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Lecture #5 Oct 02 2013.docx

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Chris Liboiron

Fraud Awareness Introduction • What is this case from? Mackesa and robins • Like a torrent of cold water the wave of publicity raised by the . . . case has shocked the accountancy profession into breathlessness. Accustomed to relative obscurity in the public prints, accountants have been startled to find their procedures, their principles, and their professional standards the subject of sensational and generally unsympathetic headlines What could have been done to prevent this fraud? • IMPACT • led to significant changes in procedures for appointing auditors and conducting audits. The committee’s first standard, Statements on Auditing Procedure No. 1, “Extensions of Auditing Procedure,” made observing inventory and confirming accounts receivable— two procedures that would have helped detect the McKesson & Robbins fraud— standard audit procedures Conclusions? • Resemblance to other cases? • Themes? • Auditors not policing for fraud • History repeats itself What is Fraud? • Fraud is a generic term, embracing all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppressions of truth, and includes all surprise, trick, cunning or dissembling, and any unfair way by which another is cheated… • Blacks Law Dictionary What is Fraud? 1. Deception 2. Intended to financially benefit the deceiver Potential Midterm Question • Compare and contrast the ways of fraud “2 certain cases” Fraudulent Fin Reporting • Most common techniques? Fraud Perpetrator • Review question from the 3349 textbook… • What does a fraud perpetrator look like? How does he or she act… • According to “Profile of a Fraudster”? o Male o Greed o Egotistical o Risk taker o Rule breaker o Under stress o Big spender o Pressured to Perform o Close relationship with vendors, suppliers Fraud Detection: Red Flags • Observation of a person’s habits and lifestyle may reveal some red flags. • Fraudster Characteristics: o lose sleep o take drugs o can’t relax o can’t look people in the eye o work standing up o drink too much o become irritable easily o get defensive, argumentative o sweat excessively o find excuses or scapegoats for mistakes o work alone, work late Conditions/Elements necessary for Fraud? • Opportunity • Motive • Rationalization Describe Motivation • Greed (desire for better lifestyle) • Ego, desperation (crave success, fear failure) • Need (addictions) • Revenge (unfair treatment) • Fear (lose job) Describe Opportunity • Trust placed in: • Employees • Management • Business Partner • Poor i/c and acctg controls  Comptroller steals $2k from petty cash o Inadequate mgmt procedures Describe Rationalization • Not really “criminal”??? • More like borrowing – will pay back • No one really gets hurt • Not likely to get caught • Everybody does it • Essential for survival High Risk Conditions FS Fraud • Define Motivation • Low barriers to entry, high competition, combined with declining margins • Vulnerability to technological change, product obsolescence, or interest rates • Inability to generate operating cash flows • Close to debt covenants • Management has significant financial interests in the company • Senior mgmt places excessive pressure to meet fin targets • Others High Risk Conditions FS Fraud • Opportunity • A,L R & E based on significant estimates involving judgment or uncertainty • Significant unusual or highly complex transactions close to period end pose substance over form issues o Unusual timing (end of a period) o Pricing (large even amounts) o Not description on the transaction • Ineffective monitoring of mgmt – dominant manager without compensating controls, ineffective BOD • High turnover of senior management o People don’t know what is going on • Ineffective accounting and info systems • Others High Risk Conditions FS Fraud • Rationalization • Management does not place high priority on entity’s values or ethical standards • Mgmt justifying marginal/inappropriate acctg treatment as immaterial Typically Need all three • Increasing one increases likelihood • Decreasing one decreases likelihood • Which one can auditors play the biggest role in? (i.e.: which is the easiest one to decrease? o Opportunity is the biggest role Auditors’ Ranking of F/S Fraud Warning Signals 1. Managers have lied to the auditors or have been overly evasive in response to audit enquiries. 2. The auditor’s experience with management indicates a degree of dishonesty. 3. Management places undue emphasis on meeting earnings projections of the quantitative targets. 4. Management has engaged in frequent disputes with auditors, particularly about aggressive application of accounting principles that increases earnings. 5. The client has engaged in opinion shopping. 6. Management's attitude toward financial reporting is unduly aggressive. 7. The client has a weak control environment. 8. A substantial portion of management compensation depends on meeting quantified targets. 9. Management displays significant disrespect for regulatory bodies. 10. Management operating and financial decisions are dominated by a single person or a few persons acting in concert. Main Methods – 2002 Report to Nation on Occupational Fraud and Abuse • Cash Larceny – 7% • Skimming – 25% • Billing schemes; Lapping – 25% • Payroll schemes – 10% • Expense reimbursements – 12% o You ate a sandwich, but you wrote you ate a steak  Get more money because steak cost more than the sandwich • Check Schemes tampering – 16% o Intercept the check and redirect the check • Non cash misappropriations – 9% • Corruption schemes – 12% • Fraudulent statements – 5% Skimming • Business mgr of church stole $200K from collection plate until volunteer treasurer noticed trend (attendance up, contr down) • Hired CFE • What would you audit approach be? o Duel control (2 people monitor the donation) Cash Larceny • Office manager of 24 person business insisted on handling certain bank transactions such as deposits and reconciliations herself • Removed cash from deposit – then altered bank copy to reflect lower amount • But left company’s copy unchanged • So what happens eventually? How could this be fixed? o Independent review of the bank copy o Segregation of duties Cheque Schemes • Controller for 400 person company liked to brag about fool proof gambling system • Had racehorses, mansion, big-time lifestyle • Boss investigated – discovered he had been forging cheques and deposited in checking account which he withdrew for gambling • How did this get concealed? o Expensed “misalliances expense” o Expensed “repair and maintenance expense” o Expensed “professional service expense” o Expensed “utilities Expense” o Expensed “salary expense” make a fake employee • How could this be fixed? o Independent review of the statement o Small internal audit department Inventory Fraud • Purchasing manager of large company dreamed of starting hardware store in another state • Figured his current employer could help out • So he rented a warehouse and began approving merchandise – and shipped it to company’s warehouse – and then reshipped to his warehouse out of state • Had $5,000 authority – so kept purchases under that – so there were MANY
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