Chapter 5 Textbook Outline
Chapter 5 Textbook Outline ACC 375
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This 5 page Class Notes was uploaded by Lauren95 on Wednesday March 30, 2016. The Class Notes belongs to ACC 375 at Pace University taught by Dr. Farrell in Spring 2016. Since its upload, it has received 44 views.
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Date Created: 03/30/16
Chapter 5 – Fraud Examination and Fraud Management Fraud examination and fraud investigation interchangeably refer to the application of accounting and other specialized skills to the prevention, detection, investigation, correction, and reporting of fraud. o Fraud examination can apply to any type of fraud relating to an organization. Forensic accounting is an area within accounting that applies specialized skills to actual or potential legal matters. Fraud management is a process that involves several closely related phases: o Prevention At the most basic level, fraud prevention within the organization is a matter of good internal control. Specialized Information Security Management Systems Confidentiality: Data are available only to authorized persons. Integrity: Data are accurate and complete. Availability: Data are available when and where needed. Fraud prevention is part of the Enterprise Risk Management (ERM) process Optimal fraud prevention requires much more than simply implementing control checklists that contains items such as firewalls, anti-virus software, and so on. Starts with threats and vulnerabilities and ends with implementing corresponding risk based controls. o Detection Fraud detection is part of the larger group of processes that include fraud prevention, investigation, correction, reporting, and recovery. Fraud detection involves identifying indicators of fraud that suggest a need for further investigation. Fraud indicators can be individual indicators or composite indicators. Red flags include events such as a mismatch in an inventory count, a cash register that doesn’t balance, a suspicious invoice, etc. Composite indicators are typically based on combining multiple individual indicators that when viewed one at a time might not signal possible fraud. o Risk scores Ex: FICO Data driven fraud detection involves the formal analysis of large sets of data in search for fraud indicators. o Includes basic tips, incidents of internal control violations, security breaches, and pattern data. Pattern data tend to indicate fraud when various data items are considered jointly. Include risk scores Fraud detection software and services sometimes used sophisticated statistical techniques such as logistic regression, decision trees, and time series analysis. Content and text analysis analyze the content of documents and conversations to identify possible fraud indicators. Benford analysis exploits an interesting patters relating to the first digit of numbers appearing in a random data set. A Type I error occurs when a fraud indicator falsely signals fraud. Result in unnecessary fraud investigations. A Type II error occurs when a fraud indicator fails to signal fraud. Results in frauds escaping detection. The goal is to minimize total fraud costs defined as follows: Total fraud costs = costs of prevention + costs of investigation + cost of detection + cost of losses o Investigation The process of systematically gathering and reviewing evidence for the purpose of documenting the presence or absence of fraud. Four phases: The fraud engagement process. This phase begins with a fraud indicator and the investigators first contact with the case, and ends with the launching of an investigation. The evidence collection process. This phase includes various steps in which evidence is collected in support of the scope and objectives of the investigation. The investigation reporting process. The phase involves documenting and summarizing the results of the fraud investigation. The loss recovery process. This phase includes events such as enabling civil and criminal litigation, resolving tax issues, and collecting insurance. The fraud engagement process: Create and review an incident report. Conduct the initial notifications and evaluations. Consider legal issues. Evaluate the loss mitigation and recovery considerations. Define the scope, objectives, and costs of the investigation; and Create an engagement letter or memorandum. A financial incident report can be anything from a red flag to a formal report written by a responsible person. Doesn’t always lead to an investigation. They can take on legal significance Evidence is anything that relates to the truth or falsity of an assertion made in an investigation or legal proceeding. The principle of prediction requires investigations be started or continued only when there is a reasonable basis to do so. Without prediction, there is no clear fraud to investigate, and the issue become one of either detection or simply fishing for fraud. Investigators collect three types of evidence: Physical and Document evidence o Fingerprints, trace evidence, and forged or incriminating documents. o Physical evidence is usually obtained at the crime scene. o Document evidence is typically collected by fraud investigators and includes a wide range of items such as personnel files, resumes, public records, tax returns, credit files, credit applications, vehicle records, accounting records etc. o Subpoena is an order from a government agency or officer of a court that compels the recipient, under penalty, to produce physical evidence, documents, or testimony. o Search warrant is a court order that authorizes law enforcement officials to search for and seize evidence. o Tracing involves beginning with a source document and following the relate transaction through the entire accounting cycle. o Vouching is the same as tracing but works in reverse: it begins with numbers in accounts and follows them backward to the source documents. o Questioned documents are when the documents authenticity or authorship is in question. o Document examiners specialize in analyzing questioned documents. Observation evidence o Monitoring suspects o Observation involves the use of the sense to assess the behavior of persons and other activities such as business processes. o Invigilation is an observation technique. This involves observing a suspects behavior before, during, and after an announced investigation. Interview evidence o Results of interviews o They begin with those furthest from the prime suspect and work their way to the prime suspect. o Always prepare for the interview. Fraud triangle: opportunity, pressure, and rationalization. o Introductory questions seek to establish rapport, seek the interviewee’s cooperation, and seek to observe the demeanor of suspects when they are asked non-sensitive questions and non-incrimination questions. o The process of carefully observing suspects under each condition is called calibration. o Informational questions seek information relevant to the investigation. o Concluding questions focuses on thanking the interviewee for his cooperation, confirming information provided by the interviewee as part of the interview, seeking any additional information that the interviewee may want to volunteer, and seeking the interviewee’s continued cooperation in the future. o Verbal cues can include things like evasiveness, hesitation, inconsistencies, and vagueness in answering questions. o Nonverbal cues can include things like body language and eye movements. o Once the suspect confesses, they should be handed a written confession to sign. Order of Collection of Evidence Physical and document evidence is collected, then observations are conducted, and finally the interviews are conducted. o Reporting Prepare a report that is a conclusion of the investigation. Reports are used for various purposes, such as to justify tax deductions for fraud loss, to justify firing an employee in possible litigation relating to the firing, to justify civil or criminal litigation relating to the fraud etc. Contains sections: for whom the report was prepared, contain background information relating to the case, an executive summary, the scope and objectives of the investigation, a description of the fraud investigation team, and the methods used, and the findings and recommendations resulting from the investigation. o Litigation and Recovery Loss recovery options include accepting the loss, collecting insurance if available, and pursuing the perpetrator in court. Expert consultants provide expert opinions and analyze to attorneys under the umbrella of attorney-client privilege. o Not subject to discovery. Discovery is the process in which opposing parties can require each other and relevant parties to produce out-of-court evidence. o Granted special consideration in court proceedings. o Permitted to state opinions and conclusions based on facts admitted into evidence and other information on which they choose to reasonably rely. o Must demonstrate expert qualifications: Degrees, certifications, publications, training, and experience. Financial statement fraud is the intentional misrepresentation (either by commission or omission) of any information included as part of a financial statement or report. Earnings management refers to management acting within generally accounting principles (GAAP) to produce financials reports in a way that some might consider biased or unethical. Managers commit financial statement fraud either as a way of boosting financial performance or as a way of hiding theft, bribery, or other illegal activities. Prevention of financial statement fraud: o Good internal control o Good corporate governance. CEO/CFO, Board of Directors, audit committee, internal auditor, external auditor, and the public oversight board. Revenue Cycle Fraud o Collection of cash favorite target. o Sales skimming schemes involve an employee pocketing cash but not recording its collection. The employee might give the customer a forged receipt or no receipt at all. o Robbing the cash register cash register receipts are not reconciled with sales receipts per each individual cash register, the employee is free to rob the cash register. o Swapping checks for cash removing cash from the cash register and replacing it with bogus checks. o Shortchanging the customer - cashier uses a distraction or deception in order to pocket part of the change due to the customer. o Stealing cash in the mailroom o Stealing cash in transmission when cash exchanges hands, some of it can get “lost”. o Lapping of accounts receivable bookkeeper for accounts receivable are also handling incoming payments for customer accounts. o Short bank deposits person who makes bank deposits can fail to deposit all the funds. o Noncustodial theft of cash Check washing involves using chemicals to remove checks payment details and then adding new details for the payee, date, or amount of payment. Check laundering involves using a stolen customer check to make a payment on account. Expenditure Cycle Fraud o Improper purchases, payments, and payroll-related payments and activities. o Big rigging funds – a dishonest purchasing agent might purchase from a friend or relative even though doing so is not in the nest interest of the company. o Kickback frauds – a dishonest purchasing manager might accept secret payment or favors in exchange for favoring a particular vendor. o Theft of petty cash o Abuse of company credit cards o Theft of company checks o Fraudulent returns – Employees can return properly purchased goods in exchange for cash then convert the cash to personal use. o Theft of inventory and other assets o Payroll fraud Production Cycle Fraud o Involve the misappropriation of waste, scrap, and spoiled goods. o Short shipments the vendor ships fewer than the ordered amount of goods but bills for the amount ordered. o Substandard or defective goods the vendor can only get away with this scheme is the buyer does not properly inspect incoming goods, and/or trace returns from customers back to vendors. o Balance due billing Bills the buyer for the balance due on account and not for specific invoices. o Fraudulent cost-plus billing vendors bill customers for the vendor’s costs plus a markup. Computer forensics is the application of computer science to computer related matters that might come before a court. o (1) identify perpetrators of crimes or undesirable behavior o (2) locate missing or hidden data o (3) Reconstruct damaged files and databases. A variety of issues relating to obtaining and preserving evidence were discussed. o These include problems with deleted files and whether or not to “pull the plug” – to cut power to a computer that potentially possesses evidence. o The investigator might seek to finds the physical location associated with a computer device that is used to communicate over the internet. o This is normally accomplished through analysis of the IP address. IP tracing is not a foolproof method. Hackers use various services to hide their real IP addresses. o Cracking venerable programs, passwords, and encryption keys simply requires use of one of the many programs sold on the market for that purpose.