Fraud Examination FOURTH EDITION W. STEVE ALBRE HT CHAD. ALBRE'CHI COSNSA \1 C. ALBRECHT- MARK F. ZIMBELEVSAW. SOUTH-WESTERN CENGAGE Learning-

Transcription

1 Fraud Examination FOURTH EDITION W. STEVE ALBRE HT Brigham Young University CHAD. ALBRE'CHI Utah State University COSNSA \1 C. ALBRECHT- Brigham Young University MARK F. ZIMBELEVSAW Brigham Young University SOUTH-WESTERN CENGAGE Learning- Australia Brazil Japan Korea Mexico Singapore Spain United Kingdom United States

2 Contents About the Authors Foreword Preface PART 1 Introduction to Fraud xii xv.xvii CHAPTER 1 The Nature of Fraud 3 Seriousness of the Fraud Problem 4 What Is Fraud? 6 Fraud, Greed, Deception, and Confidence 8 Types of Fraud 9 Employee Embezzlement 10 Vendor Fraud 11 Customer Fraud 11 Management Fraud 11 Investment Scams and Other Consumer Frauds 12 Criminal and Civil Prosecution of Fraud 13. Criminal Law 14., Civil Law 15 - How to Prepare to Be a Fraud-Fighting Professional 16 Certified Fraud Examiners 17 Academic Requirements 17». v Professional Requirements 17 "* ** ' Fraud-Related Careers 17 Review of the Learning Objectives 19 Key Terms 20 Questions 20 Short Cases 23 Case Studies 25 Internet Assignments 28 Debates 28 End Notes 28 CHAPTER 2 Why People Commit Fraud. Who Commits Fraud 33 The Fraud Triangle 34 The Element of Pressure 36 Financial Pressures 36 Vice Pressures Work-Related Pressures 38 >7- " Other Pressures 38,,; The Element of Opportunity 39 Controls That Prevent and/or Detect Fraudulent Behavior 39. "...'.., "';......' '. '. " Summary of the Controls That Prevent or Detect Fraud 44 ',.', ' 'J ' \, ' ; 'y./.'tw}- ' ',,,, - Inability to Judge the Quality of Performance 45 Failure to Discipline Fraud Perpetrators 46 Lack of Access to Information ; 47;' ;, Ignorance, Apathy, and Incapacity 47; > Lack of an Audit Trail 48 ' ' "' )., ' " '"'.""''.' ' ' \ The Element of Rationalization 4? Summary of the Fraud Triangle 51 ; Fraud Recruitment,53!.'. -,./ -; ;';,', _, '-. y y y } P o w e r " "..'., ; ; - v ] ' ' ' Review of the Learning Objectives 55 ; K e y T e r m s 5 6,.- ' ".-;.; v'-,",-'.' ' ; ' '. '""'' Q u e s t i o n s 5 6 "'' '...' ' Short Cases 58 '. '.' " '. [.' ;,*.' -; Case Studies 63 Internet Assignment 65, % Debate 65 E n d N p t e s 6 5 '. " '.'.,,;.. '.'.' ; '. "; ';" '.'.. '..'.'.'., CHAPTER 3 Fighting Fraud An Overview ;'...'.'., Knowing Different Ways That Organizations Fight F r a u d 7 0 '... ' ' '.;'-'. -''- -', ; - - " ' " Fraud Prevention 71 Creating a Culture of Honesty and High Ethics 71 Assessing and Mitigating the Risk of Fraud 75 Fraud Detection 77, ' ^- "''' ' ' /."-'y.,','.; i [" ',''., Fraud Investigation 79 ; ; V ;, ; Approaches to Fraud Investigation 80',''. Conducting a Fraud Investigation 81, ', Follow-Up Legal Action 82!'. Civil Action' 83; '". * -; ''' "V ''- ; v. ;'-'.'.'\-,, Criminal Action 83 '""', -*,,, ;.'.,,-;,. Review of the Learning Objectives 84.." ; K e y T e r m s. 8 5 '. '. ' '".,,.'- f -;;. ' ]' '- Q u e s t i o n s 8 5 ' ' r '' ' '. /''".-."./,.; -. ' ; '. ]

3 vi Contents Short Cases 88 Case Studies 89 Internet Assignments 91 Debates 92 End Notes 92 APPENDIX A Red Hat Code of Business Conduct and Ethics 93 PART 2 Fraud Prevention CHAPTER 4 Preventing Fraud.101 Just About Everyone Can Be Dishonest 103 Creating a Culture of Honesty, Openness, and Assistance 103 Hiring Honest People and Providing Fraud Awareness Training 103 Creating a Positive Work Environment 106 Implementing Employee Assistance Programs (EAPs) 112 Eliminating Opportunities for Fraud to Occur 113 Having a Good System of Internal Controls 113 Discouraging Collusion between Employees and Others and Alerting Vendors and Contractors to Company Policies 116 Monitoring Employees and Having a Whistle-Blowing System 117 Creating an Expectation of Punishment 119 Conducting Proactive Fraud Auditing 119 Preventing Fraud A Summary 120 " A Comprehensive Approach to Fighting Fraud 120 Organizations and Fraud The Current Model 121 Review of the Learning Objectives 124 Key Terms 125 Questions 125 Short Cases 126 Case Studies 129 Internet Assignments 130 Debates 131 End Notes 131 PART 3 Fraud Detection CHAPTER 5 Recognizing the Symptoms of Fraud Symptoms of Fraud 137 Accounting Anomalies Irregularities in Source Documents 139 Faulty Journal Entries 140 Inaccuracies in Ledgers. 141^ ;..' Internal Control Weaknesses 143 L. Analytical Fraud Symptoms 144 Extravagant Lifestyles 148, Unusual Behaviors 149 Tips and Complaints 151 Company Employees Are in the Best Position to Detect Fraud 152 Tips and Complaints Are Fraud Symptoms 152 New Laws Protect Whistle-Blowers and Promote Fraud Detection 153 Review of the Learning Objectives 158 Key Terms 159 Questions 159 Short Cases 161 Case Studies 163 Internet Assignments 165 End Notes 165 CHAPTER 6 Data-Driven Fraud Detection Anomalies and Frauds 168 Audit Sampling and Fraud 169 The Data Analysis Process 169 Step 1 Understand the Business 169 Step 2 Identify Possible Frauds That Could Exist 170 Step 3 Catalog Possible Fraud Symptoms 171 ; '/ Step 4 Use Technology to Gather Data about " Symptoms 171 Step 5 Analyze Results 172 Step 6 Investigate Symptoms 172 Data Analysis Software 172 Data Access 173 Open Database Connectivity 173 Text Import 174. Hosting a Data Warehouse 174 Data Analysis Techniques 175 Data Preparation 175 Digital Analysis 175 Outlier Investigation 179., Stratification and Summarization 179 Time Trend Analysis 180 Fuzzy Matching 181 Real-Time Analysis 182 Analyzing Financial Statement Reports 183 Review of the Learning Objectives 190 Key Terms 190 -

4 , '., Contents vii Questions 191 Short Cases 193 Case Studies 196 ' Internet Assignments 202 Debates 202 End Notes 202 APPENDIX A Examples of the Data-Driven Approach 203 PART 4 Fraud Investigation CHAPTER 7 Investigating Theft Acts 209 When to Investigate 210 Theft Act Investigative Methods 212 Developing a Vulnerability Chart 213 Surveillance and Covert Operations 214 Invigilation 216 Physical Evidence 218. Electronic Evidence 218. Forensic Software Packages Systems 221 A Comprehensive Example of Using Theft Act Investigation Methods 2-22 Review of the Learning Objectives 224 Key Terms 224 Questions 225 Short Cases 226 Case Studies 229 Internet Assignments 230 Debates 230 End Notes 230 CHAPTER 8 Investigating Concealment Concealment Investigative Methods 233 Aspects of Documentary Evidence 233 Obtaining Documentary Evidence 237 Audits 237 Document Experts 242 Review of the Learning Objectives 246 Key Terms 246 Questions 246 Short Cases 248 Case Studies 249 Internet Assignments 250 Debates 250 End Notes 250 CHAPTER 9..,;;; ;'.. '- V,v,y,.'7.,-,', Conversion Investigation Methods;... I.. Conversion Searches 253 ' " ' ;.'.',' Government Sources of Information 254 Federal Sources 254 ",.',-,.. '- '.' State Sources of Information 255 County and Local Records 256 Private Sources of Information Online Databases 258, Internet Search 260 The Net Worth Method 261 Review of the Learning Objectives 263 Key Terms. 264.''. - '' ;;. V"-C'..' ' "...--V - Q u e s t i o n s ; ',',". " ' '. '. ''',- '.-'.-," Short Cases 266 ^ Case Studies ''270 '.'.. " ;..> ' ',- \ >' - ;';'' ; -. Internet Assignments ". ;, ; [ Debates 272.'^,;'; v, ; [" ',[' ; '," )' ' ^ -y. End Notes,273 '.v.,''. ''' -; ' y ->;V.v,.'-.;,. C H A P T E R TO '.,; ' ' -.", ' ' ;',;, -;;,- ',' ;,f Inquiry Methods and Fraud Reports, v...'... Interviewing An Overview 276 ' " ; Characteristics ofa Good Interview 276 Characteristics of a Good Interviewer 277 Understanding Reaction to Crisis 277 Stage 1. Denial 279.,-,. '.,, ;. '.' '[ Stage 2. Anger '.., -.-,, ' \ ' *,/ Stage 3. Bargaining and Rationalization 280 Stage 4. Depression 280; ".'.' Stage 5. Acceptance 280 /. Planning an Interview 280 ', The Interviewer's Demeanor 281 ''>.." The Language of Interviews 281 Question Typology 281 Elements of Conversation 282 Inhibitors of Communication 283 v. Facilitators of Communication 284 Mechanics of the Interview 285.,. Introductory Questions 285 Methodology. 286 ;*,,..;'... ;.; Informational Questions 288. Question Sequence 289 ; ' ' Informational Question Techniques 289 Note-Taking 289 "-,,, ;, iv,» ;./ ^; Observing Respondent Reactions 290 Theme Development 291- ' Transition Methodology 291' ;. Dealing with Resistance 292 V Difficult People 292. ; > ; Volatile Interviews 293 '..251 ;275

5 viii Contents * Assessment Questions 294 Detecting Deception 294 Methodology of Assessment Questions 296 Closing Questions 298 Admission-Seeking Questions 299 Steps in the Admission-Seeking Interview 300 Refute Alibis 303 Motive for the Fraud 305 Others Involved 306 Physical Evidence 306 Specifics of Each Offense 307 Signed Statements 307 Key Points in Signed Statements 308 Honesty Testing 308 Pencil-and-Paper Test 309 Graphology 309 Voice Stress Analysis and Polygraphs 309 The Fraud Report 309 Review of the Learning Objectives 310 Key Terms 311 ' Questions 311 Short Cases 313 Case Studies 316 Internet Assignments 318 Debates 318 End Notes 318 APPENDLX A Sample Signed Statement 319 APPENDIX B An Example Fraud Report 320 PART 5 Management Fraud CHAPTER 11 Financial Statement Fraud 357 The Problem of Financial Statement Fraud 359 Financial Statement Fraud in Recent Years 359 Why These Problems Occurred 360 Element 1 A Booming Economy 361 Element 2 Decay of Moral Values 361 Element 3 Misplaced Incentives 361 Element 4 High Analysts' Expectations 361 Element 5 High Debt Levels 362 Element 6 Focus on Accounting Rules Rather Than Principles 362 ' Element 7 Lack of Auditor -Independence 362 Element 8 Greed 363 Element 9 Educator Failures 363 Nature of Financial Statement Fraud 364 Financial Statement Fraud Statistics 364 Phar-Mor An Example of Financial Statement Fraud 366 ' Motivations for Financial Statement Fraud 367 A Framework for Detecting Financial Statement Fraud 368 Management and the Board of Directors 370 Managements' Backgrounds 370 Managements' Motivations 371 Managements' Influence in Making Decisions for the Organization 371 Relationships with Others 372 Relationship with Financial Institutions 373 Relationship with Related Organizations and Individuals 373 Relationship with Auditors 373 ; Relationship with Lawyers 374 Relationship with Investors 374 Relationship with Regulatory Bodies 374 Organization and Industry 376 Financial Results and Operating Characteristics 377 Review of the Learning Objectives 379 Key Terms 379 Questions 380 Short Cases 382 Case Studies 383 Internet Assignments 387 Debates 387 End Notes 388 APPENDIX A Recent Laws and Corporate Governance Changes Following the Sarbanes-Oxley Act 389 CHAPTER 12 Revenue- and Inventory-Related Financial Statement Frauds.399 Revenue-Related Fraud 400 Acceptable Alternatives 401 Ease of Manipulating Net Income Using Revenues and Receivables 401 Identifying Revenue-Related Fraud Exposures 402 Identifying Revenue-Related Fraud Symptoms 404 Actively Searching for Revenue-Related Fraud Symptoms 406 Actively Searching for Revenue-Related Analytical Symptoms 407 Actively Searching for Accounting or Documentary Symptoms 410 Actively Searching for Control Symptoms 411 Actively Searching for Behavioral or Verbal and Lifestyle Symptoms 412 Actively Searching for Tips and Complaints 413 Following Up on;revenue-related Fraud Symptoms 413

6 Contents ix Inventory and Cost of Goods Sold Frauds 414 Identifying Inventory-Related Fraud Exposures 415 Identifying Inventory-Related Fraud Symptoms 416 Proactively Looking for Inventory-Related Fraud Symptoms 418 Searching for Inventory and Cost of Goods Sold Analytical Symptoms 419 Actively Searching for Accounting or Documentary Symptoms 422 Actively Searching for Inventory-Related Control Symptoms 422 Actively Searching for Behavioral or Verbal and Lifestyle Symptoms 422 Actively Searching for Tips and Complaints 422 Review of the Learning Objectives 423 Key Terms 423 Questions 424 Short Cases 427 Case Studies^ 431 Internet Assignments 433 Debates 434 End Notes 434 APPENDIX A Strategic Reasoning and Detecting Revenue- and Inventory-Related Fraud 435 CHAPTER 13 liability, Asset, and Inadequate Disclosure Frauds. 445 Understating Liabilities 446 Ways to Manipulate Liabilities 447 Identifying Understatement of Liability; Fraud Exposures; 448 Understating Accounts Payable 448 Understating Accrued Liabilities 449 Recognizing Unearned Revenue (Liability) as Earned Revenue 450. Underrecording Future Obligations 450 Not Recording or Underrecording Various Types of Debt (Notes, Mortgages, etc.) 451 Omission of Contingent Liabilities 451 Detecting Understatement of Liability Fraud Symptoms 451 Analytical Symptoms 452 Accounting or Documentary Symptoms 452 Proactively Searching for Symptoms Related to the Underreporting of Liabilities 453 Focusing on Changes in Recorded Balances from Period to Period 453 Focusing on Changes in Relationships from Period to Period 454 Comparing Financial Statement Information with Other Companies 454 Comparing Financial Statement Amounts with Assets They Are Supposed to Represent or with Nonfinancial Statement Factors 456 Actively Searching for "Accounting and Documentary" Symptoms 456 Overstatement of Asset Fraud 456 Identifying Asset Overstatement Fraud 458 Improper Capitalization of Costs as Assets That Should Be Expensed in the Current Period 458 The Slippery Slope of Earnings Management 459 Inflated Assets through Mergers and Acquisitions (or Restructuring) or by Manipulating Intercompany Accounts and/or Transactions 459 Overstatement of Fixed Assets (Property, Plant, and Equipment) 462 Cash and Short-Term Investment Fraud 462 Overstatement of Accounts Receivable (Not Related to Revenue Recognition) or Inventory (Not Related to Cost of Goods Sold) 463 Summary of Overstatement of Asset Fraud, Exposures 463 ' Identifying and Actively Searching for Asset -v. Overstatement Fraud Symptoms 463 Inappropriately Capitalizing Costs That Should Be Expensed 464 Overstating Assets through Mergers, Acquisitions, or Restructurings or Manipulating Intercompany Accounts or Transactions 466 Overstatement of Cash and Short-Term Investments (Including Marketable Securities) 468 Overstatement of Receivables and/or Inventory (Not Revenue- or Cost of Goods Sold-Related) 469 Inadequate Disclosure Fraud 469 Kinds of Disclosure Fraud 470. Misrepresentations about the Nature of the Company or Its Products 470 Misrepresentations in MD&A and Other Nonfinancial Information in Financial Reports 471 Misleading Footnote Disclosures 471 Detecting Inadequate Disclosure Fraud 472 Symptoms Related to Overall Misrepresentation about the Company or Its Assets 473 Disclosure Fraud Related to Financial Reports and Financial Statement Footnotes 474 Other Types of Financial Statement Fraud 475 Inappropriate Accounting for Nonmonetary Transactions 475 Inappropriate Accounting for Roundtrip Transactions 475 Improper Accounting for Foreign Payments in Violation of the Foreign Corrupt Practices Act (FCPA) 476 Improper Use of Non-GAAP Financial Measures 476

7 x Contents Improper Use of Off-Balance-SheeJ; Arrangements Review of the Learning Objectives 477 Key T e r m s 478, '. " "} [ " ' ' ' Questions 478 -' '. ' ' - '. Short Cases 481 /,;;\'... ;...-,.-.,..,. Case Studies 485 ' "' '..'.,., Internet Assignments 488 ' ]' D e b a t e s ' ",..'. ' / ']'7" ',"-'*.'' E n d N o t e s 489 ; ; ;., ' y ' ',',.' ", v. ' APPENDIX A Strategic Reasoning and Detecting Liability, Asset, and Inadequate Disclosure ' -Frauds.;490'\,, ' ';'.- " "'- >'',', " ' PART 6 Other Types of Fraud 476 ' CHAPTER 14 Fraud against Organizations 503 Fraud Statistics 505, Asset Misappropriations 506,. Theft of Cash through Larceny 507 Theft of Cash through Skimming 508 Cash Theft thrbugh Fraudulent Disbursements 508. Theft of Inventory and Other Assets 514 '. Corruption 516 \ ' " ' '-. '*' ' ; B r i b e r y ' '..',. ** '''' ''"/ ' ;-,,' ' > - - Conflicts of Interest 518 ";' Economic Extortion and Illegal Gratuities 519 Review of the Learning Objectives 520 Key Terms' 520 '., ',,.' " '.. Questions 520,, 'Short Cases-.522-,. '. -' ' '.''-..'; ''-;';'/ Case Studies 525 Internet Assignments 526. Debates 526 ' "" "" '"' ' V,. ','' E n d Notes'' 526" v '-' ' " ' ' '."'", '"''.' ' ' CHAPTER 15 Consumer Fraud...,..vi...'.. Consumer Fraud and Its Seriousness 530 Identity Theft 531 f How Identity Theft Occurs 532 j How Fraudsters Convert Personal Information to Financial Gain 534 ;, Stealing a Victim's Identity 535. Minimizing the Risk 536 Prosecution of Identity Theft 539 Once Identity Theft Has Occurred 540 Identity Theft Concluding Comments Other Types of Consumer and Investment Scams 543 Foreign Advance-Fee Scams 543 Work-at-Home Schemes 545 '.'.'.. Bogus Mystery Shopping Scams 549 Telemarketing Fraud 549. Investment Scams 553. Review of the Learning Objectives 555 Key Terms 556 Questions 556 Short Cases 558 Cases Studies 560 Internet Assignments 562 Debates 562 End Notes 562 CHAPTER 16 Bankruptcy, Divorce, and Tax Fraud.565 Overview of Tax, Divorce, and Bankruptcy Frauds 566 Fraud Examiners' Roles in Bankruptcy and Divorce Cases 566 Tax Fraud 567 Fraud and the Criminal Investigation Division 568 CI Investigative Careers 571 Divorce Fraud 571 Participants in Divorce Cases 572.' ; Bankruptcy Fraud 572 The Bankruptcy Code 574 Civil and Criminal Bankruptcy Fraud Statutes 574 Civil Bankruptcy Statutes 575 Participants in the Bankruptcy Process 576 Fraud Investigator's Relationship to Participants in Bankruptcy Proceedings 578 ' Bankruptcy and Divorce Fraud Schemes The Planned Bankruptcy (Bust-Out) 579 Fraudulent Concealment of Assets or Income in Bankruptcies or Divorces 580 The Debtor's or Divorcee's Estate 580 Bankruptcy Statutes Concerning Concealment of Assets 580, Means of Concealing Assets or Income 581 Indicators of Concealment 581 Fraudulent Transfers 581 Civil Liability for False Accusations 582 Money Laundering 582 The Money Laundering Process 583 Efforts to Combat Money Laundering 583 Detecting Money Laundering Schemes 583 Review of the Learning Objectives 585 Key Terms 586 Questions 586 r

8 Contents id Short Cases 588 Case Studies 592 Internet Assignments 593 End Notes 593 APPENDIX A Affidavit of Proposed Investigator 594 APPENDIX B Application for Retention of Investigator 598 CHAPTER 17 Fraud in E-Commerce 601 Fraud Risks in E-Commerce 603 E-Commerce Risks Inside Organizations 603 E-Commerce Risks Outside Organizations 606 Preventing Fraud in E-Commerce 607 The Control Environment 608 Risk Assessment 609 Preventing Fraud through Control Activities 609 Detecting E-Business Fraud 611 Review of the Learning Objectives 612 Key Terms 612 Questions 612 Short Cases 614 Cases Studies 615, End Notes 617" ', - ^ PART 7 Resolution of Fraud CHAPTER 18 Legal Follow-Up. The Court System State Courts.622, '/- ' "'.y'']'y-'''. \'...< -', /, Federal Courts 623 *." ','"' "''"'"'..*.' ''.-".' -*. Civil and Criminal Fraud Trials ; ' \ Overview of the Civil Litigation Process 625 Investigation and Pleadings 625 ; < '< ', '. D i s c o v e r y 6 2 5,."., ' ;''7*7 [";-' '? ''.'. ".'.--.'. Settlement Negotiations.,627"'.,.'' f.';-.;'-\.- ',_' Trial and Appeal, 627, r... ' - /", - -'-.'.;'.'". ; ', ''' ; ; ; Overview of the Criminal Litigation Process 628 ; Filing Criminal Charges 628,...-,.', ' Arresting and Charging the Defendant 628, Preliminary Hearings 628 ; G r a n d Jury ' '.'. ' '-'- ""' ".' -.,' ' - '.' -.'.-- /. Arraignment 629,.,-... ' \[ ",*"' '" > "' D i s c o v e r y '.. -' ' ' ",',',.;' ; ' ', ; " ';; -.'.' Pretrial Motions 629, ; Trial and Appeal- 630.,',,7.';..' -, ; ;. ', -. ", 1 Being an Expert Witness 63T ; ; > y..., Review of the Learning Objectives 633 Key Terms ', ' ' ' ' ' ' ;.;,' ' -' \.'.'-. ';... Questions 634, - '-,..;-.' ;. ';', -.",. ; '; Short Cases ' " ;'..'."''" f,-..';; ; '.,.-,"'.'; ",-.''-.,. Case Studies.638 " -,; '.../} ( ' ;> '';^.';"''.'.",' " /;. I n t e r n e t A s s i g n m e n t s 6 3 9,. ;,,. D e b a t e s 640.,- ;," '.-;;./' 7';.. ',,-.. '.,;-,{*.'",.., - ' E n d N o t e s ' ' '. '" ','. \,.,.'; *" '-^.v'-."; ' ''-'.' Appendix Financial Statement Fraud Standards...' Bibliography ,>..v Glossary ;.;...,;.;...'.' Index.,...;,-..\...7..;...;...664