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How the fraudsters fool the auditors · PDF file Bank balance 12,000,000 Cheque 230,000 Cheque 6,000 Cheque 4,000 EFT 1,500,000 EFT 750,000 Cheque 510,000 General ledger bank balance

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  • How the fraudsters fool the auditors

    6 November 2012

  • Financial statement fraud

  • Sarbanes Oxley

    perpetuates change

    • higher standards for corporate governance

    • independent regulatory framework

    • quality and transparency of financial reports

    • severe civil and criminal penalties

    • protections for corporate whistleblowers

  • CLERP 9 impact

    Establish ‘auditor obligations’ to guide financial

    reporting. Requirements:

    • auditor registration

    • ASIC reporting requirements

    • transaction specific disclosure relating to

    securities, financial services and markets

    • disclosure for the on-sale of securities and

    other financial products

  • PCAOB established by

    Sarbane’s Oxley

    • registered public accounting firms

    • establishing or adopting auditing, quality

    control, ethics and independence

    • investigating registered public accounting

    firms

    • enforcing compliance with the Sarbanes-

    Oxley Act

  • PCAOB Model: Asia Pacific

  • Fraud still happens….

  • 0% 10% 20% 30% 40% 50%

    Deloitte & Touche

    PricewaterhouseCoopers

    KPMG

    Ernst & Young

    Big Four Total

    19%

    12%

    22%

    9%

    15%

    45%

    39%

    23%

    21%

    33%

    2010

    2009

    Deficient audits

    \Source: New York Times, The percentage of audits reviewed by the Public Company Accounting Oversight Board that were found to be

    deficient by inspectors rose sharply in 2010 from 2009.

  • 2007

    2008

    2009

    2010

    2011

    163

    209

    157

    174

    191

    Law suits filed per year

    Shareholder class actions not declining

    Source: Figure 1, Page 5, The ever-changing landscape of litigation comes full circle: 2011 Securities Litigation study , April

    2012

  • Internal Controls

    Revenue Recognition

    Other

    Overstatement of assets

    Understatement of liabilities & expenses

    Estimates

    Purchase accounting

    62%

    32%

    27%

    26%

    16%

    14%

    8%

    Financial statement fraud has many hats

    Source: Figure 5, Page 13, Percentage of accoutning cases citing specific issues, 2010-2011, April 2012

  • The auditor’s responsibility

    “An auditor is responsible for

    obtaining reasonable assurance

    that the financial report taken as

    a whole is free from material

    misstatement, whether caused

    by fraud or error.”

    Source: Auditing Standard ASA 240 The Auditor's Responsibilities Relating to Fraud in an Audit of a Financial Report

  • What % of frauds do

    auditors detect?

    What % of fraud do

    auditors prevent?

    ACFE Report to the Nations on Occupational Fraud and Abuse, 2012

    Tip

    Management Review

    Internal Audit

    By Accident

    Account Reconciliation

    Document Examination

    External Audit

    Notified by Police

    Surveillance/Monitoring

    Confession

    IT Controls

    Other

    43.3

    14.6

    14.4

    7

    4.8

    4.1

    3.3

    3

    1.9

    1.5

    1.1

    1.1

    Percent of Cases

  • What is a quality audit?

     audit staff collects sufficient, competent, and

    reliable evidence

     auditor raises issues with the audit team

     issues reported to management, board, and/or

    audit committee

    But, too often fraud slips through the cracks…

  • Causes of audit failures

     overly complex structure

     management bullying

     restricted contact with staff

     change in operations (acquisition)

     artificial time pressure/deadline

     reliance on junior staff

     lack of sufficient fees v

  • Causes of audit failures

     incompetence / poor judgment

     greed

     mis-aligned incentives

     dependence on fees

  • Auditors have the best intentions

  • Stuff rolls downhill

  • Client

    Stuff

  • Partner

  • Senior

    Manager

  • Manager

  • Senior

  • Crest of Ignorance

    Junior auditor

    Senior

  • Cave of Unreported Exceptions

    Junior

    auditor

  • Fermented stuff

    Analysts

  • Fermented stuff

    Analysts

  • Actions have consequences…

  • Why commit financial

    statement fraud?

     conceal embezzlement

     conceal true business wealth

     preserve personal status and control

     maintain personal income/wealth

     achieve incentives

  • Bank reconciliation

    manipulation…

  • Bank balance 12,000,000

    Cheque 230,000

    Cheque 6,000

    Cheque 4,000

    EFT 1,500,000

    EFT 750,000

    Cheque 510,000

    General ledger bank balance 15,000,000

    Auditors checked balance

    to bank confirmation

    Auditors agreed

    subsequent cheque

    and EFT deposits to an

    online bank statement

    printed from online by

    employee

    Auditors agreed balance

    to general ledger

    Employee produced a forged bank statement

    Employee stole $2,250,000

  • Lessons learned

     internal control audit identified cash controls

    HIGH risk

     auditors failed to consider HIGH risk

     audit standards require more stringent

    substantive procedures

  • Judgement & manipulation

  • Setting the scene…

    AUDITORS

    AUDIT COMMITTEE

    BOARD OF DIRECTORS

    CEO

    CFO

    GM GM GM GM GM

    ACCOUNTING

    TEAM

  • Aggressive accounting or fraud?

     inventory provision

     impairment of intangibles

     accounts receivable provision

  • Judging management’s intention…

  • Judging management’s intention…

  • Lessons learned

     Auditors detailed concerns but severity of the

    issues was not properly communicated to the

    Board of Directors.

     Board relied on management to explain and

    justify any issues raised by the auditors.

  • Loan fraud and a

    questionable audit

  • Timeline of events

    Bank discovered

    red flag transaction

    Missing computer equipment: offices

    appeared closed down. Forensic

    technologists recovered data

    External auditor refused

    access: power failure

    Bank appointed receivers

    and managers

    Identified and documented

    $20m fraud

  • Related-party transactions and

    complex organisational structures

    ADMINISTRATORS OWNERS

    LOAN BOOK

  • Lessons learned

     Auditors failed to understand complex

    structure of entities and transactions resulting

    in improper disclosure.

     Requesting documents prior to arriving does

    not represent good investigative skills.

  • Improper acquisition

    accounting and co-opting

    of auditors

  • Yellow Star Industries

    2005

    2006 2008

    2009

    2010

    2007

    Yellow Star IPO

    Hope Electronics

    Jenkins Manufacturing

    Other Acquisitions

  • Key perpetrators

  • What was their strategy?

     aggressive number of acquisitions

     cut costs wherever possible

     manipulated the financial statements of the

    acquired companies pre consolidation

  • Financial statement fraud

     defer revenue

     overbook reserves

     pre-pay expenses

     write down inventory

     REVERSE all entries on consolidation of

    Yellow Star

  • Then, the “stuff” hit the fan

  • Former CEO turns Whistleblower

  • What % of frauds are detected by

    whistleblowers/tips?

    ACFE Report to the Nations on Occupational Fraud and Abuse, 2012

    Tip

    Management Review

    Internal Audit

    By Accident

    Account Reconciliation

    Document Examination

    External Audit

    Notified by Police

    Surveillance/Monitoring

    Confession

    IT Controls

    Other

    43.3

    14.6

    14.4

    7

    4.8

    4.1

    3.3

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