Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Fraud Examination, 4E Chapter 5: Recognizing the Symptoms of Fraud

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objectives  Understand how symptoms help in the detection of fraud.  Identify and understand accounting symptoms of fraud.  Describe internal controls that help detect fraud.  Identify and understand analytical symptoms of fraud.

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objectives  Explain how lifestyle changes help detect fraud.  Discuss how behavioral symptoms help detect fraud.  Recognize the importance of tips and complaints as fraud symptoms.

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Symptoms of Fraud Can be separated into six groups: 1.Accounting anomalies 2.Internal control weaknesses 3.Analytical anomalies 4.Extravagant lifestyle 5.Unusual behavior 6.Tips and complaints

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elgin Aircraft Case Accounting Anomalies  result from unusual processes or procedures in the accounting system Example:  the 22 phony doctors  checks were sent to the same two common addresses Why?  managers trusted the perpetrator completely  auditors merely matched claim forms with canceled checks

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elgin Aircraft Case Internal Control Weaknesses Example:  Manager had not taken a vacation in 10 years  Employees never received payment confirmations  Payments to new doctors were never investigated or cleared

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elgin Aircraft Case Analytical Anomalies  relationships in financial or nonfinancial data that do not make sense $12 million be paid to only 22 doctors over a period of four years

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elgin Aircraft Case Lifestyle Symptoms The manager…  took the employees to lunch in a limousine  lived in a very expensive house  drove luxury cars  wore expensive clothes and jewelry  was “independently wealthy”  inherited a large sum of money  yet never took a vacation!

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elgin Aircraft Case Behavioral Symptoms  The manager had a “Dr. Jekyll and Mrs. Hyde” personality  Her highs and lows had become more intense and more frequent in recent months The Eligin Aircraft fraud was discovered because an observant auditor noticed a fraud symptom.

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Accounting Anomalies Common anomaly frauds involve:  Irregularities in source documents  Faulty journal entries  Inaccuracies in ledgers

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Accounting Anomalies Irregularities in Source Documents Include the following:  Missing documents  Stale items on bank reconciliations  Excessive voids or credits  Common names or addresses of payees or customers  Increased past-due accounts  Increased reconciling items  Alterations on documents

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Accounting Anomalies Irregularities in Source Documents Include the following (cont.):  Duplicate payments  Second endorsements on checks  Document sequences that do not make sense  Questionable handwriting on documents  Photocopied documents

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Faulty Journal Entries Fraud is hidden by using accounting language Legal Expense ,000 Cash ……………5,000 English:  “An attorney was paid $5,000 in cash” Accounting:  “Debit Legal Expense; Credit Cash” Was the attorney really paid $5,000?

Albrecht, Albrecht, Albrecht, Zimbelman Faulty Journal Entries Do embezzlers leave the accounting equation in balance?????? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Faulty Journal Entries  An embezzler steals assets, such as cash or inventory  Embezzler must decrease either liabilities or equities  Decreasing liabilities is not a good concealment method  Reasons not to change dividends, stock accounts, or revenues  Embezzler usually increases expenses

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Faulty Journal Entries Common journal entry fraud symptoms:  Journal entries without documentary support  Unexplained adjustments to receivables, payables, revenues, or expenses  Journal entries that do not balance  Journal entries made by individuals who would not normally make such entries  Journal entries made near the end of an accounting period

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Inaccuracies in Ledgers Fraud symptoms relating to ledgers:  Ledger that does not balance  the total of all debit balances does not equal the total of all credit balances  Master (control) account balances do not equal the sum of the individual customer or vendor balances

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Internal Control Weaknesses Internal control fraud symptoms include :  Lack of segregation of duties  Lack of physical safeguards  Lack of independent checks  Lack of proper authorization  Lack of proper documents and records  Overriding of existing controls (most common)  Inadequate accounting system

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Internal Control Weaknesses  Three simple procedures to prevent small business fraud 1.Owners should open and reconcile bank statements 2.Pay everything by check so there is a record 3.Owners should sign every check themselves

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Analytical Fraud Symptoms Analytical Fraud symptoms include:  Unexplained inventory shortages or adjustments  Deviations from specifications  Increased scrap  Excess purchases  Too many debit or credit memos  Significant increases or decreases in account balances, ratios, or relationships

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Analytical Fraud Symptoms  Physical abnormalities  Cash shortages or overages  Excessive late charges  Unreasonable expenses or reimbursements  Excessive turnover of executives

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Analytical Fraud Symptoms  Strange financial statement relationships, such as  Increased revenues with decreased inventory  Increased revenues with decreased receivables  Increased revenues with decreased cash flows  Increased inventory with decreased payables  Increased volume with increased cost per unit  Increased volume with decreased scrap  Increased inventory with decreased warehousing costs

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Extravagant Lifestyles Example Kay…  Embezzled $3 million from her employer  Bought a $500,000 or more home  Bought five luxury cars  Filled home with artwork and glass  Bought a boat  Paid cash to have yard landscaped  Served lobster flown in from the east coast

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Unusual Behaviors

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Tips and Complaints  Elements of fraud  Theft act  Concealment  Conversion  Company employees are in the best position to detect fraud

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Tips and Complaints Why are tips and complaints just symptoms?  Many tips and complaints turn out to be unjustified  Difficult to know what motivates a person to complain or provide a tip  Customers may feel taken advantage of  Employee may have malice, personal problems, or jealousy  Spouses and friends may be motivated by anger, divorce, or blackmail  Individuals should always be considered innocent until proved guilt

Albrecht, Albrecht, Albrecht, Zimbelman © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Tips and Complaints Why people are hesitant to come forward:  Impossible to know for sure that a fraud is taking place  Fear of being the whistle-blower  Intimidation by the perpetrator  Feel that squealing on someone is wrong  Not easy to come forward Three frauds that were detected by tips and complaints or that involved whistle-blowers are the GE fraud, the Revere Amored Car Company fraud, and the fraud at Enron.