1. Fraud & Corruption
By
Ali Amani
• Member of Supreme Court of Iranian Association of Certified Public Accountants (IACPA)
• IICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAA
Gholamhossein Davani
• Member of High council of Iranian Association of Certifeid Public Accountants (IACPA )
• IICA,IMA,AAA,CFE,IIA,BAA,EAA,CAAA
Dayarayan Auditing & Financial Services Firm(RSMi Iran)
1

2. Your honor,
Just now sitting at the patio with your honorable
sibling and having a bite of board with her honor, I
was informed that your honor has prattled and
reappointed price Movasegholdoleh, governor of
Qom, formerly deposed due to bribery and buying
off.
I had him sent to Tehran under guard, so that your
Majesty will understand that one can not rule a
country on his aunt’ prescriptions.
Forgive me for being over impertinent,
Taghi
“Amir Kabir’s (Current Pre minister) letter to King Naseraldin Shah”
2

3. If men were angels, no government
would be necessary. If angels were
to govern men, neither external nor
internal controls on government
would be necessary.
James Madison, The Federalist Papers, No. 51, 1788
3

4. Just as one can not let go of the taste of honey or
poison on the tip of his tongue, a governmental
agent dealing with governmental budget, can not
avoid tasting at least a little of the King’s
wealth.
“Kaochila ertashsetra,”
Indian edifications, first decade Annone Domini
4

5. Fraud:
Any illegal act characterized by deceit,
concealment, or violations of trust to obtain
money, property, services, avoid payment; or
secure personal or business advantage (IIA)
5

6. Definition of Fraud
A generic term, embracing all multifarious
means which human ingenuity can devise, and
which are resorted to by one individual to get
advantage over another by false suggestions or
by suppression of truth, and includes all
surprise, trick, cunning, dissembling, and any
unfair way by which another is cheated.
“Johnson v. McDonald, 39 P2d 150”
6

7. • In the broadest sense, a fraud is a deception made for
personal gain, although it has a more specific legal
meaning, the exact details varying between
jurisdictions. Many hoaxes are fraudulent, although
those not made for personal gain are not best
described in this way. Not all frauds are hoaxes -
electoral fraud, for example. Fraud permeates many
areas of life, including art, archaeology and science.
In the broad legal sense a fraud is any crime or civil
wrong for gain that utilises some deception practiced
on the victim as its principal method.
7

8. • In criminal law, fraud is the crime or offense of
deliberately deceiving another in order to damage
them — usually, to obtain property or services from
him or her unjustly. Fraud can be accomplished
through the aid of forged objects. In the criminal law
of common law jurisdictions it may be called "theft
by deception," "larceny by trick," "larceny by fraud
and deception" or something similar. Fraud can be
committed through many methods, including mail,
wire, phone, and the internet (see computer crime and
internet fraud.)
8

9. Acts which may constitute criminal fraud include:
• bait and switch
• confidence tricks such as the fraud, Spanish Prisoner, and the shell game
• false advertising
• identity theft
• false billing
• forgery of documents or signatures
• taking money which is under your control, but not yours (embezzlement)
• health fraud, selling of products of spurious use, such as quack medicines
• creation of false companies or "long firms"
• false insurance claims
• bankruptcy fraud, is a US federal crime that can lead to criminal prosecution under
the charge of theft of the goods or services
• investment frauds, such as Ponzi schemes
• securities frauds such as pump and dump
9

10. Fraud means:
• Inducing a course of action by deceit or other
dishonest conduct
• Involves acts or omissions or the making of
false statements
• Can be orally or in writing
• Object – to obtain a benefit or evade a liability
10

11. Fraud:
The term fraud may be defined as intentional
misrepresentation of financial information by one or
more individuals among management, employees or
third parties. Fraud may involve:
Falsification or alteration of accounting records or
other documents
Misappropriation of assets or theft;
Suppression or omission of the effects of transactions
from records or documents.
Recording of transactions without substances.
Intentional misapplication of accounting policies or
Willful misrepresentations of transactions or of the
entity's state of affairs.
11

12. Nature of the Frauds (Source:Coso report)
• Cumulative amounts of frauds were relatively large in light of the relatively
small sizes of the companies involved. The average financial statement
misstatement or misappropriation of assets was $25 million and the median was
$4.1 million. While the average company had assets totaling $533 million, the
median company had total assets of only $16 million.
• Most frauds were not isolated to a single fiscal period. Most frauds overlapped
at least two fiscal periods, frequently involving both quarterly and annual
financial statements. The average fraud period extended over 23.7 months,
with the median fraud period extending 21 months. Only 14 percent of the
sample companies engaged in a fraud involving fewer than 12 months.
• Typical financial statement fraud techniques involved the overstatement of
revenues and assets. Over half the frauds involved overstating revenues by
recording revenues prematurely or fictitiously. Many of those revenue frauds
only affected transactions recorded right at period end (i.e., quarter end or
year end). About half the frauds also involved overstating assets by
understating allowances for receivables, overstating the value of inventory,
property, plant and equipment and other tangible assets, and recording assets
that did not exist.
12

13. Fraud and abuse covers various issues including:
• Conflicts of interests e.g. a corrupt relationship can
involve an employee setting up a company, the
company supplies goods and services to the
organization, the employee does not tell the
organization about it
• Breach of trust e.g. leaking of confidential or
sensitive information
• Employee malpractice e.g. excessive use of the
telephone for private calls, e-mail abuse
• Criminal offence
13

14. • corruption
noun
1 [U] illegal, immoral or dishonest behavior, especially by people in
positions of power
• corroput
verb [T]
to make someone or something become dishonest or immoral:
• n.) The act of changing, or of being changed, for the worse; departure from
what is pure, simple, or correct; as, a corruption of style; corruption in
language.
• (n.) The act of corrupting or of impairing integrity, virtue, or moral
principle; the state of being corrupted or debased; loss of purity or
integrity; depravity; wickedness; impurity; bribery.
• (n.) The product of corruption; putrid matter.
• (n.) The act of corrupting or making putrid, or state of being corrupt or
putrid; decomposition or disorganization, in the process of putrefaction;
putrefaction; deterioration.
14

15. • corruption as ‘doing something beyond the existing rules regulation intending
personal or group interest or doing something illegally for personal or group
interest. Respondents think that terrorism, theft, snatching, robbery, bribing are the
different forms of corruption. Vote rigging, use of muscles power in election,
trafficking of children and women, rape, cheating, abduction- these are the another
form of corruption.
• Respondents also comment that corruption can be economic, social as well as
political.
• The following comments by the participants support this finding:
• doing something illegally is corruption
• doing something violating existing set of rules regulations and law is corruption
• doing something beyond principles is corruption
• doing something for the personal interest violating the prevailing system and social
values is corruption
• vote rigging is a corruption
• dispute of land is corruption
• (terrorism), bribing, theft is corruption
• bribing, nepotism in the case of employment is corruption
• unconsciousness is one sort of corruption
• drug abuse, drug smuggling is a corruption
• for the sack of own interest, all the economical, social injustice is corruption
• negligence of duty is corruption
• misuse of political power is corruption
15

16. • Corruption is defined in section 83 of the Criminal Code (WA) and is taken
to mean any public officer who, without lawful authority or a reasonable
excuse:
• acts upon any knowledge or information obtained by reason of his or her
office or employment;
• acts in any matter, in the performance or discharge of the functions of his
or her office or employment, in relation to which he or she has, directly or
indirectly, any pecuniary interest; or
• acts corruptly in the performance or discharge of the functions of his or her
office; or
• employment, so as to gain a benefit, whether pecuniary or otherwise, for
himself or herself or any person, or so as to cause a detriment, whether
pecuniary or otherwise, to any person, is guilty of a crime and is liable to
imprisonment for 3 years.
16

17. Money Laundering:
Money laundering is the process by which
criminals attempt to conceal the true origin and
ownership of their criminal activities. If
undertaken successfully, it also allows them to
maintain control over those proceeds and
ultimately to provide a legitimate cover for their
source of funds. Their dirty funds appear clean.
It is generally linked with money required to
finance cross border drug trafficking, arms deal
or tax evasion or other similar crimes.
17

18. THEORIES OF FRAUD:
A number of theoretical models have been constructed in
the past in an attempt to explain why people commit fraud.
Some of the key characteristics of recent models include
the following:
A perceived opportunity such as the absence of or circumvention of
controls that enable fraud to be prevented or detected.
An offender with a motivation to steal money, whether through cupidity,
living beyond one's means, the existence of debts some times associated
with drug or gambling addiction, presence of a financial crisis or various
work related pressures.
The presence of a rationalization for acting illegally, such as belief that
the victim can afford the loss, that the funds stolen will be repaid or that
the money will be used for a good purpose by the offender; and finally.
The absence of a capable guardian, whether through proper business
administration, lack of fraud prevention resources or the absence of an
effective police service or regulatory authority.
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19. History of Fraud
• Considering the enormous impact, relatively little
research has been done on the subject of occupational
fraud and abuse. Much of the current literature is
based on the early works of Edwin H. Sutherland
(1883-1950), a criminologist at Indiana University.
Sutherland coined the term “Wite-Collar” crime in
1939.
• Sutherland believed that crime was a learned activity
at a time when most experts believed that crime was
genetically based.
19

20. WHITE COLLAR CRIME
• In 1995, Albanese explained white-collar crime as: “Planned
or organized illegal acts of deception or fraud, usually
accomplished during the course of legitimate occupational
activity, committed by an individual or corporate entity.” It is
clear from these two definitions that a certain form of behavior
is required for white-collar offences, which distinguishes it
from conventional crimes like robbery and assault. For
practical reasons, it is proposed that the definition of white-
collar crime be as follows: “White-collar crime is the unlawful,
intentional commitment of deceit, deception, concealment,
manipulation, breach of trust, subterfuge or any other similar
trickery, by an individual, syndicate or organization, normally
after meticulous planning, with out the use of physical
violence which causes actual economic prejudice or potential
economic prejudice to another.”
20

21. White-collar crime is distinguished from other conventional
crimes like robbery by way of the following general
characteristics:
•Unlike robbery which involves the use of force, white-collar offences are
characterized by careful planning and deception, usually without the use of violence;
• Some form of premeditation and fraudulent activity is typical;
•There is usually an element of concealed misappropriation or deception;
•The white-collar offence is often of a complicated nature which makes it difficult to
prosecute; the crime normally has low visibility in order to obscure its existence;
•There is usually a diffusion of responsibility for the crime;
•Diffusion of victimization is also a characteristic of theses types of crimes
•There does not seem to be a true “victim” when a person defrauds the company he
works for;
•Although the element of fraud is usually found in most white-collar schemes, these
offences can go much further including corruption, forgery, theft and complicated
statutory offences like money laundering of which deceit is usually an element; −
White-collar offences are often demarcated as “rational crimes”;
•A white-collar criminal’s occupation or working conditions often provides 21
opportunities that may be exploited.

22. Some reasons why fraud happens include:
• failure to look for it
• internal audit cover and fraud risk management
skills not always adequate
• poor data integrity and security
• inappropriate authority levels
• recruitment of dishonest employees
• abuse of separation of duties
22

23. The Fraud Triangle
Incentives/Pressures
Opportunities Attitudes/Rationalization
23

24. Types of Fraud
Fraudulent financial reporting
Misappropriation of assets
24

25. TYPES OF FRAUD
Frauds can be categorized by the type of
victim involved. The most common groups of
victims encountered by investigators include:
• Investors
• Creditors
• Businesses
• Banks or other financial institutions
• Central or local government
• Fraud by manipulating financial markets
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26. Stock Fraud
• A crime in which securities investing or trading laws have
been violated. Stock fraud encompasses many things including
stocks, bonds, commodities and other investments. Stock fraud
is illegal and can be described as deceptive practices in the
stock and commodity markets. Stock fraud occurs when
investors are enticed to buy securities based upon false
statements or records. Stock fraud includes providing false
information on a companies financial statement, profit and loss
statements, SEC filings, lying to an auditor, stock
manipulation schemes, insider trading, and embezzlement.
Stock fraud is otherwise known as securities fraud.
26

27. Identity Fraud Survey Report 2006
Source:Javelin 27
Stratgy&Research

28. Brief History of Financial Fraud
• 1907 to 1919 Charles Ponzi, inventor of the
pyramid or "Ponzi" scheme, was sentenced to
10 years in prison for larceny and fraud. He
had raised $15 million before he was caught.
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29. • 1929 International Power's stock price
dropped 78% in one day when it was
revealed that they "cooked the books". The
Securities and Exchange Commission (SEC)
was created in response to the rampant
fraud of the go-go 1920's which were
exposed in the 1929 stock market crash.
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30. • 1932 Ivar Kreuger was caught switching
assets and liabilities and making up assets.
He raised $500 million before he was
caught. In March 1932 he shot himself in
Paris.
30

31. • 1937 Phillip Musica (aka Frank Donald
Coster) was caught with $10 million of
inventory and $9 million of accounts
receivable that didn't exist.
31

32. • 1963 Anthony (Tino) De Angelis of Allied Crude
Vegetable Oil Refining Co. used bottles of water, not
oil, as collateral for $175 million in loans. 1973 Equity
Funding Corporation's net worth of $143.4 million was
discovered to be negative $42.1 million. The company
had been recording fictitious income since
• 1965. Stanley Goldblum and 22 other people were
sentenced for fraud. 1988 Wedtech (Welbilt Electronic
Die Co) was caught using the percentage of completion
method to record revenue that didn't exist, bribing
government officials, lying on government proposals
and contracts, and falsifying invoices. The scandal
involved Congress and the Reagan administration.
Auditors sued for $105 million in damages.
32

33. • 1987 Lincoln Savings and Loan costs taxpayers $2.5 billion
for fraud schemes that involved members of Congress.
Charles Keating recorded profits on junk bonds and real
estate loans that they knew were worthless, and he his
family received $34 million in salary and sales of American
Continental Corporation stock before the scheme crashed.
Savings and Loan scandals cost taxpayers an estimated
$500 billion during the 1980's. 1989 MiniScribe
Corporation, a disk drive manufacturer, fooled their
auditors for 2 years by filling their inventory boxes with
bricks. The auditing company, Coopers & Lybrand, had to
pay $100 million in an out-of-court settlement.
33

34. • 1991 The Bank of Commerce and Credit International (BCCI), known
today as "The Bank of Crooks and Criminals International", was used
to launder money by drug smugglers and embezzling dictators
throughout the world. When the bank was finally shut down, in July
1991, it was found to have stolen, lost, or swindled $20 billion. 1991
Maxwell Communications president Robert Maxwell resorted to
looting when his publishing empire started to collapse, taking $1.4
billion including $800 million from the employee pension fund alone.
He was found dead on November 5, 1991. 1998 When Cendant was
created from the 1997 merger of HFS and CUC, HFS management
discovered that CUC (Comp-U-Card) had been cooking the books, by
reporting false membership sales, since at least 1983. They were
charged with fraud on April 16, 1998. The company had to pay
billions to defrauded investors, and the auditor, Ernst & Whinny, paid
$335 million in an out-of-court settlement. 2000 Micro Strategy had
their share price collapse from $333 to $86 when they announced their
financial reports would be restated to show huge losses. Investors had
pushed the price up based on the hype from one of the tech industry's
most flamboyant CEO's, Michael Saylor, along with bogus financial
statements. The share price was $3 one year later. 2001 Enron,
WorldCom.
34

35. BETTER AUDITS, LESS FRAUD
• As financial and economic pressures tighten for corporate
executives, it is more important than ever for auditors to
develop sound fraud-detection audit techniques. The audit
deficiencies alleged by the SEC between 1987 and 1997 are,
in our view, issues the profession and individual firms can
effectively address. The recommendations included in this
article may help firms reduce the chance of undetected
material financial statement fraud as they strive to continually
improve fraud risk assessment tools. The audit deficiencies the
SEC identified also have important implications for standard
setters as they seek to strengthen professional standards
related to the auditor’s fraud detection responsibilities.
35

36. The result was the following new set of skills needed
by accountants
• Better technology skills
• Better analytical skills—to understand complex
transactions (derivatives, reserves, leverage, etc.)
• Better communication skills – to participate in decision-
making teams
• Better interviewing skills
• Better skills working in teams
• A better global understanding
• Better understanding of fraud
What gave accountants an advantage in the past is no longer nearly as valuable! 36

37. Competencies/Skills Learned
• Risk analysis
• Controls and control environment
• Better auditing skills
• Knowledge of the legal system
• Availability of information (public, private,
databases, etc.)
• Problem-solving ability
Today’s winners are those who have access to the best information a fraud course teaches
how to access information 37

38. :For better Audits educators must
• Need to teach Ethics more
• Need to teach students about fraud—offer
a “fraud” course
• Need to teach students how to think
• We have taught them how to copy, not think
• We have asked them to memorize, not think
• We have done what is easiest for us and easiest for
our students
38

39. • First and foremost is the urgent need for change:
• External and internal auditors must train thoroughly in fraud-
detection procedures and attitudes.
• The university education of the next generation of auditors
should reflect the new emphasis on fraud deterrence,
detection, and investigation.
• The formal standards governing audit processes and objectives
should evolve without delay to an updated and more rigorous
approach to fraud detection.
• Executives and directors must become fully aware of the threat
of fraud and do all they can to institute measures to deter it,
ranging from robustly enforced codes of ethics to internal
controls that make fraud less likely and easier to detect.
39

40. The six key drivers of audit quality (identified in Audit
Quality) are:
• Leadership, including tone at the top and audit firm strategy;
• People of competence, quality and integrity;
• Client Relationships, including effective management of client
portfolios and working with individual clients;
• Working Practices and quality control procedures;
• Internal Monitoring by audit firms of leadership, people, client
relationships and working practices; and
• External Monitoring under public oversight to encourage and
assist firms to improve audit quality.
40

41. 41

42. Risk & Fraud cycle
42

43. Role of Internal & External auditors in fraud detection
• Internal Auditors’ Assessment of Fraud Implications for External Auditors
• Warning Signs: Implications for External Auditors
• External Auditors Can Partner with Internal Auditors
• The AICPA’s have issued SAS 99, Consideration of Fraud in a Financial
Statement Audit, directs external auditors to ask a company’s internal audit
personnel about the risk of fraud and any knowledge of actual or suspected
fraud. The impetus for this directive comes from the important role internal
auditors play in corporate governance. As recognized by the Treadway
Commission Report in 1987, internal auditors are expected to assume an active
role in preventing and detecting fraudulent financial reporting.
43

44. Fraud Conditions
According to SAS 99, three fundamental
conditions are generally present when fraudulent
financial reporting occurs:
1) incentive or pressure to perpetrate fraud,
2) an opportunity to carry out the fraud,
3) attitude or rationalization to justify the fraudulent action.
Within each of the three fundamental conditions, there are
a number of specific warning signs of fraud, including
some factors directed toward corporate governance.
44

45. Auditor’s Professional responsibility
• Certified auditors are required by Statement on Auditing Standards no. 99,
Consideration of Fraud in a Financial Statement Audit, to assess the risk
that financials are materially misstated.
• The Association of Chartered Certified Accountants (ACCA) welcomes
the opportunity to comment on the revised International Standard on
Auditing 240 The Auditor’s Responsibility to Consider Fraud in an Audit
of Financial Statements proposed by the International Auditing and
Assurance Standards Board (IAASB).
• The Institute of Chartered Accountants in England and Wales (ICAEW)
issued comprehensive guidance notes for Chartered Accountants following
the Money Laundering Regulations enactment in 1993. Regarding
conventional frauds, ICAEW issued SAS 110.1 on fraud and error and
fixed up the responsibility of auditors
45

46. • In February 1997, the AICPA auditing standards board (ASB) will issue
Statement on Auditing Standards (SAS) no. 82, Consideration of Fraud in
a Financial Statement Audit (product no. 060675). The new standard
articulates the independent auditor’s responsibility to plan and perform the
audit to obtain reasonable assurance as to whether the financial statements
are free of material misstatement, whether caused by error or fraud, and
provides expanded operational guidance in fulfilling that responsibility.
• Specifically, SAS no. 82
• Describes two types of fraud fraudulent financial reporting and
misappropriation of assets.
• Requires the auditor to specifically assess the risk of material misstatement
due to fraud. It provides categories of risk factors that should be considered
and examples that might indicate the presence of fraud.
• Provides guidance on how the auditor responds to the results of the
assessment and provides guidance on how this should be done and on how
to evaluate test results.
• Requires the auditor to document identified risk factors and any related
response.
46

47. Three of these ISAs (UK and Ireland), which concern the
areas of audit risk and fraud, include a number of
requirements that are additional to those set out in the
SASs theory replace. This Bulletin provided
supplementary guidance for auditors of charities on
these additional requirements, by replacing the sections
of Practice Note (PN) 11 “The Audit of Charities in the
United Kingdom (Revised)” Which cover:
• SAS 210: ‘Knowledge of the business’,
• SAS 300: ‘Accounting and internal control systems and
audit risk assessments’; and
• SAS 110: ‘Fraud and error’.
47

48. Iranian Auditor’s Responsibility to Consider Fraud &
Error in an audit of Financial statements Accordance
with Iran audit standards sec.24
SAS Says:
•Its management’s responsibility:
•Setting the proper tone
•Creating and maintaining a culture of honesty and ethics
•Establishing appropriate controls
48

49. Auditor's Responsibility under Generally
Accepted Auditing Standards
It is important for audit committees to understand what
an audit is and what it is not. Usually, audit committees
are most concerned about the system of internal control
and that the financial statements are free of material
misstatement. The auditor should make sure the audit
committee understands the level of responsibility that
the auditor assumes for the system of internal control
and the financial statements under generally accepted
auditing standards (GAAS). It is also important that the
auditor make sure that the audit committee understands
that an audit is designed to obtain reasonable rather than
absolute assurance about the financial statements.
49

50. The following statistics about fraud and white-collar crime are from the
Association of Certified Fraud Examiners (US) report:
Fraud and abuse costs US organizations more than $400 billion annually.
The average organization loses more than $9 per day per employee to
fraud and abuse.
The average organizations lose about 6% of its total annual revenue to
fraud and abuse committed by its own employees.
The median loss caused by mails is about $185000; by females about
$48000 and thus men commit nearly 75% of the offenses.
Losses caused by managers are four times those caused by employees.
Median losses caused by executives are 16 times those of their
employees
The highest median losses occur in the real estate financing sector.
Occupational fraud and abuses fall into these main categories; asset
misappropriation, fraudulent statements and bribery and corruption.
50

51. Fraud effect in UK
• It is estimated that fraud cost £13 billion in 2000 or £230 for every man, woman
and child in Britain (figures exclusive of money laundering) (City of London
Police, 2002; National Economic Research Associates for the Home office, 2000)
• False motor and household claims cost the insurance industry and policy holders
£20 million per week (Association of British Insurers, April 2003)
• 51% of British businesses have been the victims of fraud in the last two years
(PricewaterhouseCoopers, July 2003)
• Benefit fraud costs £2 billion a year, £80 for every family in the country
(Department of Work and Pensions, June 2003)
• Plastic card fraud alone cost £424.6 million in 2002 – 30% up on the year before
(Association for Payment Clearing Services, April 2003)
• Card-not-present fraud is the largest type of card fraud in the UK. In 2003 losses
were £116.4 million (Association for Payment Clearing Services, April 2004)
• Fraud wrecks ordinary lives by destroying jobs, savings and pensions. 16 investors
took their own lives in the aftermath of the Barlow Clowes fraud (The Serious
Fraud Office, 2002)
51

52. Auditors under fire
Andrew Ratcliffe Chairman of the ICAEW Audit and Assurance
Faculty:
• “Auditors are not, and indeed should not be, held responsible
for detecting all fraud, but we must play our part to improve
the overall detection rate to help maintain public trust in
published accounts following the recent spate of US
accounting scandals.
• We are also concerned about companies that adopt aggressive
accounting practices which might stop short of being clearly
fraudulent. Faced with this risk, auditors will need to more
actively search out aggressive accounting and help ensure that
the right judgments are applied."
52

53. Introduction to Fraud Detection
There are more advanced techniques on this site, but
this is the place to start to get some idea what
techniques you can use for spotting funny numbers.
• Examine cash flow.
• Watch out for "capitalizing" of assets.
• Watch for "channel stuffing.
• Beware "Pro Forma.
• Look for routine write-offs.
• Understand the business.
53

54. Frauds can also be categorized by the technique or activity used by the fraudster.
These include:
•Advance fee frauds
•Bogus invoices
•Computer hacking of information or property
•Corruption and bribery
•Counterfeiting, forgery, or copyright abuse
•Credit Card fraud
•False Accounting - manipulation of accounts and accounting records
•Fraudulent bankruptcy - exploitation of cross-border corporate structures
•Insurance fraud
•Internet online scams - auctions, credit card purchases, investment scams
•Investment fraud
•Long Firm fraud
•Misappropriation of assets
•Money laundering
•Mortgage Fraud
•Payroll fraud
•Principal agents - failure of systems to restrict key individuals
•Pyramid schemes
•Unsolicited letter frauds. 54

55. Fraud Detection: Basic Techniques
• Watch out for two or more businesses controlled by
the same person.
• Revenue and expenses can be arbitrarily shifted
between the two businesses. For example, if a person
controls a retail business and a real estate business, he
can shift revenue from the real estate business when
the retail business has a bad year. Public corporations
frequently share board members and executives with
other corporations.
55

56. • Check their income tax expense and footnotes.
Fraudulent corporations have an incentive to make
their profit number as big as possible for their annual
and quarterly reports, but they have an incentive to
make that number as small as possible for the IRS,
because they have to pay income tax on it! So if the
corporation is reporting large profits but is paying
next to nothing on income tax, they might be lying
either to you, or to the IRS. NOTE: Unfortunately,
this doesn't prove fraud, as the tax code is so ridden
with loopholes that multi-billion-dollar corporations
like General Electric routinely get away with paying
no income tax at all!
56

57. Beware discontinuities that become
“continuities”
• An extraordinary loss or gain should not
become a regular feature of a business's income
statement. If a business is having major
lawsuits, abandoning product lines, or
undergoing major restructuring, that's a sign
that management is either up to something
(fraud), or don't know what they are doing
(poor management).
57

58. • Beware discontinuities that become opportunities to
dump too many write-downs and losses.
• This is the "big bath" theory. The company may run
losses for years, without reporting them, and then
take a "big bath" and write down the losses all at
once. If the company has done this is the past, they
might do it again, and as an investor you don't want
to get caught in the bath.
58

59. Watch for high debt
• A company with too high debt is walking on
the edge of a cliff. Any major problem, and
they get pushed over. Note: Even an acid-test
ratio .
• 1-to-1 may not be enough if you're dealing
with a type of business that depends heavily
on short-term debt.
59

60. • Pay attention to the accounting methods. What
method are they using to determine
• inventory,
• cost of goods sold, and
• depreciation of assets.
• Are they using "mark-to-market" for accounting
their sales revenue? (Enron was.) Companies do
not have to report what their income would have
looked like if they were using different accounting
rules.
60

61. Beware "free cash flow"
• Free cash flow has no officially defined
meaning determined by any authoritative
accounting rule-making body.
61

62. • Look for special gains and losses on the statement
of stockholders' equity.
• The general format of the statement of
stockholders' equity is to use a column for each
class of stock (common stock, preferred stock,
treasury stock, and so on), a column for retained
earnings, and any other components of
stockholders' equity. Special gains and losses
should be reported on the income statement,
underneath the net income line. They should not
be here, on the statement of stockholders' equity.
62

63. • Look for "window dressing" on the balance
sheet.
• This is where numbers are nudged from one
account to another, without changing the
total amount. For example, money could be
moved from accounts receivable to cash, to
make the cash balance look better.
63

64. Watch out for profit smoothing
• A company that has large changes in revenue will
usually use profit smoothing. This involves
moving current income to the future. For
example, suppose the company is a video game
company, and they get massive revenue "spikes"
when a game is released, but relatively low sales
the rest of the time. The company will spread the
money from the "spikes" out over the year, so that
their revenue shows a steady increase from year to
year. Using profit smoothing is legal, but can be
abused.
64

65. Look for sales skimming.
• This is when the owners pocket sales money
without reporting it. One way to spot this is to
look at the gross profit and operating profit
ratios.
65

66. Look for unnecessary dilution of stock.
• If a company is creating shares of stock for sale,
but doesn't actually need the money, then they
could be doing something sneaky. Watch out
for managers that give themselves stock options
(and create new shares in the process) and then
have the company buy back the company stock
off the market. By doing this, they increase their
own share of ownership in the company, at the
expense of everybody else (including you).
66

67. Beware of LLC's
• Limited Liability Corporations, or LLC's, can
have extremely complicated ownership
structures.
67

68. • Examine how indirect costs are allocated.
Indirect costs are costs that cannot be
obviously attributed to specific products,
organizational units, or activities. A book
publisher's phone bill is a cost of doing
business, but it can't be attributed to a
particular book, or a particular step in the
process of producing books. Allocation of
indirect costs is ultimately arbitrary.
Because it is arbitrary, it can be abused. For
example, misclassification of manufacturing
costs as operational costs will make the cost
of producing a product look too low.
68

69. • Watch out for products sold "on approval"
or with right of return. Revenues should
only be booked after the sale is complete
and the goods can no longer be returned.
69

70. • Examine how indirect costs are allocated.
Indirect costs are costs that cannot be
obviously attributed to specific products,
organizational units, or activities. A book
publisher's phone bill is a cost of doing
business, but it can't be attributed to a
particular book, or a particular step in the
process of producing books. Allocation of
indirect costs is ultimately arbitrary.
Because it is arbitrary, it can be abused.
For example, misclassification of
manufacturing costs as operational costs
will make the cost of producing a product
look too low.
70

71. • Watch out for products sold "on approval"
or with right of return. Revenues should
only be booked after the sale is complete
and the goods can no longer be returned.
71

72. Watch out for LIFO inventory.
LIFO is usually the wrong accounting method for
inventory, because:
• most businesses don't raise prices as soon as
replacement costs increase, or base their sales
price on the most recent purchase costs,
• the inventory cost value can get seriously out
of date, especially if the business sells products
that have long lives (an equipment
manufacturer, for example),
• LIFO figures can be more easily manipulated
by unscrupulous management.
72

73. • Make sure the company is using "Lower of
Cost or Market" (LCM) to calculate their
inventory.
• Lower of Cost or Market gives a more
conservative inventory value. Some
managers cheat and use LCM to report an
unusually low inventory for cheating on
income tax.
73

74. • Did the company change depreciation
rules? An unexplained change from
accelerated depreciation to straight-line
depreciation, or to mark-to-market
depreciation should set off alarms.
Companies can make funny money by
playing with depreciation rules, either
writing off too little (and boosting their
balance sheet) or too much. If they write off
too much, it makes their current financial
results look bad, but gives them hidden cash
reserves. They can use these reserves to
boost future sales or offset future expenses.
74

75. • Compare profit ratios with past statements.
• Calculate the gross margin (profit as a
percentage of sales) and see if it changes from
quarter to quarter. Normally it will not
change suddenly. There are many other ratios
you can look at.
75

76. • Examine extraordinary losses.
• Often an extraordinary loss is not the result
of a one-time event, but the cumulative
result of years of bad accounting.
76

77. • See if earnings per share kept up with profit.
• If profit increased by a larger percentage than
earnings per share, and there wasn't any stock
split, or stock offering (with a clearly
explained justification), then management is
diluting the shares. While this doesn't
necessarily mean fraud, it is a red flag that
management doesn't care about shareholder
interests.
77

78. • Compare profit increase with cash flow.
These should increase in lockstep. Usually if
cash flow is low (or negative) it's because all
the profits are in accounts receivable and
haven't been collected yet.
78

79. • Check that increases in assets and liabilities
are consistent with the business's growth.
• If the company is reporting profits quarter
after quarter, but total assets is shrinking,
something is wrong. If most balance sheet
items increase by a few percentage each
year, but one item has a huge jump
• Positive or negative
• Make sure you know the reason why.
79

80. • Look for "other." Most balance sheets have
a catch-all category called "Other assets."
Likewise, most income statements have a
catch-all category called "Other expenses."
These "other" categories should be small
and insignificant. If a significant amount of
assets is in the "other" category, beware!
80

81. 10 STEP ANTIFRAUD PLAN (PWC)
1) Anticipate Questions and Manage Expectations.
2) Assess existing antifraud programs and controls.
3) Secure management and audit committee sponsorship.
4) Assemble fraud expertise within internal auditing.
5) Organize a fraud and reputation risk assessment.
7) Evaluate and test the design and operating
effectiveness of controls.
8) Refine the audit plan to address residual risk and
incorporate fraud auditing.
9) Establish a standard process for responding to fraud
allegations or suspicions.
10) Remediate and prevent recurrence
81

82. What did the auditor say?
Just because the auditor says the books are clean
doesn't mean they are, of course. You should
never trust the auditor. But if the auditor did
raise a red flag, take it very, very seriously! If
the auditor's opinion is qualified by anything,
you should be more skeptical of the entire
financial statement -- not just the item that the
auditor expressed concern about. If the auditor
expresses concern about the company's ability to
be a "going concern", the auditor is saying the
business is about to be forced into bankruptcy.
82

83. What Arthur Anderson Said
Bauer, the chief auditor of Enron’s wholesale division,
“I did not know the company was using reserves to
meet earnings targets and would not have approved if
he had known, the Chicago Tribune reports. “No one
gave me this information,” Bauer said. “That’s
earnings management; that’s never OK. . . . Enron had
an obligation to me to provide all documents, all
agreements, oral or written and they didn’t do that,”.
AccountingWEB.com - Mar-24-2006
83

84. • Is the auditor also doing consulting?
Consulting may be referred to as
"corporate finance," "eBusiness," "human
capital," " legal services," "outsourcing,"
"risk management," "tax services", and so
on. Doing audits and consulting is a deep
conflict of interest, as the Enron scandal
well demonstrates.
84

85. Consequences of Fraud
• Lost confidence in capital markets
• Lawsuits—one company has over 3,000
• Firms going out of business—huge bankruptcies
• Lost reputation and bad press
• Longer and more expensive audits, special inquiries
• Fines & investigations
• Damaged employees & reputations
• Lost retirement and pension funds—now down 45%
• Directors with personal liability, forced resignations
• Losses from fraud
• Significant legislative activity
85

86. Financial Statement Frauds
• Revenue/Accounts Receivable Frauds (Global
Crossing, Quest, ZZZZ Best)
• Inventory/Cost of Goods Sold Frauds
(PharMor)
• Understating Liability/Expense Frauds (Enron)
• Overstating Asset Frauds (WorldCom)
• Overall Misrepresentation (Bre-X Minerals)
86

87. Revenue-Related Transactions and Frauds
Transaction Accounts Involved Fraud Sche me s
1. Estimate all Bad debt expense, allowance for 1. Understate allowance for doubtful accounts, thus
uncollectible accounts doubtful accounts overstating receivables
receivable
2. Sell goods and/or Accounts receivable, revenues 2. Record fictitious sales (related parties, sham sales,
services to customers (e.g. sales revenue) (Note: cost of sales with conditions, consignment sales, etc.)
goods sold part of entryh is 3. Recognize revenues too early (improper cutoff,
included in Chapter 5) percentage of completion, etc.)
4. Overstate real sales (alter contracts, inflate
amounts, etc.)
3. Accept returned goods Sales returns, accounts receivable 5. Not record returned goods from customers
from customers 6. Record returned goods after the end of the period
4. Write off receivables as Allowance for doubtful accounts, 7. Not write off uncollectible receivables
uncollectible accounts receivable 8. Write off uncollectible receivables in a later period
5. Collect cash after Cash, accounts receivable 9. Record bank transfers as cash received from
discount period customers
10. Manipulate cash received from related parties
6. Collect cash within Cash, sales discounts, accounts 11. Not recognize discounts given to customers
discount period receivable
87

88. Inventory/Cost of Goods Sold Frauds
Transaction Accounts Involve d Fraud Sche me s
1. Purchase inventory Inventory, accounts 1. Under-record purchase
payable 2. Record purchases too late
3. Not record purchases
2. Return merchandise to Accounts payable, 4. Overstate returns
supplier inventory 5. Record returns in an earlier period (cutoff problem)
3. Pay vendor within discount Accounts payable, 6. Overstate discounts
period inventory, cash 7. Not reduce inventory cost
4. Pay vendor without discount Accounts payable, cash Considered in another chapter
5. Inventory is sold; cost of Cost of goods sold, 8. Record at too low an amount
goods sold is recognized inventory 9. Not record cost of goods sold nor reduce inventory
6. Inventory becomes obsolete Loss on write-down of 10. Not write off or write down obsolete inventory
inventory, inventory
7. Inventory quantities are Inventory shrinkage, 11. Over-estimate inventory (use incorrect ratios,
estimated inventory etc.)
8. Inventory quantities are Inventory shrinkage, 12. Over-count inventory (double counting, etc.)
counted inventory
9. Inventory cost is Inventory, cost of goods 13. Incorrect costs are used
determined sold 14. Incorrect extensions are made
15. Record fictitious inventory
88

89. Role of Andersen in Enron Case
• Was paid $52 million in 2000, the majority for non-audit related consulting
services.
• Failed to spot many of Enron’s losses
• Should have assessed Enron management’s internal controls on derivatives
trading—expressed approval of internal controls during 1998 through 2000
• Kept a whole floor of auditors assigned at Enron year around
• Enron was Andersen’s second largest client
• Provided both external and internal audits
• CFOs and controllers were former Andersen executives
• Accused of document destruction—was criminally indicted
• Went out of business
• My partner friend “I had $4 million in my retirement account and I lost it all. ”
Some partners who transferred to other firms now have two equity loans and
no retirement savings.
89

90. Timeline of Arthur Anderson events
1996 Arthur Andersen has an audit failure in Waste Management; Andersen paid a
censure of $7 million.
1997 Arthur Anderson has an audit failure in Sunbeam; Andersen paid $110 million to
settle shareholder litigations.
January 1997 Jeffery Schilling is named president and COO of Enron. Schilling implements his
assets are bad intellectual assets are good campaign to “clean up” Enron’s financial
statements. Begins using the LJM partnerships run by Andrew Fasted, Enron’s CFO.
Early 2001 Jim Chinos takes note of Enron’s lack of money-making activities and begins to
wonder about the LJM partnerships.
February 2001 Skilling’s promotion to CEO takes effect, he replaced Charles Lay.
June 2001 Enron executives sell shares as stocks slid 39% in the first quarter.
August 2001 Schilling quits for personal reasons, and Charles Lay is named CEO again.
Oct. 16, 2001 Enron reports a third quarter loss of $618 million. They cite the loss as being
partially due to the LJM partnerships.
Oct. 22, 2001 SEC starts an investigation into the LJM partnerships, and CFO Fasted leaves
Enron.
Nov. 8, 2001 Enron’s Net income back through 1997 is revalued by $586 million.
Nov. 9, 2001 Synergy offers to buy Enron for $10 billion.
Nov. 28, 2001 Synergy refuses to buy Enron.
Dec. 2 ,2001 Enron Files for Bankruptcy.
90

91. Largest Bankruptcy Filings
(1980 to Present)
from BankruptcyData.com
Company Assets (Billions) When Filed
1. World Com $103.9 July 2002
2. Enron $63.4 Dec. 2001
3. Conseco $61.4 Dec. 2002
4. Texaco $35.9 April 1987
5. Financial Corp of America $33.9 Sept. 1988
6. Global Crossing $30.2 Jan. 2002
7. PG&E $29.8 April 2001
8. UAL $25.2 Dec. 2002
9. Adelphia $21.5 June 2002
10. MCorp $20.2 March 1989
91

92. Fraud Trick
Revenue Recognition
One means of manipulating financial results is to record revenue before it has
been earned. This historically has been accomplished by recording revenue
early or recording transactions as sales that do not meet the criteria of sales.
Some of the common revenue recognition schemes include:
1. Recognizing revenue before a sale has actually occurred
2. Keeping the books open at month’s end to record the first few days’ sales of the
following month
3. Shipping to the company’s warehouses but billing as sales
4. Shipping goods to customers knowing they will be returned without providing
appropriate return allowances
5. Shipping and billing goods not wanted by the customer until a later date
6. Shipping to accounts funded by the vendor
92

93. Misuse of Estimates
The use of estimates is a normal occurrence in
accounting and can include the following:
1. Allowance for bad debts
2. Allowance for inventory obsolescence
3. Allowance for anticipated warranty claims or returned
goods
4. Estimates of percentage of completion of a project Be
warned, however, that estimates are open to bad faith
manipulation. By means of adjusting estimates, earnings
can be increased or decreased by a simple journal entry.
93

94. Purchase Reserves
• In cases where a business has been acquired, it is acceptable under Generally Accepted
Accounting Principles to set up a purchase reserve. For example, the reserve may be intended
to cover costs identified with closing down part of the acquired company’s operations. Yet it is
possible that the reserve can be deliberately overstated, with the intent of writing off current
operating expenses against the reserve. This has the effect of understating expenses, thereby
overstating income.
Asset Overstatement
• Each asset has a basis of valuation. By changing the valuation basis, the asset can be
overstated. For instance, inventory may normally be valued at average cost. By changing the
valuation to most recent cost, in a market where prices are rising, the inventory value can be
adjusted upward. In other instances, companies have counted inventory in one location, then
have simply moved the inventory to another location where it is counted again, thereby
overstating inventory value.
Liability Understatement
• The simplest means of understating liabilities is to not record them in a timely manner.
Liabilities may be understated by recording a reduced accrual for vacation pay or bonuses.
Capitalization of Expenses
• The bottom line can be manipulated by capitalizing expenses rather than recognizing them
currently. Under GAAP, there are guidelines for determining when this is acceptable. On a
legitimate basis, this may involve software development, costs associated with acquisition of
capital assets and business start-ups. However, by capitalizing expenses inappropriately, the
bottom line can be increased and the assets overstated.
94

95. Undertaking the financial investigation
• Given the complexity of financial accounting and reporting today, the investigation
may need a multifaceted team. Consider the following non-legal capabilities:
• Forensic accountants are skilled in the reconstruction and analysis of accounting
records and business transactions, as well as conducting detailed financial
interviews. Knowing where to look and understanding what’s beneath the numbers
is a skill gained through years of experience.
• Computer forensics practitioners may be necessary to gather and recover evidence
that may have been stored on computer hard drives or on servers. It has become
increasingly common that critical evidence is found in recovered data files that
users thought had been erased from their hard drives or email logs.
• Technology specialists may be required due to the complexity of the computer
systems. Whether the issue is analyzing data from multiple systems at multiple
locations, or retrieving millions of relevant records and then effectively analyzing
them, it takes special expertise to design the solution that will be required. Industry
specialists may also be needed to provide insights into unique practices and
industry norms.
95

96. South Sea Company 1720 Equitable Life 2000
Saving and Loan crisis 1980 Enron Corporation 2001
Braniff International Airways 1982 HIH Insurance 2001
Laker Airways 1982 One.Tel 2001
De Lorean 1983 Ansett 2001
Zzzz Best 1987 Sabena 2001
First Jersey Securities 1987 TWA 2001
Drexel Burnham Lambert 1990 Webvan 2001
BCCI 1991 Arthur Anderson 2002
Eastern Air Lines 1991 Global Crossing 2002
Pan Am 1991 Swissair 2002
Confederation Life 1994 WorldCom 2002
Barings Bank 1995 Health South 2003
Fokker 1996 IG Farben 2003
Bre-X Minerals 1997 Parmalat 2003
Pixelon 2000 Red Letter Day 2005
Lernout & Hauspie 2000 Jetsgo Corporation 2005
96

97. ?Who turn next
• SEC considers post-Big Four world
• SEC ponders life after Big Four
• E&Y fights for its future
• Deloitte and Grant Thornton face £5bn Parmalat lawsuit
• KPMG sorry for sheltering taxes for rich
AIG reveals secretive executive pay
• Grant Thornton expels Italian firm
• Lawyers question PwC over Tyco
• PWC faces $100m lawsuit over audit work
• KPMG auditors to face SEC over Ahold
• Former KPMG partner agrees Xerox settlement
• KPMG pays the penalty for Xerox work
• Deloitte hit with record $50m charge on audit of US telecoms company Adelphia
• Deloitte could face tax probe over MG Rover accounts
• Shell auditors (PWC & KPMG) and former FD face lawsuit
• KPMG to Pay $456 Million for Criminal Violations
97

98. : Sources
1. Business Fraud (The Enron Problem), W.Stove Albert, Brigham Young University
2. FSA Presentation Fraud, W.Stove Albert, May 2003, Chicago, Illunious
3. Financial Institution Fraud and Failure report Fiscal year 2003
4. Journal of Accountancy online year 2003-2004
5. Journal of Accountancy online, 2002-2005
6. AICPA address Fraud in audit committee guidance
7. IIA Website
8. AICPA Website
9. ACFE Website
10. Research of Dayarayan Auditing & Financial Services Firm about Fraud in Tehran Stock
Exchange
11. Website of financial reporting council (FRC)
12. Audit Risk & Fraud Supplementary guidance for auditors of occupational pension schemes,
Bulletin May 2005
13. Audit Risk & Fraud Supplementary guidance for auditors of charities, Bulletin Feb. 2005
14. Audit Risk & Fraud Supplementary guidance for auditors of investment business, Bulletin April
2005
15. The auditing practices board- Bulletin
16. Fraud Examines Manual (ACFE) 2006, US edition
17. Switzerland The largest Money Laundering Centre in The World By:Dr Ali Sahraeean
18. Iran Audit Standard, sec. 24
98