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Chapter 5
Employee Fraud: The Misappropriation of Assets
CHAPTER SUMMARY
Overview
There are many ways employees can commit fraud and often, they involve false documents that help skirt
internal controls. Accountants are perhaps the most valuable employee-fraud fighters because they possess the best
understanding of how businesses operate and how transactions flow through the financial or central nervous system
of the operation.

Fraud Schemes and Their Schemers


5001

Company Susceptibility to Fraud

There are a number of schemes that employees and outsiders may use to commit fraud, so fraud detection
is important for most organizations. Often misappropriations are accomplished by false or misleading records or
documents, possibly created by circumventing internal controls. Sometimes random events will bring the fraud to light.
Auditors must be more skeptical as well, employing forensic procedures in their audits. Internal and external auditors
must demand evidentiary support for all questionable transactions. This chapter surveys the types of misappropriation
of assets and explains ways to combat such fraud.
5011

Employee Fraudsters

Those involved in forensic accounting continue to research information on employee fraud perpetrators that
is helping to develop some characteristics even if these are not yielding what might be described as a true profile.
One difficulty in trying to sketch out the type of employee who turns to fraud is that given the right pressures,
opportunities, and rationalizations, a large percentage of employees are capable of committing some types of fraud.

Types of Misappropriations
5021

Embezzlement

Embezzlement is the fraudulent appropriation of money or property lawfully in ones possession to be used
personally by the embezzler. An embezzler steals from his or her employer.
5031

Cash and Check Schemes

Cash is the favorite target of fraudsters. Fraud perpetrators use an amazing array of techniques to cipher cash
from their employers, such as larceny, skimming, theft of incoming checks, or kiting. Segregation of duties, mandatory
vacations, and rotation of duties all help to prevent these schemes.
Larceny of Cash. Larceny of cash schemes involve the numerous types of theft of cash after the cash has
been recorded on the books, such as directly from a cash register or petty cash. Prevention by segregation of duties is
important for stopping cash larceny.
Skimming. Skimming is an off-book technique to remove cash before a company records the receipts.
Skimming schemes can involve unrecorded sales, understated sales, theft of incoming checks, and swapping checks
for cash. Prevention of skimming can be as simple for some businesses as numbering receipts sequentially and tracking
down any missing numbers. Strong internal controls and separation of duties are two vital preventive measures.

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Swapping Checks for Cash. A person may take cash, but leave personal checks in the register or petty cash box
to cover the money taken in case of a surprise audit. Thus, the cash receipts and register tapes or petty cash records
appear to balance. The perpetrator removes the checks before they are cashed, so any personal checks by the cashier
found in a register may flag cover-up of a theft. An auditor should check for reversing transactions, altered cash
counts, or register tapes that are lost.
Check Tampering. Not all check tampering occurs when the person entrusted to issue checks goes bad. Many
phony checks or phony recipients are created by others in a company who gain access to blank checks. Accounts
payable groups must practice separation of responsibilities and forced vacations.
Kiting. Another cash scheme, kiting, involves building up balances in two or more bank accounts based upon
floating checks drawn against the other accounts. Forensic investigators detect this type of scheme by looking for
frequent deposits and checks in the same amount, large deposits on Fridays, and/or short time lags between deposits
and withdrawals. A bank reconciliation audit is an important accounting tool; the bank should send the bank statements
directly to the fraud auditor.
Credit Card Refund and Cancellation Schemes. Fraudulent credit card refunds are common ploys of
employees to divert refunds to their own credit card accounts. Fraudsters substitute their own credit card numbers
on customers refund slips. Another misuse of credit card transactions occurs when a customer service or cashier
employee marks actual credit card sales receipts as voided, then withdraws cash for that amount from the cash drawer.
Prevention of these scams requires diligence by supervisors and strong internal controls for cash disbursements.
Businesses that accept large numbers of credit card transactions should require immediate approval of voided sales.
5041

Accounts Receivable Fraud

Accounts receivable schemes may include lapping, fictitious receivables, borrowing against receivables, and
improper posting of credits to receivables.
Lapping. Lapping involves recording of payment on a customers account some time after the receipt of the
payment. To catch this scheme, the forensic investigator compares the checks on a sample of deposit slips to the detail
of the customer credits that are listed on the days posting to the customers account receivables.
Fictitious Receivables. Fictitious receivables involve covering a phony sale with an equally phony receivable,
which may eventually be written off. A forensic auditor should obtain evidence of the existence of accounts receivable
and sales, then scrutinize any exception responses from accounts receivable confirmations.
Borrowing Against Accounts Receivable. In these fraud cases, the perpetrator puts up accounts receivable
as collateral for a loan. Auditing steps to uncover the illegal loan setups include independently verifying account
balances of customers who have not paid, reviewing receivables write-offs, and reviewing customer complaints about
unrecorded payments or excessive billing.
5051

Inventory Fraud

Stealing Inventory. Employees may steal inventory and supplies for personal use or sell the stolen items
to outsiders at flea markets and garage sales. Signs the investigator looks for include multiple checks for the same
vendor, charged prices that are higher than for other vendors, a purchasing agent who does not take a vacation, or
availability of only photocopied invoices.
Short Shipments with Full Prices. Fraud by short shipments of inventory/partial shipment occurs when
payment is made in full to an outside accomplice. In another type of shipment scheme, once they are entered into
inventory at full price, smaller fixed assets may be stolen outright or converted to unlawful personal use. Companies
should prevent the opportunity for shorting shipments by implementing systems of using prenumbered inventory tags
matched to count sheets, counting procedures for work-inprocess items, and separation of duties between purchasing
and logging receipt of shipments.
5056

Accounts Payable Fraud

Accounts payable fraud occurs when the victim is double-billed or pays false invoices. Employees can set up
shell companies to create false invoices for their employers in pass-through schemes. In such cases, the intermediary

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shell company pays a vendors invoice before passing along an inflated invoice to the victim business. Companies
can prevent accounts payable fraud by matching invoice numbers, dates, or values; looking for rounded amounts;
looking for amounts just below approval amounts; searching for abnormal invoice volume activity; remaining wary
of vendors with sequential invoice numbers; and looking for above average payments per vendor.
5061

Fictitious Disbursements

Doctored Sales Figures. Fraudulent sales schemes include: unrecorded sales, understated sales, creating
fictitious sales, and padding prices to increase commissions. Various analytical techniques are used to detect phony
sales figures: ratio analysis, statistical sampling, and horizontal and vertical analysis of the sales account.
Sham Payments. Fraud perpetrators invent myriad fictional accounts payable. Sham payments involve a broad
spectrum of transactions and prevention will require some specific tactics depending upon whether payment is a
vendor, a benefit claimant, a customer, or employee.
Price Manipulations: Land Flipping, Pump and Dump, and Cybersmearing. A land flip involves a situation
where a company decides to purchase land for a project. A person or group will find the land and buy it using a front
name or company. The fraudster then increases the price of the land before selling it to his or her company. This same
concept may be used for stock manipulation between related entities or pump-and-sell schemes. The Internet, with
stock chat message boards and online news services, allows people to quickly provide false or misleading information
that can cause stock to move rapidly up or down. Numerous messages (or spam) can hype thinly traded stock in what
is called pump and dump, causing the stock to move up rapidly, at which time the perpetrator sells the stock at a huge
gain. Bashing a stock, called cybersmear, causes the stock to decline. A forensic investigator must always question
the valuation figure of land by comparing with similar property (comparables). Proactive measures are key to fighting
cybersmears.
Money Laundering. Money laundering is the use of techniques to take money that comes from one source,
hide that source, and make the funds available in another setting so that the funds can be used without incurring legal
restrictions or penalties. Accountants use a gross profit analysis to spot money laundering.
Bid Rigging. Bid rigging occurs when a vendor is given an unfair advantage in an open competition for a
certain contract. Companies should implement policies prohibiting vendor gifts or discounts to employees involved in
contract decision making. Policies should explicitly state opposition to bribery and bid rigging. Employees exhibiting
a sudden, more extravagant lifestyle should raise red flags.
5071

Walking the Walk of Fraud Detection Programs

Efforts to create employee fraud prevention programs are not always sufficient to deter the crimes that have
been discussed. However, there are actions that should be considered.
Business Policies. Many organizations today look at an ethics policy to set the proper tone towards motivating
positive behaviors as well preventing negative ones. Often the rules of conduct that might be found in an Employee
Handbook or other document for employee consumption reflect a companys position on fraud.
Fraud and Companys Risk Assessment. An organizations profile of business risks should be comprehensive
and include consideration of fraud. Appropriate systems need to be in place to effectively manage the risks.
Proactive Is More Beneficial. There are two major types of fraud investigations: reactive and proactive.
Reactive refers to an investigation after there is suspicion of fraud. Proactive is preventive investigation when there
is no reason to suspect fraud. The threat of a future investigation reduces the occurrence of fraudulent behavior from
75 percent to only 43 percent.
Companys Response to Risk. Getting all capable parties working together to fight fraud is important to
controlling risk. It is also important to have adequate plans and procedures in place to deal with fraud once it has been
discovered.
Fraud and Security Policy. Another way the forensic accountant can assist in the fight against fraud is in
reviewing or helping to audit the companys security measures.
Staffing Role in Fraud Detection and Prevention. Staff selection and promotion based on sound employment
practices can fight fraud and help insure that if fraud is detected, it is reported.

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Company Fraud Prevention, Detection, and Mitigation Measures


5081

Companies on the Front Lines in Preventing Employee Fraud

Certified Fraud Examiners (CFEs) rank the controls importance in detecting and limiting fraud situations as
follows:
Control
Internal Audit/FE Department
Surprise Audits
Management Review of IC
Fraud Hotline
Mandatory Job Rotation/Vacations
Rewards for Whistleblowers
Audit of ICOFR
Audit of F/S

Average Score
3.81
3.51
3.17
3.03
3.02
2.86
2.65
2.53

Source: 2008 Wells Report, ACFE

Nonprofit Entities as Special Fraud Targets


5091

Reasons for Fraud in Not-for-Profits

The website of Clark, Schaefer, Hackett & Company pinpointed a couple of major reasons why nonprofit
entities are increasingly becoming targets of fraud: Many smaller not-for-profits just dont have the personnel size
required for a real segregation of duties. They often dont require much approval for disbursements. And, when fraud
is discovered, they frequently dont prosecute it very aggressively because of the perceived negative publicity.
5101

Prevention Programs for Not-for-Profits

In the vast majority of employee fraud situations, in corporate or not-for-profit settings, prevention is the best
medicine. An Enterprise Care Not-for-Profit Services website provides many practices under which unsuspecting notfor-profits can fall prey to fraud.
5111

Fraud in Federal, State, and Local Governments

The concept of revitalizing governments is sweeping the world, and forensic accountants can play a key role
in this effort. Constituents are holding governments accountable for the resources entrusted to them. Often these
resources are misused; when that occurs, the only recourse is the court system. In the 2001 GAO report, the government
watchdog said that many federal agencies are mismanaged and unprepared for audit. The same is true for state and
local governments. Hence there is great need for forensic accountants who can assist attorneys in recovering misused
or stolen assets.

When Its Time to Call in Professionals


5121

Forensic Accountants Techniques

The crisis in accounting is again focusing attention on fraud detection and the use of forensic accounting
techniques. As described earlier in this chapter, companies and their auditors should focus not only on detection of
fraud, but also on deterrence and prevention.
There are a number of forensic techniques and tools which may be used by forensic accountants. Some of these
tools are:
Game theory and strategic reasoning.
Continuous monitoring.

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5124

45

Timeline analysis.
Link analysis.
Invigilation.
Genogram.
Proof of cash.
Entity charts.
Fulland falseinclusion tests.
Game Theory and Strategic Reasoning

Game theory and strategic reasoning concepts may be used to detect fraud.
Fraud Risk Assessment. Auditors who use long lists and checklists of fraud cues are generally inaccurate
in their fraud risk assessments. Auditors should consider how management might manipulate perceptions of fraud
cues.
Audit Planning. Auditors should develop unpredictable audit strategies that do not follow procedures from
prior audits or standard audit programs. Strategic reasoning should be used to conceive of what fraud could be
perpetrated by management and how it would be concealed from the audit.
Implementation of the Audit. Learning from experience and interactions with clients is critical to an auditors
effective performance. Audit standards can improve learning by requiring activities such as documenting and
communicating the nature of interactions with management.
5126

Continuous Monitoring

Continuous monitoring (CM) can be used to detect fraud and abuse. Management hires an independent company
to install and manage software that continuously analyzes every business transaction in order to detect improper
activities and anomalies. Incidents can be sorted into errors, misuse, and fraud; suspicious transactions can be flagged
for follow-up. Although this practice is not widely used, it can save large companies money that would otherwise be
spent hiring several internal auditors.
5128

Some Forensic Techniques and Tools

Check spreads, deposit spreads, and credit card spreads may be used to track fraud. Check spreads show patterns
of activities and can gather data for the net worth method. Deposit spreads deal with receipts into a checking account,
show patterns of activities, and gather data for the net worth and expenditures methods. Credit card spreads may be
used for legal and stolen credit cards to show where a target has been geographically over time.
Timeline analysis (TA) examines the details from the beginning of a fraud event until the apprehension of the target
and helps forensic accountants communicate the timing of case related events and summarize the investigation.
Tracing schedules show the flow of funds from one source to another and can be helpful in money laundering
cases.
Link analysis (LA) is a subset of network analysis which shows associations between people and data. It
provides crucial relationships between many objects of different types that are not apparent from isolated pieces of
data.
Invigilation. Invigilation involves keeping detailed records before and after an invigilation period in order to
determine the amount of fraud that has been committed. During the invigilation period, strict controls are imposed so
that the fraud is virtually impossible. The losses from the before, after, and invigilation periods are then compared to
gauge the extent of the fraud.
Genogram. A genogram is a pictorial display of personal relationships among related or unrelated parties.
Symbols and lines are used to chart everyone close to a suspect. Genograms can lead to determining the motive of a
crime or they can provide evidence that the person had no direct involvement in the fraud. A genogram could be useful
where there is a conspiracy involving vendors or fake vendors.

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Proof of Cash. This procedure, more detailed and extensive than a bank reconciliation, can be used to verify
that cash accounts on the books are in agreement with the cash transactions recorded by the bank.
Entity Charts. Entity charts show entities and owners with the relationship between them. The charts can show
how income and assets are diverted, particularly among seemingly unrelated parties and entities.
Full-and-False Inclusion Tests. These tests are used to ascertain the proper universe of data under investigation,
so that no appropriate data is excluded and no extraneous data is included. They may be helpful in finding hidden
assets.
Net Worth Method. Other forensic techniques, the net worth method and Source and Application of Funds
method, are covered in detail in Chapter 6.
5131

Conclusion

Auditors must be more skeptical and employ forensic techniques in their audits because only about 21 percent
of employees are honest. A combination of motive, opportunity, and rationalization cause the nicest people in the
world to commit fraud. If fraud prevention programs and internal controls do not work, companies should prosecute
and make a criminal referral.

SOLUTIONS TO CHAPTER EXERCISES


1. Misappropriation of assets involves the theft of an entitys assets by stealing, embezzling, misuse of company
assets, and causing a company to pay for goods or services that have not been received. Sometimes called
theft or defalcation.
2. Misappropriations are often accomplished by false or misleading records or documents, possibly created by
circumventing internal controls.
3. $1,200,000 = $4.8 million
25%
4. SAS No. 99 states that assets may be misappropriated by embezzling receipts, stealing assets, or causing an
entity to pay for goods or services that have not been received. Often misappropriations are accomplished by
false or misleading records or documents, possibly created by circumventing internal controls.
5.
a. Skimming involves converting business receipts to ones personal use and benefit, by such techniques as
cash register thefts and swapping checks for cash.
b. Kiting involves building up balances in bank accounts based upon floating checks drawn against similar
accounts in other banks.
c. Lapping involves recording of payment on a customers account some time after the receipt of the
payment.
d. Kickbacks involve a vendor/supplier and an employee which involves sale of unreported inventory or
payment of an inflated price.
6. Incentives/pressures; opportunity; attitudes/rationalizations.
7. An instructor may review these 10 items in the textbook.
8.
a. Transactions that are not recorded in a complete or timely manner or are improperly recorded as to amount,
accounting period, classification, or entity policy.
b. Unsupported or unauthorized balances or transactions.
c. Last-minute adjustments that significantly affect financial results.
d. Evidence of employees access to systems and records inconsistent with that necessary to perform their
authorized duties.
SAS No. 99, page 39.

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9. c. In SAS No. 99, this is an opportunity.


10. Unrecorded sales, understated sales, theft of incoming checks, and swapping checks for cash.
11. Some ways to steal cash are larceny, skimming, theft of incoming checks and kiting. Or cash can be stolen by
a person taking deposits to the bank. Segregation of duties, mandatory vacations, and rotation of duties can
help to prevent these schemes.
12. Most fast food restaurants feature two windows at the drive through lane. Having two windows speeds up
the traffic somewhat, but two windows also make it more difficult for employees to steal cash and food. To
commit larceny with a two-window setup, two employees must work together to take cash and food. A pointof-sale system sends a document to the food preparer also. See chapter 6, question 30. Segregation of duties
helps prevent cash larceny.
13. An increase in bad debts may mean that fictitious accounts receivable are established to cover a phony sale.
Write-offs to bad debt can conceal inventory thefts and kickback schemes.
14. Missing inventory may mean shoplifting or employee theft. An Eyewitness in the textbook explains a scheme
in a grocery store where the manager would open up a seventh cash register and keep all of the money. The
seventh cash register tapes were not run through the accounting system.
15. Kiting should be suspected.
16. Lapping is called robbing Peter to pay Paul.
17. White-collar crime generally refers to theft and abuse by the employees within a unit. Indiana University
Professor Edwin Sutherland coined the term.
18. Gross profit analysis, compare receipts with deposits, surprise cash count, and investigate customer
complaints.
19. Kiting involves building up balances in bank accounts based upon floating checks drawn against similar
accounts in other banks. Look for frequent deposits and checks in the same amount, large deposits on Fridays,
short time lag between deposits and withdrawals. A bank reconciliation audit is helpful, also.
20. a. Confirming accounts receivables.
21. Checks may be intercepted before they are recorded and banked by an organization. An insider passes the
checks to a crime syndicate, who chemically removes the payee and the amount from the checks (e.g., washing
checks). New payees and new amounts are recorded on these new checks, and they are deposited in some
bank accounts. The cash is withdrawn and accounts closed before the operation is uncovered.
22. Lapping involves recording of payment on a customers account some time after the receipt of the payment.
Sometimes called robbing Peter to pay Paul, here the cash is taken to be covered with the receipt from
another customer. The process goes over and over, covering each account with a subsequent payment. A fraud
auditor may compare the checks on a sample of deposit slips to the detail of the customer credits that are listed
on the days postings to the customers accounts receivable.
23. A cut-off bank statement is similar to a normal bank statement except that it covers a shorter period of time
(10 to 20 days). An auditor may compare the canceled checks and other items with the cut-off bank statement
to substantiate outstanding checks, deposits in transit, etc. By vouching the reconciling items one can check
for lapping and kiting.
24. Kickback schemes often involve a vendor/supplier and an employee, which involve sale of unreported
inventory or payment of an inflated price. Check for same vendor, prices higher than other vendors, purchasing
agent does not take a vacation, or only photocopies of invoices are available. There is data-mining software
that may be used to help find kickbacks from vendors.
25. A land flip involves a situation where a company decides to purchase land for a project. A person or group
will find the land and buy it under a front name or company. The fraudster then increases the price of the
land before selling it to the company. This same concept may be used for stock manipulation between related
entities or pump-and-sell schemes.

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26. Money laundering is the use of techniques to take money that comes from one source, hide that source, and
make the funds available in another setting so that the funds can be used without incurring legal restrictions
or penalties. This technique is covered in more detail in Chapter 7. A gross profit analysis may be used to spot
money laundering.
27. Investigate 94 percent; report 62 percent of the time.
28. b. Check the targets personal computer. Do not turn on the computer since the computer can be set to destroy
evidence.
29.
a. Limit the scope.
b. Challenge the suspects.
c. Make emotional or hasty decisions.
d. Deface or damage any evidence.
e. Turn on personal computers.
f. Ignore the fact that losses may still be continuing.
g. Allow conflicts of interest.
30. Incentives/pressures; opportunities; attitudes/rationalizations.
31.
a. Personal financial obligations.
b. Known or anticipated future employee layoffs.
c. Promotions, rewards, or compensation inconsistent with expectations.
32. e. Go over the list in Appendix 1, pp. A-23 and A-24.
33. Probably not.
34. a. Personal financial obligation (e.g., wife is sick).
35. The following are some principles to follow to help stop fraud and abuse:
Have a fraud hotline.
Surprise audits.
External audits.
Internal audits.
Fraud training.
Institute a mandatory vacation policy.
Rotation of assignments.
Have a written and signed ethics policy.
Do different things each time you audit a unit.
Avoid telling client what you are doing.
Look and listen. Look for lifestyle changes.
Really understand the business unit, and what they really do.
When you ask a question, do not give the employee/client the answer.
Do not allow employee or executive to get away with anything.
In a small business, the monthly bank statements should be received unopened by the owner.
Always reconcile the bank statements.
Try to think like a criminal.
Get inside the criminals mind. Be a detective.

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36.
37.
38.
39.
40.
41.
42.

49

Do not assume you have honest employees.


Check employee references and resume.
Think outside the box.
Obtain and read all side agreements.
Review hotline data and follow-up red flags.
Bond employees.
Use positive pay.
Use a lock box.
Strong internal controls (1.62) and background checks of new employees (3.70).
Some experts say no, but other forensic accountants engage in covert surveillance. Certainly forensic
accountants have to be constantly alert to the psychological aspects of their clients.
SAS No. 99 suggests that not-for-profit organizations face incentives and pressures to cook books and records.
Fraud may be more prevalent in nonpublic entities since they are dealing with other peoples money.
These warning signs are outlined in the textbook.
Probably not a great problem as in the private sector, but misappropriation of assets is certainly a problem.
Constituents are holding governments accountable for the assets entrusted with them.
Although bankruptcy is not common for government units, there have been some Chapter 9 reorganizations
over the years (e.g., Orange County, California). Currently, California is having severe financial problems.
Using the Internet, students may have various examples (e.g., California, New York City, Orange County
various states, etc.).

43.
a. Yes, a negative indicator.
b. No, a positive indicator.
c. Yes.
d. Yes.
e. Yes.
f. No, a positive indicator.
g. Yes.
h. Yes.
i. No, favorable.
j. Yes.
k. No, favorable. Less than 50 percent is unfavorable.
l. No, favorable.
m. Yes.
n. No, favorable.
44. About 50 percent of current liabilities and 75 percent of average monthly expenditures.
45.
$27 + $36
= 2.25
$28
Favorable quick ratio. Below 50 percent is unfavorable.
Current ratio
$27 + $36 + $12 + $2.5
=
$28

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77.5
28

= 2.77 favorable

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46.
$62
= 15.5% favorable
$401
$54
Unreserved Fund
= 13.5% favorable
$401
Above five percent is considered favorable.
General Fund

47.
$5 million
= 13.89%
$36 million
$3.5 million
Reserved Fund
= 9.7%
$36 million
Both are favorable since at least five percent of revenues.
Unreserved Fund

48.
Tax Limit Exhausted =
Debt Limit Exhausted =

$8.5 million
$11 million
$9 million
$13 million

= 77.3%
=

69%

49.
$16.2
= 23%
$70.1 million
Susan M. Wincker and Dewey Ward would say the ratio is negative (greater than 20 percent), but a leading
textbook suggests 25 percent instead (J.R. Razek et al, Introduction to Governmental and Not-for-Profit
Accounting, footnote 55).
50. The steps to the fraud hypothesis testing approach are:
a. Identify the frauds that may exist in a particular situation.
b. Formulate null hypothesis stating that the frauds do not exist.
c. Identify the red flags that each of the frauds would create.
d. Design customized queries to search for the specific red flags or combination of red flags.
A Type II error occurs when a false null hypothesis fails to be rejected. It is an error to a forensic investigator
in the sense that an opportunity to reject the null hypothesis correctly is lost. So in order to be useful the red
flags have to be fraud and company specific.
51. A fraud review may include flow charting the major transactions in a business. One way to perform such a
review is the gap analysis approach.

Actual Internal Control


Organizations Stated Internal Controls
Best Practices Internal Controls
An instructor may wish to go through the two casino flow charts in the textbook.
52. The song points out how pervasive fraud is in most entities. Notice how the employee rationalized that he
was not really stealing when he was taking one piece at time. He did not consider himself a thief because GM
wouldnt miss just one piece. He took it out in his lunch box and in his buddys mobile home. Buddy did not
report him; neither did his wife.
53. See the flow chart in chapter 5.

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{

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54. These five audit procedures were judged as being more effective for detecting fraud in the sales and collection
cycle (in descending order):
Observe the proper and appropriate segregation of duties.
Review monthly bank reconciliation and observe independent reconciliation of bank accounts.
Investigate the difference between accounts receivable confirmations and customer account receivable
balances in the subsidiary ledger and describe all these exceptions, errors, irregularities, and disputes.
Review sales journal, general ledger, cash receipts journal, accounts receivable subsidiary ledger, and
accounts receivable trial balance for large or unusual amounts.
Verify accounts receivable balances by mailing positive confirmations.
See Glen D. Moyes and C. Richard Baker, Auditors Beliefs about the Fraud Detection Effectiveness of
Standard Audit Procedures, Journal of Forensic Accounting 4 (2003), pp. 204-205.
55. External and internal auditors have judged these five procedures to be more effective in detecting fraud in the
acquisition and payment cycle (in descending order):
Examine bank reconciliation and observe whether they are prepared monthly by an employee who is
independent and recording cash disbursement or custody of cash.
Examine the supporting documentation such as vendors invoices, purchase orders, and receiving reports
before signing of checks by an authorized person.
Examine the purchase requisitions, purchase orders, receiving reports and vendors invoices which are
attached to the vouchers for existence, propriety, reasonableness, and authenticity.
Examine internal controls to verify the cash disbursements are recorded for goods actually rendered to the
company.
Discuss with personnel and observe the segregation of duties between accounts payable and custody of
signed checks for adequacy.
See Glen D. Moyes and C. Richard Baker, Auditors Beliefs about the Fraud Detection Effectiveness of
Standard Audit Procedures, Journal of Forensic Accounting 4 (2003), pp. 204-205.
56. The six audit procedures judged most effective for detection fraud in the payroll/personnel cycle are:
Sample terminated employees and confirm that they are not included on subsequent payrolls and confirm
propriety of termination payments.
Observe the actual distribution of payroll checks to employees.
Observe the duties of employees being performed to insure that separation of duties between personnel,
timekeeping, journalizing payroll transactions, posting payroll transactions, and payroll disbursements
exists.
Examine internal controls to verify that hiring, pay rates, payroll deductions, and terminations are
authorized by the personnel department.
Sample personnel files and physically observe the presence of personnel in the work place.
Examine internal controls over payroll records to verify that payroll transactions are properly authorized.
See Glen D. Moyes and C. Richard Baker, Auditors Beliefs about the Fraud Detection Effectiveness of
Standard Audit Procedures, Journal of Forensic Accounting 4 (2003), p. 208.
57. These five standard audit procedures were judged by external and internal auditors as being more effective for
detecting fraud in the inventory and warehousing cycle (in descending order):
Discover related party transactions
Follow up exceptions to make sure they are resolved.
Review major adjustments for propriety.

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Forensic and Investigative Accounting

58.
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79.
80.

Review inventory count procedures: a. Accounting for items in transit (in and out); b. Comparison of
counts with inventory records; and c. Reconciliation of difference between counts and inventory records.
Review adequacy of physical security for the entire inventory.
See Glen D. Moyes and C. Richard Baker, Auditors Beliefs about the Fraud Detection Effectiveness of
Standard Audit Procedures, Journal of Forensic Accounting 4 (2003), pp. 206-207.
The hockey stick pattern refers to the situation that companies managing their earnings will have a significant
increase in revenues near the end of a quarter or year end.
Just as the cockroach has been here and will be here forever, so too is fraud. Just like cockroaches, there
generally is never just one red flag or indicator of fraud.
A shell company may be used to steal assets through accounts payable. An employee may create a shell
company (phantom vendor) with the secretary of state, open a bank account, and send false invoices to his or
her employer.
In a pass-through scheme, an intermediary shell company inserts itself between a real vendor and a company.
The vendor sends a $16,000 invoice to the intermediary company and the invoice is paid. The shell company
sends a new, inflated invoice to the victims business for $20,000 in order to make an unauthorized profit of
$4,000.
About two percent of total purchases are duplicate invoices.
c.
a.
e.
e.
b.
e.
b.
c.
c.
a.
b.
a.
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e.
b.
c.
c.
a.
Simon Kareri, a former Riggs Bank Senior Vice President, and his wife, Ndeye Nene Fall Kareri, embezzled
funds from various bank accounts owned by the country of Equatorial Guinea. The funds were then laundered
through shell companies established by Kareris wife in the British Virgin Islands. The investigation further
revealed that Kareri accepted illegal kickbacks from a contractor for inflating work contracts on behalf of
the Benin Embassy in Washington, D.C. In 2005, Kareri and his wife pled guilty to conspiracy, bank fraud,
and money laundering. On November 16, 2006, Nene Kareri was sentenced to 75 days in prison and three
years supervised release, and Simon Kareri was sentenced to 27 months in prison and four years supervised
release. The FBI successfully seized more than $1.1 million in assets as a result.

Chapter 5

2009 CCH. All Rights Reserved.

53

Textbook Solutions

On October 11, 2007, Simon Kareri surrendered to the FBI a check in the amount of $631,021.24, which
represented a money judgment included in his plea agreement.
From the FBI Internet site.
81. Employees will steal and rationalize their behavior.
82. Catch Me If You Can: Fraud Bingo.
T
R Michael Oxley
U Kenneth Lay
L
E
S

Catch Me If
You Can
Maurice E.
Peloubet
Kiting

IRS or FBI

Ghost
Employee

Sunbeam

Richard
Scrushy

ZZZZ Best

Larry Stewart

Ernst & Young

FREE SPACE

Ponzi Scheme

Scott Sullivan

Sherron
Watkins

SEC

Cynthia Cooper Lapping

No. 99

PCAOB

Pamalat

Arthur
Andersen
Waste
Management

James
McClelland

U-E: Barry Minkow: Cooking the books by forgery, theft, and fraud. Imaginary contracts.

2009 CCH. All Rights Reserved.

Chapter 5