Indiana State University

Forensic Accounting

By Dr. Thomas D. Harris

Background

Two events really brought forensic accounting to the forefront from 2000-2002 September 11, 2001 Corporate Frauds & Scandals

Definitions

Forensic Accounting Involves not only fraud, but also

bankruptcy, business valuation & disputes, divorce and a host of other litigation support services – used as expert witnesses

Definitions

Fraud Examination May be defined as resolving allegations of

fraud from tips, complaints, or accounting clues.

Typically performed by accountants but they are also conducted by professionals in other fields, such as law enforcement agencies, corporate security, specialists or private investigators.

Definitions

Fraud Examination and Auditing Related, but not the same. A fraud

examination encompasses much more than just a review of financial data; it also involves techniques such as interviews, statement analysis, public record searches and forensic document examination.

Definitions

Fraud can be defined as any crime for gain that uses deception as its principle modus operandi

Definitions

Under Common Law, four elements must be present for a fraud to exist: Material false statement Knowledge that the statement was false

when it was uttered Reliance on the false statement by the

victim Damages resulting from the victim’s

reliance on the false statement

2006 ACFE Report to the Nation

Association of Certified Fraud Examiners Report to the Nation on Occupational Fraud and Abuse The study is based on data compiled from

1134 cases of occupational fraud investigated between Jan 2004 and 2006.

Each case was reported by a CFE who investigated the case

2006 ACFE Report to the Nation

Joseph Wells has written a book on Occupational Fraud & Abuse Asset Misappropriation – any scheme that

involves the theft or misuse of an organization’s assets

Corruption – any scheme in which a person uses his or her influence in a business transaction to obtain an unauthorized benefit contrary to that person’s duty to his or her employer

2006 ACFE Report to the Nation

Fraudulent Financial Statements -Falsification of an organization’s financial statements to make it appear more or less profitable

Executive Summary

Occupational fraud and abuse imposes enormous costs on an organization Median loss was $159,000 Nearly ¼ of the cases were at least 1

million 9 cases caused losses of $1 billion or more

Executive Summary

CFE estimated that 5% of an organization’s revenues are lost to fraud 5% of revenues translates to

approximately $652 billion Occupational frauds are more likely to be

detected by a tip than by other means such as internal audits, external audits or internal controls

Executive Summary

Certain anti-fraud controls can have a measurable impact on organization’s exposure to fraud Organizations with anonymous fraud

hotlines suffered a median loss of $100,000, whereas organizations without hotlines had a median loss of $200,000

Executive Summary

Report includes organizations representing a wide range of industries

Highest Median Losses Wholesale Trade $1 million Construction $ 500,000 Manufacturing $ 413,000

Lowest Median Losses Government Orgs $ 82,000 Retail Organization $ 80,000

Executive Summary

Small Businesses continue to suffer disproportionate fraud losses Less than 100 employees median loss

$190,000 Fraudulent Check Writing Skimming Revenues Processing Fraudulent Invoices

Executive Summary

One reason small businesses suffer such fraud is that they generally do a poor job of proactively detecting fraud Less than 10% had a fraud hotline Less than 20% had internal audit

departments

Executive Summary

Size of the loss caused by occupational fraud is strongly related to the position of the perpetrator Owner/Executive – median loss $1 million Five times more than Managers Thirteen times more than Employees

Executive Summary

Less than 8% of the perpetrators had convictions prior to committing frauds

The Fraud Triangle

Donald R. Cressey (1919-1987) Indiana University Criminologist “Trusted persons become trust violators when they

conceive of themselves as having a financial problem which is non-sharable, are aware the problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct that situation verbalization which enables them to adjust their conceptions of themselves as trusted persons with their conception of themselves as users of the entrusted funds or property.”

Fraud Triangle

Perceived Pressures

Fraud Triangle

Opportunity

Rationalization

Primary Control Procedures

Segregation of Duties Systems of Authorization Independent Checks Physical Safeguards Documents and Records

Adopting Proactive Anti-Fraud Deterrence Policies Tone at the top Employee Education in Fraud Deterrence

The fraud-educated workforce is the fraud examiner’s best weapon – by far

Proactive Fraud Policies begin with a higher stance by managers, auditors & fraud examiners i.e. bring fraud out of the closet. You must let employees know you are looking for

fraud

Adopting Proactive Anti-Fraud Deterrence Policies Increase the use of Analytical Review

Use computer-aided audit tests

Surprise audits where feasible Adequate Reporting Programs to deter fraud

Fraud, waste, and abuse occur at some level in nearly every organization

This conduct costs jobs, raises and profits The organization actively encourages employees to

come forward with information

Adopting Proactive Anti-Fraud Deterrence Policies

There are no penalties for furnishing good-faith information

There is an exact method for reporting such as the fraud hotline

A report of suspicious activity does not have to be made by the employee to his or her immediate supervisor