FRAUD EXAMINATION
ALBRECHT, ALBRECHT, & ALBRECHT
Proactive
Approaches to
Detecting Fraud
CHAPTER 6
Learning Objectives
1. Explain the importance of proactive
fraud detection.
2. Describe the role of commercial datamining software plays in detection.
3. List the advantages and disadvantages
of data mining and digital analysis.
4. Recognize Benford’s Law.
Learning Objectives
5. Understand
inductive fraud
detection.
6. Identify how
fraud is detected
by analyzing
financial
statements.
How is the Case of Mr. Hamanaka
Typical of Most Frauds?
It started small and grew
much larger!
Match Terms and
Definitions.
Inductive
fraud
detection
Determining the types of fraud
that can occur then query to see
if they exist
Deductive
fraud
detection
Proactively searching for fraud
without determining the type of
fraud to look for
Commercial
data-mining
software
Benford’s Law
A mathematical algorithm that
predicts the percentage a digit
will occur
Commercial software used to
detect patterns in data
Differentiate Between
Detecting & Investigating
Fraud.
Detection
Discovery of Fraud
Answers the Question: Does a fraud exist?
Investigation
Preceded by Detection
Proving a Fraud
Answers the Questions: How? Who? Why?
What? Where? When a fraud took place?
Explain Data-Mining as a
Means of Detecting Fraud.
ACL- Audit Command Language
Looking for Anomalies in
Databases
Difficulty Because ACLs Are
Limited in What They Can Handle
The Result Is They May Identify
Thousands of Symptoms
Because of Their Limitations
Review How Benford’s Law
Works.
Examines the Frequency
of Digits Appearing
in a Database of
Invoice #s or Amounts
0-9 Do Not Appear
10% Each
List Disadvantages of
Benford’s Law?
Looks at a Large Company as a
Whole, May Not Show Problems
With Some Individual Vendors
Not Precise
Broad Identification of
Symptoms
Does Not Zero in on Perpetrators
What is the 5 step Process for
Inductive Fraud Detection?
1. Understand the Business
2. Understand the Types of Fraud
that Occur in this Business
3. Understand the Symptoms these
Types of Fraud Create
4. Use Databases & Information Systems to
Search for Symptoms
5. Follow Through with Investigation to Determine if
Fraud Exists or Not
Compare the 3 Approaches.
Commercial Data Mining
Packages are least costly, but
have limited usefulness. They
provide excessive symptoms,
but are easy to use and
modify.
Compare the 3 Approaches.
Statistical analysis provides lots
of symptoms and is very useful
for discovering vendor kickback
frauds.
Compare the 3 Approaches
The Inductive Approach is the
most expensive to use.
Summarize the Process Which
Results in Financial Statements.
Economic
Transaction
Journal
Entry
Financial
Statements
Produces
Posted
Analysis
Source
Documents
General
Ledger
Effects Investor
or Creditor
Decisions
Analysis
Summarized
What Effect Does the Size of
the Fraud Have on the F/S?
Small
frauds are
unlikely to affect
F/S, usually
detected when
examining source
documents
Large
frauds effect
F/S, detected
during analysis of
unexplained
changes in
F/S
Explain How Revenue Affects
the Company’s Accounts.
Accounts
Receivable
Revenue
Cost of
Goods
Sold
If Sales
Increase
Then
Inventory
How Can You Convert Balance
Sheets & Income Statements to
Change Statements?
Compare
Calculate Key
Account
Ratios Compare
Balances from
from Period to
Period to Period
Period
Perform
Horizontal
Analysis
Perform
Vertical
Analysis
Match Ratio to Name.
Current
Quick Test
CA – Inventory
Average A/R
Current Assets
Current Liabilities
A/R Turnover
Sales
Average A/R
Days in
Receivables
365 Days
A/R Turnover
Match Ratio to Name.
Receivables %
Bad Debt Expense
Average A/R
Bad Debt %
365 Days
Inventory Turnover
Inventory
Turnover
Days in
Inventory
Cost of Goods Sold
Average A/R
Accounts/Receivable
Total Assets
Match Ratio to Name.
Cost of Goods
Sold Percent
Cost of Goods Sold
Total Sales
Inventory
Percent
Sales Returns
Total Sales
Property, Plant
& Equipment
Percent
Inventory
Total Assets
Sales
Return
Percent
Sales
Ave. Property Plant
& Equipment
Match Ratio to Name.
Debt to
Equity
Total Liabilities
Total Assets
Debt
Percentage
Net Income
# Share of Stock
Outstanding
Profit
Margin
Days in
Receivables
Total Liabilities
Total Equity
Net Income
Net Sales
Describe How to Perform
Vertical Analysis on:
•An Income Statement
•A Balance Sheet
Describe How to Perform
Horizontal Analysis on:
•An Income Statement
•A Balance Sheet
What Questions Should Asked
When Using a Statement of
Cash Flows to Detect Fraud?
Are there any
unexpected
changes in cash?
Did A/R go up or
down? Why?
Why did inventory
go up or down?
Statement of Cash Flows
From Investments
From Earnings
From Borrowings and Stock
Issuances
Cash Flows
Cash Balance
Cash Flows
Dividends
To Operations
For Investments
To Pay Off Loans
Discuss the Use of Software for
Detecting & Identifying
Fraudsters.
Difficulty of the List
Information - Information
can be in multiple formats
Fuzzy Logic