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Today’s Topics

Today’s Topics. Intro to financial fraud Revenue Frauds Inventory Frauds Liability Frauds Other Asset Frauds Disclosure Frauds. Barriers to Transparency. Transparency defined WYSIWYG Management bias Measurement bias. Financial Fraud Statistics. Key players COSO

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Today’s Topics

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  1. Today’s Topics • Intro to financial fraud • Revenue Frauds • Inventory Frauds • Liability Frauds • Other Asset Frauds • Disclosure Frauds FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  2. Barriers to Transparency • Transparency defined • WYSIWYG • Management bias • Measurement bias FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  3. Financial Fraud Statistics • Key players • COSO • The Treadway Comm.-NCFFR • SEC’s AAERs • Accounting & Auditing Enforcement Releases • Treadway Commission: 1987 • Infrequent but costly • COSO Update: 1999 • 300 AAERs 1987-1997 FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  4. Drivers of 2000’s Meltdown • Booming economy • Moral decay • Incentives • Analysts’ expectations • Debt • Rules versus principles • Auditor independence issues • Greed • Educator failure • Failure to forecast FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  5. Financial Fraud Motivation • Greed • Fear of failure • Lack of accounting expertise • Scope of operations—too broad FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  6. 18 Key Tidbits • Average period: 23.7 months • Revenue frauds were #1 • Asset misstatement-spread around • Mean misstatement = $25 M • CEO involved in 72% of the cases • Last audit was unqualified in 55% of the cases • Mean assets = $532 M; revenues = $232 M • S/W and manufacturing involved in 12% of the cases • NASDAQ had 78% • 36% filed for bankruptcy • Non-existent or uninvolved audit committees • Insiders on Boards of Directors • Family relationships were common • Financial pressures were high • 56% of auditors were Big 6 • Auditors named in 30% of cases • 25% changed auditors after the fraud • Relatively few executives went to prison FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  7. Financial Fraud Detection • KTT is the key • Use the Fraud Exposure Rectangle • Management & Directors • Background, motivation & influence • Company relationships • Obligations, related party transactions & compliance • Nature of organization & industry • Financial results & operations • GAAP, attitude FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  8. General Detection Model • Period to period account balance analysis • Period to period relationship analysis • Comparison with industry averages • Comparison with physical assets • General horizontal and vertical analysis FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  9. Revenue Frauds • Shenanigans #1 and #2 • Tables pps. 403-405 • Revenue cycle • Sell goods or services • Estimate collectibility • Returns • Write-offs • Collect cash FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  10. Revenue Fraud Detection • Detection • Accounting anomilies • Ratios (p.408) FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  11. Inventory Frauds • Shenanigan #4 • Tables pps. 416-417 • Inventory cycle • Purchase inventory • Returns • Payment • Sell inventory • Write offs • Estimate or count inventory • Value inventory FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  12. Inventory Fraud Detection • Detection • Statement of cash flows • Comparison with physical assets • Ratios (p.421) FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  13. Liability Fraud • Shenanigan #5 • Table p. 449 • Liability cycle • Purchase goods and services • Incur accruals • Sell goods and services • Borrow money • Payments on account • Assess contingencies FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  14. Liability Fraud Detection • Types • Understatement • Unearned revenue • Omission of debt and contingencies • Detection • Accounting anomilies • Ratios (p.455) FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  15. Other Asset Fraud • Shenanigan #4 • Chart-p. 458 • Table-p. 464 • Types • Overstatement • Improper capitalization • Understated write offs FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  16. Other Asset Fraud Detection • Detection • Accounting anomilies • Ratios (pps. 465-469) FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  17. Inadequate Disclosure Fraud • Misrepresentation • Company and its products • Via financial reports • Via footnote disclosures FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  18. Disclosure Fraud Detection • Detection • KTT • Questions on pps. 473-477 • Use common sense • Compare footnotes • Vigorous use of inquiries • Go outside the box! • Fraud Buster Ratio • (NI - CFO)/Total Assets; should approach zero • Condition worsens as result grows FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  19. Financial Fraud Detection • KTT is the key • Note audit related procedures C12 & C13-Appendix A • Use the Fraud Exposure Rectangle • Management & Directors • Background, motivation & influence • Company relationships • Obligations, related party transactions & compliance • Nature of organization & industry • Financial results & operations • GAAP, attitude FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

  20. Transparency is Key • Are the #s telling the story or making the story? • Is the company managing the business or managing the #s? • What is, is? versus What is. Is! • Recall SFAC #1, now #8 • Improved decision making • Insight into future cash flows • Resource information FORENSIC ACCOUNTING - MSA 220I – Spring 2014 Slide 18-1

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