Writer of numerous eBooks and whitepapers on CAATs and data analytics for Auditors 3. 3/19/2014 3 CopyrightFraudResourceNet LLC This webinar and its material are the property of FraudResourceNet LLC. Unauthorized usage or recording of this webinar or any of its material is strictly forbidden. We are recording the webinar and you will be provided with a link access to that recording as detailed below. 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Webinar Housekeeping CopyrightFraudResourceNet LLC The views expressed by the presenters do not necessarily represent the views, positions, or opinions of FraudResourceNet LLC (FRN) or the presenters respective organizations. These materials, and the oral presentation accompanying them, are for educational purposes only and do not constitute accounting or legal advice or create an accountant-client relationship. While FRN makes every effort to ensure information is accurate and complete, FRN makes no representations, guarantees, or warranties as to the accuracy or completeness of the information provided via this presentation. FRN specifically disclaims all liability for any claims or damages that may result from the information contained in this presentation, including any websites maintained by third parties and linked to the FRN website Any mention of commercial products is for information only; it does not imply recommendation or endorsement by FraudResourceNet LLC 6 Disclaimers 4. 3/19/2014 4 CopyrightFraudResourceNet LLC Phantom inventory: How to know whats really in your warehouses and whats not How managers conceal inventory and capital asset theft by reporting fraudulently inflated values Case studies of inventory / fixed asset theft and concealment Effective data analytics tests revealing red flags of inventory theft and asset value misstatement What to do after data analytics has uncovered signs of asset fraud / misstatement Learning Objectives CopyrightFraudResourceNet LLC Introduction In the news: Costliest forms of fixed asset and inventory fraud Fixed asset and inventory fraudsters AssetCo case Planning for fixed asset and/or inventory fraud engagements Data gathering and software introduction Discovery with data analysis: Is there fraud at AssetCo Red flag detection and collusion Finding fixed asset and inventory fraud and next steps Agenda 5. 3/19/2014 5 CopyrightFraudResourceNet LLC According to ACFE's "Report to the Nations on Occupational Fraud and Abuse: > 7% of Fraud Cases in Financial Statement Fraud with < 99 Employees > 15% of Fraud Cases in Non-Cash Schemes (i.e. financial statement manipulation) Private Companies at 39%+ of 2012 Fraud, $200k+ per Incident Banking & Financial Services, Government, and Manufacturing Highest Fraud % Costliest forms of fixed asset and inventory fraud Examplefixedassetcycle Source:rksolution.co.in CopyrightFraudResourceNet LLC Fixed Assets Booking fictitious assets Misrepresenting asset valuation Improper capitalization Asset theft Inventory Stealing inventory Diverting inventory in transit Manipulating inventory quantities on hand / creating phantom inventory Inflating inventory costs Misrepresenting inventory valuation Reversing inventory adjustments at period-end Fraud schemes 6. 3/19/2014 6 CopyrightFraudResourceNet LLC What percentage of all frauds are non-cash schemes (e.g. financial statement frauds)? A 5% B 10% C 15% D 25% Polling Question 1 CopyrightFraudResourceNet LLC Description: The perpetrator and his companies were the guarantors of several large loans related to entertainment contracts. The loans were participation loans with several foreign banks. Fraud began with failure to record or disclose a liability caused by a failed loan. Perpetrators internal accountants relayed that the bankers had requested that the loss be kept off financial statements and that the external CPAs did not know about it. The fraud grew to include overstatement of assets and understatement of liabilities to keep the businesses functioning. Dollar loss: $236 million. What was done to conceal the fraud: Extensive internal collusion helped to hide the fraud. Audit evidence provided to external CPAs included falsified contracts and invoices that presented certain assets as company- owned. Assets that were sold were not removed from the books, assets that were borrowed were presented as owned, and certain guarantees of loans were not disclosed. How the scheme was detected: A whistleblower tipped off authorities to the fraud. AICPA Fraud Task Force & Six Men & $4bn in Fraud Itallstartedwithaloanfailure 7. 3/19/2014 7 CopyrightFraudResourceNet LLC Perpetrators of fraud CopyrightFraudResourceNet LLC Data analytics software Couple of TOPCAATS selling points Benefits Data analytics Traditional audit techniques Save time Identify red flags quickly Computerised procedures Delays in identifying red flags Manual procedures Reduce risk Test entire populations Perform continuous analysis Test a sample from the population Not feasible to perform continuous analysis Add value Identify every individual anomaly Determine trends Identify large or ongoing anomalies Difficult to determine trends Create opportunities Handle huge amounts of data Handle limited amounts of data 8. 3/19/2014 8 CopyrightFraudResourceNet LLC Using set rules to identify transactions of higher risk Every company is different, has a different environment, different systems, different risks, etc. Need to use judgment to select testing Need to use judgment to evaluate results Just because a transaction matches a red flag doesnt mean fraud is present Using data analytics does not guarantee finding fraud or finding all fraud! Principles of Using Data Analytics to Detect Fraud CopyrightFraudResourceNet LLC The Data Analysis Cycle Planyour testing Request Data Obtainand CleanData Carryout testing Evaluateand Followup Review Continuous Learning 9. 3/19/2014 9 CopyrightFraudResourceNet LLC 1. Open / import data file 2. Cleanse data (if necessary) 3. Check column statistics (check-totals) TopCAATs - Getting Started CopyrightFraudResourceNet LLC Ima Tipster calls AssetCos whistleblowers hotline with anonymous tip that: There is massive theft going on in the warehouse They think assets are being overstated to meet loan covenants They have general concerns about fixed asset and inventory fraud Theyre scared to come forward or raise anything with management AssetCo Case Study: First Contact 10. 3/19/2014 10 CopyrightFraudResourceNet LLC 1000+ assets with no physical review (maybe this wasnt a material site?) Profits are increasing but cash flow is negative Havent performed a comparison of sales price vs. book value for inventory Caught Operations Manager stealing stock via CCTV Tight loan covenants, EBITDA close to breaching covenants every quarter Two people are responsible for fixed assets and inventory but they are centralized (Corporate) All inventory-holding locations are decentralized AssetCo: Interview Findings CopyrightFraudResourceNet LLC Choose all of the following that are components of the data analytics cycle: A Request data B Clean data C Conduct testing D Review E All of the above Polling Question 2 11. 3/19/2014 11 CopyrightFraudResourceNet LLC Operations Manager Assumed CCTV cameras were not working Thought he would never get caught Hadnt had a raise in over 3 years Worked at AssetCo for 10 years Claims he had not stolen anything before Needed the extra money to pay the rent Fixed Asset Clerk Reviewed CCTV tapes and notified management Told by manager that its okay not to do physical counts AssetCo: Interview Findings CopyrightFraudResourceNet LLC Walk through processes Asset additions, disposal and transfer Inventory booking in and out Purchase to Pay (P2P) cycle and CoGS transfer Understand key controls in place and gaps e.g. Inventory counts, fixed asset verification Ensure you include those operated both locally and centrally Understand relevant and notable history Process changes, significant acquisitions, inventory transfers, etc. Develop hypotheses Develop plan to test hypotheses incorporating data analysis Planning 12. 3/19/2014 12 CopyrightFraudResourceNet LLC When considering financial statement fraud Completeness are there any assets off-balance sheet? Existence are these assets actually there? Accuracy are the costs of these assets correct? Valuation are the values of these assets appropriate? Ownership does the company have rights to the assets? Presentation are the assets correctly classified? Assertion Risks CopyrightFraudResourceNet LLC Which three of these would normally be the primary focus when looking for inventory asset fraud using data analysis? A Completeness B Existence C Accuracy D Valuation E Ownership F Presentation Polling Question 3 13. 3/19/2014 13 CopyrightFraudResourceNet LLC No asset revaluation other than write-up with acquisitions No policy in relation to capital vs expense items and no review No recalculation of depreciation (should have a system control but someone could get around it). No capital or inventory budgetary review No oversight of transfer of inventory to CoGS Monthly inventory values are submitted by each site (no corporate-wide inventory system) Inventory transfer in from another site before year-end Recurring negative cash flows AssetCo: Planning observations CopyrightFraudResourceNet LLC Fixed Assets Compare asset register totals to ledgers Recalculate depreciation Review asset lives for each category Identify duplicate assets Review for incorrectly capitalized assets Review significant additions Initial Test Plan 14. 3/19/2014 14 CopyrightFraudResourceNet LLC Inventory Check totals to corporate submissions Join for Stock, Sales and Purchase data sources Test stock against Benfords Law Compare stock value to purchase prices Review for aged / obsolete inventory Compare stock value to sales prices Review for purchase of obsolete inventory Check CoGS transfer dates Compare dispatched vs received for inter-site transfer Also consider tests with sales, accounts payable, closing entries Initial Test Plan CopyrightFraudResourceNet LLC Request all data fields and files in line with desired tests Data gathering Inventory Part number Part description Unit cost Quantity Total value Part status (e.g. current, obsolete) Inventory purchases GRN date GRN quantity Unit cost Vendor ID, name, address Purchase order number Posted by and approved by ID Budgets by vendor or product Comments Sales Sold quantity Sales price Transfer to COGS Customer ID, name, address Date of sale Date of transfer to CoGS 15. 3/19/2014 15 CopyrightFraudResourceNet LLC Request all data fields and files in line with desired tests Data gathering (contd) Fixed assets Asset ID Depreciation for period Accumulated depreciation Net book value Asset description Date of purchase Date of sale Date of disposal Loss / Gain on Sale Acquisition revaluations and dates CopyrightFraudResourceNet LLC Which of the following are useful tests for inventory manipulation? A. Test stock against Benfords Law B. Compare stock value to purchase prices C. Review for aged / obsolete inventory D. None of the above E. All of the above Polling Question 4 16. 3/19/2014 16 CopyrightFraudResourceNet LLC Speak to IT departments not just process owners Flat files (e.g. .csv) are best Be specific the more information you can provide the better Use a data request template Getting the data You can find an example data request template at www.topcaats.com/datarequestform CopyrightFraudResourceNet LLC 1. Assets under-depreciated 2. Various lives within an asset category Assets - Red flags 17. 3/19/2014 17 CopyrightFraudResourceNet LLC 3. Duplicated assets 4. Repairs and maintenance capitalized Assets - Red flags CopyrightFraudResourceNet LLC 5. Low value items capitalized 6. Significant additions Assets - Red flags 18. 3/19/2014 18 CopyrightFraudResourceNet LLC 1. Stock listing totals not agreeing to ledger (E) 2. Receipt of obsolete inventory (E/V) Inventory - Red flags CopyrightFraudResourceNet LLC 3. Inventory site transfer received despatched (E) Inventory - Red flags Add screenshot 19. 3/19/2014 19 CopyrightFraudResourceNet LLC 4. CoGS transfer in period after sale made (E) 5. Stock value much greater than last purchase prices Inventory - Red flags CopyrightFraudResourceNet LLC 6. Stock value not between max/min purchase prices 7. Values not conforming to Benfords law Inventory - Red flags 20. 3/19/2014 20 CopyrightFraudResourceNet LLC 8. Sales prices lower than cost held in stock 9. Aged inventory Inventory - Red flags CopyrightFraudResourceNet LLC Sales prices that are lower than cost held in stock is a red flag of inventory fraud A True B. False Polling Question 5 21. 3/19/2014 21 CopyrightFraudResourceNet LLC 1. Compile a summary of data used and findings in each area 2. Determine any additional tests required and perform 3. Discuss initial findings with CEO and recommend follow-up steps 4. Conduct follow-up interviews with employees 5. Review control gaps and deficiencies and make recommendations 6. Recommend management develop a business case and implement ASAP 7. Determine if client has fraud insurance rider, recommend consideration 8. Contact insurer (if applicable) and begin claim process 9. Contact the authorities and file a report 10. Determine if prosecution is viable 11. Complete report (see ACFE.com) 12. Compile required supporting documentation for insurer and authorities Next steps CopyrightFraudResourceNet LLC Fixed Assets Implement capital vs expense items policy Add review controls for capitalization of assets over $X Add system controls to prevent capitalization of assets under $X Default depreciation calculation based on asset category Add test of comparison of anticipated value to book value Implement capital and inventory budgetary review Add surprise physical verification of assets Obtain expected industry valuation and decline by year for significant assets Inventory Add control at month-end over CoGS transfer period Add system controls over price and quantity adjustments Implement provisioning policy for aged / obsolete stock Perform audited counts of all inventory of high volume sites (PI or annual) Corporate oversight of significant transfers between sites Implement inventory budgetary review Fraud prevention 22. 3/19/2014 22 CopyrightFraudResourceNet LLC Continuous Monitoring Complete risk assessment and develop annual audit plan Determine monthly and quarterly testing by priority Implement data analysis testing and incorporate into annual audit plan Perform and complete ongoing control assessments Fraud prevention CopyrightFraudResourceNet LLC Questions? 23. 3/19/2014 23 CopyrightFraudResourceNet LLC Peter Goldmann FraudResourceNet LLC 800-440-2261 www.fraudresourcenet.com pgoldmann@fraudresourcenet.com Jim Kaplan FraudResourceNet LLC 800-385-1625 www.fraudresourcenet.com jkaplan@fraudresourcenet.com Stefan Davis Reinvent Data Ltd www.topcaats.com stefan.davis@reinventdata.com Thank You! CopyrightFraudResourceNet LLC ComingUp Upcoming March Anti-Fraud Webinar "Background Checks: Best Practices for Reducing Employee Fraud, April 17, 2014 "Effective General Ledger and Journal Entry Fraud Testing Using Data Analytics, April 23, 2014 Sign up at: http://www.fraudresourcenet.com