FRAUD EXAMINATION ALBRECHT, ALBRECHT, & ALBRECHT Proactive Approaches to Detecting Fraud CHAPTER 6

Learning Objectives 1.Explain the importance of proactive fraud detection. 2.Describe the role of commercial data- mining software plays in detection. 3.List the advantages and disadvantages of data mining and digital analysis. 4.Recognize Benford’s Law.

Learning Objectives 5.Understand inductive fraud detection. 6.Identify how fraud is detected by analyzing financial statements.

How is the Case of Mr. Hamanaka Typical of Most Frauds? It started small and grew much larger!

Match Terms and Definitions. Inductive fraud detection Deductive fraud detection Commercial data-mining software Benford’s Law Determining the types of fraud that can occur then query to see if they exist Proactively searching for fraud without determining the type of fraud to look for A mathematical algorithm that predicts the percentage a digit will occur Commercial software used to detect patterns in data

Differentiate Between Detecting & Investigating Fraud. Detection Discovery of Fraud Answers the Question: Does a fraud exist? Investigation Preceded by Detection Proving a Fraud Answers the Questions: How? Who? Why? What? Where? When a fraud took place?

Explain 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

Review How Benford’s Law Works. Examines the Frequency of Digits Appearing in a Database of Invoice #s or Amounts 0-9 Do Not Appear 10% Each

List 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

5. Follow Through with Investigation to Determine if Fraud Exists or Not What is the 5 step Process for Inductive 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

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.

Compare the 3 Approaches. Statistical analysis provides lots of symptoms and is very useful for discovering vendor kickback frauds.

Compare the 3 Approaches The Inductive Approach is the most expensive to use.

Summarize the Process Which Results in Financial Statements. Effects Investor or Creditor Decisions Economic Transaction Produces Journal Entry Posted Financial Statements Analysis General Ledger Summar- ized Source Documents Analysis

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 effect F/S, detected during analysis of unexplained changes in F/S

Explain How Revenue Affects the Company’s Accounts. If Sales Increase Then Accounts Receivable Revenue Cost of Goods Sold Inventory

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

Match Ratio to Name. Current CA – Inventory Average A/R Current Assets Current Liabilities Sales Average A/R 365 Days A/R Turnover Days in Receivables Quick Test

Match Ratio to Name. Receivables % Inventory Turnover Days in Inventory Bad Debt % Bad Debt Expense Average A/R 365 Days Inventory Turnover Cost of Goods Sold Average A/R Accounts/Receivable Total Assets

Match Ratio to Name. Cost of Goods Sold Percent Property, Plant & Equipment Percent Sales Return Percent Inventory Percent Cost of Goods Sold Total Sales Sales Returns Total Sales Inventory Total Assets Sales Ave. Property Plant & Equipment

Match Ratio to Name. Debt to Equity Total Liabilities Total Assets Net Income # Share of Stock Outstanding Total Liabilities Total Equity Net Income Net Sales Profit Margin Days in Receivables Debt Percentage

Describe How to Perform Vertical Analysis on: An Income Statement A Balance Sheet

Describe How to Perform Horizontal Analysis on: An Income Statement A Balance Sheet

What Questions Should Asked 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?

Statement of Cash Flows Cash Flows From Investments From Borrowings and Stock Issuances From Earnings To Operations For InvestmentsTo Pay Off Loans Dividends Cash Balance

Discuss the Use of Software for Detecting & Identifying Fraudsters.  Difficulty of the List Information - Information can be in multiple formats  Fuzzy Logic