CFE - Financial Transactions and Fraud Schemes

accounting equation

assets = liabilities + owners' equity

accounting

the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results for an enterprise's decision-makers and other interested parties

asset

a resource owned by an entity that has economic value and will provide a future benefit

typical asset accounts

-cash

-accounts receivable

-inventory

-property

-equipment

-intangible items (e.g., patents, licenses, and trademarks)

liabilities

the obligations of an entity or outsider's claims against a company's assets

typical liability accounts

-accounts payable

-notes payable

-interest payable

-long-term debt

owners' equity

the investment of a company's owners plus accumulated profits (revenues minus expenses)

type of entry that goes on the left side of an account

debit

type of entry that goes on the right side of an account

credit

types of accounts that are increased by debits and decreased by credits

-assets

-expenses

types of accounts that are increased by credits and decreased by debits

-liabilities

-owners' equity

-revenue

journal entry

an accounting record consisting of a debit side and a credit side that shows the detailed components of a particular transaction

2 primary methods of accounting

-cash basis

-accrual basis

financial statements

presentations of financial data and accompanying notes prepared in conformity with generally accepted accounting principles

balance sheet (or statement of financial position)

a financial statement that provides insight into a company's financial position at a specific point in time

accounts typically found on a balance sheet

-assets

-liabilities

-owners' equity

income statement (or statement of profit or loss and other comprehensive income)

a financial statement that shows how much profit (or loss) a company earned over a period of time

gross profit (also called gross margin)

net sales minus cost of goods sold

net profit

gross profit minus operating expenses

gross revenue

total sales during an accounting period before any deductions are made

items typically found on an income statement

-net sales revenue

-cost of goods sold

-gross profit (or gross margin)

-operating expenses (depreciation, interest, rent, utilities, salaries, etc.)

-net profit/income or net loss

statement of changes in owners' equity (or statement of retained earnings)

a financial statement that acts as the connecting link between the income statement and balance sheet by detailing the change in owners' equity over a period

statement of cash flows

a financial statement that reports a company's sources and uses of cash during the accounting period

3 categories on a statement of cash flows

-cash flows from operating activities

-cash flows from investing activities

-cash flows from financing activities

GAAP

Generally Accepted Accounting Principles, which are the rules by which a company's financial transactions are recorded into their appropriate account classifications

IFRS

International Financial Reporting Standards, which is one form of GAAP and is intended to be used as a uniform set of globally accepted accounting standards

qualitative characteristic of relevance under IFRS

any information that might affect a decision made by a user of the financial statements is considered ( )

matching principle

expenses are recorded in the same accounting period as the revenues they helped generate

qualitative characteristic of comparability under IFRS

enables users to understand and base their decisions on comparisons between different entities and on similar information from a single entity for another reporting period

qualitative characteristic of verifiability under IFRS

helps assure users that information is accurate and faithfully represents the entity's financial position

qualitative characteristic of timeliness under IFRS

providing information to decision-makers in time to be capable of influencing their decisions

qualitative characteristic of understandability under IFRS

enough information should be provided about the organization's economic events so that a reasonable financial statement user can understand what occurred

qualitative characteristic of faithful representation under IFRS

every effort shall be made to ensure that the financial information presented is complete, neutral, and free from error

when an items that meets the definition of an element should be recognized

-there is probable future economic benefit that will flow to or from the entity

-the item has a cost or value that can be measured with reliability

going concern principle

the underlying assumption that the life of the entity will be long enough to fulfil its financial and legal obligations; any evidence to the contrary must be reported in the entity's financial statements

when a departure from GAAP is acceptable

-there is concern that assets or income would be overstated and expenses or liabilities would be understated

-it is common practice in the industry

-the substance of the transaction is better reflected a different way

-following GAAP will produce misleading financial statements and the departure is properly disclosed

-the transaction is immaterial to the financial statements

-the expected costs of following GAAP exceed the expected benefits of compliance

depreciation expense

an expense recorded to reflect the expected decline of a company's physical property from normal use; it is recorded on the income statement as an operating expense

amortization expense

an expense taken for a decline in value of the intangible property; it is recorded on the income statement as an operating expense

accumulated depreciation

an amount that represents the cumulative expense recorded to reflect the expected decline of a company's physical property from normal use; it is recoded on the balance sheet as an offset to the company's fixed assets

accumulated amortization

an amount that represents the cumulative decline in value of the company's intangible property; it is recorded on the balance sheet as an offset to the company's intangible assets

financial statement fraud

the deliberate misrepresentation of the financial condition of an enterprise through the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive users

typical effect of fraud on the financial statements

-overstated assets and revenues

-understated liabilities and expenses

5 classifications of financial statement fraud schemes

-fictitious revenues

-timing differences

-improper asset valuations

-concealed liabilities and expenses

-improper disclosures

fictitious revenue scheme

recording revenue from the sale of goods or services that did not occur, involving either fake customers or legitimate customers

timing difference scheme

recording of revenues or expenses in improper periods

income smoothing

moving revenues or expenses between 1 period and the next to increase or decrease earnings as desired and give the illusion of a more stable enterprise

4 classifications of improper asset valuation schemes

-inventory valuation

-accounts receivable

-business combinations

-fixed assets

according to GAAP and IFRS, how inventory should be valued

lower of cost, market value, or net realizable value

2 ways account receivable are commonly manipulated

-creating fictitious receivables

-failing to properly account for uncollectible customer accounts

bad debt expense

the amount of accounts receivable that the entity does not expect to collect

what it means to improperly capitalize an expenditure

to add the cost of the expenditure to an asset account rather than properly recording it as an expense

the effect of improperly capitalizing an expenditure

an increase in assets (and therefore a stronger balance sheet) and a decrease in expenses (and therefore a higher net income) for the period

5 common types of improper financial statement disclosures

-contingent liabilities

-subsequent events

-management fraud

-related-party transactions

-accounting changes

contingent liability

a potential obligation that will materialize only if certain events occur in the future

3 types of accounting changes that must be disclosed

-changes in accounting principles

-changes in accounting estimates

-changes in reporting entities

vertical analysis

a technique for analyzing the relationships among the items on the financial statements during a specific accounting period by expressing components as percentages of a specified base value

item on the income statement that is assigned 100% when conducting vertical analysis

total sales

items on the balance sheet that are assigned 100% when conducting vertical analysis

-total assets

-total liabilities + owners' equity

horizontal analysis

a technique for analyzing the percentage change in individual line items on a financial statement from 1 accounting period to the next

ratio analysis

a means of measuring the relationship between any 2 different financial statement amounts

current ratio

current assets / current liabilities

what the current ratio measures

a company's ability to meet present obligations from its liquid assets

calculation of the quick ratio

(cash + marketable securities + receivables) / current liabilities

what the quick ratio measures

the company's ability to meet sudden cash requirements

calculation of the asset turnover ratio

net sales / average assets

what the asset turnover ratio measures

the efficiency with which asset resources are used

calculation of the debt-to-equity ratio

total liabilities / total equity

what the debt-to-equity ratio measures

the relationship between the company's total debt and the owners' financial contributions plus earnings to date

calculation of the accounts receivable turnover ratio

net sales on account / average net receivables

what the accounts receivable turnover ratio measures

the number of times accounts receiable is turned over during the accounting period (i.e., a firm's effectiveness in extending credit and in collecting debts on that credit)

2 types of cash receipts schemes

-skimming

-cash larceny

skimming

an off-book fraud that involves the removal of cash from a victim entity prior to its entry into an accounting system

unrecorded sales skimming scheme

when an employee keeps the cash received from a customer in a sales transaction and makes no record of the sale

understated sales skimming scheme

when a legitimate sales transaction is recorded, but the employee records the sale for a lower amount and keeps the remainder

receivables skimming scheme

instead of applying a customer's payment to the customer's account, the employee steals the payment so that the customer's account appears delinquent

receivables lapping

a method used to conceal receivables skimming by taking an incoming customer payment and applying it to an account that was stolen from, then taking the next incoming payment and applying it to the previous account, and so on

types of journal entries that should be examined when looking for a skimming scheme

-false credits to inventory

-write-offs of lost, stolen, or obsolete inventory

-write-offs of accounts receivable

-irregular entries to cash

cash larceny scheme

an off-book fraud scheme in which an employee physically misappropriates cash that has already appeared on the victim organization's books

deposit lapping

a method used to conceal a cash larceny scheme by stealing the cash from a deposit, replacing it with the next day's deposit, repeating the same procedure the next day, and so on

fraudulent disbursement scheme

a distribution of company funds for a dishonest purpose

register disbursement scheme

stealing cash from the register while recording its removal as a legitimate transaction

2 types of register disbursement schemes

-false refunds

-false voids

fictitious refund scheme

a scheme in which the cashier processes a transaction as if a customer were returning merchandise, even though there is no actual return, and then takes cash from the register in the amount of the false return

the effect on inventory in a fictitious refund scheme

inventory is overtstated by the amount of the fictitious refund

overstated refund scheme

a scheme in which an employee overstates the amount of a legitimate refund and keeps the excess money

3 types of billing schemes

-false invoicing via shell companies

-false invoicing via nonaccomplice vendors

-personal purchases with company funds

shell company

a business entity with no physical presence or employees that generates little (if any) independent economic value

pass-through scheme

when an employee in the purchasing department sets up a shell company, buys merchandise through the shell company, and sells it back to their employer at an increased price

pay and return scheme

when an employee intentionally sends an incorrect payment to a legitimate vendor, requests that the vendor return the payment, and intercepts and keeps the returned payment

what constitutes personal purchases with company funds

when an employee orders goods that are unnecessary to their employer and keeps the goods for themselves

3 categories of payroll fraud

-ghost employee schemes

-falsified hours and salary schemes

-commission schemes

ghost employee

a real or fictitious person on the payroll who does not work for the victim company

4 requirements for a ghost employee scheme to work

-the ghost must be added to the payroll

-timekeeping and wage rate information must be collected

-a paycheck must be issued to the ghost

-the check must be delivered to the perpetrator or an accomplice

2 ways hourly employees can fraudulently inflate their pay

-falsify the number of hours worked

-increase their rate of pay

2 ways commissioned employees can fraudulently inflate their commissions

-falsify the amount of sales made

-increase their commission rate

4 categories of expense reimbursement schemes

-mischaracterized expenses

-overstated expenses

-fictitious expenses

-multiple reimbursements

mischaracterized expense reimbursement scheme

requesting reimbursement for a personal expense by claiming that the expense is business related

overstated expense reimbursement scheme

overstating the cost of actual business expenses to generate excess reimbursements for expenses paid for with personal funds

fictitious expense reimbursement scheme

when an employee invents an expense that never occurred to request reimbursement

multiple reimbursement scheme

submitting a reimbursement request for the same expense more than once