2. Avoiding Fraudulent Dealings Cooking the books

3. Cooking the Books 10% of all frauds are financial statement frauds Average cost of about 2 million per scheme Collusion and Power are the main contributors

4. Frequency of Fraud

5. Cost in Value

6. Who Commits Financial Statement Fraud? Senior management Mid- and lower-level employees Organized criminals

7. Why Do People Commit Financial Statement Fraud To conceal true business performance To preserve personal status/control To maintain personal income/wealth

8. Why Senior Management Will Overstate Business Performance To meet or exceed the earnings or revenue growth expectations of stock market analysts To comply with loan covenants To increase the amount of financing available from asset-based loans To meet a lender’s criteria for granting/extending loan facilities To meet corporate performance criteria set by the parent company

9. Why Senior Management Will Overstate Business Performance To meet personal performance criteria To trigger performance-related compensation or earn-out payments To support the stock price in anticipation of a merger, acquisition, or sale of personal stockholding To show a pattern of growth to support a planned securities offering or sale of the business

10. Why Senior Management Will Understate Business Performance To defer “surplus” earnings to the next accounting period. To take all possible write-offs in one “big bath” now so future earnings will be consistently higher. To reduce expectations now so future growth will be better perceived and rewarded. To preserve a trend of consistent growth, avoiding volatile results. To reduce the value of an owner-managed business for purposes of a divorce ­settlement. To reduce the value of a corporate unit whose management is planning a buyout

11. Types of Fraud Overstatement of Income Understatement of Income Improper Use of Resources Mischaracterization of one-time expenses Misapplication of the accounting rules Omission or misrepresented information

12. Anti-Fraud Methods Financial Statement Audits  Code of Conduct Internal Audit  Independent Audit

13. Bottom of the List Fraud Training Anti-Fraud Policy

14. Most Effective Surprise Audit Mandatory Vacation - Job Rotation Hotline Employee Support Executive Training

15. Why is it Easy to Commit Fraud? Companies trust employees Employees with authority Autonomy with lack of over-sight Poor controls Mergers, acquisitions, spinoffs Discontinued services Relationship between auditing firm and clients

16. Users of Financial Statements Transaction Activity Transaction Activity Information Users Information Users Financial Statements Financial Statements Accounting System Accounting System Bankers Investors Vendors Government Management Bankers Investors Vendors Government Management Balance Sheet Income Statement Statement of Owner Equity Statement of Cash Flows Balance Sheet Income Statement Statement of Owner Equity Statement of Cash Flows Decisions Loan Approval Financial Investment Credit Approval Operational & Financial Decisions Loan Approval Financial Investment Credit Approval Operational & Financial Decisions

17. Audit Design Flaws Not designed to prevent fraud Primarily check math and accounting rules Look only for material misstatements Relies on internal controls Tests only a percentage

18. How They Do It!

19. Hide Fraud in Key Accounts High volume accounts – write-offs, bad debt, supplies Accounts auditors don’t understand Predictable accounts that will be tested, inventory, accounts receivable

20. Use Account that Require Judgment and Estimates Warranty Reserve Allowance of Bad Debt Sales Allowances and Returns Restructuring / Discontinued Services Grey Area

21. Abuse Reserve Cookie Jar Accounting Large Companies Require Large Reserve Easy to Manipulate Audit looks at Risk of Understating Reserve

22. Plan around Auditors Scope and Announced Procedures Exploit Scope and Materiality Move Inventory locations Falsify Documents Force Auditors to choose alternate items to test

23. Follow the Basic Accounting Principals Pretend to be Conservative Give auditors the answers they want to hear Make numbers fall within acceptable historic lines Make sure there are adjustments for auditors to book Being stupid is not a crime Simple mistake

24. Cooking the Books Income Statement Recording sales before all conditions are met Order has been received Product has been shipped Little risk the shipment will not be accepted No other reactions are required Title ownership has changed payments due

25. Puff Up the Income Statement Improperly increased revenue Sales recorded before completed Goods are shipped before sale is final Revenue recorded while future services are still due Bogus Revenue Supplier refunds recorded as income Revenue recorded from self dealings Revenue recorded from asset exchanges

26. Puff Up the Income Statement Improper lowered costs or expenses Current expenses shifted into later period Expenses capitalized on Balance Sheet Assets depreciated slower than normal Liabilities not accrued Operating losses masked in discontinued services

27. Sweeten the Balance Sheet Improperly increased income Expenses shifted to different periods Capitalize costs as inventory Assets depreciate or amortized too slowly Worthless asset not written off immediately Shift revenue and income into later periods with reserves

28. Sweeten the Balance Sheet Improperly increased assets and equity Increased equity through one time gains Report gains on exchange of similar assets Report gains by selling undervalued assets Retire debt Report revenue rather than liability on receipt of cash