Accounting Fraud

Accounting Fraud

Non cash assets


Two most common: equipment and inventory

Proprietary information least likely but has high costs


Graphs on pg 230 -233

Usually employees



Unconcealed larceny

Assets requisitions and transfers

Purchasing and receiving schemes

Fraudulent shipments




Can be borrowed

Or stolen


Fake sales



Requisitioning, purchasing and receiving should be segregated




Asset requisitions and transfers

Moving assets within a company

Transfer documents

During process of moving asset it is stolen


Purchasing and receiving schemes

Falsifying incoming shipments

Would say only 900 of 1000 items received


False shipments of inventory and other assets

Send product to person stealing or made up person

Acts like it is sold

Allows someone other than fraudster to remove items from storeroom

May be written off as uncollectible



Other schemes

Trick those in charge that old equipment is new equipment and steal new



Concealing inventory shrinkage

Shrinkage is a red flag


Altered inventory records

Forced reconciliation

Fake sales and acct receivables

Write off inventory

Physical padding- empty boxes


Audit tests on page 248






Act done with the intent to give some advantage inconsistent with official duty and the rights of others




Illegal gratuities

Economic extortion

Conflicts of interest


Official – deals with govt

Commercial – business


Commercial is most often


Offering a payment can constitute a bribe, money doesn’t have to be exchanged


Does not have employer’s consent

Unreported gifts from vendors


Economic extortion – pay up or else

–          Ex. If you don’t pay you lose their business



Ph 257 -260 is graphs


Most corruption is conflict of interest


Employee tip is most common detection

Usually done by management





Kickback schemes

Collusion between vendors and employees

Employee makes sure inflated invoice gets paid to vendor

Employee gets kickback from vendor


Diverting business to vendor


Divert business to a vendor


Overbilling scheme

Employees with approval authority

False invoice can overstate cost of goods or have fake sales

Employee approves invoice

Gets kickback


Lacking approval authority

False purchase requisition

False vouchers

Forge signature

Fake invoice


Other kickback schemes


Slush Funds

Bribes are 2 sided transactions

Divert company funds into an account to pay for bribes



Monitor trends

Price thresholds

Monitor purchase levels

Right to audit clause on vendors

Written policies against gifts

-explains what is proper

-allows for termination if violated

Pg 266









Bid rigging schemes

Inside influence gives a vendor a contract

Can rig process

Usually occur in pre-solicitation phase



Before bids are officially sought


Need recognition scheme- employee is paid to convince company a project is needed

High requirements for inventory levels and even still requesting more

Write off surplus to scrap

No back up list of vendors



Specifications scheme- tailor contract to specifications

Elements, materials, dimensions and other relevant requirements

Restricts competition

Prequalification to eliminate competitors

-example: must have certain % of women ownership

Sole source or noncompetitive procurement- saying only one vendor can be used

Writing off of vague specifications- employee paid off to add amendments to raise price

Bid splitting- if value of bid is over a certain value it must have bidding, so they break the bid into smaller parts

Payoff to see specifications in advance


Solicitations Phase

Restrict the pool of competitors

Bid pooling – bidders conspire to split up contracts

Fictitious Suppliers – fake bids are used to justify high bids

Other- restricting time


Submission Phase

When bids are proffered to buyer

Abuse of sealed bid process

-bids are supposed to be confidential

-shows one supplier other bids so they can beat it



Unusual bidding patterns

Unusually high contract price

Pg 271



Something of Value

-must be given for bribes


Illegal Gratuities

Gift after the fact but not meant to influence


Economic Extortion

Opposite of a bribe


Conflict of interest

Purchasing schemes

Sale Schemes

Buying or selling at high or low price to someone with a hidden interest




-turnaround sales

Flip- resell at higher price




Writing off sales



Business diversions

Siphon off clients for own company

Resource diversions – use for development of own business

Financial Disclosures- related party transactions



Company ethics

Annual disclosure to reveal interests


Audit tests pg 280

Accounting Principles and Fraud


Who commits financial statement fraud

Senior management

Mid and low level employees

Organized criminals


Why do people commit financial statement fraud

Conceal true performance

Preserve person control

Maintain personal income/wealth


Why senior management will overstate business performance

Pg 289

May understate pg 289


How do people commit financial statement fraud

Playing the accounting system

Beating the accountint system

Going outside the accounting system

Pg 290


Conceptual framework for accounting pg 290-194


Responsibility for financial statements

Company’s ethic – code of conduct


Users of financial statements – pg 295

Types of financial statements 296


SOX  pg 297-300



Established by sox

Pg 301-309


Graphs on page 310-314



Fraudulent Financial Statement Schemes



Top management: ceo and cfo

Pg 323 is list of scandals

Treadway commission- definition of financial statement fraud



Types of fraud

Falsification, alteration or manipulation of records

Material omission or misrepresentation

Deliberate misapplication of accounting principles

Intentional omissions of disclosures or presenting inadequate documents


T types of misstatements

Intentional misstatements or omissions of amounts or disclosures

Misappropriation of assets


Harmful because:

Undermines the reliability, quality and transparency of reporting process

Jeopardizes the integrity and objectivity of the auditing profession

… for full list – go to page 326


Methods of financial statement fraud

Fictitious revenues

Timing differences

Improper asset valuations

Concealed liabilities and expenses

Improper disclosures


Fictitious revenue

Revenue is realizable when:

Evidence of arrangement exists

Delivery has occurred or service rendered

Seller’s price is determinable

Collection is reasonably assured


Change in assets to occur

Change can be measured

Revenue is substantiated with change in assets and liabilities

Contractual rights enforceable


Sales with conditions

-sale is booked despite not all terms being completed


Pressures to boost revenue


Red flags

Rapid growth or unusual level of profits

Recurring negative cash flows from operations

Many related party transactions

Unusual growth in the number of says’s sales in receivables

Pg 330


Timing differences


Matching revenues with expenses


Premature revenue recognition


Arrangement does not exist

No written or verbal record of agreement

Written Agreement is customary, but now its verbal

Conditional order

Contains right of return

With related party which is not disclosed

Pg 332


Delivery has not occurred or service not rendered

Shipment not made to standard location

Items of wrong specification shipped

No services provided

Mix of goods misstated

Pg 333


Sellers price to buyer is not fixed

Price is based on some future event

Service fee unpredictable

Option to exchange products in contract

Pg 333


Collection is not assured

Contingent on future event

No ability to pay

Pg 333



Long term contracts

Completed contract method or percent completed method


Channel stuffing

Trade loading

Sale of unusually large quantity of a product, buyer enticed by deep discounts

Concern over collectability


Recording expenses in wrong period

Pg 334


Red flags with timing differences

Unusual growth in gross margin

Complex transactions

Repeating negative cash flows

Pg 334


Concealed liabilities and expenses

Liability/expense omission –simply fail to report them. Simple and easy

Capitalized expenses – provide most benefit to company.  Increases income and assets. As assets  are depreciated, income in subsequent periods will be understated

Expensing what should be capitalization

Failure to disclose warranty  – fail to report proper expenses related to repairs for warranties




Red flags

Allowance for sales returns

Unusual growth in gross margin

Pg 339



Improper Disclosures

Liability omissions

Subsequent events

Management fraud

Related party transactions

Accounting changes

Pg 339-341


Red flags

Domination of management by one person

Ineffective BoD

Rapid growth


Improper Asset valuation

Inventory valuation- failing to write down

Accounts receivable – fake accounts, failure to write down

Business combos- goodwill pg 344

Fixed assets

-booking fake assets – making up assets and recording them

Misrepresenting asset valuation- should be recoded at cost

n  Govt related companies have incentive to understate

Improperly capitalizing inventory and startup costs – interest and finance charge, misclassify assets


Red flags pg  347detection of financial statement schemes

Pg 347-356

-has entire step by step process


Financial statement analysis

Vertical – analyze relationship between items on a financial statement

Horizontal – measuring percentage change over periods




Reduce pressure to commit fraud

Reduce opportunity

Reduce rationalization pg 363



Interviewing Witnesses


Guest speakers


Ben franklin was first inspector

Accounting Fraud


Federal agents

No 1811 status

Mail fraud, identity theft, illegal content


Federal Statute

Title 18 usc section 1341


Elements: Devising or intended devising of scheme

Intent to defraud

Use mail carrier to fraud


Punishment: fine or up to 20 yrs


Chain letters

Foreign lotteries

Merchandise schemes

Investment schemes

Work at home schemes



Types of mail fraud: Business

Government look a like mail

–          Need to order to be in compliance

Solicitations disguised as invoice

–          Yellow pages advertisements

–          Disguised to look like a real company

Manipulations of mailings by mass mailer

Victims: car dealership




Actions taken

Criminal prosecution presented to us attorney office

Civil action presented to usao




-law enforcement, AG’s office, BBB


–          Complaints

–          Database searches

Case must:

-meet fraud elements

Be in jurisdiction

Meet prosecution guidelines


Identity theft

9-10 million victims a yr

50 billion dollar hit to economy per yr


Theft is acquiring info

Fraud is using the info


Sources of theft

Wallet, checks, credit card = 14%

Family members 14%

Credit card transactions 13%

Mail theft 4%

Phishing, viruses, key logs 55%


Mike wagner

First job was selling windows

Loan to take equity out of house to pay for windows

-if house is worth 100,000 they’d say after windows it would be worth 150,000

-mortgage fraud


steve warshak

3 phases

1 is no problem

2 is condition but not full on problem

3 is disease and need treatment


Joined in 2002 and in charge of the books


High revenue came from continuity. Charges from credit cards that was not from initial trial.

-“wanted to make sure customer never ran out”

– to remain effective


Sent card that said it was an auto renew


Have to fully disclose process before credit card info is obtained. Cannot tell customers they are going to be auto-renewed at the end.


Double dinging- splitting sales transaction into 2


Charge back ratio


Charge back / total sale transactions


They broke sales down to create higher transaction numbers to lower ratio


1% is acceptable


Chargeback is a dispute of credit card transaction


2002 = 30 mil sales

2003 = 85 mil sales

2004 = 185 mil sales

.1% complained to BBB


Raided in 2005


100 mil dollar fraud = 25 yrs


Villa Hills Civic Club Fraud


–          Property worth 2 mil

–          27k savings in bank

–          7k in operating account

Theft started months within Steve Sparks taking charge


5 member board, secretary and treasurer

Steve convinced president that contacting treasurer was too hard, so he got a stamp with everyone’s signature


Non-payments kept happening. Phones, cable…


Place is always packed, but losing money????


Property was about to be sold for non payment of taxes

–          Steve was on vacation


Feb 7th, 2007- police call about club finances


Had 76 dollars in bank!


Tried to deposit check at wrong bank. Teller noticed he was acting weird. So he ran out and left town.


Poor record keeping made it hard to track what happened


Had mother write 75k check to trick company into thinking money was in account


300k + missing


He and his wife faced threats


50k loan taken against property

No payment for 3 yrs

-forgery involved on loan


Club has not worked on rebuilding and becoming trusted again


Court date on march 20th


Check tampering


-fake bank statements

Payroll fraud


10 rules for being expert witness:



Qualified through training or education

–          Seminars


Certified in a field


Have resume and questions together

Follow policy


Photo arrays

Officer investigating cannot present lineup


Document everything




Knowing facts


Practice testimony


Familiarize with science

-show how you think


First impression

Eye contact


Knowing role


Tv is big influence


Accounting methods being protected is essential for protecting the public and for CPA firms.



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