A
Presentation To:
Main Line Association For Continuing Education
Presentation By:
Leon A. LaRosa, Jr., CPA, CFE, CFF, MST
Member
September 18, 2014

1.
Improve Client Service
2.
Clarify Understanding of the CPA’s Client Expectations
3.
Clarify Understanding of the CPA’s Professional
Responsibilities
4.
Develop a Better Understanding of the Fraud Environment
5.
Provide Practical and Economic Fraud Prevention Strategies
6.
Improve Client Service

 $3.7 Trillion Problem
 $154 K Per Scheme – Companies With Under 100 Employees
 5.4% Detected by External Audit - < 100 Employees
 1.9% Detected by External Audit - > 100 Employees

34.2% Detected by Tip - < 100 Employees
 45.2% Detected by Tip - > 100 Employees
 Typical Scheme – 30-32 months

Most Common Frauds
 Employees Fraudulently Writing Company Checks

Revenue Skimming
 Processing Fraudulent Invoices
 Misuse of Company Credit Cards
 Payroll
 Financial Statement

Company downsizing is weakening Internal controls segregation of duties
Internal Controls
Company budgets are decreasing
– do the same work with less people
Increased pressure and decreased controls people may explore more ways to commit fraud
Layoffs increasing
Declining stock prices
Credit crisis
Internal/External
Pressure
Source: Association of Certified Fraud Examiners
Opportunity to
Commit Fraud

“Degree of care, skill or competence exercised by reasonably competent members of the profession under the circumstances.”
MEASUREMENT APPROACH
1.
2.
3.
Compliance with Rule 201 of the AICPA Code of
Professional Conduct
Conformity with Professional Standards
What another competent accountants would have done in the circumstances.

RULE 201:
Professional Competence –
Undertake only those professional services that the member or the member’s firm can reasonably expect to be completed with professional competence.
Due Professional Care –
Exercise due professional care in the performance of professional services.
Planning and Supervision –
Adequately plan and supervise the performance of professional services.
Sufficient Relevant Data –
Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to ANY professional service performed.

Responsibilities:
1.
2.
3.
4.
5.
Select, regularly evaluate, and, if necessary, replace the
CEO; determine management compensation; and review succession planning.
Review, and, where appropriate, approve the major strategies and financial and other objectives and plans for the corporation.
Advise Management on significant issues facing the corporation.
Oversee processes for evaluating the adequacy of internal controls, risk management, financial reporting, and compliance, and satisfy itself as to the adequacy of such processes.
Nominate directors and ensure that the structure and practices of the board provide for sound corporate governance.

Responsibilities:
5.
6.
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2.
3.
4.
Design and implement programs and controls to prevent, detect, and deter fraud
Ensure that the company complies with applicable laws and regulations
Safeguard assets
Establish and maintain sound accounting information systems in compliance with GAAP or other comprehensive bases of accounting.
Use appropriate and reasonable accounting estimates
Ensure that financial statements are free from material misstatements cause by errors or fraud.

Responsibilities:
1.
2.
3.
4.
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6.
7.
8.
Plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement whether caused by error or fraud.
Be knowledgeable of the red flags of fraud.
Consider the opportunities and motivations for the occurrence of fraud.
Conduct discussions among engagement personnel regarding the risks of material misstatements due to fraud
Assess the engagement and control environment risks factors that may result in a material misstatement due to fraud.
Assess management’s response regarding the risk of fraud.
Document the auditor’s consideration of fraud.
Communicate to senior management, the audit committee or others, whether the auditor has determined there is evidence that fraud may exist.

CPA Responsibilities:
• Possess a level of knowledge of the accounting principles and practices of the industry in which the entity operates.
• Possess a general understanding of the entity’s organization and operating characteristics to include knowledge of the entity’s production, distribution, and compensation methods, types of products and services, operating locations, and material transactions with related parties.
• Perform inquiry and analytical procedures.

CPA Responsibilities:
• Obtain a representation letter signed by the chief executive officer and chief financial officer.
• Obtain additional or revised information or perform additional procedures when the accountant becomes aware that information supplied by the entity is incorrect, incomplete or otherwise unsatisfactory to achieve limited assurance that there are no material modifications that should be made to the financial statements in order for the statements to be in conformity with generally accepted accounting principles (GAAP).

CPA Responsibilities:
• SSARS-12 states that the accountant is not required to plan a review engagement specifically to discover fraudulent financial statements.
• Does NOT relieve an accountant of responsibility if incorrect, incomplete, or otherwise unsatisfactory information comes to his/her attention during the engagement.
• The accountant is required to establish an understanding with the client, preferably in writing, which includes a statement that the accountant will inform the appropriate level of management of any fraud or illegal acts that come to his/her attention.
• The accountant need not report any matters regarding illegal acts that may have occurred that are clearly inconsequential.
• The accountant is required to report all matters involving fraud.

CPA Responsibilities:
• Possess a level of knowledge of the accounting principles and practices of the industry in which the entity operates.
• Possess a general understanding of the nature of the entity’s business transactions, the form of its accounting records, the stated qualifications of its accounting personnel, the accounting basis on which the financial statements are to be presented, and the form and content of the financial statements.
• Obtain additional or revised information when the accountant becomes aware that information supplied by the entity is incorrect, incomplete, or otherwise unsatisfactory for the purpose of compiling financial statements.
• Read the compiled financial statements to assure they are appropriate in form and free from obvious material errors.

CPA Responsibilities:
• SSARS-12 states that the accountant is not required to plan a compilation engagement specifically to discover fraudulent financial statements.
• Does NOT relieve an accountant of responsibility if incorrect, incomplete, or otherwise unsatisfactory information comes to his/her attention during the engagement.
• The accountant is required to establish an understanding with the client, preferably in writing, which includes a statement that the accountant will inform the appropriate level of management of any fraud or illegal acts that come to his/her attention.
• The accountant need not report any matters regarding illegal acts that may have occurred that are clearly inconsequential.
• The accountant is required to report all matters involving fraud.

CPA Responsibilities:
• May in good faith rely, without verification, on information furnished by the taxpayer or by third parties.
• May not ignore the implications of information furnished and should make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known.
• Should refer to the taxpayer’s returns for one or more prior years whenever feasible.
• Must exercise due diligence in preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters (Treasury Department Circular
No. 230).

How We Lose Skepticism How We Can Get It Back
Personal Relationship
We have a personal relationship with the client, who has never lied to us before. To question the client’s integrity seems like a violation of the friendship.
Make it clear the investigation and corroboration is part of your engagement. It is nothing personal – professional audit standards require evidence.
Past History
We Rationalize: No one at this client has tried to commit fraud before, why should things be different now?
Things Change: Changes in personal circumstances may provide incentive; changes in controls may provide opportunities. The past is not audit evidence for the current period.
Lack of Experience
It is rare that independent auditors experience a fraud at one of their clients. For this reason, we can
“let our guard down” and fail to see the red flags.
Become familiar with the most common frauds in your client’s industry, how they are concealed, and the signs that they have occurred.
Limited Interactions
Most of our inquiries are made of the accounting personnel, who only reinforce our assumptions.
Get Outside the accounting department. Talk to operational personnel; get a different point of view that challenges your assumptions.

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Lack of Controls that Prevent and/or Detect
Fraudulent Behavior
 Loose Controls (No Separation of Duties)
 Lax Controls (Unenforced)
Inability to Judge Quality of Performance
Failure to Discipline Fraud Perpetrators
Lack of Access to Information
Ignorance, Apathy, and Incapacity
Lack of an Audit Trail
No Documentation of Systems, Procedures or
Policies

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Economic Need or Greed
Living Beyond One’s Means
Desire for Social Acceptance
High Bills or Personal Debt
Poor Credit
Personal Financial Losses
Gambling and/or Drug Additions
Failing Marriages/Multiple Partners
Unexpected Financial Needs
Failing Health Needs

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The Rewards Outweigh the Risks of Apprehension and Punishment
Stealing is Easier Than Working
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Nobody Will Get Hurt
It’s For a Good Purpose
We’ll Fix the Books as Soon as We Get Over This
Financial Difficulty
Everybody’s Doing it
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I’m Just Borrowing, Not Stealing
I’m Not Stealing, the Money is Owed to Me

1. Changes in behavior
2. Changes in lifestyle
3. Irritability, suspiciousness or
Defensiveness
4. Instability in life
Circumstances
5. Excessive family or peer pressure for success
6. Unexpected financial needs
7. Past legal problems
8. Divorce or family problems
9. Living beyond one’s means
10.Poor credit
11. Wheeler-dealer attitude
12. Addiction problems
13. Control issues/unwillingness to share duties
14. Refusal to take vacations
15. Unusually close association with vendor or customer
16. Excessive pressure from within organization
17. Complaining about lack of authority
18.Complaining about inadequate pay
19. Past employment – related problems
20.Anticipating future layoff

The Non – Profit High Risk Environment
1.
Enhanced credibility and trust by virtue of being a nonprofit.
2.
Motivated by their mission and, not necessarily by making a profit.
3.
Often place excessive control in their founder, executive director or substantial contributor.
6.
Frequently have an all-volunteer Board of
Directors with little or no financial oversight expertise.
7.
Typically have non-reciprocal transactions, such as charitable contributions, which are easier to steal than other sources of revenue where there is consideration exchanged.
8.
Often have large amounts of cash flow from donations, fundraisers, etc.
4.
5.
Often allocate limited resources to accounting, internal controls and financial oversight.
Often have many volunteers working in the organization who are privy to confidential information.
9.
Often lack benchmarks or typical ratio analysis as a means of monitoring performance.
10.
Highly susceptible to the effects of negative publicity and, therefore, reluctant to report, or even discuss fraud, when it occurs.

Variable
Management Style
High Fraud Potential
Autocratic
Management Orientation Low Trust
Power Driven
Low Fraud Potential
Participative
High Trust
Achievement Driven
Distribution of Authority Centralized
Planning Short Range
Performance Quantitatively ; shortterm basis
Decentralized
Long Range
Quantitatively and
Qualitatively; long-term basis
Business Focus
Management Strategy
Reporting
Policies and Rules
Profit
Crisis
By Routine
Rigid and Inflexible; strongly enforced
Customer
Objectives
By Exception
Reasonable; fairly enforced

Variable
Primary Management
Concern
Reward System
High Fraud Potential
Capital Assets
Punitive, Penurious,
Politically Administered
Feedback on Performance Critical, Negative
Interaction Mode Issues are Repressed
Payoffs for Good Behavior Monetary
Business Ethics Ambivalent; rides the tide
Low Fraud Potential
Human, then Capital
Generous, Reinforcing,
Fairly Administered
Positive, Stroking
Issues are Addressed
Promotion, Recognition
Clearly Defined; regularly followed
Internal Relationships
Values and Beliefs
Success Formula
Human Resources
Competitive; hostile Competitive; supportive
Economic; self-centered Social; group-centered
Works Harder Works Smarter
Burnout, High Turnover Low Turnover, Satisfaction

Variable
Company Loyalty
High Fraud Potential
Low
Major Financial Concern Cash Flow Shortage
Low Fraud Potential
High
Opportunities for New
Investment
Growth Pattern
Relationship with
Competitors
Innovativeness
CEO Characteristics
Sporadic
Hostile
Reactive, Follower
Self-interested,
Insensitive
Consistent
Professional
Proactive, Leader
Professional, Respected,
Thoughtful
Systems and Controls Bureaucratic,
Regimented, Inflexible
Internal Communication Formal, Written, Stiff
Peer Relationships Hostile, Aggressive
Collegial, Systematic,
Horizontal
Informal, Clear, Candid
Cooperative, Friendly

Early Stage
Stagnating/Declining Unit
Sales Volume
Aging Payables
Mid Stage Late Stage
Continued Decline in Sales Production and Distribution
Schedules Missed Repeatedly
Increasing Inventory Levels Significant Increases in
Inventory
Declining Operating Margins Operating Loses
Widespread Customer
Complaints
Problems Collecting Accounts
Receivable
Vendors Requiring COD
Less Operating Cash
Vendors Reluctant to
Provide Credit
Low Liquidity Negative Cash and Capital
Increased Borrowing
Interest Rising faster than
Sales
Difficulty Making Debt
Service Payments
Difficulty Meeting NET
Payroll
Creditors Threatening to Call
Loans or Seize Collateral
Late or No Payroll Tax
Deposits
Declining Morale Increasing Turnover Turnover High/Morale Low

Business
Law Firm
General Contractor
Catalogue Co.
Architecture Firm
Oil Distributor
Senior Center
Annual
Revenues
$2M
$10M
$15M
$8M
$6M
$300K
Embezzlement
Amount
$580K
Period
2 ½ Yrs
$963K 4 ½ Yrs
$760K
$900K
$600K
$37K
6 Yrs
2 ½ Yrs
2 Yrs
1 ½ Yrs

1.
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Clearly Communicate Behavior Expected Of Employees
Be Alert To Changes In Employee Attitude, Behavior, And Lifestyle
Perform Background Checks On All Employees
Require Uninterrupted Vacations And Rotation Of Responsibilities
For All Employees
Limit Number Of Authorized Check Signers
Account For Sequences
Establish Budget And Monitor Actual Results Monthly
Obtain Fidelity Bond Coverage
Don’t Limit Focus To Financial Fraud
Set The Example For High Ethical Standards
Owner/Chief Executive Approval For Any changes To Master Files

“A key defense against management override of internal controls is a process for anonymous submission of suspected wrongdoing…Various forms of fraud are detected 40 percent of the time by tips which [makes] this the leading method of detecting fraud.”

3.
4.
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Minimizes the fear of retaliation by either informal peer groups or supervisors.
Earlier detection is the best way to limit the loss. Fraud losses are generally 50% less when detected through a hotline tip.
Can be used to early report discrimination or harassment claims.
Interactive communication generates significantly more information than a one-way communication.
An outside complaint mechanism provides a second means of handling issues not previously addressed by those close to the problem.

1.
Guide to acceptable and appropriate behavior
Employees – Vendors – Customers.
2.
Expectation of full compliance within the letter and spirit of the rules presented.
3.
Guide to disciplinary action for violators.
4.
Not a substitute for common sense.

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Fair competition
Compliance with laws and regulations
Conflicts of interest
Gifts and entertainment
Outside employment
Relationships with suppliers and customers
Confidential information and privacy of communication
Cash and bank accounts
9.
10.
Expense reimbursement
Company credit cards
11.
12.
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14.
Software and computers
Political contributions
Conduct on company business
Violation reporting
15.
Discipline
16.
Annual representations in writing of no known violations