1. Forensic and Investigative Accounting Chapter 18 Forensic Accounting in Action © 2011 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com

2. Chapter 18Forensic and Investigative Accounting2 Questions Answered by Fraud Investigation Who had the opportunity to commit fraudulent activity? Who had the opportunity to commit fraudulent activity? How and when was the fraud committed? How and when was the fraud committed? What was taken (how much money was lost)? What was taken (how much money was lost)? Where were the assets moved (how were the assets converted to the benefit of the perpetrator)? Where were the assets moved (how were the assets converted to the benefit of the perpetrator)? Why was the activity intentional, rather than accidental, or the result of mistake or misunderstanding? Why was the activity intentional, rather than accidental, or the result of mistake or misunderstanding?

3. Chapter 18Forensic and Investigative Accounting3 Accounting Anomalies Accounting anomalies often signal the presence of fraud. Examples of accounting anomalies include: Irregularities in source documents (e.g., missing documents, excessive voids or credits, common names or addresses of customers, increases in past due receivables, increased reconciling of items, etc.). Irregularities in source documents (e.g., missing documents, excessive voids or credits, common names or addresses of customers, increases in past due receivables, increased reconciling of items, etc.). Faulty journal entries. Faulty journal entries. Inaccuracies in ledgers. Inaccuracies in ledgers.

4. Chapter 18Forensic and Investigative Accounting4 Internal Control Weaknesses Lack of segregation of duties Lack of segregation of duties Lack of physical safeguards Lack of physical safeguards Lack of independent checks Lack of independent checks Lack of proper authorization Lack of proper authorization Lack of proper documents and records Lack of proper documents and records Overriding of existing controls Overriding of existing controls Inadequate accounting system Inadequate accounting system

5. Chapter 18Forensic and Investigative Accounting5 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships What Was Taken? $6 million USD of inventory missing from the Shanghai warehouse. $6 million USD of inventory missing from the Shanghai warehouse. $6 million USD cash associated with sales to customers. $6 million USD cash associated with sales to customers. $5 million USD of accounts receivable (70% of which was for sales that were claimed never to have occurred) associated with customers claiming never to have ordered any inventory. $5 million USD of accounts receivable (70% of which was for sales that were claimed never to have occurred) associated with customers claiming never to have ordered any inventory.

6. Chapter 18Forensic and Investigative Accounting6 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships Who Had the Opportunity? Hong Wu, the sales manager in Shanghai who was responsible for sales. Hong Wu, the sales manager in Shanghai who was responsible for sales. Daqing Yang, the logistics manager for the Shanghai warehouse. Daqing Yang, the logistics manager for the Shanghai warehouse. Xiang Chu, accounting manager who made accounting entries and deposits. Xiang Chu, accounting manager who made accounting entries and deposits. Alex Richards, Wu’s and Yang’s supervisor. Alex Richards, Wu’s and Yang’s supervisor. Grant Williams, Chu’s supervisor. Grant Williams, Chu’s supervisor.

7. Chapter 18Forensic and Investigative Accounting7 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships How Were the Assets Moved? Individuals—likely not actual customers—picked up inventory from the warehouse, sometimes without the need for required documentation. Individuals—likely not actual customers—picked up inventory from the warehouse, sometimes without the need for required documentation. Logistics manager released inventory to individuals (supposedly customers) for cash. Logistics manager released inventory to individuals (supposedly customers) for cash. Cash was transferred from Yang to Wu. Cash was transferred from Yang to Wu.

8. Chapter 18Forensic and Investigative Accounting8 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships How Was the Theft Concealed? Wu attributed all/some of cash received by legitimate customers to other customers—some of which would have been used as down payments for other fictitious/improper sales. Wu attributed all/some of cash received by legitimate customers to other customers—some of which would have been used as down payments for other fictitious/improper sales. Part of cash received from individuals for inventory used to account for actual sales and part of cash withheld by Yang and Wu. Part of cash received from individuals for inventory used to account for actual sales and part of cash withheld by Yang and Wu. (continued on next slide) (continued on next slide)

9. Chapter 18Forensic and Investigative Accounting9 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships How Was the Theft Concealed? (continued) Sales made to future customers could have been made for amounts below those approved by TruGloss Shanghai JV. Sales made to future customers could have been made for amounts below those approved by TruGloss Shanghai JV. Yang and Wu could have involved Chu, Richards, and/or Williams to help ensure that fraud was not detected. Yang and Wu could have involved Chu, Richards, and/or Williams to help ensure that fraud was not detected.

10. Chapter 18Forensic and Investigative Accounting10 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships How Were the Assets Converted? Inventory sold to individuals (who are not actual customers) at below market prices for cash—not possible to trace payments originating from certain customers to accounting transactions (because of the nature of a cash transaction). Inventory sold to individuals (who are not actual customers) at below market prices for cash—not possible to trace payments originating from certain customers to accounting transactions (because of the nature of a cash transaction). Yang and Wu may have laundered cash. Yang and Wu may have laundered cash. Lapping of accounts receivable enabled turnover to occur until fraud detected. Lapping of accounts receivable enabled turnover to occur until fraud detected.

11. Chapter 18Forensic and Investigative Accounting11 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships What Were the Red Flag Symptoms? Better than expected growth relative to local competition. Better than expected growth relative to local competition. Lack of proper separation of duties for operations, custody, accounting, and monitoring of assets. Lack of proper separation of duties for operations, custody, accounting, and monitoring of assets. Insufficient oversight of operational employees. Insufficient oversight of operational employees. Above average performance for one segment of the joint venture, involving only a few individuals. Above average performance for one segment of the joint venture, involving only a few individuals. Sales of inventory for cash at the warehouse, often without necessary documentation. Sales of inventory for cash at the warehouse, often without necessary documentation. High concentrations of repeat customers for one segment of the joint venture. High concentrations of repeat customers for one segment of the joint venture. Increase in accounts receivable aging. Increase in accounts receivable aging.

12. Chapter 18Forensic and Investigative Accounting12 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships What Pressures and Rationalization Might Have Motivated the Frauds? None—perpetrators could be sociopathic fraud perpetrators—TruGloss Shanghai happens to be the latest victim. None—perpetrators could be sociopathic fraud perpetrators—TruGloss Shanghai happens to be the latest victim. Financial pressures on any individual: Wu, Yang, Chu, Richards, and/or Williams. Financial pressures on any individual: Wu, Yang, Chu, Richards, and/or Williams. Pressure to achieve growth targets in a new market. Pressure to achieve growth targets in a new market. Competitive pressure among sales or logistics managers. Competitive pressure among sales or logistics managers. Belief that other competitors are conducting business in the same fashion. Belief that other competitors are conducting business in the same fashion. Culturally acceptable to conduct sales based on cash transactions at warehouse locations, regardless of internal controls imposed by partner from the United States. Culturally acceptable to conduct sales based on cash transactions at warehouse locations, regardless of internal controls imposed by partner from the United States.

13. Chapter 18Forensic and Investigative Accounting13 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships What Key Internal Controls Could Have Prevented or Detected the Fraud? Background checks of managers at TruGloss Shanghai JV. Background checks of managers at TruGloss Shanghai JV. Proper oversight by General Manager (Richards) and Finance Manager (Williams). Proper oversight by General Manager (Richards) and Finance Manager (Williams). Completion of required monitoring mechanism (i.e., internal audits) as required by policy. Completion of required monitoring mechanism (i.e., internal audits) as required by policy. Insistence by accounting managers that no transaction be recorded without proper documentation and approval. Insistence by accounting managers that no transaction be recorded without proper documentation and approval. Periodic and diligent comparisons of the joint venture to local competition and other international joint ventures— are the results at TruGloss Shanghai “too good to be true”? Periodic and diligent comparisons of the joint venture to local competition and other international joint ventures— are the results at TruGloss Shanghai “too good to be true”? (continued on next slide) (continued on next slide)

14. Chapter 18Forensic and Investigative Accounting14 TruGloss Shanghai JV: Unusual or Unrealistic Procedures and Relationships What Key Internal Controls Could Have Prevented or Detected the Fraud? (continued) Periodic monitoring and follow-up for aged accounts receivable. Periodic monitoring and follow-up for aged accounts receivable. Required physical counts of inventories and mandatory reconciliations. Required physical counts of inventories and mandatory reconciliations. Periodic analysis of gross margins and any other key ratios based on recorded amounts. Periodic analysis of gross margins and any other key ratios based on recorded amounts. Mandatory vacations for all management positions. Mandatory vacations for all management positions.

15. Chapter 18Forensic and Investigative Accounting15 Tallahassee BeanCounters: Problem- Based Learning to Ask the Right Questions Questions to answer with respect to the potential or likely fraud circumstances in this case: Who could have committed a fraud? Who could have committed a fraud? How could the fraud have been committed? How could the fraud have been committed? Evidence of intent (which can be shown by repeated instances of taking). Evidence of intent (which can be shown by repeated instances of taking). Economic impact (difference in reported and actual revenue, plus (if negative) underpaid sales tax (to the state) and arena rent (to the stadium owner) must be included as total loss due to theft. Economic impact (difference in reported and actual revenue, plus (if negative) underpaid sales tax (to the state) and arena rent (to the stadium owner) must be included as total loss due to theft. Evidence of conversion tracing funds to “dummy” (usually bank) account of employee suspect under a different, or possibly assumed, name. Evidence of conversion tracing funds to “dummy” (usually bank) account of employee suspect under a different, or possibly assumed, name.

16. Chapter 18Forensic and Investigative Accounting16 Tallahassee BeanCounters: The Fraud Schemes Ghost employee fraud Ghost employee fraud Ticket fraud Ticket fraud Equipment purchase fraud Equipment purchase fraud