Fraud 3

• Misuse
• unconcealed Larceny
• asset requisitions and transfers
• purchasing and receiving schemes
• fraudulent shipments

• Typical Misuse of company vehicles, company supplies, computers, other office equipment
• doing personal work on company time
• runnin side businesses

• Loss of Productivity
• need to hire additional employees to compensate
• lost business if employee's business competes
• unauthorized use of equipment can mean additional wear and tear sonner or more often

• greater concern than misuse of assets
• most schemes are not complex
• some employees know their co workers are stealing but refrain from reporting it
• many of the employees who steal company property are highly trusted
• assets misappropriated after-hours or mailed to perpetrator

• needs an accomplice
• sale is not rung up but the accomplice takes the merchandise
• accomplice may return merchandise for cash

• segregate the duties of requisitioning, purchasing, and receiving
• segregate the duties of payables, purchasing, and receiving
• maintain physical security of merchandise
• tracj those who enter secure areas through access logs
• install security cameras and let their presence be known
• conduct inventory counts on a periodic basis by someone independent of the purchasing and warehousing functions
• suspend shipping and receiving activities during physical counts
• investigate significant discrepancies
• independently follow-up on customer complaints

• documentation enables non-cash assets to be moved from one location to another
• Internal documents can be used to fraudulently gain access to merchandise
• basic scheme os to requisition materials to complete a work-related project, then steal the materials
• inventory stored in multiple locations creates opportunities

• assets were intentionally purchased by tthe company but misappropriated
• falisfying incoming shipments
• - may also reject portion of the shipment as being substandard and the perpetrator keeps the "substandard" merchandise

• fals shipping ans sales documents are created to make it appear that the inventory was sold
• false packing slips can allow the inventory to be delivered to fraudster or accomplice
• to hide theft a false sale is created
• receivable is aged and written off
• legitimate sale is understated

• key concealment issue is shrinkage
• inventory shrinkage is the unaccounted-for reduction in the company's inventory due to theft
• since shrinkage signals fraud, the fraudser must prevent anyone from looking for the missing assets
• physical count of inventory detects shrinkage
• Altered inventory records - forced reconciliation - deleting or convering up the correct totals and entering new totals

ficticous sales and accounts receivable - charge sale to existing account - write off to discounts and allowances or bad debt expense

write off inventory and other assets

physical padding - make it appear that there are more assets present than there actually are

• seperate the duties of
• - ordering goods
• - receiving goods
• - maintaning perpetual inventory records
• - issuing payments
• match the invoices to receiving reports before payments are issued
• match the packing slip to an approved purchase order
• match outgoing shipments to sales ordes before merchandise does out
• periodically match inventory shipments to sales records
• investigate shipments that cannot be traced to a sale
• check out unexplained increases in bad debt expense
• compare shipping addresses to employee addresses
• reveiwq unexplained entries in perpetual inventory records
• reconcile materials ordered for specific projects with actual work done
• Perform trend analysis on scrap inventory
• check to make sure that inventory removed from inventory is properly removed

• Misappripriation of information
• -includes theft of completely sensitive information
• - can undermine value, reputation and competitive advantage
• - can result in legal liabilities
• - identofy most valuable information and take steps to protect it
• misappropriation of securities
• - proper internal controls over investment portfolio

• Offering, Giving, receiving, or soliciting anything of value to influence and official act
• buys influence of the recipient
• commercial bribery
• kickbacks
• bid-rigging schemes

• Involce submission of invoices for goods and services that are either overpriced or completely ficticious
• involve collusion between employees and vendors
• almost always attack the purchasing function of the victim company

• diverting business to vendors
• - vendor pays the kickbacks to ensure a steady stream of business from the purchasing company
• - no incentive to provide quality merchandise or low price
• almost always leads to overpaying for goods or services

• Employees with approval authority
• - vendor submits inflated invoices to the victim company
• - overstates the cost of actual goods or services or reflects fictiouc sales
• ability to authorize purchases is key to the scheme

• Employees lacking approval authority
• - circumvent purchasing controls
• - may prepare false vouchers to make it appear that the invoice is legitimate
• - may forger and approval signature or have access to a restricted password in a computerized system
• - difficult to detect since the victim company is being attacked from two directions

• Discounts are given in exchange for bribes
• slush funds
• - other side of transaction
• - funds can be paid from other accounts or paid as "consulting fees"

• Normal controls may not setect kickback schemes
• look for price inflation
• monitor trends in cost of goods sold and services purchased - often start small but increase over time
• Look for excessive quantities purchased
• investigate inventory shortages
• look for inferior goods purchased
• compare actual amounts to budgeted amounts

• Assign an employee independent of the purchasing department to routinely review buying patterns
• make sure taht all contracts have a "right to audit" clause
• establish written policies prohibiting employees from soliciting or accepting any gift orfavor from a customer or supplier
• expressly forbid any employee from engaging in any transaction, on behalf of the company, in which he or she has an undisclosed personal intrest
• inplement and ethics policy that clearly explains what improper behavior is and provides grounds from termination if an employee accepts a bribe or kickback

• all bidders are expected to be on an even playing field - bidding on the same specifications
• the more power a person has over the bidding process, the more influence he or she can exert over the selection of the winning bid
• Potential targets include: buyers, contracting officials, engineers and technical representatives, quality or produce assurance representatives, subcontractor liason employees

• Need recognition schemes
• - employee of the purchasing company convinces the company that a particular project is necessary
• - has the specifications tailored to the strengths of a particular supplier
• Trends indicating a need recognition scheme is occurring
• - higher requirements for stock and inventory levels
• - writting off large numbers of surplus items to scrap
• - defining a need that can only be met by certain supplier
• - failure to develop a satisfactory list of back up suppliers

• specifications include a list of the elements, materials, dimensions, and other relevant requirements
• set up the specifications to a particulare vendor's capabilities
• use "prequalification" procedures to eliminate certain vendors
• sole-source or noncompetitive procurement justifications
• deliberately writes vague specifications requiring amendments at a later date
• bid splitting
• gives a vendor the right to see the specifications befor his cometitors get the specs

• Restricting the pool of vendors from which to choose
• bid pooling
• ficticious suppliers
• restricting the time for submitting bids
• soliciting bids in obscure publications
• publicizing the bid during holiday periods

• fraud in teh sealed bid process
• - last bid submitted is the one that is awarded the contract
• - winning bidder finds out what the other competitors are bidding
• - winning bidder may see the other competitors' bids before submitting his bid
• gets help on preparing the bid

• look for:
• unusual bidding patterns
• low bids followed by change orders
• a very large unexplained price difference among bidders
• contactors who bid last and repeatedly receive the contract
• a predictible rotation of bidders
• losing bidders who become subcontractors
• vendors with the same address and phone number
• fewer bidders than expected for the project
• projects that have been split into smaller ones

• Cash
• promises of future employment
• promise of ownership in the supplier's firm
• gifts
• payment of credit card bills
• loans on very favorable terms
• transfers of property

• illegal gratuities
• - given to reward a decision rather than to influence it
• - decision made to benefit a person or company but is not influences by any sort of payment
• may influence future decisions

• economic extortion
• - "pay up or else"
• - Employee demands payment from a vendor in order to make a decision in the vendor's favor

• Employee, Manager, or executive has an undisclosed economic or personal interest in a transactiont hat adversly affects the company
• victin organization is unaware of the employee's divided loyalties
• Distinguished from bribery-in conflict of interest, the fraudster approves the invoice because of his over hidden interest in the vendor
• purchasing schemes
• sales schemes

• Over Billing Schemes
• - bill originated froma real company in which the fraudster has an undisclosed economic or personal interest
• - fraudster uses influence to ensure the victin company does business with this particular vendor
• - does not negotiate in good faith or attempt to get the best price from teh employer

• Turn Around sales
• - the employee knows that the company is seeking to purchase a particular asset and purchases it himself
• - Turns around and sells it the company at an inflated price

• Underbillings
• - goods are sold far below fair market value to a customet in which the perpetrator has a hidden interest
• writing off sales
• - purchases are made from the victim company and credit memos are later issued

• business diversions - siphoning off clients of the victim company to the employee's own business
• resource diversions - diverting funds and other recsources for the development of the employee's own company
• Financial disclosures - inadequate disclosures or related-party transactions to the company

• Implement, communicate, and enforce and ethics policy that addresses conflicts of interest offenses
• require employees to complete an annual disclosure statement
• establish an anonymous reporting sechanism to receive tips and complaints
• compare vendor address and telephone files to employee address and telephone files for matches

• to conceal true business performance
• to perserve personal status/ control
• to maintain personal income/ wealth

• to meet or exceed the earnings or growth expectations of stock market analysts
• to comply with loan covenants
• to increase the amount of financing available from asset-based loans
• to meet a lender's criteria for granting/extending loan facilities
• to meet corporate performance criteria set by the parent company
• to meet personal performance criteria
• to trigger performance-related compensation or earn-out payments
• to support the stock price in anticipation of a merger, acquisition. or sale of personal stock holding
• to show a pattern of growth to support a planned securities offering or sale of the business

• to defer surplus earnings into the next accounting period
• to take all posssible write-offs in one "big bath" no so future earnings will be consistently higher
• to reduce expectations now so future growth will be better perceived and rewarded
• to preserve a trend of consistent growth, avoiding volatile results
• to reduce the value of an owner-managed businesss for purposes of a divorce settlement
• to reduce the value of a corporate unit whose management is planning to buy out

• Playing the accounting system
• beating the accounting system
• going outside the accounting system

• company management is responsible for financial statements
• company's board of directors and senior management set the code of conduct
• company's "ethic" - the standard by which all other employees will tend to conduct themselves

• Establishing higher standards for corporate governance and accountability
• creating and independent regulatory framework for the accounting profession
• enhancing the quality and transparency of financial reports
• developing severe civil and criminal penalties for corporate wrongdoers
• establishing new protections for corporate whistleblowers

• management's report on internal control over financial reporting and certification of disclosure in periodic reports
• improper influence on conduct of audits
• new standards of professional conduct for attorneys
• standards and procedured related to listed compnay audit committees
• strengthening the commission's requirements regarding auditor independence
• disclosure in management's discussion and analysis about off-balance sheet arrangements and aggregate contractual obligations
• disclosures regarding a code of ethics for senior financial officers and sudit committee financial expert
• retention of records relevant to audits and reviews
• insider trades during pension fund blackout periods
• conditions for use of non-GAAP financial measures
• certification of disclosure in companies' quarterly and annual reports

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

• Registering public accounting firms that audit publicly traded companies
• establishing or adoption auditing, quality control, ethics, independence, and other standards relating to audits of publicly traded companies
• inspecting registered public accounting firms
• Investigating registered public accounting firms and their employees, conducting disciplinary hearings, and imposing sanctions where justified
• performing such other duties as are necessary to promote high professional standards among registered accounting firms, to improve the quality of audit services offered by thos firms, and to protect investors
• enforcing compliance with the sarbanes oxley act, the rules of the board, professional standards, and securities laws relating to public company audits

• corporate officers who knowingly violate the certification requirements are subject to fines of up to 1 million and up to 10 years imprisonment or both
• corporate officers who willfully violate the certification requirements are subject to fines of up to 5 million and up to 20 years imprisionment or both

• They have personally reviewed the report
• based on their knowledge, the report does not contain any material missstatement that would render the financials misleading
• based on their knowledge, the financial information in the report fairly presents in all material respects the financial conditions, results of operations, and cash flows of the company
• accepted responsibility for designing, maintaining, and evaluating the company's internal controls; have evaluated the controls within 90 days prior to the report; and have presented their conclusions about the effectiveness of those controls in the report
• disclosed to the auditors and the audit committee any material weaknesses in the controls and any fraud, whether material or not, that involves management or other employees who have a significant role in the company's internal controls
• indicated in their report whether there have been significant changes in the company's internal controls since the filing of the last report

• All annual reports are required to contain an internal control report that
• - states management's responsibility for extablishing and maintaining an adequate internal control structure and procedures for financial reporting
• - contains an assessment of the effectiveness of the internal control structure and procedures of the company for financial reporting

• Restrictions on non-audit activity
• - book keeping services
• - financial information systems design and implementation
• - appraisal or valuation services, fairness opinions, or contribution-in-kind reports
• - actuarial services
• - internal audit outsource services
• - Management funtions or human resources
• - borker or dealer, investment advisor, or investment banking services
• -legal services and expert services unrelated to the audit
• - any other service that PCAOB proscribes
• Mandatory audit partner rotation
• conflict of interest provisions
• audtitor reports to audit committees
• - all critical accounting policies and proceedures used
• - alternative GAAP methods that were discussed with management, the ramifications of the use of those alternative policies, and the treatment preferred by the auditors
• - any other material wirtten communications between the auditors and management
• auditors' attestation to internal controls
• improper influense on audits

• off-balance sheet transations
• pro forma financial information
• prohibitions on personal loans to executives
• restrictions on insider trading
• code of ethics for senior financial officers
• enhanced review of periodic filings
• real-time disclosures

• creates civil liability for companies that regulate against whistleblowers
• protects only employees of publically traded companies
• the employee must report the suspected miscondict to a federal regulatory or law enforcement agency, a member of congress or committee of congress, or a supervisor
• Employees are protected against retaliation for filing, testifying in, participating in, or otherwise assisting in a proceeding filed or about to be filed
• protected even if the company is ultimately found not to have committed securities fraud

• Makes it a crime to knowingly, with the intent to retaliate, take any harmful action against a person for providing truthful information relating to the commission or possible commission of any federal offense
• information must be provided to a law enforcement officer in order for protection to be tirggered
• broader than the civil liability protections
• protections covers all individuals regardless of where they work

• attempt and conspiracy
• mail fraud and wire fraud
• securities fraud
• document destruction
• freezing of assets
• bankruptcy loopholes
• disgorgement of bonuses

Deliberate misstatements or omissions of amounts or disclosures of financial statement users, particularly investors and creditors

• - Falisfication, alteration, or manipulation of material financial records, supporting documents, or business transactions
• - material intentional omissions or missrepresentations of events, transactions, accounts, or other significant information from which financial statements are prepared
• - deliberate misapplication of accounting principles, policies, and procedures used to measure, recognize, report, and disclose economic events and business transactions
• - intentional omissions of disclosures, or presentation of inadequate disclosures, regarding accounting principled and policies and related financial amounts

• - legal costs, increased insurance costs, loss of productivity, adverse impacts on employees' morale, customers' good will, suppliers trust, and negative stock market reactions - these costs are impossible to measure
• - undermines the reliability, quality, transparency, and integrity of the financial reporting process
• - jeopardizes the integrity and objectivity of the auditing profession, especially of auditors and suditing firms
• - diminished the confidence of the capital markets, as well as of market participants, in the relaibility of financial information
• - makes the capital markets less efficient
• - adversely affect the nation's economic growth and prosperity
• - rsults in huge litigation costs
• - destroys careers of individuals involved
• - causes bankruptcy or substantial economic losses by the company engaged in financial statement fraud
• - encourages regulatory intervention
• - causes devastation in the normal operations and performance of alleged companies
• - raises serioud doubt about the efficacy of financial statement audits
• - erodes public confidence and trust in the accounting and auditing profession

• fictitous revenues
• timing differences
• improper asset valuations
• concealed liabilities and expenses
• improper disclosures

• recording of goods or services that did not occur
• fake or phantom customers
• legitimate customers
• sales with conditions
• pressures to boost revenues

• rapid growth or unusual profitability, expecially compared to that of other companies in the same industry
• recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth
• significant transactions with related parties of special purpose entities not in teh ordinary course of business of where those entities are not audited or are audited bu another firm
• Significant, unusual, or highly complex transactions, ecpecially those close to period- end that pose difficult "substance over form" questions
• unusual growth in the nmber of days' sales in receivables
• a significant volume of sales to entities whose substance and ownership are not known
• an unusual surge in sales bu a minority of units within a company, or of sales recordes by corporate headquarters

• Recording revenue and/or expenses in improper periods
• shifting revenues or expenses between one period and the next, increasing or decreasing earnings as desired
• Matching revenues with expenses
• premature revenue recognition
• long-term contracts
• channel stuffing
• recording expenses in the wrong period

• Rapid growth or unusual profitability, expecially compared to that of other companies in teh same industry
• recurring negative cash flows from operations, or and inability to generate cash flows from operations, while reporting earnings and earnings growth
• significant, unusual, or highly complex transactions, especially those close to period-end that pose difficult "substance over form" questions
• unusual increase in gross margin or margin in excess of industry peers
• unusual growth in the number of days' in sales receivables
• unusual decline in the number of days' purchases in accounts payable

• Liability/expense omissions
• capitalized expenses
• failure to disclose warranty costs and liabilities

• Recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth
• assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgements of uncertainties that are difficult to corroborate
• nonfinancial management's excessive participation or peroccupation witht he selection of accounting principles of the determination od significant estimates
• unusual increase in gross margin or margin in excess of industry peers
• allowances for sales returns, warranty claims, and so on that are shrinking in percentage terms or are otherwise out of line with industry peers
• unusual reduction in the number of days' purchases in accounts payable
• reducing accounts payable while competitors are stretching out payments to vendors

• liability omissions
• subsequent events
• management fraud
• related-party transactions
• accounting changes

• Domination of management by a single person or small group withough compensating controls
• ineffective board of directors or audit committee oversight over the financial reporting process and internal control
• ineffective communication, implementation, support, or enforcement of the entity's values or ethical standards by management, or the communication of inappropriate values or ethical standards
• rapid growth or unusual profitability, especially compared to that of other companies in teh same industry
• Significant, unusual, or highly complex transactions, especially those close to period-end that pose difficult "substance over form" questions
• significant related-party transactions not in the ordinary course of business, or with relates entities not audited or audited by another firm
• significant bank accounts, or subsidiary or branch operations, in tax haven jurisdictions for which there appears to be no cllear business justification
• overly complex organizational structure involving unusual legal entities or managerial lines of authority
• Known history of violations of securites laws or other laws and regultiosn; or claims against the entity, its senior management, or board members, alleging fraud or violations of laws and regulations
• recurring attempts by management to justify marginal or inapropriate accounting on the basis of materiality
• formal or informal restrictions on the auditor that inappropriately limit access to people or information or the ability to communicate effectively with the board of directors or audit committee

• Inventory Valuation
• Accounts Receivable
• Business Combinations
• Fixed Assets

• unusual growth in the number of days' sales in receivables
• unusual growth in the number of day's purchases in inventory
• allowances for bad debts, excess and obsolete invetory, and so on that are shrinking in percentage terms or are otehrwise out of line with industry peers
• unusual change in the relationship between fixed assets and depreciation
• adding to addets while competitors are reducing capital tied up in assets
• recurring negative cahs flows from operationd or an inability to generate cash flows from operations while reporting earnings and growth
• significant declines in customer demand and increasing business failures in either industry or over all economy
• assets, liabilities, revenues, or expenses based on significant extimates that involve subjective judgements or uncertianties that are difficult to corroborate
• nonfinancial management's excessive participation in or preoccupation eith the selection of accounting principled of the determination of significant eztimates
• unusual increase in gross margin in excess of industry peers

• SAS 99 - Consideration of fraud in a financial statement audit
• "the auditor has a responsibility to plan and perfom the audit to btain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud."

• Description and characteristics of fraud
• importance of exercising professional skepticism
• discussion among engagement personnet regarding risk of material misstatement due to fraud
• obtaining information needed to identify risks of material misstatement due to fraud
• Identifying risks that may result in material misstatement due to fraud
• assessing the ifrntified risks after taking into account an evaluation of the entity's programs and controls
• Responding to the results of the assessment
• Evaluating Audit evidence
• communicating about fraud to management, the audit committee and others
• documenting the auditor's consideration of fraud

• Vertical Analysis - analyzes relationships between items on an income statement, balance sheet, or statement of cash flows by experessing componenets as percentages
• Horiszontal Analysis - analyzes the percentage change in an individual financial statement items
• Ratio Analysis - Measures the relationship between two different financial statement amounts

• reduce pressures to commit financial statement fraud
• reduce the opportunity to commit finaincial statement fraud
• reduce rationalization of financial statement fraud

• Estabilsh effective board over sight of the "tone at the top" created by management
• avoid setting unachievable financial goals
• avoid applying excessive pressure on employees to achieve goals
• change goals if changed market conditions require it
• ensure compensation systems are fair and do not create incentive to commit fraud
• Discourage excessive external expectations of future corporate performance
• remove operational obsticals blocking effective performance

• Maintain accurate and complete internal accounting records
• carefully monitor the business transactions and interpersonal relationships of suppliers, buyers, purchsing agents, sales representatives, and others who participate in the transactions between financial units
• Establish a physical security system to secure company assets, including finished goods, cash, capital equipment, tools and other valuable items
• maintain accurate personnel records, including background checks on new employee
• encourage strong supervisory and leadership relationships within groups to ensure enforcement of accounting proceedures
• establish clear and uniform accounting proceedures with no exception clauses

• Promote strong values, based on integrity, thoughout the organization
• have policies that clearly define prohibited behavior with respect to accounting and financial statement fraud
• provide regular trainign to all employees communicating prohibited behavior
• Have confidential advice and reporting mechanisms to communicate inappropriate behavior
• have senior executives communicate to employees that integrity takes priority and that goals must never be acheived through fraud
• ensure management practices what it preached and sets and example by promoting honesty in the accounting area
• clearly communicate the consequences of violating the rules and punishment for violators.