Fraud Detection: Recognizing the Symptoms of Fraud

Slide1School of AccountingFlorida International University Fraud Detection Recognizing the symptoms of Fraud Proactive Approaches to Detecting Fraud

Slide2School of AccountingFlorida International University Discuss the Symptoms of Fraud

Slide3School of AccountingFlorida International University List 6 Symptoms of Fraud Accounting Anomalies Ledger Doesn’t Balance Internal Control Weakness No Vacation Analytical Anomalies 1 = 1

Slide4School of AccountingFlorida International University List 6 Symptoms of Fraud Extravagant Lifestyle Unusual Behavior Tips & Complaints

Slide5School of AccountingFlorida International University Accounting Anomalies: Irregularities in Source Documents • Missing Documents • “Stale Items” on Bank Reconciliation • Excessive Voids or Credits • Payee Names & Addresses = Customer Names & Addresses • Photocopied Documents • Payee Names & Addresses = Employee Names & Addresses • Doc sequences that do not make sense • Questioning handwriting on doc • Altered Documents • Duplicate Payments • Second Endorsements on Checks

Slide6School of AccountingFlorida International University Accounting Anomalies • Faulty Journal Entries • Inaccuracies in the Ledgers – Ledger Doesn’t Balance – Master or Control Accounts Do Not Equal the sum of individual customer or vendor accounts

Slide7School of AccountingFlorida International University Internal Control Weaknesses Lack of Segregation of Duties Lack of Physical Safeguards Lack of Independent Checks & Reviews Lack of Proper Authorization Overriding of Existing Controls Inadequate Accounting System

Slide8School of AccountingFlorida International University Some Common Examples of Analytical Anomalies • Unexplained Inventory Shortages or Adjustments • Increased Scrap • Excess Purchases • Too Many Debit or Credit Memos • Significant increase or decrease in account balances • Physical Anomalies • Cash Shortages or Overages • Excessive Late Charges • Unreasonable Expenses or Reimbursements

Slide9School of AccountingFlorida International University    Revenues with    Receivables    Revenues with    Inventory Strange Financial Statement Relationships      Inventory with    Payables    Volume with    Increase Cost Per Unit     Volume with    Scrap    Inventory with    Warehousing Costs    Revenues with    Cash Flows

Slide10School of AccountingFlorida International University Accounting Anomalies

Slide11School of AccountingFlorida International University Extravagant Lifestyles • Financial Pressure • Greed • Spend What They Steal • Significant Improvement in Lifestyle • Living Way Beyond Their Legal Means

Slide12School of AccountingFlorida International University What is the chain that leads to unusual behavior? Guilt Fear Stress Behavior Changes

Slide13School of AccountingFlorida International University Some Unusual Behaviors • Insomnia • Increase Drinking • Drug Abuse • Unusually Irritable & Suspicious • Unable to Relax • Lack of Pleasure in Former Pleasing Things • Inability to Look People in the Eyes • Unusually Belligerent • Working Standing Up • Sweating • Increased Smoking • Fear of Getting Caught

Slide14School of AccountingFlorida International University Why are more frauds discovered through tips & complaints? • Auditors Focus on Paperwork, Systems & Information • Fellow Employees Notice Lifestyle Changes • Complaints & Tips Are Only Symptoms - the Actual Investigation Can Show if a Fraud Exists

Slide15School of AccountingFlorida International University Why do employees hesitate to come forward with fraud information? 1. They’re Not 100% Sure a Fraud Is Occurring 2. They Don’t Want to Wrongly Accuse Someone 3. They Have Heard Horror Stories About What Happens to Whistle Blowers 4. Intimidation by Fraudsters 5. Condition Against Squealing

Slide16School of AccountingFlorida International University Discuss the Use of Hotlines • Hotlines are “800”  Phone Numbers Where Employees Can Provide Anonymous Tips & Information • Sometimes Set Up by the Company or Contracted with a Service or Organization Like ACFE

Slide17School of AccountingFlorida International University What is typical of most frauds, as in the case of Mr. Hamanaka?

Slide18School of AccountingFlorida International University Differentiate Between Detecting & Investigating Fraud Detection Discovery of Fraud Answers the Question Does a fraud exist? Investigation Preceded by Detection Proving a Fraud Answers the Questions How? Who? Why? What? Where? When a fraud took place?

Slide19School of AccountingFlorida International University Data-Mining as a Means of Detecting Fraud • ACL- Audit Command Language • Looking for Anomalies in Databases • Difficulty Because ACLs Are Limited in What They Can Handle • The Result Is They May Identify Thousands of Symptoms Because of Their Limitations

Slide20School of AccountingFlorida International University How Benford’s Law Works

Slide21School of AccountingFlorida International University What are some disadvantages of Benford’s Law? • Looks at a Large Company as a Whole, May Not Show Problems With Some Individual Vendors • Not Precise • Broad Identification of Symptoms • Does Not Zero in on Perpetrators

Slide22School of AccountingFlorida International University Detecting or Identifying Fraud Perpetrators • Use technology to search through vast sources of data to identify strange, abnormal relationships.

Slide23School of AccountingFlorida International University 5. Follow Through with Investigation to Determine if Fraud Exists or Not What is the 5 step Process for Deductive Fraud Detection 4. Use Databases & Information Systems to Search for Symptoms 3. Understand the Symptoms these Types of Fraud Create 2. Understand the Types of Fraud that Occur in this Business 1. Understand the Business

Slide24School of AccountingFlorida International University Compare the 3 Approaches Commercial Data Mining Packages are least costly, but have limited usefulness. They provide excessive symptoms, but are easy to use and modify.

Slide25School of AccountingFlorida International University Compare the 3 Approaches Statistical Analysis provides lots of symptoms and is very useful for discovering vendor kickback frauds.

Slide26School of AccountingFlorida International University Compare the 3 Approaches The Deductive Approach is the most expensive to use.

Slide27School of AccountingFlorida International University Summarize the Process Which Results in Financial Statements Effects Investor or Creditor Decisions Economic Transaction Produces Journal Entry Posted Financial Statements Analysis General Ledger Summar- ized Source Documents Analysis

Slide28School of AccountingFlorida International University What Effect Does the Size of the Fraud Have on the F/S? Small frauds are unlikely to affect  F/S usually detected when examining source documents Large frauds effect F/S detected during analysis of unexplained changes in F/S

Slide29School of AccountingFlorida International University How Revenue Affects the Company’s Accounts If Sales Increase Then Accounts Receivable Revenue Cost of Goods Sold Inventory

Slide30School of AccountingFlorida International University Perform Vertical Analysis Perform Horizontal Analysis Calculate Key Ratios Compare from Period to Period How can you convert balance sheets & income statements to change statements? Compare Account Balances from Period to Period

Slide31School of AccountingFlorida International University Describe How to Perform Vertical Analysis on

Slide32School of AccountingFlorida International University Describe How to Perform Horizontal Analysis on

Slide33School of AccountingFlorida International University What questions should be the focus when using a Statement of Cash Flows to detect fraud? • Are there any unexpected changes in cash? • Did A/R go up or down? Why? • Why did inventory go up or down?