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Fraud & CorruptionFraud & CorruptionByBy Ali AmaniAli Amani

• Member of Supreme Court of Iranian Association of Certified Public Accountants (IACPA)Member of Supreme Court of Iranian Association of Certified Public Accountants (IACPA)• IICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAA IICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAA

Gholamhossein DavaniGholamhossein Davani• Member of High council of Iranian Association of Certifeid Public Accountants (IACPA )Member of High council of Iranian Association of Certifeid Public Accountants (IACPA )• IICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAAIICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAA

Dayarayan Auditing & Financial Services Firm(RSMi Iran)Dayarayan Auditing & Financial Services Firm(RSMi Iran)

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Your honor,Just now sitting at the patio with your honorable sibling and having a bite of board with her honor, I was informed that your honor has prattled and reappointed price Movasegholdoleh, governor of Qom, formerly deposed due to bribery and buying off.I had him sent to Tehran under guard, so that your Majesty will understand that one can not rule a country on his aunt’ prescriptions.Forgive me for being over impertinent,Taghi

“Amir Kabir’s (Current Pre minister) letter to King Naseraldin Shah”

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If men were angels, no government If men were angels, no government would be necessary. If angels were would be necessary. If angels were to govern men, neither external nor to govern men, neither external nor internal controls on government internal controls on government would be necessary.would be necessary.

James Madison, The Federalist Papers, No. 51, 1788James Madison, The Federalist Papers, No. 51, 1788

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Just as one can not let go of the taste of honey or poison on the tip of his tongue, a governmental agent dealing with governmental budget, can not avoid tasting at least a little of the King’s wealth.

“Kaochila ertashsetra,”

Indian edifications, first decade Annone Domini

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Fraud:Fraud:

Any illegal act characterized by deceit, Any illegal act characterized by deceit, concealment, or violations of trust to obtain concealment, or violations of trust to obtain money, property, services, avoid payment; or money, property, services, avoid payment; or secure personal or business advantage secure personal or business advantage (IIA(IIA))

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Definition of FraudDefinition of Fraud

A generic term, embracing all multifarious A generic term, embracing all multifarious means which human ingenuity can devise, and means which human ingenuity can devise, and which are resorted to by one individual to get which are resorted to by one individual to get advantage over another by false suggestions or advantage over another by false suggestions or by suppression of truth, and includes all by suppression of truth, and includes all surprise, trick, cunning, dissembling, and any surprise, trick, cunning, dissembling, and any unfair way by which another is cheated.unfair way by which another is cheated.““Johnson v. McDonald, 39 P2d 150Johnson v. McDonald, 39 P2d 150””

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• In the broadest sense, aIn the broadest sense, a fraudfraud is a deception made for is a deception made for personal gain, although it has a more specific legal personal gain, although it has a more specific legal meaning, the exact details varying between meaning, the exact details varying between jurisdictions. Manyjurisdictions. Many hoaxes are fraudulent, although are fraudulent, although those not made for personal gain are not best those not made for personal gain are not best described in this way. Not all frauds are hoaxesdescribed in this way. Not all frauds are hoaxes - - electoral fraud, , for example. Fraud permeates many for example. Fraud permeates many areas of life, includingareas of life, including art, , archaeology andand science. . In the broadIn the broad legal sense a fraud is any crime or civil sense a fraud is any crime or civil wrong for gain that utilises some deception practiced wrong for gain that utilises some deception practiced on the victim as its principal methodon the victim as its principal method..

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• InIn criminal law, , fraudfraud is the crime or offense of is the crime or offense of deliberatelydeliberately deceiving another in order to damage another in order to damage them them —— usually, to obtain property or services from usually, to obtain property or services from him or her unjustly.him or her unjustly. Fraud can be accomplished Fraud can be accomplished through the aid ofthrough the aid of forged objects. In the criminal law objects. In the criminal law ofof common law jurisdictions it may be called "theft jurisdictions it may be called "theft by deceptionby deception," "," "larceny by trickby trick," "," "larceny by fraud by fraud and deception" or something similar. Fraud can be and deception" or something similar. Fraud can be committed through many methods, includingcommitted through many methods, including mail, , wire, , phone, , and theand the internet (see (see computer crime andand internet fraud..))

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Acts which may constitute criminal fraud includeActs which may constitute criminal fraud include::• bait and switch • confidence tricks such as thesuch as the fraud, , Spanish Prisoner, , and theand the shell game • false advertising • identity theft • false billingfalse billing • forgeryforgery of documents or signaturesof documents or signatures • taking money which is under your control, but not yourstaking money which is under your control, but not yours (embezzlement)(embezzlement)• health fraudhealth fraud, , selling of products of spurious use, such asselling of products of spurious use, such as quackquack medicinesmedicines • creation of false companies orcreation of false companies or " "long firmslong firms" " • false insurance claimsfalse insurance claims • bankruptcy fraudbankruptcy fraud, , is a US federal crime that can lead to criminal prosecution under is a US federal crime that can lead to criminal prosecution under

the charge of theft of the goods or servicesthe charge of theft of the goods or services • investment fraudsinvestment frauds, , such assuch as Ponzi schemesPonzi schemes • securitiessecurities frauds such asfrauds such as pump and dumppump and dump

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FraudFraud means:means:

• Inducing a course of action by deceit or other Inducing a course of action by deceit or other dishonest conductdishonest conduct

• Involves acts or omissions or the making of Involves acts or omissions or the making of false statementsfalse statements

• Can be orally or in writingCan be orally or in writing

• Object Object –– to obtain a benefit or evade a liability to obtain a benefit or evade a liability

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Fraud:Fraud:The term fraud may be defined as intentional The term fraud may be defined as intentional misrepresentation of financial information by one or misrepresentation of financial information by one or more individuals among management, employees or more individuals among management, employees or third parties. Fraud may involve: third parties. Fraud may involve:

Falsification or alteration of accounting records or Falsification or alteration of accounting records or other documentsother documentsMisappropriation of assets or theft;Misappropriation of assets or theft;Suppression or omission of the effects of transactions Suppression or omission of the effects of transactions from records or documents.from records or documents.Recording of transactions without substances. Recording of transactions without substances. Intentional misapplication of accounting policies or Intentional misapplication of accounting policies or Willful misrepresentations of transactions or of the Willful misrepresentations of transactions or of the entity's state of affairs.entity's state of affairs.

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Nature of the Frauds (Source:Coso report)Nature of the Frauds (Source:Coso report)

• Cumulative amounts of frauds were relatively large in light of the relatively Cumulative amounts of frauds were relatively large in light of the relatively small sizes of the companies involved. The average financial statement small sizes of the companies involved. The average financial statement misstatement or misappropriation of assets was $25 million and the median misstatement or misappropriation of assets was $25 million and the median was $4.1 million. While the average company had assets totaling $533 million, was $4.1 million. While the average company had assets totaling $533 million, the median company had total assets of only $16 million. the median company had total assets of only $16 million.

• Most frauds were not isolated to a single fiscal period. Most frauds overlapped Most frauds were not isolated to a single fiscal period. Most frauds overlapped at least two fiscal periods, frequently involving both quarterly and annual at least two fiscal periods, frequently involving both quarterly and annual financial statements. The average fraud period extended over 23.7 months, financial statements. The average fraud period extended over 23.7 months, with the median fraud period extending 21 months. Only 14 percent of the with the median fraud period extending 21 months. Only 14 percent of the sample companies engaged in a fraud involving fewer than 12 months. sample companies engaged in a fraud involving fewer than 12 months.

• Typical financial statement fraud techniques involved the overstatement of Typical financial statement fraud techniques involved the overstatement of revenues and assets. Over half the frauds involved overstating revenues by revenues and assets. Over half the frauds involved overstating revenues by recording revenues prematurely or fictitiously. Many of those revenue frauds recording revenues prematurely or fictitiously. Many of those revenue frauds only affected transactions recorded right at period end (i.e., quarter end or only affected transactions recorded right at period end (i.e., quarter end or year end). About half the frauds also involved overstating assets by year end). About half the frauds also involved overstating assets by understating allowances for receivables, overstating the value of inventory, understating allowances for receivables, overstating the value of inventory, property, plant and equipment and other tangible assets, and recording assets property, plant and equipment and other tangible assets, and recording assets that did not exist. that did not exist.

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Fraud and abuse covers various issues including:Fraud and abuse covers various issues including:• Conflicts of interests e.g. a corrupt relationship can Conflicts of interests e.g. a corrupt relationship can

involve an employee setting up a company, the involve an employee setting up a company, the company supplies goods and services to the company supplies goods and services to the organization, the employee does not tell the organization, the employee does not tell the organization about it organization about it

• Breach of trust e.g. leaking of confidential or Breach of trust e.g. leaking of confidential or sensitive informationsensitive information

• Employee malpractice e.g. excessive use of the Employee malpractice e.g. excessive use of the telephone for private calls, e-mail abusetelephone for private calls, e-mail abuse

• Criminal offenceCriminal offence

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• corruptioncorruption      nounnoun1 [U] illegal, immoral or dishonest behavior, especially by people in 1 [U] illegal, immoral or dishonest behavior, especially by people in positions of powerpositions of power

• corroput corroput      verb [T] verb [T] to make someone or something become dishonest or immoral:to make someone or something become dishonest or immoral:

• n.)n.) The act of changing, or of being changed, for the worse; departure from The act of changing, or of being changed, for the worse; departure from what is pure, simple, or correct; as, a corruption of style; corruption in what is pure, simple, or correct; as, a corruption of style; corruption in language. language.

• (n.)(n.) The act of corrupting or of impairing integrity, virtue, or moral The act of corrupting or of impairing integrity, virtue, or moral principle; the state of being corrupted or debased; loss of purity or principle; the state of being corrupted or debased; loss of purity or integrity; depravity; wickedness; impurity; bribery. integrity; depravity; wickedness; impurity; bribery.

• (n.)(n.) The product of corruption; putrid matter. The product of corruption; putrid matter. • (n.)(n.) The act of corrupting or making putrid, or state of being corrupt or The act of corrupting or making putrid, or state of being corrupt or

putrid; decomposition or disorganization, in the process of putrefaction; putrid; decomposition or disorganization, in the process of putrefaction; putrefaction; deterioration.putrefaction; deterioration.

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• corruption as corruption as ‘‘doing something beyond the existing rules regulation intending doing something beyond the existing rules regulation intending personal or group interest or doing something illegally for personal or group personal or group interest or doing something illegally for personal or group interest. Respondents think that terrorism, theft, snatching, robbery, bribing are the interest. Respondents think that terrorism, theft, snatching, robbery, bribing are the different forms of corruption. Vote rigging, use of muscles power in election, different forms of corruption. Vote rigging, use of muscles power in election, trafficking of children and women, rape, cheating, abduction- these are the another trafficking of children and women, rape, cheating, abduction- these are the another form of corruption.form of corruption.

• Respondents also comment that corruption can be economic, social as well as Respondents also comment that corruption can be economic, social as well as political.political.

• The following comments by the participants support this finding:The following comments by the participants support this finding:• doing something illegally is corruptiondoing something illegally is corruption• doing something violating existing set of rules regulations and law is corruptiondoing something violating existing set of rules regulations and law is corruption• doing something beyond principles is corruptiondoing something beyond principles is corruption• doing something for the personal interest violating the prevailing system and social doing something for the personal interest violating the prevailing system and social

values is corruptionvalues is corruption• vote rigging is a corruptionvote rigging is a corruption• dispute of land is corruptiondispute of land is corruption• (terrorism), bribing, theft is corruption(terrorism), bribing, theft is corruption• bribing, nepotism in the case of employment is corruptionbribing, nepotism in the case of employment is corruption• unconsciousness is one sort of corruptionunconsciousness is one sort of corruption• drug abuse, drug smuggling is a corruptiondrug abuse, drug smuggling is a corruption• for the sack of own interest, all the economical, social injustice is corruptionfor the sack of own interest, all the economical, social injustice is corruption• negligence of duty is corruption negligence of duty is corruption • misuse of political power is corruptionmisuse of political power is corruption

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• CorruptionCorruption is defined in section 83 of the is defined in section 83 of the Criminal Code (WA) Criminal Code (WA) and is taken and is taken to mean any public officer who, without lawful authority or a reasonable to mean any public officer who, without lawful authority or a reasonable excuse:excuse:

• acts upon any knowledge or information obtained by reason of his or her acts upon any knowledge or information obtained by reason of his or her office or employment;office or employment;

• acts in any matter, in the performance or discharge of the functions of his acts in any matter, in the performance or discharge of the functions of his or her office or employment, in relation to which he or she has, directly or or her office or employment, in relation to which he or she has, directly or indirectly, any pecuniary interest; orindirectly, any pecuniary interest; or

• acts corruptly in the performance or discharge of the functions of his or her acts corruptly in the performance or discharge of the functions of his or her office; oroffice; or

• employment, so as to gain a benefit, whether pecuniary or otherwise, for employment, so as to gain a benefit, whether pecuniary or otherwise, for himself or herself or any person, or so as to cause a detriment, whether himself or herself or any person, or so as to cause a detriment, whether pecuniary or otherwise, to any person, is guilty of a crime and is liable to pecuniary or otherwise, to any person, is guilty of a crime and is liable to imprisonment for 3 years.imprisonment for 3 years.

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Money Laundering:Money Laundering:

Money laundering is the process by which Money laundering is the process by which criminals attempt to conceal the true origin and criminals attempt to conceal the true origin and ownership of their criminal activities. If ownership of their criminal activities. If undertaken successfully, it also allows them to undertaken successfully, it also allows them to maintain control over those proceeds and maintain control over those proceeds and ultimately to provide a legitimate cover for their ultimately to provide a legitimate cover for their source of funds. Their dirty funds appear clean. source of funds. Their dirty funds appear clean. It is generally linked with money required to It is generally linked with money required to finance cross border drug trafficking, arms deal finance cross border drug trafficking, arms deal or tax evasion or other similar crimes.or tax evasion or other similar crimes.

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THEORIES OF FRAUD:THEORIES OF FRAUD:

A number of theoretical models have been constructed in A number of theoretical models have been constructed in the past in an attempt to explain why people commit fraud. the past in an attempt to explain why people commit fraud. Some of the key characteristics of recent models include Some of the key characteristics of recent models include the following:the following:

A perceived opportunity such as the absence of or circumvention of A perceived opportunity such as the absence of or circumvention of controls that enable fraud to be prevented or detected.controls that enable fraud to be prevented or detected.An offender with a motivation to steal money, whether through cupidity, An offender with a motivation to steal money, whether through cupidity, living beyond one's means, the existence of debts some times associated living beyond one's means, the existence of debts some times associated with drug or gambling addiction, presence of a financial crisis or various with drug or gambling addiction, presence of a financial crisis or various work related pressures.work related pressures.The presence of a rationalization for acting illegally, such as belief that The presence of a rationalization for acting illegally, such as belief that the victim can afford the loss, that the funds stolen will be repaid or that the victim can afford the loss, that the funds stolen will be repaid or that the money will be used for a good purpose by the offender; and finally.the money will be used for a good purpose by the offender; and finally.The absence of a capable guardian, whether through proper business The absence of a capable guardian, whether through proper business administration, lack of fraud prevention resources or the absence of an administration, lack of fraud prevention resources or the absence of an effective police service or regulatory authority.effective police service or regulatory authority.

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History of FraudHistory of Fraud• Considering the enormous impact, relatively little Considering the enormous impact, relatively little

research has been done on the subject of occupational research has been done on the subject of occupational fraud and abuse. Much of the current literature is fraud and abuse. Much of the current literature is based on the early works of Edwin H. Sutherland based on the early works of Edwin H. Sutherland (1883-1950), a criminologist at Indiana University. (1883-1950), a criminologist at Indiana University. Sutherland coined the term Sutherland coined the term ““Wite-CollarWite-Collar”” crime in crime in 1939. 1939.

• Sutherland believed that crime was a learned activity Sutherland believed that crime was a learned activity at a time when most experts believed that crime was at a time when most experts believed that crime was genetically based. genetically based.

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WHITE COLLAR CRIMEWHITE COLLAR CRIME

• In 1995, Albanese explained white-collar crime as: In 1995, Albanese explained white-collar crime as: ““Planned Planned or organized illegal acts of deception or fraud, usually or organized illegal acts of deception or fraud, usually accomplished during the course of legitimate occupational accomplished during the course of legitimate occupational activity, committed by an individual or corporate entity.activity, committed by an individual or corporate entity.”” It is It is clear from these two definitions that a certain form of behavior clear from these two definitions that a certain form of behavior is required for white-collar offences, which distinguishes it is required for white-collar offences, which distinguishes it from conventional crimes like robbery and assault. For from conventional crimes like robbery and assault. For practical reasons, it is proposed that the definition of white-practical reasons, it is proposed that the definition of white-collar crime be as follows: collar crime be as follows: ““White-collar crime is the White-collar crime is the unlawful, intentional commitment of deceit, deception, unlawful, intentional commitment of deceit, deception, concealment, manipulation, breach of trust, subterfuge or any concealment, manipulation, breach of trust, subterfuge or any other similar trickery, by an individual, syndicate or other similar trickery, by an individual, syndicate or organization, normally after meticulous planning, with out the organization, normally after meticulous planning, with out the use of physical violence which causes actual economic use of physical violence which causes actual economic prejudice or potential economic prejudice to another.prejudice or potential economic prejudice to another.””

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White-collar crime is distinguished from other conventional crimes White-collar crime is distinguished from other conventional crimes like robbery by way of the following general characteristics:like robbery by way of the following general characteristics:

•Unlike robbery which involves the use of force, white-collar offences are Unlike robbery which involves the use of force, white-collar offences are characterized by careful planning and deception, usually without the use of violence;characterized by careful planning and deception, usually without the use of violence;• Some form of premeditation and fraudulent activity is typical;Some form of premeditation and fraudulent activity is typical;•There is usually an element of concealed misappropriation or deception;There is usually an element of concealed misappropriation or deception;•The white-collar offence is often of a complicated nature which makes it difficult to The white-collar offence is often of a complicated nature which makes it difficult to prosecute; the crime normally has low visibility in order to obscure its existence; prosecute; the crime normally has low visibility in order to obscure its existence; •There is usually a diffusion of responsibility for the crime;There is usually a diffusion of responsibility for the crime;•Diffusion of victimization is also a characteristic of theses types of crimes Diffusion of victimization is also a characteristic of theses types of crimes •There does not seem to be a true There does not seem to be a true ““victimvictim”” when a person defrauds the company he when a person defrauds the company he works for;works for;•Although the element of fraud is usually found in most white-collar schemes, these Although the element of fraud is usually found in most white-collar schemes, these offences can go much further including corruption, forgery, theft and complicated offences can go much further including corruption, forgery, theft and complicated statutory offences like money laundering of which deceit is usually an element; − statutory offences like money laundering of which deceit is usually an element; − White-collar offences are often demarcated as White-collar offences are often demarcated as ““rational crimesrational crimes””;;•A white-collar criminalA white-collar criminal’’s occupation or working conditions often provides s occupation or working conditions often provides opportunities that may be exploited.opportunities that may be exploited.

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Some reasons why fraud happens include:Some reasons why fraud happens include:• failure to look for itfailure to look for it

• internal audit cover and fraud risk management internal audit cover and fraud risk management skills not always adequateskills not always adequate

• poor data integrity and securitypoor data integrity and security

• inappropriate authority levelsinappropriate authority levels

• recruitment of dishonest employeesrecruitment of dishonest employees

• abuse of separation of dutiesabuse of separation of duties

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The Fraud TriangleThe Fraud Triangle

Incentives/PressuresIncentives/Pressures

OpportunitiesOpportunities Attitudes/RationalizationAttitudes/Rationalization

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Types of FraudTypes of Fraud

Fraudulent financial reportingFraudulent financial reporting

Misappropriation of assetsMisappropriation of assets

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TYPES OF FRAUDTYPES OF FRAUDFrauds can be categorized by the type of Frauds can be categorized by the type of victim involved. The most common groups of victim involved. The most common groups of victims encountered by investigators include: victims encountered by investigators include:

• Investors Investors

• Creditors Creditors

• Businesses Businesses

• Banks or other financial institutions Banks or other financial institutions

• Central or local government Central or local government

• Fraud by manipulating financial markets Fraud by manipulating financial markets

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Stock FraudStock Fraud • A crime in which securities investing or trading laws have A crime in which securities investing or trading laws have

been violated. Stock fraud encompasses many things including been violated. Stock fraud encompasses many things including stocks, bonds, commodities and other investments. Stock fraud stocks, bonds, commodities and other investments. Stock fraud is illegal and can be described as deceptive practices in the is illegal and can be described as deceptive practices in the stock and commodity markets. Stock fraud occurs when stock and commodity markets. Stock fraud occurs when investors are enticed to buy securities based upon false investors are enticed to buy securities based upon false statements or records. Stock fraud includes providing false statements or records. Stock fraud includes providing false information on a companies financial statement, profit and information on a companies financial statement, profit and loss statements, SEC filings, lying to an auditor, stock loss statements, SEC filings, lying to an auditor, stock manipulation schemes, insider trading, and embezzlement. manipulation schemes, insider trading, and embezzlement. Stock fraud is otherwise known as securities fraud.Stock fraud is otherwise known as securities fraud.

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2006 Identity Fraud Survey Report

Source:Javelin Stratgy&Research

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Brief History of Financial FraudBrief History of Financial Fraud

• 1907 to 1919 Charles Ponzi, inventor of the 1907 to 1919 Charles Ponzi, inventor of the pyramid or "Ponzi" scheme, was sentenced to pyramid or "Ponzi" scheme, was sentenced to 10 years in prison for larceny and fraud. He 10 years in prison for larceny and fraud. He had raised $15 million before he was caught.had raised $15 million before he was caught.

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• 1929 International Power's stock price 1929 International Power's stock price dropped 78% in one day when it was dropped 78% in one day when it was revealed that they "cooked the books". The revealed that they "cooked the books". The Securities and Exchange Commission (SEC) Securities and Exchange Commission (SEC) was created in response to the rampant was created in response to the rampant fraud of the go-go 1920's which were fraud of the go-go 1920's which were exposed in the 1929 stock market crash. exposed in the 1929 stock market crash.

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• 1932 Ivar Kreuger was caught switching 1932 Ivar Kreuger was caught switching assets and liabilities and making up assets. assets and liabilities and making up assets. He raised $500 million before he was He raised $500 million before he was caught. In March 1932 he shot himself in caught. In March 1932 he shot himself in Paris. Paris.

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• 1937 Phillip Musica (aka Frank Donald 1937 Phillip Musica (aka Frank Donald Coster) was caught with $10 million of Coster) was caught with $10 million of inventory and $9 million of accounts inventory and $9 million of accounts receivable that didn't exist. receivable that didn't exist.

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• 1963 Anthony (Tino) De Angelis of Allied Crude 1963 Anthony (Tino) De Angelis of Allied Crude Vegetable Oil Refining Co. used bottles of water, not Vegetable Oil Refining Co. used bottles of water, not oil, as collateral for $175 million in loans. 1973 Equity oil, as collateral for $175 million in loans. 1973 Equity Funding Corporation's net worth of $143.4 million was Funding Corporation's net worth of $143.4 million was discovered to be discovered to be negativenegative $42.1 million. The company $42.1 million. The company had been recording fictitious income since had been recording fictitious income since

• 1965. Stanley Goldblum and 22 other people were 1965. Stanley Goldblum and 22 other people were sentenced for fraud. 1988 Wedtech (Welbilt Electronic sentenced for fraud. 1988 Wedtech (Welbilt Electronic Die Co) was caught using the percentage of completion Die Co) was caught using the percentage of completion method to record revenue that didn't exist, bribing method to record revenue that didn't exist, bribing government officials, lying on government proposals government officials, lying on government proposals and contracts, and falsifying invoices. The scandal and contracts, and falsifying invoices. The scandal involved Congress and the Reagan administration. involved Congress and the Reagan administration. Auditors sued for $105 million in damages. Auditors sued for $105 million in damages.

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• 1987 Lincoln Savings and Loan costs taxpayers $2.5 billion 1987 Lincoln Savings and Loan costs taxpayers $2.5 billion for fraud schemes that involved members of Congress. for fraud schemes that involved members of Congress. Charles Keating recorded profits on junk bonds and real Charles Keating recorded profits on junk bonds and real estate loans that they knew were worthless, and he his estate loans that they knew were worthless, and he his family received $34 million in salary and sales of American family received $34 million in salary and sales of American Continental Corporation stock before the scheme crashed. Continental Corporation stock before the scheme crashed. Savings and Loan scandals cost taxpayers an estimated Savings and Loan scandals cost taxpayers an estimated $500 billion during the 1980's. 1989 MiniScribe $500 billion during the 1980's. 1989 MiniScribe Corporation, a disk drive manufacturer, fooled their Corporation, a disk drive manufacturer, fooled their auditors for 2 years by filling their inventory boxes with auditors for 2 years by filling their inventory boxes with bricks. The auditing company, Coopers & Lybrand, had to bricks. The auditing company, Coopers & Lybrand, had to pay $100 million in an out-of-court settlement.pay $100 million in an out-of-court settlement.

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• 1991 The Bank of Commerce and Credit International (BCCI), known 1991 The Bank of Commerce and Credit International (BCCI), known today as "The Bank of Crooks and Criminals International", was used today as "The Bank of Crooks and Criminals International", was used to launder money by drug smugglers and embezzling dictators to launder money by drug smugglers and embezzling dictators throughout the world. When the bank was finally shut down, in July throughout the world. When the bank was finally shut down, in July 1991, it was found to have stolen, lost, or swindled $20 billion. 1991 1991, it was found to have stolen, lost, or swindled $20 billion. 1991 Maxwell Communications president Robert Maxwell resorted to Maxwell Communications president Robert Maxwell resorted to looting when his publishing empire started to collapse, taking $1.4 looting when his publishing empire started to collapse, taking $1.4 billion including $800 million from the employee pension fund alone. billion including $800 million from the employee pension fund alone. He was found dead on November 5, 1991. 1998 When Cendant was He was found dead on November 5, 1991. 1998 When Cendant was created from the 1997 merger of HFS and CUC, HFS management created from the 1997 merger of HFS and CUC, HFS management discovered that CUC (Comp-U-Card) had been cooking the books, by discovered that CUC (Comp-U-Card) had been cooking the books, by reporting false membership sales, since at least 1983. They were reporting false membership sales, since at least 1983. They were charged with fraud on April 16, 1998. The company had to pay charged with fraud on April 16, 1998. The company had to pay billions to defrauded investors, and the auditor, Ernst & Whinny, paid billions to defrauded investors, and the auditor, Ernst & Whinny, paid $335 million in an out-of-court settlement. 2000 Micro Strategy had $335 million in an out-of-court settlement. 2000 Micro Strategy had their share price collapse from $333 to $86 when they announced their their share price collapse from $333 to $86 when they announced their financial reports would be restated to show huge losses. Investors had financial reports would be restated to show huge losses. Investors had pushed the price up based on the hype from one of the tech industry's pushed the price up based on the hype from one of the tech industry's most flamboyant CEO's, Michael Saylor, along with bogus financial most flamboyant CEO's, Michael Saylor, along with bogus financial statements. The share price was $3 one year later. 2001 Enron, statements. The share price was $3 one year later. 2001 Enron, WorldCom.WorldCom.

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BETTER AUDITS, LESS FRAUDBETTER AUDITS, LESS FRAUD

• As financial and economic pressures tighten for corporate As financial and economic pressures tighten for corporate executives, it is more important than ever for auditors to executives, it is more important than ever for auditors to develop sound fraud-detection audit techniques. The audit develop sound fraud-detection audit techniques. The audit deficiencies alleged by the SEC between 1987 and 1997 are, deficiencies alleged by the SEC between 1987 and 1997 are, in our view, issues the profession and individual firms can in our view, issues the profession and individual firms can effectively address. The recommendations included in this effectively address. The recommendations included in this article may help firms reduce the chance of undetected article may help firms reduce the chance of undetected material financial statement fraud as they strive to continually material financial statement fraud as they strive to continually improve fraud risk assessment tools. The audit deficiencies the improve fraud risk assessment tools. The audit deficiencies the SEC identified also have important implications for standard SEC identified also have important implications for standard setters as they seek to strengthen professional standards setters as they seek to strengthen professional standards related to the auditor’s fraud detection responsibilities. related to the auditor’s fraud detection responsibilities.

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The result was the following new set of skills needed The result was the following new set of skills needed by accountantsby accountants

• Better technology skillsBetter technology skills

• Better analytical skills—to understand complex transactions Better analytical skills—to understand complex transactions (derivatives, reserves, leverage, etc.)(derivatives, reserves, leverage, etc.)

• Better communication skills – to participate in decision-Better communication skills – to participate in decision-making teamsmaking teams

• Better interviewing skillsBetter interviewing skills

• Better skills working in teamsBetter skills working in teams

• A better global understandingA better global understanding

• Better understanding of fraudBetter understanding of fraud

What gave accountants an advantage in the past is no longer nearly as valuable!What gave accountants an advantage in the past is no longer nearly as valuable!

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Competencies/Skills LearnedCompetencies/Skills Learned

• Risk analysisRisk analysis

• Controls and control environmentControls and control environment

• Better auditing skillsBetter auditing skills

• Knowledge of the legal systemKnowledge of the legal system

• Availability of information (public, private, Availability of information (public, private, databases, etc.)databases, etc.)

• Problem-solving abilityProblem-solving ability

Today’s winners are those who have access to the best information a fraud course teaches how to access information

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For better Audits educators mustFor better Audits educators must::

• Need to teach Ethics moreNeed to teach Ethics more

• Need to teach students about fraudNeed to teach students about fraud——offer offer a a ““fraudfraud”” course course

• Need to teach students how to thinkNeed to teach students how to think• We have taught them how to copy, not thinkWe have taught them how to copy, not think

• We have asked them to memorize, not thinkWe have asked them to memorize, not think

• We have done what is easiest for us and easiest for We have done what is easiest for us and easiest for our studentsour students

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• First and foremost is the urgent need for change:First and foremost is the urgent need for change:• External and internal auditors must train thoroughly in fraud-External and internal auditors must train thoroughly in fraud-

detection procedures and attitudes. detection procedures and attitudes. • The university education of the next generation of auditors The university education of the next generation of auditors

should reflect the new emphasis on fraud deterrence, should reflect the new emphasis on fraud deterrence, detection, and investigation. detection, and investigation.

• The formal standards governing audit processes and objectives The formal standards governing audit processes and objectives should evolve without delay to an updated and more rigorous should evolve without delay to an updated and more rigorous approach to fraud detection. approach to fraud detection.

• Executives and directors must become fully aware of the Executives and directors must become fully aware of the threat of fraud and do all they can to institute measures to threat of fraud and do all they can to institute measures to deter it, ranging from robustly enforced codes of ethics to deter it, ranging from robustly enforced codes of ethics to internal controls that make fraud less likely and easier to internal controls that make fraud less likely and easier to detect.detect.

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The six key drivers of audit quality (identified in The six key drivers of audit quality (identified in Audit Audit QualityQuality) are:) are:

• Leadership,Leadership,  including tone at the top and audit firm strategy;including tone at the top and audit firm strategy;• People of competence, quality and integrity;People of competence, quality and integrity;• Client Relationships, including effective management ofClient Relationships, including effective management of  client client

portfolios and working with individual clients;portfolios and working with individual clients;• Working Practices and quality control procedures;Working Practices and quality control procedures;• Internal Monitoring by audit firms of leadership, people, client Internal Monitoring by audit firms of leadership, people, client

relationships and working practices; andrelationships and working practices; and• External Monitoring under public oversight to encourage and External Monitoring under public oversight to encourage and

assist firms to improve audit quality.assist firms to improve audit quality.

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Risk & Fraud cycle

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Role of Internal & External auditors in fraud detectionRole of Internal & External auditors in fraud detection

• Internal AuditorsInternal Auditors’’ Assessment of Fraud Implications for External Auditors Assessment of Fraud Implications for External Auditors• Warning Signs: Implications for External AuditorsWarning Signs: Implications for External Auditors• External Auditors Can Partner with Internal Auditors External Auditors Can Partner with Internal Auditors • The AICPAThe AICPA’’s have issued SAS 99, s have issued SAS 99, Consideration of Fraud in a Financial Consideration of Fraud in a Financial

Statement AuditStatement Audit, directs external auditors to ask a company, directs external auditors to ask a company ’’s internal audit s internal audit personnel about the risk of fraud and any knowledge of actual or suspected personnel about the risk of fraud and any knowledge of actual or suspected fraud. The impetus for this directive comes from the important role internal fraud. The impetus for this directive comes from the important role internal auditors play in corporate governance. As recognized by the Treadway auditors play in corporate governance. As recognized by the Treadway Commission Report in 1987, internal auditors are expected to assume an active Commission Report in 1987, internal auditors are expected to assume an active role in preventing and detecting fraudulent financial reporting. role in preventing and detecting fraudulent financial reporting.

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Fraud ConditionsFraud Conditions According to SAS 99, three fundamental According to SAS 99, three fundamental conditions are generally present when fraudulent conditions are generally present when fraudulent financial reporting occurs:financial reporting occurs:

1) incentive or pressure to perpetrate fraud, 1) incentive or pressure to perpetrate fraud, 2) an opportunity to carry out the fraud,2) an opportunity to carry out the fraud,3) attitude or rationalization to justify the fraudulent action. 3) attitude or rationalization to justify the fraudulent action.

Within each of the three fundamental conditions, there are Within each of the three fundamental conditions, there are a number of specific warning signs of fraud, including a number of specific warning signs of fraud, including some factors directed toward corporate governancesome factors directed toward corporate governance..

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AuditorAuditor’’s Professional responsibilitys Professional responsibility

• Certified auditors are required by Statement on Auditing Standards no. 99, Certified auditors are required by Statement on Auditing Standards no. 99, Consideration of Fraud in a Financial Statement Audit,Consideration of Fraud in a Financial Statement Audit, to assess the risk to assess the risk that financials are materially misstated.that financials are materially misstated.

• The Association of Chartered Certified Accountants (ACCA) welcomes The Association of Chartered Certified Accountants (ACCA) welcomes the opportunity to comment on the revised International Standard on the opportunity to comment on the revised International Standard on Auditing 240 Auditing 240 The AuditorThe Auditor’’s Responsibility to Consider Fraud in an Audit s Responsibility to Consider Fraud in an Audit of Financial Statements of Financial Statements proposed by the International Auditing and proposed by the International Auditing and Assurance Standards Board (IAASB).Assurance Standards Board (IAASB).

• The Institute of Chartered Accountants in England and Wales (ICAEW) The Institute of Chartered Accountants in England and Wales (ICAEW) issued comprehensive guidance notes for Chartered Accountants following issued comprehensive guidance notes for Chartered Accountants following the Money Laundering Regulations enactment in 1993. Regarding the Money Laundering Regulations enactment in 1993. Regarding conventional frauds, ICAEW issued SAS 110.1 on fraud and error and conventional frauds, ICAEW issued SAS 110.1 on fraud and error and fixed up the responsibility of auditorsfixed up the responsibility of auditors

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• In February 1997, the AICPA auditing standards board (ASB) will issue In February 1997, the AICPA auditing standards board (ASB) will issue Statement on Auditing Standards (SAS) no. 82, Statement on Auditing Standards (SAS) no. 82, Consideration of Fraud in Consideration of Fraud in a Financial Statement Audita Financial Statement Audit (product no. 060675). The new standard (product no. 060675). The new standard articulates the independent auditorarticulates the independent auditor’’s responsibility to plan and perform the s responsibility to plan and perform the audit to obtain reasonable assurance as to whether the financial statements audit to obtain reasonable assurance as to whether the financial statements are free of material misstatement, whether caused by error or fraud, and are free of material misstatement, whether caused by error or fraud, and provides expanded operational guidance in fulfilling that responsibility.provides expanded operational guidance in fulfilling that responsibility.

• Specifically, SAS no. 82Specifically, SAS no. 82• Describes two types of fraud fraudulent financial reporting and Describes two types of fraud fraudulent financial reporting and

misappropriation of assets. misappropriation of assets. • Requires the auditor to specifically assess the risk of material misstatement Requires the auditor to specifically assess the risk of material misstatement

due to fraud. It provides categories of risk factors that should be considered due to fraud. It provides categories of risk factors that should be considered and examples that might indicate the presence of fraud. and examples that might indicate the presence of fraud.

• Provides guidance on how the auditor responds to the results of the Provides guidance on how the auditor responds to the results of the assessment and provides guidance on how this should be done and on how assessment and provides guidance on how this should be done and on how to evaluate test results. to evaluate test results.

• Requires the auditor to document identified risk factors and any related Requires the auditor to document identified risk factors and any related response. response.

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Three of these ISAs (UK and Ireland), which concern the Three of these ISAs (UK and Ireland), which concern the areas of audit risk and fraud, include a number of areas of audit risk and fraud, include a number of requirements that are additional to those set out in the requirements that are additional to those set out in the SASs theory replace. This Bulletin provided SASs theory replace. This Bulletin provided supplementary guidance for auditors of charities on supplementary guidance for auditors of charities on these additional requirements, by replacing the sections these additional requirements, by replacing the sections of Practice Note (PN) 11 of Practice Note (PN) 11 ““The Audit of Charities in the The Audit of Charities in the United Kingdom (Revised)United Kingdom (Revised)”” Which cover: Which cover:

• SAS 210: SAS 210: ‘‘Knowledge of the businessKnowledge of the business’’,,

• SAS 300: SAS 300: ‘‘Accounting and internal control systems and Accounting and internal control systems and audit risk assessmentsaudit risk assessments’’; and ; and

• SAS 110: SAS 110: ‘‘Fraud and errorFraud and error’’..

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Iranian AuditorIranian Auditor’’s Responsibility to Consider Fraud & s Responsibility to Consider Fraud & Error in an Error in an auditaudit of Financial statements Accordance of Financial statements Accordance with Iran audit standards sec.24with Iran audit standards sec.24

SAS Says:SAS Says:

•Its managementIts management’’s responsibility:s responsibility:•Setting the proper toneSetting the proper tone

•Creating and maintaining a culture of honesty and ethicsCreating and maintaining a culture of honesty and ethics

•Establishing appropriate controlsEstablishing appropriate controls

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Auditor's Responsibility under Generally Auditor's Responsibility under Generally Accepted Auditing StandardsAccepted Auditing Standards

It is important for audit committees to understand what It is important for audit committees to understand what an audit is and what it is not. Usually, audit committees an audit is and what it is not. Usually, audit committees are most concerned about the system of internal control are most concerned about the system of internal control and that the financial statements are free of material and that the financial statements are free of material misstatement. The auditor should make sure the audit misstatement. The auditor should make sure the audit committee understands the level of responsibility that committee understands the level of responsibility that the auditor assumes for the system of internal control the auditor assumes for the system of internal control and the financial statements under generally accepted and the financial statements under generally accepted auditing standards (GAAS). It is also important that the auditing standards (GAAS). It is also important that the auditor make sure that the audit committee understands auditor make sure that the audit committee understands that an audit is designed to obtain reasonable rather than that an audit is designed to obtain reasonable rather than absolute assurance about the financial statements.absolute assurance about the financial statements.

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The following statistics about fraud and white-collar crime are from the The following statistics about fraud and white-collar crime are from the Association of Certified Fraud Examiners (US) report:Association of Certified Fraud Examiners (US) report:

Fraud and abuse costs US organizations more than $400 billion annually.Fraud and abuse costs US organizations more than $400 billion annually.The average organization loses more than $9 per day per employee to fraud The average organization loses more than $9 per day per employee to fraud and abuse.and abuse.The average organizations lose about 6% of its total annual revenue to fraud The average organizations lose about 6% of its total annual revenue to fraud and abuse committed by its own employees.and abuse committed by its own employees.The median loss caused by mails is about $185000; by females about $48000 The median loss caused by mails is about $185000; by females about $48000 and thus men commit nearly 75% of the offenses.and thus men commit nearly 75% of the offenses.Losses caused by managers are four times those caused by employees.Losses caused by managers are four times those caused by employees.Median losses caused by executives are 16 times those of their employeesMedian losses caused by executives are 16 times those of their employeesThe highest median losses occur in the real estate financing sector.The highest median losses occur in the real estate financing sector.Occupational fraud and abuses fall into these main categories; asset Occupational fraud and abuses fall into these main categories; asset misappropriation, fraudulent statements and bribery and corruption.misappropriation, fraudulent statements and bribery and corruption.

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Fraud effect in UKFraud effect in UK• It is estimated that fraud cost It is estimated that fraud cost ££13 billion in 2000 or 13 billion in 2000 or ££230 for every man, woman 230 for every man, woman

and child in Britain (figures exclusive of money laundering) and child in Britain (figures exclusive of money laundering) (City of London (City of London Police, 2002; National Economic Research Associates for the Home office, 2000)Police, 2002; National Economic Research Associates for the Home office, 2000)

• False motor and household claims cost the insurance industry and policy holders False motor and household claims cost the insurance industry and policy holders ££20 million per week 20 million per week (Association of British Insurers, April 2003)(Association of British Insurers, April 2003)

• 51% of British businesses have been the victims of fraud in the last two years 51% of British businesses have been the victims of fraud in the last two years (PricewaterhouseCoopers, July 2003)(PricewaterhouseCoopers, July 2003)

• Benefit fraud costs Benefit fraud costs ££2 billion a year, 2 billion a year, ££80 for every family in the country 80 for every family in the country (Department of Work and Pensions, June 2003) (Department of Work and Pensions, June 2003)

• Plastic card fraud alone cost Plastic card fraud alone cost ££424.6 million in 2002 424.6 million in 2002 –– 30% up on the year before 30% up on the year before (Association for Payment Clearing Services, April 2003)(Association for Payment Clearing Services, April 2003)

• Card-not-present fraud is the largest type of card fraud in the UK. In 2003 losses Card-not-present fraud is the largest type of card fraud in the UK. In 2003 losses were were ££116.4 million 116.4 million (Association for Payment Clearing Services, April 2004)(Association for Payment Clearing Services, April 2004)

• Fraud wrecks ordinary lives by destroying jobs, savings and pensions. 16 investors Fraud wrecks ordinary lives by destroying jobs, savings and pensions. 16 investors took their own lives in the aftermath of the Barlow Clowes fraud took their own lives in the aftermath of the Barlow Clowes fraud (The Serious (The Serious Fraud Office, 2002) Fraud Office, 2002)

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Auditors under fireAuditors under fire

Andrew Ratcliffe Chairman of the ICAEW Audit and Assurance Andrew Ratcliffe Chairman of the ICAEW Audit and Assurance Faculty:Faculty:

• ““Auditors are not, and indeed should not be, held responsible Auditors are not, and indeed should not be, held responsible for detecting all fraud, but we must play our part to improve for detecting all fraud, but we must play our part to improve the overall detection rate to help maintain public trust in the overall detection rate to help maintain public trust in published accounts following the recent spate of US published accounts following the recent spate of US accounting scandals. accounting scandals.

• We are also concerned about companies that adopt aggressive We are also concerned about companies that adopt aggressive accounting practices which might stop short of being clearly accounting practices which might stop short of being clearly fraudulent. Faced with this risk, auditors will need to more fraudulent. Faced with this risk, auditors will need to more actively search out aggressive accounting and help ensure that actively search out aggressive accounting and help ensure that the right judgments are applied."the right judgments are applied."

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Introduction to Fraud DetectionIntroduction to Fraud DetectionThere are more advanced techniques on this site, but There are more advanced techniques on this site, but this is the place to start to get some idea what this is the place to start to get some idea what techniques you can use for spotting funny numbers. techniques you can use for spotting funny numbers.

• Examine cash flow. Examine cash flow.

• Watch out for "capitalizing" of assets. Watch out for "capitalizing" of assets.

• Watch for "channel stuffing.Watch for "channel stuffing.

• Beware "Pro Forma. Beware "Pro Forma.

• Look for routine write-offs.Look for routine write-offs.

• Understand the business. Understand the business.

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Frauds can also be categorized by the technique or activity used by the fraudster. Frauds can also be categorized by the technique or activity used by the fraudster. These include:These include: •Advance fee frauds Advance fee frauds •Bogus invoices Bogus invoices •Computer hacking of information or property Computer hacking of information or property •Corruption and bribery Corruption and bribery •Counterfeiting, forgery, or copyright abuse Counterfeiting, forgery, or copyright abuse •Credit Card fraud Credit Card fraud •False Accounting - manipulation of accounts and accounting records False Accounting - manipulation of accounts and accounting records •Fraudulent bankruptcy - exploitation of cross-border corporate structures Fraudulent bankruptcy - exploitation of cross-border corporate structures •Insurance fraud Insurance fraud •Internet online scams - auctions, credit card purchases, investment scams Internet online scams - auctions, credit card purchases, investment scams •Investment fraud Investment fraud •Long Firm fraud Long Firm fraud •Misappropriation of assets Misappropriation of assets •Money laundering Money laundering •Mortgage Fraud Mortgage Fraud •Payroll fraud Payroll fraud •Principal agents - failure of systems to restrict key individuals Principal agents - failure of systems to restrict key individuals •Pyramid schemes Pyramid schemes •Unsolicited letter frauds. Unsolicited letter frauds.

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Fraud Detection: Basic TechniquesFraud Detection: Basic Techniques• Watch out for two or more businesses controlled by Watch out for two or more businesses controlled by

the same person. the same person.

• Revenue and expenses can be arbitrarily shifted Revenue and expenses can be arbitrarily shifted between the two businesses. For example, if a person between the two businesses. For example, if a person controls a retail business and a real estate business, he controls a retail business and a real estate business, he can shift revenue from the real estate business when can shift revenue from the real estate business when the retail business has a bad year. Public corporations the retail business has a bad year. Public corporations frequently share board members and executives with frequently share board members and executives with other corporations. other corporations.

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• Check their income tax expense and footnotes. Check their income tax expense and footnotes. Fraudulent corporations have an incentive to make Fraudulent corporations have an incentive to make their profit number as big as possible for their annual their profit number as big as possible for their annual and quarterly reports, but they have an incentive to and quarterly reports, but they have an incentive to make that number as make that number as smallsmall as possible for the IRS, as possible for the IRS, because they have to pay income tax on it! So if the because they have to pay income tax on it! So if the corporation is reporting large profits but is paying corporation is reporting large profits but is paying next to nothing on income tax, they might be lying next to nothing on income tax, they might be lying either to you, or to the IRS. NOTE: Unfortunately, either to you, or to the IRS. NOTE: Unfortunately, this doesn't prove fraud, as the tax code is so ridden this doesn't prove fraud, as the tax code is so ridden with loopholes that multi-billion-dollar corporations with loopholes that multi-billion-dollar corporations like General Electric routinely get away with paying like General Electric routinely get away with paying no income tax at all! no income tax at all!

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Beware discontinuities that become Beware discontinuities that become “continuities”“continuities”

• An extraordinary loss or gain should not An extraordinary loss or gain should not become a regular feature of a business's become a regular feature of a business's income statement. If a business is having major income statement. If a business is having major lawsuits, abandoning product lines, or lawsuits, abandoning product lines, or undergoing major restructuring, that's a sign undergoing major restructuring, that's a sign that management is either up to something that management is either up to something (fraud), or don't know what they are doing (fraud), or don't know what they are doing (poor management).(poor management).

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• Beware discontinuities that become opportunities to Beware discontinuities that become opportunities to dump too many write-downs and losses. dump too many write-downs and losses.

• This is the "big bath" theory. The company may run This is the "big bath" theory. The company may run losses for years, without reporting them, and then losses for years, without reporting them, and then take a "big bath" and write down the losses all at take a "big bath" and write down the losses all at once. If the company has done this is the past, they once. If the company has done this is the past, they might do it again, and as an investor you don't want might do it again, and as an investor you don't want to get caught in the bath. to get caught in the bath.

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Watch for high debtWatch for high debt

• A company with too high debt is walking on A company with too high debt is walking on the edge of a cliff. Any major problem, and the edge of a cliff. Any major problem, and they get pushed over. Note: Even an acid-test they get pushed over. Note: Even an acid-test ratio .ratio .

• 1-to-1 may not be enough if you're dealing 1-to-1 may not be enough if you're dealing with a type of business that depends heavily with a type of business that depends heavily on short-term debt. on short-term debt.

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• Pay attention to the accounting methods. What Pay attention to the accounting methods. What method are they using to determine method are they using to determine

• inventory, inventory,

• cost of goods sold, and cost of goods sold, and

• depreciation of assets.depreciation of assets.

• Are they using "mark-to-market" for accounting Are they using "mark-to-market" for accounting their sales revenue? (Enron was.) Companies do their sales revenue? (Enron was.) Companies do not have to report what their income would have not have to report what their income would have looked like if they were using different accounting looked like if they were using different accounting rules. rules.

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Beware "free cash flow"Beware "free cash flow"

• Free cash flow has Free cash flow has nono officially defined officially defined meaning determined by any authoritative meaning determined by any authoritative accounting rule-making body. accounting rule-making body.

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• Look for special gains and losses on the statement Look for special gains and losses on the statement of stockholders' equity. of stockholders' equity.

• The general format of the statement of The general format of the statement of stockholders' equity is to use a column for each stockholders' equity is to use a column for each class of stock (common stock, preferred stock, class of stock (common stock, preferred stock, treasury stock, and so on), a column for retained treasury stock, and so on), a column for retained earnings, and any other components of earnings, and any other components of stockholders' equity. Special gains and losses stockholders' equity. Special gains and losses should be reported on the income statement, should be reported on the income statement, underneath the net income line. They should underneath the net income line. They should notnot be here, on the statement of stockholders' equity. be here, on the statement of stockholders' equity.

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• Look for "window dressing" on the balance Look for "window dressing" on the balance sheet. sheet.

• This is where numbers are nudged from one This is where numbers are nudged from one account to another, without changing the account to another, without changing the total amount. For example, money could be total amount. For example, money could be moved from accounts receivable to cash, to moved from accounts receivable to cash, to make the cash balance look better. make the cash balance look better.

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Watch out for profit smoothingWatch out for profit smoothing• A company that has large changes in revenue will A company that has large changes in revenue will

usually use profit smoothing. This involves usually use profit smoothing. This involves moving current income to the future. For moving current income to the future. For example, suppose the company is a video game example, suppose the company is a video game company, and they get massive revenue "spikes" company, and they get massive revenue "spikes" when a game is released, but relatively low sales when a game is released, but relatively low sales the rest of the time. The company will spread the the rest of the time. The company will spread the money from the "spikes" out over the year, so that money from the "spikes" out over the year, so that their revenue shows a steady increase from year to their revenue shows a steady increase from year to year. Using profit year. Using profit smoothing is legal, but can be smoothing is legal, but can be abused. abused.

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Look for sales skimming. Look for sales skimming. • This is when the owners pocket sales money This is when the owners pocket sales money

without reporting it. One way to spot this is to without reporting it. One way to spot this is to look at the gross profit and operating profit look at the gross profit and operating profit ratios. ratios.

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Look for unnecessary dilution of stock. Look for unnecessary dilution of stock. • If a company is creating shares of stock for sale, If a company is creating shares of stock for sale,

but doesn't actually need the money, then they but doesn't actually need the money, then they could be doing something sneaky. Watch out could be doing something sneaky. Watch out for managers that give themselves stock options for managers that give themselves stock options (and create new shares in the process) and then (and create new shares in the process) and then have the company buy back the company stock have the company buy back the company stock off the market. By doing this, they increase their off the market. By doing this, they increase their own share of ownership in the company, at the own share of ownership in the company, at the expense of everybody else (including you). expense of everybody else (including you).

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Beware of LLC'sBeware of LLC's• Limited Liability Corporations, or LLC's, can Limited Liability Corporations, or LLC's, can

have extremely complicated ownership have extremely complicated ownership structures. structures.

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• Examine how indirect costs are allocated. Examine how indirect costs are allocated. Indirect costs are costs that cannot be Indirect costs are costs that cannot be obviously attributed to specific products, obviously attributed to specific products, organizational units, or activities. A book organizational units, or activities. A book publisher's phone bill is a cost of doing publisher's phone bill is a cost of doing business, but it can't be attributed to a business, but it can't be attributed to a particular book, or a particular step in the particular book, or a particular step in the process of producing books. Allocation of process of producing books. Allocation of indirect costs is ultimately arbitrary. indirect costs is ultimately arbitrary. Because it is arbitrary, it can be abused. For Because it is arbitrary, it can be abused. For example, misclassification of manufacturing example, misclassification of manufacturing costs as operational costs will make the cost costs as operational costs will make the cost of producing a product look too low. of producing a product look too low.

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• Watch out for products sold "on approval" Watch out for products sold "on approval" or with right of return. Revenues should or with right of return. Revenues should only be booked after the sale is complete only be booked after the sale is complete and the goods can no longer be returned. and the goods can no longer be returned.

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• Examine how indirect costs are allocated. Examine how indirect costs are allocated. Indirect costs are costs that cannot be Indirect costs are costs that cannot be obviously attributed to specific products, obviously attributed to specific products, organizational units, or activities. A book organizational units, or activities. A book publisher's phone bill is a cost of doing publisher's phone bill is a cost of doing business, but it can't be attributed to a business, but it can't be attributed to a particular book, or a particular step in the particular book, or a particular step in the process of producing books. Allocation of process of producing books. Allocation of indirect costs is ultimately arbitrary. indirect costs is ultimately arbitrary. Because it is arbitrary, it can be abused. For Because it is arbitrary, it can be abused. For example, misclassification of manufacturing example, misclassification of manufacturing costs as operational costs will make the cost costs as operational costs will make the cost of producing a product look too low. of producing a product look too low.

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• Watch out for products sold "on approval" Watch out for products sold "on approval" or with right of return. Revenues should or with right of return. Revenues should only be booked after the sale is complete only be booked after the sale is complete and the goods can no longer be returned. and the goods can no longer be returned.

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Watch out for LIFO inventory.Watch out for LIFO inventory.

LIFO is usually the wrong accounting method for LIFO is usually the wrong accounting method for inventory, because: inventory, because: • most businesses don't raise prices as soon as most businesses don't raise prices as soon as

replacement costs increase, or base their sales replacement costs increase, or base their sales price price onon the most recent purchase costs, the most recent purchase costs,

• the inventory cost value can get seriously out the inventory cost value can get seriously out of date, especially if the business sells products of date, especially if the business sells products that have long lives (an equipment that have long lives (an equipment manufacturer, for example), manufacturer, for example),

• LIFO figures can be more easily manipulated LIFO figures can be more easily manipulated by unscrupulous management. by unscrupulous management.

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• Make sure the company is using "Lower of Make sure the company is using "Lower of Cost or Market" (LCM) to calculate their Cost or Market" (LCM) to calculate their inventory. inventory.

• Lower of Cost or Market gives a more Lower of Cost or Market gives a more conservative inventory value. Some conservative inventory value. Some managers cheat and use LCM to report an managers cheat and use LCM to report an unusually low inventory for cheating on unusually low inventory for cheating on income tax. income tax.

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• Did the company change depreciation Did the company change depreciation rules? An unexplained change from rules? An unexplained change from accelerated depreciation to straight-line accelerated depreciation to straight-line depreciation, or to mark-to-market depreciation, or to mark-to-market depreciation should set off alarms. depreciation should set off alarms. Companies can make funny money by Companies can make funny money by playing with depreciation rules, either playing with depreciation rules, either writing off too little (and boosting their writing off too little (and boosting their balance sheet) or too much. If they write off balance sheet) or too much. If they write off too much, it makes their current financial too much, it makes their current financial results look bad, but gives them hidden cash results look bad, but gives them hidden cash reserves. They can use these reserves to reserves. They can use these reserves to boost future sales or offset future expenses. boost future sales or offset future expenses.

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• Compare profit ratios with past statements. Compare profit ratios with past statements. • Calculate the gross margin (profit as a Calculate the gross margin (profit as a

percentage of sales) and see if it changes from percentage of sales) and see if it changes from quarter to quarter. Normally it will not quarter to quarter. Normally it will not change suddenly. There are many other ratios change suddenly. There are many other ratios you can look at.you can look at.

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• Examine extraordinary losses. Examine extraordinary losses. • Often an extraordinary loss is not the result Often an extraordinary loss is not the result

of a one-time event, but the cumulative of a one-time event, but the cumulative result of years of bad accounting. result of years of bad accounting.

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• See if earnings per share kept up with profit. See if earnings per share kept up with profit. • If profit increased by a larger percentage than If profit increased by a larger percentage than

earnings per share, and there wasn't any stock earnings per share, and there wasn't any stock split, or stock offering (with a clearly split, or stock offering (with a clearly explained justification), then management is explained justification), then management is diluting the shares. While this doesn't diluting the shares. While this doesn't necessarily mean fraud, it is a red flag that necessarily mean fraud, it is a red flag that management doesn't care about shareholder management doesn't care about shareholder interests. interests.

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• Compare profit increase with cash flow. Compare profit increase with cash flow. These should increase in lockstep. Usually if These should increase in lockstep. Usually if cash flow is low (or negative) it's because all cash flow is low (or negative) it's because all the profits are in accounts receivable and the profits are in accounts receivable and haven't been collected yet. haven't been collected yet.

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• Check that increases in assets and liabilities Check that increases in assets and liabilities are consistent with the business's growth.are consistent with the business's growth.

• If the company is reporting profits quarter If the company is reporting profits quarter after quarter, but total assets is shrinking, after quarter, but total assets is shrinking, something is wrong. If most balance sheet something is wrong. If most balance sheet items increase by a few percentage each items increase by a few percentage each year, but one item has a huge jumpyear, but one item has a huge jump

• Positive or negativePositive or negative• Make sure you know the reason why. Make sure you know the reason why.

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• Look for "other." Most balance sheets have Look for "other." Most balance sheets have a catch-all category called "Other assets." a catch-all category called "Other assets." Likewise, most income statements have a Likewise, most income statements have a catch-all category called "Other expenses." catch-all category called "Other expenses." These "other" categories should be small These "other" categories should be small and insignificant. If a significant amount of and insignificant. If a significant amount of assets is in the "other" category, beware! assets is in the "other" category, beware!

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10 STEP ANTIFRAUD PLAN (PWC)10 STEP ANTIFRAUD PLAN (PWC)1) 1) Anticipate Questions and Manage Expectations. Anticipate Questions and Manage Expectations. 2) Assess existing antifraud programs and controls. 2) Assess existing antifraud programs and controls. 3) Secure management and audit committee sponsorship. 3) Secure management and audit committee sponsorship. 4) Assemble fraud expertise within internal auditing. 4) Assemble fraud expertise within internal auditing. 5) Organize a fraud and reputation risk assessment. 5) Organize a fraud and reputation risk assessment. 7) Evaluate and test the design and operating 7) Evaluate and test the design and operating

effectiveness of controls. effectiveness of controls. 8) Refine the audit plan to address residual risk and 8) Refine the audit plan to address residual risk and

incorporate fraud auditing.incorporate fraud auditing.9) Establish a standard process for responding to fraud 9) Establish a standard process for responding to fraud

allegations or suspicions.allegations or suspicions.10) Remediate and prevent recurrence 10) Remediate and prevent recurrence

8282

What did the auditor say?What did the auditor say?Just because the auditor says the books are clean Just because the auditor says the books are clean doesn't mean they are, of course. You should doesn't mean they are, of course. You should never trust the auditor. But if the auditor did never trust the auditor. But if the auditor did raise a red flag, take it very, very seriously! If raise a red flag, take it very, very seriously! If the auditor's opinion is qualified by anything, the auditor's opinion is qualified by anything, you should be more skeptical of the entire you should be more skeptical of the entire financial statement -- not just the item that the financial statement -- not just the item that the auditor expressed concern about. If the auditor auditor expressed concern about. If the auditor expresses concern about the company's ability to expresses concern about the company's ability to be a "going concern", the auditor is saying the be a "going concern", the auditor is saying the business is about to be forced into bankruptcy. business is about to be forced into bankruptcy.

8383

What Arthur Anderson SaidWhat Arthur Anderson Said

Bauer, the chief auditor of EnronBauer, the chief auditor of Enron ’’s wholesale division, s wholesale division,

““I did not know the company was using reserves to I did not know the company was using reserves to meet earnings targets and would not have approved if meet earnings targets and would not have approved if he had known, the Chicago Tribune reports. he had known, the Chicago Tribune reports. ““No one No one gave me this information,gave me this information,”” Bauer said. Bauer said. ““ThatThat’’s s earnings management; thatearnings management; that’’s never OK. . . . Enron had s never OK. . . . Enron had an obligation to me to provide all documents, all an obligation to me to provide all documents, all agreements, oral or written and they didnagreements, oral or written and they didn ’’t do that,t do that,””..

AccountingWEB.comAccountingWEB.com  --  Mar-24-2006Mar-24-2006

8484

• Is the auditor also doing consulting? Is the auditor also doing consulting? Consulting may be referred to as Consulting may be referred to as "corporate finance," "eBusiness," "human "corporate finance," "eBusiness," "human capital," " legal services," "outsourcing," capital," " legal services," "outsourcing," "risk management," "tax services", and so "risk management," "tax services", and so on. Doing audits and consulting is a deep on. Doing audits and consulting is a deep conflict of interest, as the Enron scandal conflict of interest, as the Enron scandal well demonstrates. well demonstrates.

8585

Consequences of FraudConsequences of Fraud• Lost confidence in capital marketsLost confidence in capital markets• Lawsuits—one company has over 3,000Lawsuits—one company has over 3,000• Firms going out of business—huge bankruptciesFirms going out of business—huge bankruptcies• Lost reputation and bad pressLost reputation and bad press• Longer and more expensive audits, special inquiriesLonger and more expensive audits, special inquiries• Fines & investigationsFines & investigations• Damaged employees & reputationsDamaged employees & reputations• Lost retirement and pension funds—now down 45%Lost retirement and pension funds—now down 45%• Directors with personal liability, forced resignationsDirectors with personal liability, forced resignations• Losses from fraudLosses from fraud• Significant legislative activitySignificant legislative activity

8686

Financial Statement FraudsFinancial Statement Frauds

• Revenue/Accounts Receivable Frauds (Global Revenue/Accounts Receivable Frauds (Global Crossing, Quest, ZZZZ Best)Crossing, Quest, ZZZZ Best)

• Inventory/Cost of Goods Sold Frauds Inventory/Cost of Goods Sold Frauds (PharMor)(PharMor)

• Understating Liability/Expense Frauds (Enron)Understating Liability/Expense Frauds (Enron)• Overstating Asset Frauds (WorldCom)Overstating Asset Frauds (WorldCom)• Overall Misrepresentation (Bre-X Minerals)Overall Misrepresentation (Bre-X Minerals)

8787

Transaction Accounts Involved Fraud Schemes

1. Estimate all uncollectible accounts receivable

Bad debt expense, allowance for doubtful accounts

1. Understate allowance for doubtful accounts, thus overstating receivables

2. Sell goods and/or services to customers

Accounts receivable, revenues (e.g. sales revenue) (Note: cost of goods sold part of entryh is included in Chapter 5)

2. Record fictit ious sales (related parties, sham sales, sales with conditions, consignment sales, etc.)3. Recognize revenues too early (improper cutoff, percentage of completion, etc.)4. Overstate real sales (alter contracts, inflate amounts, etc.)

3. Accept returned goods from customers

Sales returns, accounts receivable 5. Not record returned goods from customers6. Record returned goods after the end of the period

4. Write off receivables as uncollectible

Allowance for doubtful accounts, accounts receivable

7. Not write off uncollectible receivables8. Write off uncollectible receivables in a later period

5. Collect cash after discount period

Cash, accounts receivable 9. Record bank transfers as cash received from customers10. Manipulate cash received from related parties

6. Collect cash within discount period

Cash, sales discounts, accounts receivable

11. Not recognize discounts given to customers

Revenue-Related Transactions and Frauds

8888

Transaction Accounts Involved Fraud Schemes

1. Purchase inventory Inventory, accounts payable

1. Under-record purchase2. Record purchases too late3. Not record purchases

2. Return merchandise to supplier

Accounts payable, inventory

4. Overstate returns5. Record returns in an earlier period (cutoff problem)

3. Pay vendor within discount period

Accounts payable, inventory, cash

6. Overstate discounts7. Not reduce inventory cost

4. Pay vendor without discount Accounts payable, cash Considered in another chapter

5. Inventory is sold; cost of goods sold is recognized

Cost of goods sold, inventory

8. Record at too low an amount9. Not record cost of goods sold nor reduce inventory

6. Inventory becomes obsolete Loss on write-down of inventory, inventory

10. Not write off or write down obsolete inventory

7. Inventory quantities are estimated

Inventory shrinkage, inventory

11. Over-estimate inventory (use incorrect ratios, etc.)

8. Inventory quantities are counted

Inventory shrinkage, inventory

12. Over-count inventory (double counting, etc.)

9. Inventory cost is determined

Inventory, cost of goods sold

13. Incorrect costs are used14. Incorrect extensions are made15. Record fictitious inventory

Inventory/Cost of Goods Sold FraudsInventory/Cost of Goods Sold Frauds

8989

Role of Andersen in Enron CaseRole of Andersen in Enron Case

• Was paid $52 million in 2000, the majority for non-audit related consulting Was paid $52 million in 2000, the majority for non-audit related consulting services.services.

• Failed to spot many of EnronFailed to spot many of Enron’’s lossess losses

• Should have assessed Enron managementShould have assessed Enron management’’s internal s internal controlscontrols on derivatives on derivatives tradingtrading——expressed approval of internal controls during 1998 through 2000expressed approval of internal controls during 1998 through 2000

• Kept a whole floor of auditors assigned at Enron year aroundKept a whole floor of auditors assigned at Enron year around• Enron was AndersenEnron was Andersen’’s second largest clients second largest client• Provided both external and internal auditsProvided both external and internal audits• CFOs and controllers were former Andersen executivesCFOs and controllers were former Andersen executives• Accused of document destructionAccused of document destruction——was criminally indictedwas criminally indicted• Went out of businessWent out of business• My partner friend My partner friend ““I had $4 million in my retirement account and I lost it all.I had $4 million in my retirement account and I lost it all.””

Some partners who transferred to other firms now have two equity loans and Some partners who transferred to other firms now have two equity loans and no retirement savings.no retirement savings.

9090

Timeline of Arthur Anderson eventsTimeline of Arthur Anderson events19961996 Arthur Andersen has an audit failure in Waste Management; Andersen paid a Arthur Andersen has an audit failure in Waste Management; Andersen paid a

censure of $7 million.censure of $7 million.19971997 Arthur Anderson has an audit failure in Sunbeam; Andersen paid $110 million Arthur Anderson has an audit failure in Sunbeam; Andersen paid $110 million

to to settle shareholder settle shareholder litigations.litigations.January 1997January 1997 Jeffery Schilling is named president and COO of Enron. Schilling implements Jeffery Schilling is named president and COO of Enron. Schilling implements

his his assets are bad assets are bad intellectual assets are good campaign to intellectual assets are good campaign to ““clean upclean up”” Enron Enron’’s s financial statements. Begins using the LJM partnerships run by Andrew Fasted, financial statements. Begins using the LJM partnerships run by Andrew Fasted, EnronEnron’’s CFO.s CFO.

Early 2001Early 2001 Jim Chinos takes note of EnronJim Chinos takes note of Enron ’’s lack of money-making activities and begins to s lack of money-making activities and begins to wonder about thewonder about the LJM partnerships.LJM partnerships.

February 2001February 2001 SkillingSkilling’’s promotion to CEO takes effect, he replaced Charles Lay.s promotion to CEO takes effect, he replaced Charles Lay.June 2001June 2001 Enron executives sell shares as stocks slid 39% in the first quarter.Enron executives sell shares as stocks slid 39% in the first quarter.August 2001August 2001 Schilling quits for personal reasons, and Charles Lay is named CEO again.Schilling quits for personal reasons, and Charles Lay is named CEO again.Oct. 16, 2001Oct. 16, 2001 Enron reports a third quarter loss of $618 million. They cite the loss as being Enron reports a third quarter loss of $618 million. They cite the loss as being

partially due to the LJM partnerships.partially due to the LJM partnerships.Oct. 22, 2001Oct. 22, 2001 SEC starts an investigation into the LJM partnerships, and CFO Fasted leaves SEC starts an investigation into the LJM partnerships, and CFO Fasted leaves

Enron.Enron.Nov. 8, 2001Nov. 8, 2001 EnronEnron’’s Net income back through 1997 is revalued by $586 million.s Net income back through 1997 is revalued by $586 million.Nov. 9, 2001Nov. 9, 2001 Synergy offers to buy Enron for $10 billion.Synergy offers to buy Enron for $10 billion.Nov. 28, 2001Nov. 28, 2001 Synergy refuses to buy Enron.Synergy refuses to buy Enron.Dec. 2 ,2001Dec. 2 ,2001 Enron Files for Bankruptcy.Enron Files for Bankruptcy.

9191

Largest Bankruptcy Filings Largest Bankruptcy Filings (1980 to Present)(1980 to Present)

from BankruptcyData.comfrom BankruptcyData.com

CompanyCompanyAssets (Billions)Assets (Billions)When FiledWhen Filed

1. World Com1. World Com$103.9$103.9July 2002July 2002

2. Enron2. Enron$63.4$63.4Dec. 2001Dec. 2001

3. Conseco3. Conseco$61.4$61.4Dec. 2002Dec. 2002

4. Texaco4. Texaco$35.9$35.9April 1987April 1987

5. Financial Corp of America5. Financial Corp of America$33.9$33.9Sept. 1988Sept. 1988

6. Global Crossing6. Global Crossing$30.2$30.2Jan. 2002Jan. 2002

7. PG&E7. PG&E$29.8$29.8April 2001April 2001

8. UAL8. UAL$25.2$25.2Dec. 2002Dec. 2002

9. Adelphia9. Adelphia$21.5$21.5June 2002June 2002

10. MCorp10. MCorp$20.2$20.2March 1989March 1989

9292

Fraud TrickFraud Trick

Revenue RecognitionRevenue RecognitionOne means of manipulating financial results is to record revenue before it has One means of manipulating financial results is to record revenue before it has been earned. This historically has been accomplished by recording revenue been earned. This historically has been accomplished by recording revenue early or recording transactions as sales that do not meet the criteria of sales. early or recording transactions as sales that do not meet the criteria of sales. Some of the common revenue recognition schemes include:Some of the common revenue recognition schemes include:

1. Recognizing revenue before a sale has actually occurred1. Recognizing revenue before a sale has actually occurred2. Keeping the books open at month2. Keeping the books open at month ’’s end to record the first few dayss end to record the first few days’’ sales of the sales of the

following month following month 3. Shipping to the company3. Shipping to the company’’s warehouses but billing as saless warehouses but billing as sales4. Shipping goods to customers knowing they will be returned without providing 4. Shipping goods to customers knowing they will be returned without providing

appropriate return allowancesappropriate return allowances5. Shipping and billing goods not wanted by the customer until a later date5. Shipping and billing goods not wanted by the customer until a later date6. Shipping to accounts funded by the vendor6. Shipping to accounts funded by the vendor

9393

Misuse of EstimatesMisuse of EstimatesThe use of estimates is a normal occurrence in The use of estimates is a normal occurrence in accounting and can include the following:accounting and can include the following:

1. Allowance for bad debts1. Allowance for bad debts2. Allowance for inventory obsolescence2. Allowance for inventory obsolescence3. Allowance for anticipated warranty claims or returned 3. Allowance for anticipated warranty claims or returned

goodsgoods4. Estimates of percentage of completion of a project Be 4. Estimates of percentage of completion of a project Be

warned, however, that estimates are open to bad faith warned, however, that estimates are open to bad faith manipulation. By means of adjusting estimates, earnings manipulation. By means of adjusting estimates, earnings can be increased or decreased by a simple journal entry.can be increased or decreased by a simple journal entry.

9494

Purchase ReservesPurchase Reserves• In cases where a business has been acquired, it is acceptable under Generally Accepted In cases where a business has been acquired, it is acceptable under Generally Accepted

Accounting Principles to set up a purchase reserve. For example, the reserve may be intended Accounting Principles to set up a purchase reserve. For example, the reserve may be intended to cover costs identified with closing down part of the acquired companyto cover costs identified with closing down part of the acquired company ’’s operations. Yet it is s operations. Yet it is possible that the reserve can be deliberately overstated, with the intent of writing off current possible that the reserve can be deliberately overstated, with the intent of writing off current operating expenses against the reserve. This has the effect of understating expenses, thereby operating expenses against the reserve. This has the effect of understating expenses, thereby overstating income.overstating income.

Asset OverstatementAsset Overstatement• Each asset has a basis of valuation. By changing the valuation basis, the asset can be Each asset has a basis of valuation. By changing the valuation basis, the asset can be

overstated. For instance, inventory may normally be valued at average cost. By changing the overstated. For instance, inventory may normally be valued at average cost. By changing the valuation to most recent cost, in a market where prices are rising, the inventory value can be valuation to most recent cost, in a market where prices are rising, the inventory value can be adjusted upward. In other instances, companies have counted inventory in one location, then adjusted upward. In other instances, companies have counted inventory in one location, then have simply moved the inventory to another location where it is counted again, thereby have simply moved the inventory to another location where it is counted again, thereby overstating inventory value.overstating inventory value.

Liability UnderstatementLiability Understatement• The simplest means of understating liabilities is to not record them in a timely manner. The simplest means of understating liabilities is to not record them in a timely manner.

Liabilities may be understated by recording a reduced accrual for vacation pay or bonuses.Liabilities may be understated by recording a reduced accrual for vacation pay or bonuses.Capitalization of ExpensesCapitalization of Expenses• The bottom line can be manipulated by capitalizing expenses rather than recognizing them The bottom line can be manipulated by capitalizing expenses rather than recognizing them

currently. Under GAAP, there are guidelines for determining when this is acceptable. On a currently. Under GAAP, there are guidelines for determining when this is acceptable. On a legitimate basis, this may involve software development, costs associated with acquisition of legitimate basis, this may involve software development, costs associated with acquisition of capital assets and business start-ups. However, by capitalizing expenses inappropriately, the capital assets and business start-ups. However, by capitalizing expenses inappropriately, the bottom line can be increased and the assets overstated.bottom line can be increased and the assets overstated.

9595

Undertaking the financial investigationUndertaking the financial investigation

• Given the complexity of financial accounting and reporting today, the investigation Given the complexity of financial accounting and reporting today, the investigation may need a multifaceted team. Consider the following non-legal capabilities:may need a multifaceted team. Consider the following non-legal capabilities:

• Forensic accountants are skilled in the reconstruction and analysis of accounting Forensic accountants are skilled in the reconstruction and analysis of accounting records and business transactions, as well as conducting detailed financial records and business transactions, as well as conducting detailed financial interviews. Knowing where to look and understanding what’s beneath the numbers interviews. Knowing where to look and understanding what’s beneath the numbers is a skill gained through years of experience. is a skill gained through years of experience.

• Computer forensics practitioners may be necessary to gather and recover evidence Computer forensics practitioners may be necessary to gather and recover evidence that may have been stored on computer hard drives or on servers. It has become that may have been stored on computer hard drives or on servers. It has become increasingly common that critical evidence is found in recovered data files that increasingly common that critical evidence is found in recovered data files that users thought had been erased from their hard drives or email logs.users thought had been erased from their hard drives or email logs.

• Technology specialists may be required due to the complexity of the computer Technology specialists may be required due to the complexity of the computer systems. Whether the issue is analyzing data from multiple systems at multiple systems. Whether the issue is analyzing data from multiple systems at multiple locations, or retrieving millions of relevant records and then effectively analyzing locations, or retrieving millions of relevant records and then effectively analyzing them, it takes special expertise to design the solution that will be required. Industry them, it takes special expertise to design the solution that will be required. Industry specialists may also be needed to provide insights into unique practices and specialists may also be needed to provide insights into unique practices and industry norms.industry norms.

9696

South Sea Company1720

Saving and Loan crisis1980

Braniff International Airways1982

Laker Airways1982

De Lorean1983

Zzzz Best1987

First Jersey Securities1987

Drexel Burnham Lambert1990

BCCI1991

Eastern Air Lines1991

Pan Am1991

Confederation Life1994

Barings Bank1995

Fokker1996

Bre-X Minerals1997

Pixelon2000

Lernout & Hauspie2000

Equitable Life2000

Enron Corporation2001

HIH Insurance2001

One.Tel2001

Ansett2001

Sabena2001

TWA2001

Webvan2001

Arthur Anderson2002

Global Crossing2002

Swissair 2002

WorldCom2002

Health South2003

IG Farben2003

Parmalat2003

Red Letter Day2005

Jetsgo Corporation2005

9797

Who turn nextWho turn next? ? • SEC considers post-Big Four worldSEC considers post-Big Four world• SEC ponders life after Big FourSEC ponders life after Big Four• E&Y fights for its futureE&Y fights for its future• Deloitte and Grant Thornton face £5bn Parmalat lawsuitDeloitte and Grant Thornton face £5bn Parmalat lawsuit• KPMG sorry for sheltering taxes for richKPMG sorry for sheltering taxes for rich

AIG reveals secretive executive payAIG reveals secretive executive pay• Grant Thornton expels Italian firmGrant Thornton expels Italian firm• Lawyers question PwC over TycoLawyers question PwC over Tyco• PWC faces $100m lawsuit over audit workPWC faces $100m lawsuit over audit work• KPMG auditors to face SEC over AholdKPMG auditors to face SEC over Ahold• Former KPMG partner agrees Xerox settlementFormer KPMG partner agrees Xerox settlement• KPMG pays the penalty for Xerox workKPMG pays the penalty for Xerox work• Deloitte hit with record $50m charge on audit of US telecoms company AdelphiaDeloitte hit with record $50m charge on audit of US telecoms company Adelphia• Deloitte could face tax probe over MG Rover accountsDeloitte could face tax probe over MG Rover accounts• Shell auditors (PWC & KPMG) and former FD face lawsuitShell auditors (PWC & KPMG) and former FD face lawsuit• KPMG to Pay $456 Million for Criminal Violations KPMG to Pay $456 Million for Criminal Violations

9898

1.1. Business Fraud (The Enron Problem), W.Stove Albert, Brigham Young UniversityBusiness Fraud (The Enron Problem), W.Stove Albert, Brigham Young University2.2. FSA Presentation Fraud, W.Stove Albert, May 2003, Chicago, IlluniousFSA Presentation Fraud, W.Stove Albert, May 2003, Chicago, Illunious3.3. Financial Institution Fraud and Failure report Fiscal year 2003Financial Institution Fraud and Failure report Fiscal year 20034.4. Journal of Accountancy online year 2003-2004Journal of Accountancy online year 2003-20045.5. Journal of Accountancy online, 2002-2005Journal of Accountancy online, 2002-20056.6. AICPA address Fraud in audit committee guidanceAICPA address Fraud in audit committee guidance7.7. IIA WebsiteIIA Website8.8. AICPA WebsiteAICPA Website9.9. ACFE WebsiteACFE Website10.10. Research of Dayarayan Auditing & Financial Services Firm about Fraud in Tehran Stock ExchangeResearch of Dayarayan Auditing & Financial Services Firm about Fraud in Tehran Stock Exchange11.11. Website of financial reporting council (FRC)Website of financial reporting council (FRC)12.12. Audit Risk & Fraud Supplementary guidance for auditors of occupational pension schemes, Bulletin May 2005Audit Risk & Fraud Supplementary guidance for auditors of occupational pension schemes, Bulletin May 200513.13. Audit Risk & Fraud Supplementary guidance for auditors of charities, Bulletin Feb. 2005Audit Risk & Fraud Supplementary guidance for auditors of charities, Bulletin Feb. 200514.14. Audit Risk & Fraud Supplementary guidance for auditors of investment business, Bulletin April 2005Audit Risk & Fraud Supplementary guidance for auditors of investment business, Bulletin April 200515.15. The auditing practices board- BulletinThe auditing practices board- Bulletin16.16. Fraud Examines Manual (ACFE) 2006, US editionFraud Examines Manual (ACFE) 2006, US edition17.17. Switzerland The largest Money Laundering Centre in The World By:Dr Ali SahraeeanSwitzerland The largest Money Laundering Centre in The World By:Dr Ali Sahraeean18.18. Iran Audit Standard, sec. 24Iran Audit Standard, sec. 24

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