FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Today’s Topics n Revenue Frauds n Inventory Frauds n Liability Frauds n Other Asset Frauds n Disclosure Frauds

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 General Detection Model n Period to period account balance analysis n Period to period relationship analysis n Comparison with industry averages n Comparison with physical assets n General horizontal and vertical analysis

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Revenue Frauds n Shenanigans #1 and #2 n Tables pps n Revenue cycle n Sell goods or services n Estimate collectibility n Returns n Write-offs n Collect cash

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Revenue Fraud Detection n Detection n Accounting anomilies n Ratios (p.408)

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Inventory Frauds n Shenanigan #4 n Tables pps n Inventory cycle n Purchase inventory n Returns n Payment n Sell inventory n Write offs n Estimate or count inventory n Value inventory

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Inventory Fraud Detection n Detection n Statement of cash flows n Comparison with physical assets n Ratios (p.421)

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Liability Fraud n Shenanigan #5 n Table p. 449 n Liability cycle n Purchase goods and services n Incur accruals n Sell goods and services n Borrow money n Payments on account n Assess contingencies

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Liability Fraud Detection n Types n Understatement n Unearned revenue n Omission of debt and contingencies n Detection n Accounting anomilies n Ratios (p.455)

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Other Asset Fraud n Shenanigan #4 n Chart-p. 458 n Table-p. 464 n Types n Overstatement n Improper capitalization n Understated write offs

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Other Asset Fraud Detection n Detection n Accounting anomilies n Ratios (pps )

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Inadequate Disclosure Fraud n Misrepresentation n Company and its products n Via financial reports n Via footnote disclosures

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Disclosure Fraud Detection n Detection n KTT n Questions on pps n Use common sense n Compare footnotes n Vigorous use of inquiries n Go outside the box! n Fraud Buster Ratio n (NI - CFO)/Total Assets; should approach zero n Condition worsens as result grows

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Financial Fraud Detection n KTT is the key n Note audit related procedures C12 & C13- Appendix A n Use the Fraud Exposure Rectangle n Management & Directors n Background, motivation & influence n Company relationships n Obligations, related party transactions & compliance n Nature of organization & industry n Financial results & operations n GAAP, attitude

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Shenanigan #4- Expense Shifting with Assets… Think WorldCom n Technique #1: n Capitalizing normal operating costs-AOL n Technique #2: n Shift of expenses to earlier period due to accounting change-Snapple n Technique #3: n Slow amortization (somewhat subjective)-Orion Pictures n Technique #4: n Failing to write-down impaired assets-Lockheed n Technique #5: n Reducing asset reserves-Lucent

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Shenanigan #4 Red Flags n Changes in capitalization policy pre- IPO n Late accounting change announcements

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Shenanigan #5- Liability Games… Failure to record or understatement n Technique #1: n Failure to record-intentional or unintentional n Technique #2: n Reducing liabilities by changing assumptions-tax provisions and reserves n Technique #3: n Questionable cookie jar reserves-Chainsaw Al Dunlap and Sunbeam Corporation n Technique #4: n Sham rebates-rebate used to reduce COGS n Technique #5: n Early revenue recognition versus revenue received in advance

FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1 Transparency is Key n Are the #s telling the story or making the story? n Is the company managing the business or managing the #s? n What is, is? versus What is. Is! n Recall SFAC #1, now #8 n Improved decision making n Insight into future cash flows n Resource information