Chapter 10

Forensic Accounting
Research
Types of value added services

 Risk assessment of fraud and illegal acts

 Legal counsel asks you to investigate embezzlement
scheme involving hidden assets
 Vendor kickback determination
 Fact-finding for alleged frauds involving bribery,
wire fraud, securities fraud, etc.
 All of these involve forensic accounting or litigation
support
 Fraud defined

 Intentional deception, simply lying,

cheating, or stealing
 A generic term, embracing all multifarious
means which human ingenuity can devise,
and which are resorted to by one individual
to get advantage over another by false
suggestions or by suppression of truth. It
includes surprise, trickery, cunning,
dissembling, and any unfair way by which
another is cheated.
 Fraud defined (contd.)

 Fraud includes the following elements:

 A misrepresentation of a material fact
 Known to be false
 Justifiably relied upon
 Resulting in a loss
 Types of frauds

 Fraudulent financial reporting

(management fraud)
 Actions whereby management attempts
to inflate reported earnings or other
assets in order to deceive outsiders
 Overstating assets/revenues, price fixing,
contract bidding fraud, understating
expenses/liabilities
 Types of frauds (contd.)

 Misappropriation of assets (employee

fraud)
 Actions of individuals whereby they
misappropriate (steal) money or other
property from their employers
 Embezzlement, theft of company
property, kickbacks
 Types of fraud (contd.)

 Employee embezzlement – fraud in which

employees steal company assets either directly
– stealing cash or inventory –or indirectly –
taking bribes or kickbacks
 Management fraud – deception by top
management of an entity primarily through the
manipulation of the financial statements in
order to mislead users of those statements
 Investment scams – the sale of fraudulent and
often worthless investments (telemarketing and
Ponzi scheme type frauds)
 Types of fraud (contd.)

 Vendor fraud – fraud resulting from

overcharging for goods purchased, shipment
of inferior goods, or non-shipment of
inventory even when payment has been
received
 Customer fraud – fraud committed by a
customer by not paying for goods received or
deceiving the organization in various ways to
get something for nothing
 Miscellaneous fraud – all others – altering birth
records or grade reports, etc.
 Examples of fraud activities
 Misappropriation of assets  Fraudulent financial reporting
 Skimming  Fictitious revenues
 Forgery  Asset overstatement
 Kiting  Unrecorded liabilities
 Phony refunds
 Improper disclosure
 Larceny
 Fraudulent disbursements  Corruption
 Lapping  Conflict of interest
 Fictitious write-offs  Bribery
 Duplicate payments  Illegal gratuities
 Nonexistent vendor  Economic extortion
 Kickbacks
 Misdirected shipments
 Theft
 Unauthorized personal use of
assets
 Fictitious burglary
 Phantom employees
 Falsified time cards
 The Fraud Triangle

 Three factors in the triangle (usually all 3 exist

in a fraud)
 Motivation (perceived pressure or incentive)

 Perceived opportunity

 Rationalization

 Effective internal controls limit fraud

 If an organization can contain any one of the

three elements, fraud will most likely not occur
 Overview of financial fraud
examination

 Two basic categories of fraud an auditor

investigates when examining material
misstatement risk assessment
 Fraudulent financial reporting

 Misappropriation of assets
 Overview of financial fraud
examination (contd.)
 Financial reporting fraud red flags
 Incentive/pressures
 High degree of competition or market
competition in conjunction with declining profit
margins
 Perceived or real adverse effects of reporting
poor financial results
 Personal guarantees by management or board
members of entity debt
 Overview of financial fraud
(contd.)

 Financial reporting fraud (contd.)

 Opportunities – flags

Highly complex transactions

Major international operations

Deficiencies in internal controls

 Overview of financial fraud
(contd.)

 Financial reporting fraud (contd.)

 Attitudes/rationalization flags
Ineffective communication or
enforcement of ethical standards
Excessive interest by management in
maintaining or increasing the entity’s
earnings trend
 Overview of financial fraud
(contd.)
 Misappropriation of asset risk factors
 Susceptibility of assets to
misappropriation
Large amounts of cash on hand

Easily convertible assets (bonds,

diamonds)
 Controls (lack of)
 Overview of financial fraud
(contd.)
 Steps of the fraud examination
 Indentify issue/plan the investigation
 Gather the evidence/the investigation
phase
 Evaluate the evidence

 Report he findings to
management?/legal counsel
 Computer technology in fraud
investigation (contd.)
 Data mining software
 Software tool that models a database for the
purpose of determining patterns and
relationships among the data
 SAS Enterprise Miner-modeling software
 Wizrule – used for data cleaning (searching
for clerical errors) or anomaly detection.
Computer technology in fraud
investigation (contd.)
 Data mining software (contd.)
 IDEA (Audimation Services, inc) – allows user to
display, analyze, manipulate, sample or extract data
 Monarch – allows investigator to convert
electronic editions of reports into text files
 ACL for windows – data inquiry, analysis, and
reporting software
 Analyst’s notebook – assists investigators by
uncovering, interpreting, and displaying complex
information in easily understood charts.
Public records – see figure 10-7
 Courthouse records – lawsuits, judgments,
property filings, bankruptcy filings
 Company records – SEC filings, Dun and
Bradstreet has private company data, D/B/A
filings with state or county, real estate filings
 Online databases

 The Internet – KnowX, Instant Checkmate,

Zoominfo, etc.