1. Shenanigans 1-4 Article Overview Data Driven Fraud Detection Today’s Topics FORENSIC ACCOUNTING - BA124 – Spring 2015 6-1

2. FORENSIC ACCOUNTING - BA124 – Spring 2015 Shenanigan Update Shenanigan #1 Shenanigan #2 Shenanigan #3 Shenanigan #4 6-2

3. FORENSIC ACCOUNTING - BA124 – Spring 2015 Shenanigan #1 Technique #1: –Recording revenue when obligations remain Technique #2: –Recording revenue in excess of contract value Technique #3: –Recording revenue before buyer’s acceptance Technique #4: –Recording revenue when payment is not assured 6-3

4. FORENSIC ACCOUNTING - BA124 – Spring 2015 Revenue Red Flags Aggressive Rev. Rec. Policies Rise in unbilled receivables Rising receivables Rising allowance for doubtful accounts Increased returns 6-4

5. FORENSIC ACCOUNTING - BA124 – Spring 2015 Earnings Manipulation Shenanigan #2- Recording Bogus Revenue Technique #1: –Lack of economic substance Technique #2: –Lack of arm’s length Related parties “Round-trip” transactions Supplier rebates Technique #3: –Non-operating revenue transactions Investment income as operating revenue Loans recorded as revenue Technique #4: –Recording revenue at inflated amounts Priceline.com Technique #5: –Post merger deferred revenue 6-5

6. FORENSIC ACCOUNTING - BA124 – Spring 2015 Shenanigan #3- Boosting (Operating) Income Technique #1: –Boosting income using one-time events Selling of undervalued assets Technique #2: –Boosting income through misleading classifications Including investment gains in ops. income Reducing opex by investment gains Reclassifying balance sheet accounts 6-6

7. FORENSIC ACCOUNTING - BA124 – Spring 2015 Shenanigan #3 Warning Signs Turning sales proceeds into recurring income Shifting operating expenses Recurring “restructuring” costs Influence misinterpretation impact on income statement 6-7

8. FORENSIC ACCOUNTING - BA124 – Spring 2015 Shenanigan #4- Expense Shifting with Assets… Think WorldCom Technique #1: –Capitalizing normal operating costs-AOL Technique #2: –Slow amortization/depreciation (somewhat subjective)-Time Warner Telecom Technique #3: –Failing to write-down impaired assets-Coldwater Creek Technique #4: –Reducing asset reserves-Vitesse 6-8

9. FORENSIC ACCOUNTING - BA124 – Spring 2015 Shenanigan #4 Red Flags Changes in capitalization policy pre-IPO Late accounting change announcements 6-9

10. FORENSIC ACCOUNTING - BA124 – Spring 2015 Transparency is Key Are the #s telling the story or making the story? Is the company managing the business or managing the #s? What is, is? versus What is. Is! Recall SFAC #1 –Improved decision making –Insight into future cash flows –Resource information 5-10

11. “Fakin’ It”….Fraud inside the fraud at Enron “Fraud Prevention Education…”…SJSU is ahead of the curve “No Free Pass”…revised interest in enforcing FCPA “Fraud Finds…”…SOX has helped the assessment of fraud “Oddsmakers…”…finding fraud on the field Article Overview FORENSIC ACCOUNTING - BA124 – Spring 2015 6-11

12. Data Analysis & Fraud Detection Data Analysis Process Data Analysis Software Data Access Challenges Data Analysis Techniques FORENSIC ACCOUNTING - BA124 – Spring 2015 12

13. Data Analysis Process Understand the business Brainstorm frauds Identify fraud symptoms Use technology to collect symptom data Analyze the data Investigate selected symptoms FORENSIC ACCOUNTING - BA124 – Spring 2015 13

14. Data Analysis Software ACL CaseWare Picalo Microsoft + Active Data FORENSIC ACCOUNTING - BA124 – Spring 2015 14

15. Data Access Challenges and Tools Open database connectivity (ODBC) Text importing-extensible markup language (XML) Data warehousing FORENSIC ACCOUNTING - BA124 – Spring 2015 15

16. Data Analysis Techniques Benford’s Law Time trends Fuzzy matching Matosas and real time analysis FORENSIC ACCOUNTING - BA124 – Spring 2015 16

17. Benford’s Law Occurrence of digits in a random number sequence Series starting with 1’s greater than 2’s; 2’s greater than 3’s, etc. Effective for locating falsified trends FORENSIC ACCOUNTING - BA124 – Spring 2015 17

18. Financial Statement Analysis Methodology Trends Ratios Horizontal analysis Vertical analysis What looks out of the ordinary FORENSIC ACCOUNTING - BA124 – Spring 2015 18