Fruad Test 1

Occupational fraud and abuse

Occupational fraud and abuse: the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources

• Fraud Examination vs Forensic Accounting

• Fraud Examination vs Forensic Accounting

  • Forensic accounting is the use of accounting knowledge for courtroom purposes, therefore could include bankruptcy, divorce, etc

  • Fraud examinations are usually performed by accountants

• Fraud Examination vs Auditing

  • timing

  • scope

  • objective

  • relationship

  • methodology

  • presumption

• why conduct both

• Fraud Examination vs Auditing

  • Issue: 

    • Timing

      • Audit: Recurring

      • Examination: nonrecurring

    • Scope: 

      • Audit: General

      • Examination: Specific

    • Objective:

      • Audit: opinion

      • Examination: addix blame

    • Relationship:

      • Audit: Non-adversarial

      • Examination: adversarial

    • Methodology:

      • Audit: audit techniques

      • Examination: fraud examination techniques

    • Presumption:

      • Audit: Professional Skepticism

      • Examination: Proof

  • Why conduct an audit? - It is a recurring requirement

  • Why conduct a fraud examination? 

    • Based on predication: a total of circumstances exist that whenever a reasonable person thinks a fraud has, is, or will occur

  • Fraud examinations encompass more than just the review of financial data they include interviews, record searching, and forensic document examinations

• Predication 

• Predication 

  • Totality of circumstances that would lead a reasonable, professionally trained and prudent individual to believe fraud has occurred, is occurring and/or will occur

  • Fraud examinations must be based on predication

• How to conduct a fraud examination: 

• How to conduct a fraud examination: 

  • Documentary evidence

  • Interviewing witnesses

  • Writing investigative reports

  • Testifying in court

    • This is where the forensic accountancy scope must get into the courtroom

  • Analyze available data

  • Create a hypothesis

  • Test the hypothesis

  • Refine and amend the hypothesis

• Elements of Fraud

• Elements of Fraud

  • A material false statement

  • Knowledge that the statement was false when it was uttered

  • Reliance on the false statement by teh victim

Damages resulting from teh victim’s reliance on the false statement

• Researchers on occupational fraud and abuse

• Researchers on occupational fraud and abuse

  • Edward Sutherland claims that white collar crime isn’t a bad person who set out to commit a crime, it is learned and developed

  • Donald Cressey created the fraud triangle

    • Cressey’s hypothesis

  • Steve Albrecht- created the Fraud Scale

Richard Hollinger looks at data, the workplace

• Fraud Triangle

• Fraud Triangle

  • Opportunity: mitigated by internal controls

    • General information vs technical skill

      • General: doors are always unlocked, everyone has access to the system

      • Technical: I have this specific asset and expertise

  • Pressure: something unique to me, something I need that I have pressure because of

    • Cressey found that these are the nonshareable problems that fall into 6 categories

      • Violation of ascribed obligations - people in trustworth positions feel like they are being held to higher standards and when they cannot maintain that(ie they get in debt because of a drug addiction) they feel the need to steal to maintain self-image (embarrassed they are in debt due to drugs)

      • Problem resulting from personal failure - this is a result of pride and not wanting to let people know you made a bad decision (ran your business into the ground)

      • Business Reversals - your business is failing due to factors outside of your control(interest rates, a poor economy, etc)(status still plays a role even though it is outside of their control)

      • Physical Isolation - someone has nobody to ask for help and feels stuck

      • Status- gaining - desire for a better lifestyle

      • Employer- employee relations -an employee resents thier status

    • However, all situations deal in some way with status seeking or status maintaining

  • Rationalization: can be shared amongst everyone

    • You think this is essentially noncriminal

    • Somehow justified

    • Part of general irresponsibility (they are asking for it)

    • Hollinger says there is a relationship to workplace dissatisfaction

Fraud scale

• Fraud scale

  • Situational pressures

  • Opportunity

  • Integrity 

Stats

• Stats

  • Hard to quantify, may be close to 5% of all transactions

  • Most theft is done by employees, then managers, then owners/execs

    • However, owners/execs steal much more than managers do than employees do

  • Guys do it twice as often and twice the amount of $

  • The most common department a person is in is teh accounting/finance department

  • Most of the time ha never gotten charged with a crime

  • Usually frauds are detected by tips(external fraud only detects 3% of fraud)

  • Ussullay its an employee however and owenr/executive steals more

    • Usually male and men steal more

    • Usually in accounting

    • Teh hughet loss is by mangement/upper management

    • Most have never been charged

    • Usually detected by tips

Occupational fruad and abuse

• Fraud Theroy Aproach

• Fraud Theroy Aproach

  • Analayzed available data

    • Jeff skilling announced resignation

  • Create a hypotheses

    • WSJ says something seems shady

  • Test the hypothesis

    • Interview Jeff Skilling

  • Refine and amend the hypothesis

    • Jeff Skilling says the stock price impacted this decision so we go back to the related party section from teh 10Q adn then the 10K- they then relized that these arrangements have been around for awhile

      • Then we go public, and a whistleblower comes forward

      • Whistleblower confirms inappropriate structure and suggests broader significant concerns

who is responaible for the Fs

• Company management is responsible for the financial statements

  • The company’s board of directors and senior management set the code of conduct

  • The CEO and CFO sit on both the board of directors and are responsible for the financial statements

who are teh users of fs

• Users of fs

  • Transaction activity is captured in the accounting system, which then flows to fs and is communicated to users who make decisions on investments, loan terms, etc.

    • The decision aspect is where damages incur

• Who commits FS fraud? 

• Who commits FS fraud? 

  • Senior management

  • Mid and lower-level employees can do it, but are less incentivized 

  • Organized criminals

• Why do people commit fs fraud?

• Why do people commit fs fraud?

  • To conceal true business performance

  • To preserve personal status/control

  • To maintain personal income/wealth

  • Overstate performance

    • To meet or exceed the earnings or revenue growth expectations of stock market analysts

    • To show a pattern of growth to support a planned securities offering or sale of the business

    • To comply with loans covenants or  meet a lenders criteria for granting or extending loanfcitlites

    • To meet goals from parent companies

    • Satisfying analyst expectations 

    • To meet personal performance criteria

    • To trigger performance related compensation or earn payouts

    • To support the stock price in an acquisition or merger

  • Understand performance

    • To take all possible write-offs in one “big bath” now so future earnings will be consistently higher

      • Have one giant impairment loss, rather than taking some in following periods

    • To defer surplus earnings to teh next accounting period

    • To reduce expencations

    • To preserve a trend of consisten growth avoiding volatile results

    • To come out on top in a divorce settlement

    • Missed one

• How do people commit FS fraud

• How do people commit FS fraud

  • Playing the accounting system - least egregious

    • Arguing LT assets have longer lives than they do, aggressive with BDE

    • There is a level of judgement you are taking advantage of

  • Beating the accounting system

    • False and fictitious information into the accounting system

    • Documents are forged to support claimed numbers

  • Going outside the entire system

    • Produces what ever fs you want

    • Don’t record something or make false JE

    • You may just change the FS themselves or leave sometime out

    • Change numbers directly on FS

how does a change in stock price relate to fs fruad

• Damages in financial statement fraud are not changes in stock price

  • That does not fully capture the extent of damages(IE loan approval, fincncail investment decisions, etc.)

• Conceptual framework for financial reporting

• measurement assumptions

• measuremnt principles

• contratins

• qualative characteristics

• Conceptual framework for financial reporting

  • Recognition and measurement assumptions: 

    • Economic entity 

    • Going concern

    • Monetary unit

    • Periodicity

  • Recognition and measurement principles

    • Historical cost

    • Revenue recognition

    • Matching 

    • False disclosure

  • Recognition and measurement contraints

    • Cost-benefit

    • Materiality

    • Industry practice

    • Conservatism

  • Recognition adn measurement of qualitative characteristics

    • Revlaence and reliability

    • Compariablity adn consistency

SOX Goals and 7 new rules

Sarbanes-Oxley Act

• SOX GOALS:

  • Establishing higher standards for corporate governance and accountability

  • Create an independent regulatory framework for the accounting profession

  • Enhancing teh quality and transparency of financial reports

  • Developing severe civil and criminal penalties for corporate wrongdoesrs

  • Establish new protections for whistleblowers

• SOX rules: 7 new sox rules are covered in depth below

  • Management must report on IC 

  • Increase disclosures in management’s discussion

  • Conditions for use of Non-GAAP measures

  • Certification of disclosure by CEO and CFO of companies' quarterly adn annual reports 

  • Disclosures for ethics

  • New standards for attorneys

  • Standards for audit committees

  • Audio independence

  • Retention of record and workpaper

what did the estpblishmen to fthe PCAOB do

• PCAOB was established

  • Purpose: to oversee the audit of public companies that are subject to the sercuriteis laws, and related matters, in order to protect the interests of investors and further the public interest in the preparation informative, accurate, and independent audit reports for companies, the securities of which are sold to, and held by and for public investors

  • What do they do? 

    • The registered public accounting firms that audit publicly traded companies

    • Establishing or adopting auditing, quality control, ethics, independence and other standards for public companies

    • Inspecting registered public accounting firms

    • Investigate registered public accounting firms adn their employees, conducting disciplinary hearings nad imposing sanctions where jsutfiied

    • Peroform other dutires necessary to improve the quality of audit services

    • Enforce compliance with sarbanes oaxley the rules of the board, professional standards and securities law

• Certification obligations of CEOs and CFOs

• Certification obligations of CEOs and CFOs

  • Criminal certification: teh have ot say they did not

    •  knowing violates teh certification requirements is up to $1 million and up to 10yrs in prision

    • willfully(worse) violate teh cerfiticaiton is up $5 million and up to 20 years in prision

  • Civil certification, they have to say

    • They have personally reviewed teh report

    • Based on the knowledge, the report does not contain a material weakness

    • Based on management knowledge, there are no issues with teh financial conditions and internal controls

    • The disclosure to teh auditor of any material weaknesses in teh controls and any fraud

• General Standards for audit committee independence

• Standards for audit committee independence

  • The audit committee has increased responsibilities

  • There needs to be a financial expert

  • Changed teh composition of the audit committee

  • Established a whistleblowing structure

• Standards for auditor independence

• Standards for auditor independence

  • Restrictions(not necessarily never allowed) on non-audit activity: 

    • Bookkeeping services

    • Financial information system design and implementation

    • Appraisal or valuation services, fairness opinion or contribution in kind reports

    • Acutalal services

    • Internal audit outsource services

    • Management function or HR

    • Legal services and expert services unrelated to the audit

    • Any other service that the PCAOB prescribes 

  • Mandatory audit partner rotation

    • Conflict of interest provisions

    • Improper influence on audits

  • Auditor reports to audit committees

    • All critical accounting policies and procedures use

    • Aletnerative GAAP method

    • Communication of any material weakness

  • Improper influence on audits

• Enhanced fincncail disclosure requirements

• Enhanced fincncail disclosure requirements

  • Off-balance sheet transactions

  • Pro forma financial information

  • Prohibitions on personal loans to executives

  • Restrictions on insider trading

  • Code of ethics for senior fincnical officers

  • Enhanced review of periodic filings

  • Real time disclosures

• Protections for whistleblowers

• Protections for whistleblowers

  • Civil liability whistleblower protection: creates civil liability for a company that retaliates against whistleblowers

    • Protects only employees of publicly traded companies

    • Employees must report the suspected misconduct to a federal regulatory or law enforcement agency

    • Employees are protected against retaliation for filing, testifying in, participating in, or otherwise assisting in a proceeding

    • Protected even if there was no fraud, as long as it was a reasonable thought

    • The employee will also get compensatory damages if there was fraud to make the employee whole

  • Criminal: makes it a creim eot knowingly retaliate

    • Information must be provided to law enforcement

    • Broader than civil liability protections cover all individuals regardless of where the work is

• Enhanced penalties for white collar crime

• Enhanced penalties for white collar crime

  • White collar crime: 

    • Attempt and conspircay

    • Mail fraud and wire fraud 

    • Securities fraud

    • Document destruction

    • Bankruptcy loopholes

  • Repercussions: 

    • Freezing of assets

    • Disgorgement of bonuses

• Fraud Risk

• Why be concerned about fraud risk?

• Fraud Risk: vulnerability of an organization to overcoming the interrelated elements that enable someone to commit fraud

• Why be concerned about fraud risk?

  • Awareness of risk is key to establishing a mechanism to reduce risk

  • Internally or externally

  • No organizatino is immune

• Factors that influence fraud risk: 

• Factors that influence fraud risk: 

  • Nature of business

  • Operating environment

  • Effectiveness of internal controls

  • Ethics and values

• Fraud risk assessment:

• Fraud risk assessment: a process aimed at proactively identifying and addressing an organization’s vulnerabilities to internal and external fraud

  • To help an organization recognize what makes it most vulnerable so that it can take proactive measures to reduce its exposure

• Why conduct a fraud risk assessment: 

• Why conduct a fraud risk assessment: 

  • Improve communication adn awareness of fraud

  • Identify what activities are most vulnerable to fraud

  • Develop plans/techniques to mitigate and identify fraud risk

  • Comply with regulations and professional standards

    • PCAOB AS 5 effectively requires a fraud risk assessment with the assessment of internal controls

• A good risk assessment: 

• A good risk assessment: 

  • Collaborative effort of management and auditors

  • Independence and objectivity of the people leading and conducting the work

  • A good working knowledge of the  business

  • Access to all levels of the organization

  • Engendered trust 

  • A plan to keep it alive and relevant

  • Packaging it right: the deliverable - an audit gives an opinion and an audit committee deck - tailor the communication approach to the organization

    • One size does not fit all - adapt the framework to the business model and culture

    • Keeping it simple - focus on areas that are most at risk for fraud

    • Assembling the right team -

      • Accounting adn finance personnel

      • Personnel who have knowledge of day-to-day operations

      • General counsel, compliance functions, internal audit, external consultants  

  • Determing the best techniques: 

    • Interviews

    • Focus groups

    • Surveys

    • Anonymous feedback mechanisms 

  • Educating the organization and openly promoting the process

  • Obtaining the sponsor’s agreement on work

    • Scope, methods, participants, form of output

• Execution of fraud assessment: 7 steps

• Execution: 7 steps

1. Identify potential inherent fraud risks

   1. Fraud risk triangle

   2. Risk of management’s override of controls

   3. Population of fraud risks: 

      1. fraudulent financial reporting

      2. Asset misappropriation

      3. Collusion opportunities

   4. Regulatory and reputation risk

   5. Information technology 

2. Assessing the likelihood of the occurrence of the identified fraud risk 

   1. Past instances

   2. Industry

   3. Support of management

   4. Unexplained losses

   5. Complexity of risk

   6. Complaints from vendors/customers

3. Assessing the significance of fraud risks

   1. Fiancncail statement and monetary significance

   2. Financial condition of the organization

   3. Value of the threatened assets

   4. Signifcaince to the organization’s operations, brand value and reputation

4. Evaluating which periole and departments are most likely to commit fraud and identifying the methods that they are likely to use

5. Identifying and mapping existing preventative and effective controls

6. Evaluating whether the identified controls are operating effectively and efficiently

   1. Review accounting policies and procedures

   2. Interview management and employees

   3. Observe control activities

   4. Perform sample control testing

   5. Review past reports 

7. Identifying and evaluation the residual fraud risks resulting from ineffective or nonexistent controls 

• Addressing fraud risk

• Addressing fraud risk

  • Establishing an acceptable level of risk

  • Responding to residual fraud risk

    • Avoid the risk

    • Transfer the risk

    • Mitigate the risk

    • Assume the risk 

  • Report the results objectively 

    • Keep it simple

    • Identify clear and measurable objectives

• Relationship with the audit process

• Relationship with the audit process

  • Auditors should validate that the organization is managing the moderate-to-high risks

  • Evaluate internal controls

  • Assess management override of internal controls

  • Deliver reports that incorporate the results of testing controls