Transcript Forensic Accounting Update Exam II Copyrighted 2002 D

© D.L. Crumbley
Forensic Accounting: Its Role in
Discovery and Dealing with Fraud
Copyrighted 2004
D. Larry Crumbley, CPA, Cr.FA
KPMG Endowed Professor
Department of Accounting
Louisiana State University
Baton Rouge, LA 70803
225-578-6231
225-578-6201 Fax
[email protected]
Dr. Crumbley is the editor of the Journal
of Forensic Accounting: Auditing, Fraud, and
Taxation, former chair of the Executive Board of
Accounting Advisors of the American Board of
Forensic Accountants, member of the Fraud
Deterrence Board, and on the AICPA’s Fraud
Task Force.
A frequent contributor to the Forensic
Examiner, Professor Crumbley is a co-author of
CCH Master Auditing Guide, 2nd Edition, along
with more than 45 other books. His latest book
entitled Forensic and Investigative Accounting is
published by Commerce Clearing House (800224-7477). Some of his 12 educational novels have
as the main character a forensic accountant. His
goal is to create a television series based upon the
exciting life of a forensic accountant and litigation
consultant.
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Forensic Accounting Factors
• Time: Forensic accounting focuses
on the past, although it may do so in
order to look forward (e.g., damages,
valuations).
• Purpose: Forensic accounting is
performed for a specific legal forum
or in anticipation of appearing before
a legal forum.
• Peremptory: Forensic accountants
may be employed in a wide variety
of risk management engagements
within business enterprises as a
matter of right, without the necessity
of allegations (e.g., proactive).
----------------------------------------------With a single clue a forensic
accountant can solve a fraudulent
mystery.
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One Small Clue
© D.L. Crumbley
A former Scotland Yard scientist tried to create
the world’s biggest fraud by authenticating
$2.5 trillion worth of fake U.S. Treasury
bonds.
When two men tried to pass off $25 million
worth of the bonds in Toronto in 2001, a
Mounty noticed the bonds bore the word
“dollar” rather “dollars.”
Police later raided a London bank vault and
discovered that the bonds had been printed
with an ink jet printer that had not been
invented when the bonds were allegedly
produced.
Zip codes were used even though they were
not introduced until 1963.
Sue Clough, “Bungling Scientist Is Jailed for Plotting World's Biggest
Fraud,” News.telegraph.co.uk, January 11, 2003.
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Definition of Forensic Auditor
Someone who can look behind the
facade--not accept the records at
their face value--someone who has a
suspicious mind that the documents
he or she is looking at may not be
what they purport to be and someone
who has the expertise to go out and
conduct very detailed interviews of
individuals to develop the truth,
especially if some are presumed to
be lying.
Robert G. Roche, a retired chief of the IRS Criminal Investigation
Division of the IRS [D.W. Yockey, “So You Want to Be a Forensic
Accountant,” Management Accounting, November 1988, pp. 19-23.]
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Forensic Accounting Areas
Investigative Auditing
Litigation Support
Forensic: Latin for “forum,”
referring to a public place or court.
Black’s Law Dictionary: Forensic,
belonging to the courts of justice.
Note: Corporate spooks are used to check on
competitors.
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Forensic Auditing
Forensic auditing is a type of
auditing that specifically looks for
financial misconduct, and abusive or
wasteful activity.
It is most commonly associated
with gathering evidence that will be
presented in a court of law as part of a
financial crime or a fraud
investigation.
Source: B.L. Derby, “Data Mining for Improper
Payments,” Journal of Government Financial
Management, Winter, 2003, pp. 10-13
------------------------------------------------------------------
Like a competitive game of
tennis, forensic accounting skills
require practice.
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© D.L. Crumbley
Top Niche Services
1. Business Valuations
2. Estate Planning
3. Litigation Support
4. Mergers & Acquisitions
5. Business Mgt. Wealthy clients
6. Forensics/fraud
7. Employee benefits
8. Computer systems/consulting
78%
77%
73%
61%
56%
55%
55%
53%
Source: J.M. Covaleski, “Many Top 100 Growth Areas Revolve
Around Synergy of CPA/Attorney Relationship,” Accounting Today,
March 18-April 7, 2003, p.1.
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Forensic Accounting vs.
Fraud Auditing
Fraud Auditor: An accountant especially
skilled in auditing who is generally engaged
in auditing with a view toward fraud
discovery, documentation, and prevention.
-----------------------------------------------------“Economic crimes and fraud often do not
involve obvious evidence like the smoking
gun. Forensic accountants look behind the
deals and handshakes and probe beyond the
numbers to uncover the reality of financial
situations.”
Source: D.W. Squires, “Problems Solved with Forensic Accounting: A
Legal Perspective,” Journal of Forensic Accounting., Vol. IV (2003),.
P. 131.
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Find It, or I’ll Sue
Accountants must be attuned to
detecting fraud at every level of
service, including standard
accounting services, compilations,
reviews, and bank reconciliations. If
there is fraud and you don’t detect it,
you are going to be sued, and you
will likely lose, as the public
perception is the accountant is the
watchdog.
Robert J. DiPasquale, Parsippany, N.J.
Source: H.W. Wolosky, “Forensic Accounting to the Forefront,”
Practical Accountant, February 2004, pp. 23-28.
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Forensic Accounting Knowledge Base
LAW
Criminology
Investigative
auditing
Accounting
Forensic Accountant
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Be like
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Fictional Hero
“Forensic accounting is turning up more
frequently in the world of fiction, too. The
financial intrigue of fraud and the investigative
process of forensic accounting are a natural fit
with mystery of suspense novels. Add exotic
locations, colorful characters and a murder or two,
and you have all the elements of a classic thriller.
There is a selection of books featuring
forensic accountants as the heroes of their own
stories, as well. Lenny Cramer, perhaps the most
prominent of this fictional group, is the star of a
series of novels written by I.W. Collett and various
co-authors.
In one of these novels, Cramer tracks
forged receipts to uncover a plot to steal Burmese
religion treasures. Another features Cramer, while
conducting an audit at Coca-Coca, uncovering a
scheme to steal the company’s secret formula. In
yet another, Cramer uses his forensic accounting
skills to solve a series of murders in the New York
art world.”
Source: “Book ‘em! Forensic Accounting in History and Literature,”The
Kessler Report, Vol. 1, No. 2.
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Forensic-Type Organizations
•
•
•
•
•
•
•
•
•
American College of Forensic Examiners (2750 E. Sunshine,
Springfield, MO 65804; 800-423-9737; www.acfi.com. DABFA
and Cr.FA; 2000)
Certified Fraud Examiners (Association of CFEs, The Gregor
Bldg., 716 West Avenue Austin, TX 78701; 800-245-3321;
www.cfenet.com).
Certified Insolvency and Reorganization Accountant.
Accountants, lawyers, consultants included in insolvency and
bankruptcy matters. 3-part exam. 4,000 hours. 541.858.1665.
AIRA, 221Stewart Avenue, Suite 207, Medford, Or. 97501.
[email protected]
Forensic Accounting Society Of North America (FASNA, 8712
W. Dodge Road, Suite 200, Omaha, NE, 68114; 402-397-9433).
About 9 firms. Insurance.
Certified Forensic Financial Analyst (NACVA, Salt Lake City,
Utah 84106; 801-486-0600). Also, Certified Fraud Deterrence
(CFD) analyst.
National Litigation Support Services Association (NLSSA, III
East Wacker Drive, Suite 990, Chicago, IL 60601; 800-869-0491).
Not-for-profit. About 20 firms. $1,825.
Canadian Institute of Chartered Accountants (CICA) – CA.IFA
– Alliance for Excellence in Investigative Accounting.
Certified Forensic Investigator (CFI) – Canada Early 1980’s.
www.homewoodave.com
Certified Fraud Specialist (CFS), not-for-profit, educational antifraud corporation located in Sacramento, Calif., for those dealing
in white-collar crime, fraud, and abuse issues. Association of
Certified Fraud Specialists. http://acfsnet.org.
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Fraud
© D.L. Crumbley
Some accountants believe that
ethics is a place in England.
Essex, U.K.
-----------------------------------------------------A statement made by Mark Twain about
New England weather applies to fraud
and corruption:
“It’s hard to predict, but everyone agrees
there’s plenty of it.”
----------------------------------------------As Sherlock Holmes said, “the game is
afoot.”
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Fraud is Possible
The motto of a fraudster:
Anything is possible. The
impossibility simply takes longer.
Biggleman’s Safe – a safe builder
wrote blueprints of a
unbreakable safe and locked the
blueprints inside the safe.
Internal controls can be broken,
often by top executives.
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White-Collar Crime: Rich
People Steal
• Edwin Sutherland coined the term
“white-collar crime.” [Indiana
University sociology professor.]
• Sutherland believed that white-collar
crime is a learned behavior, a
consequence of corporate culture
where regulations are regarded as
harassment, and profit is the
measure of the man.
• “White-collar crime violates trust and
thus create distrust, and this lowers
social morale and produces social
disorganization on a large scale.
Cynthia Crossen, “A Thirties Revelation: Rich People Who
Steal are Criminals, Too,” Wall Street Journal, October 15,
2003, p. B-1.
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Tyco Prosecutor’s Closing
Argument
“Remember, these are two very,
very smart men; they are not
charged with being stupid men,” she
said of Mr. Kozlowski and Mr. Swartz.
“These crimes have an element of
sophistication so you can be sure
that when they were committing them
they built in an element of
deniability.”
She added: “Every good scheme
has it. That is how white-collar
criminals work.”
• Mistrial on April 2, 2004.
Source: A.R. Sorkin, “Talk of Greed and Beyond at Tyco Trial,” N.Y.
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Times, March 17, 2004, p. C-1.
© D.L. Crumbley
Michael Comer’s Types of Fraud
1. Corruptions (e.g., kickbacks).
2. Conflicts of interest (e.g., drug/alcohol
abuse, part-time work).
3. Theft of assets.
4. False reporting or falsifying
performance (e.g., false accounts,
manipulating financial results).
5. Technological abuse (e.g., computer
related fraud, unauthorized Internet
browsing).
Comer’s Rule: Fraud can happen to
anyone at anytime.
Source: M.J. Comer, Investigating Corporate Fraud,
Burlington, Vt.: Gower Publishing Co., 2003, pp. 4-5.
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Starwoods Hotels Poll of Executives
Starwoods Hotels interviewed 401 top
executives who golf. The results are
surprising.
Consider themselves to be honest in
business
Played with someone who cheats at golf
Cheated themselves at golf
Hated others who cheated at golf
Believe that business and golf behaviors
are parallel
99%
87%
82%
82%
72%
Source: Del Jones, “Many CEOs Bend The Rules (of Golf),” USA
Today, June 26, 2002, p. A-1.
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The Cost of Fraud
 Organizations lose 6 percent of
annual revenue to fraud and
abuse.
 Fraud and abuse costs U.S.
organizations more than $600
billion annually ($4,500 per
employee).
 The average organization loses
more than $12 a day per
employee due to fraud and abuse.
Source: 2002 Wells Report
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The Cost of Fraud (cont.)
 Over 80% of occupational frauds
involve asset misappropriations.
 Average length of a fraud scheme is
18 months.
 Most common way of detecting
occupational fraud is by tips from
employees, customers, vendors, or
anonymous sources.
 Second most common detection:
accident.
 The most targeted asset is cash.
Source: 2002 Wells Report
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Fraud Multiplier
Employee Fraud = $ for $ reduction in net
income
Suppose $100,000 bottom line reduction.
Suppose 20% profit margin
How much new revenue needed to offset the
lost income?
$100,000 = $500,000
20%
So ACFE says $600 billion lost per year.
$600 billion = $3 trillion needed revenue
20%
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Advantage of Compliance
Spending
General Counsel Roundtable says
that each $1 of compliance spending
saves organizations, on the average,
$5.21 in heightened avoidance of legal
liabilities, harm to the organization’s
reputation, and lost productivity.
Source: Jonny Frank, “Fraud Risk Assessments,” Internal Auditor, April
2004, p. 47.
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Scienter Necessary
• To prove any type of fraud,
prosecutors must show that scienter
was present.
• That is, the fraudster must have known
that his or her actions were intended to
deceive.
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Fraudulent Disbursements
 Fraudulent disbursements
account for three-quarters of
the losses, and the most
expensive tend to be fraudulent
disbursements through billing
schemes (45%).
 Therefore, internal auditors
seeking to get the biggest bang
for their investigative bucks
should begin by making sure
company vendors are for real.
 Check tampering (30%).
Source: J.T. Wells, “An Unholy Trinity,” Internal
Auditor, April 1998, p. 33.
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The Methods
 Asset misappropriation
accounted for more than four out
of five offenses (80%).
 Bribery and corruption
constituted about 13 % of
offenses.
 Fraudulent statements were the
smallest category of offense
(most costly). $4.25 million per
scheme.
Source: 2002 Wells Report
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Cynthia Cooper’s Suggestions
•
•
•
•
•
•
•
Improve the tone at the top (e.g.,
a fish rots from the top).
Robust Codes of Conduct.
Training on Ethics/Internal
Controls.
Holistic approach to Risk
Assessment/Internal Controls.
Fraud Hotlines.
Control self-assessment.
Control repositories.
Source: Cynthia Cooper, L.S.U., November 24, 2003.
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The Perpetrators
 First-time offenders.
 Losses from fraud caused by
managers and executives were 3.5
times greater than those caused by
non-managerial employees.
 Losses caused by men were 3 times
those caused by women. [53% males;
47% females]
 Losses caused by perpetrators 60 and
older were 27 times those caused by
perpetrators 25 or younger.
 Losses caused by perpetrators with
post-graduate degrees were more than
3.5 times greater than those caused by
high school graduates.
Source: 2002 ACFE Report
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Other Characteristics of Occupational
Fraudsters:
 Egotistical
 Inquisitive
 Risk taker
 Rule breaker
 Hard Worker
 Under stress
 Greedy
 Financial need
 Disgruntled or a
complainer
 Big spender
 Close relationship
 Overwhelming
with vendors /
desire for personal
suppliers
gain
 Pressured to
perform
Source: Lisa Eversole, “Profile of a Fraudster,” Some Fraud Stuff,
http://www.bus.lsu.edu/accounting/faculty/lcrumbley/fraudster.html
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“Finding fraud is like trying to load
frogs on to a wheelbarrow.”
Larry Crumbley
-------------------------------------------H.R. Davia suggests that for every
three fraud events which are detected, two
remain undetected, and that conclusions
drawn from studying those that are detected
do not necessarily apply to those whose
existence has not been revealed.
Source: Davia, H.R., “Fraud Specific Auditing,” Journal of Forensic
Accounting,” June 2002.
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Fraud Catching
Finding fraud is like trying to herd
cats and chickens.
There is a chicken catching
machine (150 chickens per
minute),* but there is no perfect
fraud catching machine.
D. Larry Crumbley
* PH2000 mechanical chicken harvester. Scott
Kilman, “Poultry in Motion: Chicken
Catching Goes High Tech,” Wall Street
Journal, June 4, 2003, p. A-1. Human can
catch about 1,000 an hour. $200,000 cost.
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How Fraud Is Detected
1. Tips from employees (26.3%).
2. By accident (18.8%).
3. Internal audit (18.6%).
4. Internal controls (15.4%).
5. External audits (11.5%).
6. Tips from customers (8.6%).
7. Anonymous tips (6.2%).
8. Tips from vendors (5.1%).
Therefore, 46.2% from tips.
Source: 2002 Wells Report.
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Difficult Task
More forensic techniques should become
a part of both external and internal auditing.
But Stephen Seliskar says that “in terms of
the sheer labor, the magnitude of effort, time
and expense required to do a single, very
focused [forensic] investigation -- as
contrasted to auditing a set of the financial
statements -- the difference is incredible.” It
is physically impossible to conduct a
generic fraud investigation of an entire
business.
Source: Eric Krell, “Will Forensic Accounting Go
Mainstream?” Business Finance Journal, October 2002, pp.
30-34.
www.investigation.com/artilces/library/2002Articles/15.htm.
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Stealth
Once a forensic accountant (e.g., Cr.FA,
CFE, CFFA) is engaged, Michael Kessler
says that they should not be disruptive.
Most employees are not aware that an
investigation is taking place. We go in as
just another set of auditors, favoring a
Columbo-esque investigative style. “We
don’t wear special windbreakers that say
‘forensic accountant.’”
Source: Eric Krell, “Will Forensic Accounting Go
Mainstream?” Business Finance Journal, October 2002, pp.
30-34.
www.investigation.com/articles/library/2002Articles/15.htm
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Kessler Survey (2001)
• About 13% of employees are
fundamentally dishonest.
• Employees out-steal shoplifters.
• About 21% of employees are honest.
• But 66% are encouraged to steal if
they see others doing it without
repercussion.
Source: “Studies Show 13% of employees are fundamentally dishonest,”
KesslerNews, November 1, 2001,
www.investigation.com/articles/library/2001articles.
---------------------------------------------------------------------------------------
• 30% of people in U.S. are dishonest.
• 30% situational dishonest.
• 40% are honest all of the time.
Source: R.C. Hollinger, Dishonesty in the Workplace, ParkRider, N.Y.:
London House Press, 1989, pp. 1-5.
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Fraud Pyramid
 Motive
 Excessive spending to keep up
appearances of wealth.
 Other, outside business financial strains.
 An illicit romantic relationship.
 Alcohol, drug or gambling abuse
problems.
 Opportunity
 Lack of internal controls.
 Perception of detection = proactive
preventative measure.
 Rationalization
 “Borrowing” money temporarily.
 Justifying the theft out of a sense of
being underpaid.(“I was only taking
what was mine”)
 Depersonalizing the victim of the theft.
(I wasn’t stealing from my boss; I was
stealing from the company.”)
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Greed
“I don’t see many ways to eliminate
greed; it is an inherent part of the
human character. So antifraud
measures must be aimed at educating
people on the risks and the type of
technical controls that they can
implement.”
Alan Oliphant
Source: David G. Banks, “The Fight Against Fraud,” Internal Auditor,
April 2004, pp. 36-37.
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Materiality Unimportant
“Auditing is governed by materiality. In
investigative accounting, it is the opposite. I
am looking for one transaction that will be
the key. The one transaction that is a little
different, no matter how small the
difference, and that will open the door.”
Lorraine Horton, owner of L. Horton & Associates in Kingston, R.I.
-----------------------------------------------------------------------------------------------------
“Fraud usually starts small. It begins with little
amounts, because the perpetrator is going to
test the system. If they get away with it,
then they keep on increasing and increasing
it.”
Robert J. DiPasquale
Source: H.W. Wolosky, “Forensic Accounting to the Forefront,” Practical
Accountant, February 2004, pp. 23-28.
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Forensic Accounting v. Auditing
“Forensic accounting is very different from
auditing in that there is no template to use.
There are no set rules. You don’t know when
you go into a job how it is going to be.”
Lorraine Horton, Kingston, R.I
------------------------------------------------------------------------------
“Forensic accounting “is a very competitive
field. What is interesting is that you may be a
good accountant, but not a good forensic
accountant. The training and the way you
look at transactions are different.”
Robert J. DiPasquale, Parsippany, N.J.
---------------------------------------------------------“Unlike auditing, lower-level staff often can’t
be used for an engagement. They normally
will not spot anything out of the ordinary,
and an experienced person should be the one
testifying as well as doing the investigative
work.”
Lorraine Horton, Kingston, R.I.
Source; H.W. Wolosky, “Forensic Accounting to the Forefront,”
Practical Accountant, February 2004, pp. 23-28.
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Steps Toward Forensic Audit
Traditional audit [forensic
techniques & fraud prevention
program].
If suspect fraud, bring in-house
forensic talent into the audit.
If no in-house talent or fraud
complex, engage an outside
forensic accountant (e.g., Cr.FA,
CFFA, or CFE).
As audit moves toward forensic
investigation, auditor must
comply with litigation services
standards (consulting).
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© D.L. Crumbley
Types of Forensic Engagements
 Determine if fraud is occurring.
 Support criminal or civil action against
dishonest individuals.
 Form a basis for terminating a
dishonest employee.
 Support an insurance claim.
 Support defense of an accused
employee.
 Determine whether assets or income
were hidden by a party to a legal
proceeding (such as a bankruptcy or
divorce).
 Identify internal controls to prevent it
from happening again.
Source: D.R. Carmichael, et. al, Fraud Detection, 5th, Fort
Worth: Practitioners Publishing, 2002, p. 2 – 4.
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Two Major Types of Forensic
Investigations
• Reactive: Some reason to suspect
fraud, or occurs after a significant
loss.
• Proactive: First, preventive
approach as a result of normal
operations (e.g., review of internal
controls or identify areas of fraud
exposure). There is no reason to
suspect fraud. Second, to detect
indicia of fraud.
Source: H.R. Davia, “ Fraud Specific Auditing,” Journal of
Forensic Accounting, Vol. 111, 2002, pp. 111-120
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Thinking as a Forensic Auditor
The Iceberg Theory of Fraud
Overt Aspects
Hierarchy
Financial Resources
Goals of the Organization
Skills and Abilities of Personnel
Technological State
Performance Measurement
Structural
Considerations
Water line
Covert Aspects
Attitudes
Feelings (Fear, Anger, etc.)
Values
Norms
Behavioral
Interaction
Considerations
Supportiveness
Satisfaction
Source: G.J. Bologna and R.J. Lindquist,
Fraud Auditing and Forensic Accounting,
2nd Edition, New York: John Wiley, 1995,
pp. 36-37
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Fraudsters Should Be Prosecuted
Although large frauds may be reported to
law enforcement agencies, smaller frauds
are often not reported.
This failure to report fraud incidents and the
reluctance of police to aggressively tackle
the issue only empowers the perps and
diminishes the victims. Ultimately, these
unreported incidents are precursors to
larger and larger acts of violence. If we do
not deal with simple crimes, we will
eventually have to deal with homicide.
Source: Stephen Doherty, “How Can Workplace
Violence Be Deterred,” Security Management, April
2002, p. 134.
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Top-Side Entries: Smoking Gun
An Oct. 14, 2002, New York Times article by
Joel Brinkley stated that “auditors studying the
financial records of federal government departments
find may of them so disorganized, even chaotic, that
the agencies cannot account for tens of billion of
dollars.” So how did the agencies make their books
balance? Through the magic of top-side balancing
entries.
The Forest Services, a division of the U.S.
Department of Agriculture, tried to balance its books
at the end of the 2001 fiscal year. It booked more than
15,337 adjusting entries, debits, and credits totaling
more than $11 billion gross. Auditors determined that
73 percent of these adjustments, totaling $7.9 billion,
were unsupported.
The U.S. Department of Defense alone entered
an unsubstantiated balance adjustment totaling $1.1
trillion in 2000, down from $2.3 trillion the prior year.
Source: Scott Green, “Fighting Financial Reporting Fraud,” Internal Auditor,
December 2003, pp. 58-65.
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Industry Specific Investigations:
IRS’s Audit Technique Guides
(ATGs)
•
•
•
•
•
•
•
Market Segment Specialization
Program produces ATGs.
At least 74 different ATGs.
Length: 13 to 237 pages.
58 ATGs on IRS website.
See CCH Internet Tax Research
Network.
60 more under study.
Usually contain:
 Common and unique practices.
 Industry terminology.
 Examination techniques (e.g.
interview questions).
 Other information.
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The End Is Here
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