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School of AccountingFlorida International University
Fraud Detection
Recognizing the symptoms of Fraud
Proactive Approaches to Detecting Fraud
School of AccountingFlorida International University
Discuss the Symptoms of Fraud
School of AccountingFlorida International University
List 6 Symptoms of Fraud
Accounting AnomaliesLedger Doesn’t BalanceInternal
Control Weakness
No Vacation
Analytical Anomalies
1 = 1
School of AccountingFlorida International University
List 6 Symptoms of Fraud
Extravagant Lifestyle
Unusual Behavior
Tips & Complaints
School 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
School 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
School 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
School 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
School 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
School of AccountingFlorida International University
Accounting Anomalies
School of AccountingFlorida International University
Extravagant Lifestyles
• Financial Pressure
• Greed
• Spend What They Steal
• Significant Improvement in Lifestyle
• Living Way Beyond Their Legal Means
School of AccountingFlorida International University
What is the chain that leads to unusual behavior?
Guilt
Fear
Stress
BehaviorChanges
School 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
School 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
School 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
School 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
School of AccountingFlorida International University
What is typical of most frauds, as in the case of Mr. Hamanaka?
School of AccountingFlorida International University
Differentiate Between Detecting & Investigating Fraud
DetectionDiscovery of
Fraud
Answers the Question
Does a fraud exist?
InvestigationPreceded by Detection
Proving a Fraud
Answers the Questions
How? Who? Why? What? Where? When a fraud took place?
School 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
School of AccountingFlorida International University
How Benford’s Law Works
School 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
School of AccountingFlorida International University
Detecting or Identifying Fraud Perpetrators
• Use technology to search through vast sources of data to identify strange, abnormal relationships.
School 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
School 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.
School of AccountingFlorida International University
Compare the 3 Approaches
Statistical Analysis provides lots of symptoms and is
very useful for discovering vendor kickback frauds.
School of AccountingFlorida International University
Compare the 3 Approaches
The Deductive Approach is the most expensive to
use.
School of AccountingFlorida International University
Summarize the Process Which Results in Financial Statements
Effects Investor or Creditor Decisions
Economic Transactio
n
Produces
Journal Entry
Posted
Financial Statement
s
Analysis
General Ledger
Summar-ized
Source Document
s
Analysis
School 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 effectF/S detected
during analysis of
unexplainedchanges in
F/S
School of AccountingFlorida International University
How Revenue Affects the Company’s Accounts
If SalesIncrease
Then
Accounts Receivabl
e
Revenue
Cost of Goods Sold
Inventory
School 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
School of AccountingFlorida International University
Describe How to Perform Vertical Analysis on
School of AccountingFlorida International University
Describe How to Perform Horizontal Analysis on
School 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?