CFE - Financial Transactions & Fraud Schemes

SECTION 1

What is the accounting equation?

Assets = Liabilities + Owners' Equity

What is 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

What is an asset?

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

What are some typical asset accounts?

Cash
Accounts receivable
Inventory
Property
Equipment
Intangible items (e.g., patents, licenses, and trademarks)

What are liabilities?

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

What are some typical liability accounts?

Accounts payable Notes payable Interest payable Long-term debt

What is owners' equity?

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

What type of entry goes on the left side of an account?

Debits

What type of entry goes on the right side of an account?

Credits

What types of accounts are increased by debits and decreased by credits?

Assets Expenses

What types of accounts are increased by credits and decreased by debits?

Liabilities Owners' equity Revenue

What is a 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

What are financial statements?

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

What is a 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

What accounts are typically found on a balance sheet?

Assets Liabilities Owners' equity

What is an income statement (or statement of profifit or loss and other comprehensive income)?

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

What is gross profifit (also called gross margin)?

Net sales minus cost of goods sold

What is net profifit?

Gross profit minus operating expenses

What is gross revenue?

Total sales during an accounting period before any deductions are made

What items are 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

What is the 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

What is the 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

What is GAAP?

Generally accepted accounting principles, which are the rules by which a company's financial transactions are recorded into their appropriate account classifications

What is 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

What is the qualitative characteristic of relevance under IFRS?

Any information that might affect a decision made by a user of the financial statements is considered relevant

What is the matching principle?

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

What is the qualitative characteristic of comparability under IFRS?

Comparability 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

What is the qualitative characteristic of verifiability under IFRS?

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

What is the qualitative characteristic of timeliness under IFRS?

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

What is the 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

What is the 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 should an item that meets the definition of an element 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

What is the 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 is a departure from GAAP 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 complia

What is 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

What is 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

What is 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 recorded on the balance sheet as an offset to the company's fixed assets

What is 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

What is 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

What is the 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

What is a fictitious revenue scheme?

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

What is a timing difference scheme?

Recording of revenues or expenses in improper periods

What is 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 classififications of improper asset valuation schemes

Inventory valuation Accounts receivable Business combinations Fixed assets

According to GAAP and IFRS, how should inventory be valued?

Lower of cost, market value, or net realizable value

2 ways accounts receivable are commonly manipulated

Creating fictitious receivables
Failing to properly account for uncollectible customer accounts

What is bad debt expense?

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

What does it mean to improperly capitalize an expenditure?

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

What is 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

What is a 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

What is 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

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

Total sales

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

Total assets
Total liabilities + owners' equity

What is horizontal analysis?

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

What is ratio analysis?

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

What is the calculation of the current ratio?

Current assets / current liabilities

What does the current ratio measure?

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

What is the calculation of the quick ratio?

(Cash + marketable securities + receivables) / current liabilities

What does the quick ratio measure?

The company's ability to meet sudden cash requirements

What is the calculation of the asset turnover ratio?

Net sales / average assets

What does the asset turnover ratio measure?

The efficiency with which asset resources are used

What is the calculation of the debt-to-equity ratio?

Total liabilities / total equity

What does the debt-to-equity ratio measure?

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

What is the calculation of the accounts receivable turnover ratio?

Net sales on account / average net receivables

What does the accounts receivable turnover ratio measure?

The number of times accounts receivable 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

What is skimming?

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

What is an 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

What is an 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

What is a 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

What is 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

What types of journal entries 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

What is a cash larceny scheme?

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

What is 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

What is a fraudulent disbursement scheme?

A distribution of company funds for a dishonest purpose

What is a 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

What is a 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

What is the effect on inventory in a fifictitious refund scheme?

Inventory is overstated by the amount of the fictitious refund

What is an 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

What is a shell company?

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

What is a 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

What is a 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

What is a 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 inflated 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

What is a mischaracterized expense reimbursement scheme?

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

What is an overstated expense reimbursement scheme?

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

What is a fictitious expense reimbursement scheme?

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

What is a multiple reimbursement scheme?

Submitting a reimbursement request for the same expense more than once