Fraudulent Financial Reporting
and Forensic Accounting
Presented by:
Victor Hieken, UHY Advisors
Jeffrey Streif, UHY Advisors
What is Fraud?
•
A misrepresentation of a material fact relied upon by someone to their
detriment, or
•
Concealed, improper conversion of another’s assets to one’s own benefit.
(AICPA Practice Aid 97-1)
•
One or more intentional acts designed to deceive other persons and cause
them financial loss.
(Association of Certified Fraud Examiners)
Fraud Triangle
Rationalization / Integrity
Opportunity
Motive / Pressure
Pressures to Commit Fraud
• Financial Pressures
– Debt from medical bills, credit cards
– Divorce, Investment losses, pure greed
• Personal Habits
– Alcohol, drug or gambling addiction
– Expensive extramarital affair
• Work-Related Factors
– Overworked, underpaid, not promoted
Opportunities to Commit Fraud
•
Internal controls are weak
•
Excessive levels of trust
Rationalization to Commit Fraud
Integrity
•
Most important factor in keeping a person
from misappropriating assets or committing
management fraud.
Opportunity
Where are the Opportunities?
• Most common types of employee fraud include:
– Theft of cash by diverting cash receipts, manipulating accounts
receivable cash postings (lapping), altering bank deposits, stealing or
forging checks, stealing petty cash, etc.
– Manipulation of invoices, including fictitious or overstated vendor
invoices.
– Theft of inventory or equipment.
– Kickbacks.
– Credit card fraud.
– False entries in accounts to increase performance results (management
fraud).
– Abuse of travel and entertainment reimbursement to include personal
items.
– Payroll schemes such as ghost employees or overstated hours.
Victims
The smallest organizations suffer the largest median
losses because of three factors:
1. Basic accounting controls often are lacking.
2. Higher levels of trust.
3. Small companies are less likely to be audited.
Deterring Fraud
• Internal controls
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Segregation of duties
Procedures manual
Timely financial reporting
Mandatory vacations
• Audits
• Financial analyses
• Corporate fraud policy
Types of Entities
• Nonprofit & Governmental
• Public companies
• Privately held companies
Types of Fraud
• Third party fraud
• Management fraud
• Employee fraud
Third Party Fraud
Committed by those not involved with the organization
and normally benefits the third party, rather than the
company or management.
–
–
–
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Overbilling Schemes
Defective Products
Bid Rigging
Bribery/Corruption
Economic Espionage/Extortion
Employee Fraud
(Occupational Fraud)
Committed by employees for their own benefit and to
the detriment of the organization.
- Embezzlement
- Kickbacks
- Ghost Employees
- Theft of Inventory
- Bribery/Corruption
The Cost of Occupational Fraud
• Costs U.S. organizations - $600 billion annually.
• Average 5% total annual revenues by its own
employees.
Cash Misappropriation
Over 80% of occupational fraud
involves asset misappropriation –
with cash being targeted 90% of the time.
Management Fraud
Committed by management for the direct benefit of the
organization. Management benefits indirectly.
– Financial Statement Fraud
Financial Statement Fraud
MOTIVATION
• Economy, Business Environment
• Executive incentives:
–
–
–
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Stock prices are tied to meeting Wall Street’s earnings forecasts
Focus is on short-term performance only
Companies are heavily punished for not meeting forecasts
Executives have been endowed with stock options—far exceeds
compensation (tied to stock price)
– Performance is based on earnings & stock price
• Wall Street expectations: rewards for short-term behavior
Pressures to Commit Financial
Statement Fraud
INCENTIVES
Firm A
Firm B
Which firm will have the higher stock price?
Common Financial Statement
Frauds
– Revenue/Account Receivable Frauds (Global
Crossing, Quest, ZZZ Best)
– Inventory/Cost of Goods Sold Fraud (PharMor)
– Understating Liability Expense Frauds (Enron)
– Overstating Asset Frauds (WorldCom)
– Overall Misrepresentation (Disclosure Frauds)
(Bre-X Minerals)
Company Warning Signs
• “Cowboy attitude” – improper tone
• Accounting policies that rely too much on management
judgments
• Ineffective audit committees and board governance
• Overly centralized control over financial reporting
• Ratio and benchmarks significantly differ from industry
averages
• Cash flow from operations that bear little relationship to
reported earnings
Roles and Responsibilities of
Auditors for Detecting Fraud
SAS No. 82 defines the auditor’s responsibility:
• Assess the risk of material misstatements due to fraud by
considering fraud-risk factors
• Respond to the results of the risk assessment
• Document identified fraud-risk factors and the responses to
those factors
• Communicate fraud to management
Roles and Responsibilities of
Auditors for Detecting Fraud
SAS 99 requires auditors to
• plan the audit to provide reasonable assurance that financial
statements are free of material fraud.
• adopt an attitude of professional skepticism toward clients,
• conduct brainstorming sessions to assess the risk of
material fraud and how it could be concealed,
• conduct an assessment of a client's overall antifraud
programs, and look for red flags that may indicate fraud.
Audit Process
• Gain understanding of clients operations and industry
• Understand internal control environment – operations and IT
controls
• What are outside influences or third party influences
• Are there any related parties
• Understand management involvement and responsibilities
Audit Process
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Brainstorming
Risk Assessment
Modification of procedures
Interviews of High and low level management
Review key internal controls to determine reliance
Audit Process
Computer Assisted Audit Tools are used more
frequently in the normal audit process such as
IDEA to increase coverage and quality of audit
evidence
• 100% of population tested
• Sampling
• Automated tests
What is Forensic or
Investigative Accounting?
Forensic accounting services - generally involve the application of
special skills in accounting, auditing, finance, quantitative
methods, certain areas of the law and research, and investigative
skills to collect, analyze, and evaluate evidential matter and to
interpret and communicate findings, and may involve either an
attest or consulting engagement.
Definition adopted by the AICPA Business Valuation/Forensic and
Litigation Services Executive Committee; January 2006
Tools Used in Forensic Audit
• IDEA or ACL are used to analyze, extract and
manipulate large amounts of raw data
• Benford’s Law
• Lowers scope based upon criteria
• Saves time and fees
Tools Used in Forensic Audit
Forensic software such as Encase and FTK
Imager are used to acquire and analyze
electronic data in Computer Forensic
investigations
Important to maintain proper chain of evidence in case
dispute goes to litigation
Questions?
Thank You!
Victor Hieken
vhieken@uhy-us.com
Jeffrey Streif
jstreif@uhy-us.com