82 terms

Ch.1 Core Foundation

Fraud and Forensic Accounting
Fraud, sometimes referred to as the fraudulent act, is an:
intentional deception, whether by omission or co-mission, that causes its victim to suffer an economic loss and/or the perpetrator to realize a gain; A simple working definition of fraud is theft by deception
Under common law, fraud includes four essential elements:
(1)A material false statement (2)Knowledge that the statement was false when it was spoken (3)Reliance on the false statement by the victim (4)Damages resulting from the victim's reliance on the false statement
specific methodologies used to commit and conceal the fraudulent act
There are three ways to relieve a victim of money illegally:
force, trickery, or larceny
Those offenses that employee trickery are:
The legal term for stealing is larceny, which is defined as:
felonious stealing, taking and carrying, leading, riding, or driving away with another's personal property, with the intent to convert it or to deprive the owner thereof
in order to prove that a person has committed larceny, we would need to prove the following four elements:
(1)there was a taking or carrying away (2)of the money or property of another (3)without the consent of the owner and (4)with the intent to deprive the owner of its use or possession
conversion, in the legal sense, is:
an unauthorized assumption and exercise of the right of ownership over goods or personal chattels belonging to another, to the alteration of their condition or the exclusion of the owner's rights
a person commits a conversion when he or she:
takes possession of property that does not belong to him or her and thereby deprives the true owner of the property for nay length of time
to embezzle means:
willfully to take, or convert to one's own use, another's money or property of which the wrongdoer acquired possession lawfully, by reason of some office or employment or position of trust
in order for an embezzlement to occur, the person who stole the property must:
have been entitled to possession of the property at the time of the theft
the term fiduciary, according to Black's Law Dictionary, is of Roman origin and means:
a person holding a character analogous to a trustee, in respect to the trust and confidence involved in it and the scrupulous good faith and candor which it requires
a person is said to act in a fiduciary capacity when:
the business which he transacts, or the money or property which he handles, is not for his own benefit, but for another person, as to whom he stands in a relation implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part; in short, a fiduciary is someone who acts for the benefit of another
the elements of breach of fiduciary duty vary among jurisdictions, but in general they consist of the following:
(1)a fiduciary relationship existed between the plaintiff and the defendant (2)the defendant (fiduciary) breached his or her duty to the plaintiff (3)the breach resulted in either harm to the plaintiff or benefit to the fiduciary
the major categories of fraud:
asset misappropriations, corruption, and financial statement fraud and other fraudulent statements
asset misappropriations:
involve the theft or misuse of an organization's assets. (common examples include skimming revenues, stealing inventory, and payroll fraud)
entails the unlawful or wrongful misuse of influence in a business transaction to procure personal benefit, contrary to an individual's duty to his or her employer or the rights of another (common examples include accepting kickbacks and engaging in conflicts of interest)
financial statement fraud and other fraudulent statements:
involve the intentional misrepresentation of financial or nonfinancial information to mislead others who are relying on it to make economic decisions (common examples include overstating revenues, understating liabilities or expenses, or making false promises regarding the safety and prospects of an investment)
the Association of Certified Fraud Examiners defines financial statement fraud as:
the intentional, deliberate misstatement or omission of material facts or accounting data that is misleading and, when considered with all of the information made available, that would cause the reader to change or alter his or her judgment or decision; in other words, the statement constitutes intentional or reckless conduct, whether by act or omission, that results in material misleading financial statements
even though the specific schemes vary, the major areas involved in financial statement fraud include the following:
1.fictitious revenue (and related assets) 2.improper timing of revenue and expense recognition 3.concealed liabilities 4.inadequate and misleading disclosures 5.improper asset valuation 6.improper and inappropriate capitalization of expenses
the essential characteristics of financial statement fraud are:
(1) the misstatement is material and intentional, and (2) users of the financial statements have been misled
Suspected frauds can be categorized by a number of different methods, but they are usually referred to as:
either internal or external frauds
external fraud:
refers to offenses committed by individuals against other individuals (e.g., con schemes), offenses by individuals against organizations (e.g., insurance fraud), or organizations against individuals (e.g., consumer frauds)
Internal fraud:
refers to occupational fraud committed by one or more employees of an organization; this is the most costly and most common fraud
Webster's definition of abuse comes from the Latin word abusus, to consume, it means:
(1) a deceitful act, deception; (2) a corrupt practice or custom; (3) improper use or treatment, misuse
Financial forensics is:
the application of financial principles and theories to facts or hypotheses at issue in a legal dispute and consists of two primary functions:
Financial forensics is the intersection of financial principles and the law and, therefore, applies the:
(1) technical skills of accounting, auditing, finance, quantitative methods, and certain areas of the law and research (2) investigative skills for the collection, analysis, and evaluation of evidential matter; and (3) critical thinking to interpret and communicate the results of an investigation
Fraud examination is the discipline of resolving allegations of fraud from:
tips, complaints, or accounting clues
Fraud perpetrator profile:
Male, Middle-aged to retired, With the company for five or more years, Never charged or convicted of a criminal offense, Well educated, Accountant, upper management or executive, Acts alone
The fraud triangle:
opportunity, perceived pressure, and rationalization
some integral ways to reduce opportunity include:
providing adequate training and supervision of personnel; effective monitoring of company management by auditors, audit committees, and board of directors; practice antifraud programs; a strong ethical culture; anonymous hotlines; and whistleblower protections
In addition to the fraud triangle, typical motivations of fraud perpetrators may be identified with the acronym M.I.C.E.:
Money, Ideology, Coercion, Ego
Indirect costs of fraud and litigation can have far-reaching impact:
For example, employees may lose jobs or be unable to obtain other employment opportunities; the company may have difficulty getting loans, mortgages, and other forms of credit because of the impact of fraud and litigation on the company's finances; the company's reputation in the community may be affected; and the company may become the subject of broader investigations
The effect of gender on median loss:
Generally, in the United States, men occupy higher-paying positions than their female counterparts, And as we have seen, there is a direct correlation between median loss and position
The effect of age on median loss:
The frauds in the study were committed by persons ranging in age from eighteen to eighty, As with income and gender, age is likely a secondary factor in predicting the loss associated with an occupational fraud, generally reflecting the perpetrator's position and tenure within an organization; The median age among perpetrators was forty-five
The effect of education on median loss:
As employees' educational levels rose, so did the losses from their frauds, This trend was to be expected, given that those with higher education levels tend to occupy positions with higher levels of authority
The effect of collusion on median loss:
The majority of 2008 survey cases (63.9 percent) only involved a single perpetrator, but, when two or more persons conspired, the median loss was more than four times higher
The effect of the perpetrators' tenure with the victim organization:
There was direct correlation between the length of time an employee had been employed by a victim organization and the size of the loss in the case; To some extent, these data may also be linked to the position data; The longer that an employee works for an organization, the more likely it is that the employee will advance to increasing levels of authority
Losses in the smallest companies were comparable to or larger than those in the organizations with the most employees. It is suspected that this phenomenon exists for two reasons:
First, smaller businesses have fewer divisions of responsibility, meaning that fewer people must perform more functions. Second, there is a greater degree of trust inherent in a situation where everyone knows each other by name
The most common anti-fraud measure are:
the external audit of financial statements, utilized by approximately 70 percent of the victims, followed by a formal code of conduct, which was implemented by 61.5 percent of victim organizations
Reasons fraud isn't reported:
Fear of bad publicity (40.7 percent) was the most commonly cited explanation, followed by a private settlement being reached (31 percent) and the organization considering its internal discipline to be sufficient (30.5 percent)
Frauds were most commonly detected by:
tips (46.2 percent), By accident (20 percent) was the third most common detection method, ranking higher than internal or external audits
Some of the typical forensic and litigation advisory services are:
Damage claims made by plaintiffs and in countersuits by defendants, Workplace issues, such as lost wages, disability, and wrongful death, Assets and business valuations, Costs and lost profits associated with construction delays, Costs and lost profits resulting from business interruptions, Insurance claims, Divorce and matrimonial issues, Fraud, Anti-trust actions, Intellectual property infringement and other disputes, Environmental issues, Tax disputes
SAS No.1 states that due professional care requires:
the auditor to exercise professional skepticism
Because of the characteristics of fraud, the auditor should conduct the engagement:
with a mindset that recognizes the possibility that a material misstatement due to fraud could be present; It also requires an "ongoing questioning" of whether information the auditor obtains could suggest a material misstatement as a result of fraud
Professional skepticism can be broken into three attributes:
Recognition that fraud may be present, An attitude that includes a questioning mind and a critical assessment of the evidence, A commitment to persuasive evidence
Fraud professionals and forensic accountants refer to loose thread as:
anomalies, relatively small indicators, facts, figures, relationships, patterns, breaks in patterns, suggesting that something may not be right or that the arguments being made by litigants may not be the full story
Anomalies are often referred to as:
red flags
Red flags are defined as:
a warning signal or something that demands attention or provokes an irritated reaction
Fraud professionals and forensic accountants use the term red flag synonymously with:
symptoms and badges of fraud
Symptoms of fraud may be divided into at least six categories:
1.Unexplained accounting anomalies 2.Exploited internal control weaknesses 3.Identified analytical anomalies where nonfinancial data do not correlate with financial data 4.Observed extravagant lifestyles 5.Observed unusual behaviors 6.Anomalies communicated via tips and complaints
Fraud risk factors generally fall into three categories:
1.Motivational: is management focused on short-term results or personal gain? Situational: is there ample opportunity for fraud? Behavioral: is there a company culture for a high tolerance of risk?
successful investigators base their conclusions and the results of their investigations on:
The elements of fraud include:
1.The act (e.g., fraud act, tort, breach of contract) 2.The concealment (hiding the act or masking it to look like something different) 3.The conversion (the benefit to the perpetrator)
Evidence of the act may include that gathered by:
surveillance, invigilation, documentation, posting to bank accounting, missing deposits, and other physical evidence
Conversion can be documented using:
public records searches, the tracing of cash to a perpetrator's bank account, and indirectly using financial profiling techniques
Examples of circumstantial evidence that may indicate the act, concealment, or conversion include:
1. The timing of key transactions or activities 2. Altered documents 3. Concealed documents 4. Destroyed evidence 5. Missing documents 6. False statements 7. Patterns of suspicious activity 8. Breaks in patterns of expected activity
the fraud theory approach involves the following steps, in the order of their occurrence:
1. analyze available data 2. create hypotheses 3. test the hypotheses 4. refine and amend the hypothesis 5. draw conclusions
We can never prove any hypothesis; in contrast, we can have two findings:
a. We have no evidence that directly refutes the most likely hypothesis b. We have evidence that seems to eliminate the alternative hypotheses
Testing the hypotheses:
This involves developing a "what if" scenario and gathering evidence to support or disprove the proposition
Methodologies used in fraud and financial forensic engagements. Essentially three tools are available, regardless of the nature of the fraud examination or financial forensic engagement:
First, the fraud examiner or financial forensic professional must be skilled in the examination of financial statements, books and records, and supporting documents. The second tool used by fraud examiners or financial forensic professionals is the interview, which is the process of obtaining relevant information about the matter from those with knowledge of it. Despite the fact that financial forensic professionals do not ask the questions, it is common for them to prepare questions for attorneys to ask, attend depositions of key financial personnel and those knowledgeable about the entity's finances, and provide the attorney with feedback and additional questions during the deposition of fact witnesses, who have financial knowledge related to the matters at hand
In fraud examination, evidence is usually gathered in a manner that moves from:
the general to the specific
Evidence-gathering order in fraud examinations (figure 1-6):
a. Document analysis b. Neutral third-party witnesses c. Corroborative witness d. Co-conspirator(s) e. Target
Fraud interview methodologies (figure 1-7):
a. Interview key players b. Documents c. Neutral third parties d. Corroborative witness e. Co-conspirators f. Target
With fraudulent representations, such as materially misstated financial statements and improper tax returns, the investigator starts with:
the suspected perpetrator
Nonfinancial data:
data from any source outside of the financial reporting system that can be used to generate an alternative view of the business operation
Examples of nonfinancial data include:
1. Employee records and payroll hours 2. Delivery records 3. Shipping records 4. Attorney hours charged 5. Travel times and destinations
Graphical tools:
Such as who knows who (linkages), who is connected with what business, how the scheme works (flow diagram), who must be involved (links and flows), and what the important events are (timelines). It is important to note that the investigator needs to ground these graphics in the evidence and needs to maintain backup that indicates where the data came from
Even if the fraud examiner or forensic professional is working as the only person "following the money," the broader team might include:
lawyers, managers, paralegals, and other forensic investigators
Being a successful team player requires at least two attributes:
1. Professional competence a. Contributing high-quality ideas b. Contributing high-quality written work c. Demonstrating a professional level of responsibility to the team: "get it done" 2. Character a. Attending meetings, prepared and on time with something to contribute b. Being available to meet with teammates c. Completing a fair share of the total workload d. Listening to teammates' ideas and valuing everyone's contributions
Fraud examination:
is a methodology developed by ACFE for resolving fraud allegations from inception to disposition, including obtaining evidence, interviewing, writing reports, and testifying
Fraud examiners, as designated by the ACFE, also assist in:
fraud prevention, deterrence, detection, investigation, and remediation
The totality of circumstances that lead a reasonable, professionally trained, and prudent individual to believe that a fraud has occurred, is occurring, and/or will occur. An anonymous tip or complaint is a common method for uncovering fraud and is generally considered sufficient predication
Fraud prevention refers to:
creating and maintaining environments in which the risk of a particular fraudulent activity is minimal and opportunity is eliminated, given the inherent cost-benefit trade-off
Fraud deterrence refers to:
creating environments in which people are discouraged from committing fraud, although it is still possible
The 2005 Federal Sentencing Guideline Manual defines deterrence as:
a clear message sent to society that repeated criminal behavior will aggravate the need for punishment with each recurrence
Deterrence is usually accomplished through:
a variety of efforts associated with internal controls and ethics programs that create a workplace of integrity and encourage employees to report potential wrongdoing. Can also be achieved through the use of continuous monitoring/auditing software tools
Fraud deterrence is enhanced when:
the perception of detection is present and when potential perpetrators recognize that they will be punished when caught
Fraud detection refers to:
the process of discovering the presence or existence of fraud
Fraud detection an be accomplished through:
the use of well-designed internal controls, supervision, and monitoring and the active search for evidence of potential fraud
Fraud investigation takes place when:
indicators of fraud, such as missing cash or other evidence, suggest that a fraudulent act has occurred and requires investigation to determine the extent of the losses and the identify of the perpetrator
Remediation is a three-pronged process:
a. The recovery of losses through insurance, the legal system, or other means b. Support for the legal process as it tries to resolve the matter in the legal environment c.The modification of operational processes, procedures, and internal controls to minimize the changes of similar fraud recurring