FRAUD EXAMINATION ALBRECHT, ALBRECHT,

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FRAUD EXAMINATION ALBRECHT, ALBRECHT, ALBRECHT

• Liability, Asset Inadequate Disclosure Frauds

Chapter 13
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Learning Objectives

• Identify fraudulent schemes that understate
  liabilities.
• Understand the understatement of liabilities
  fraud.
• Identify fraudulent schemes that overstate
  assets.
• Understand the overstatement of assets fraud.

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Learning Objectives

• Identify fraudulent schemes that inadequately
  disclose financial statement information.
• Understand the inadequate disclosure fraud.

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What Makes It Hard for Auditors to Detect Fraud?

• Collusion
• Forgery
• Complex Audit Trails
• Lies
• Normal Looking Transactions

• Silence
• Off-Book Frauds
• Misleading Documents
• Small Frauds
• First Time Fraudsters

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How is Liability and Revenue Fraud Committed?
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How is Liability Fraud Committed?

• Dont Record Purchase or Record in the Next
  Accounting Period
• Overstate Purchase Returns Allowances
• Make It Appear that Liabilities Are Paid or
  Forgiven

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Discuss Ways Liability Fraud is Committed.

• Fraudulent recording of payments
• Dont record accrued liabilities
• Dont record warranty liabilities or service
• Record deposits as revenues
• Borrow against equities in assets
• Write off liabilities as forgiven
• Dont record contingent liabilities that are
  probable

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What are Accrued Liabilities?
Liabilities incurred, Used goods or services,
but not recorded because paperwork not received,
Often estimated
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How Are Unearned Revenues Abused?

• Instead of recording as a liability the revenue
  is recognized recorded
• EXPLAIN
• By not recording as a debt, debts (liabilities)
  are understated revenues overstated - results
  in not disclosing debt
• By claiming debt forgiven or paid
• By claiming debt as personal, not business, debt

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Define a Contingent Liability.

• Liabilities are not incurred but have some
  probability of being incurred
• RECORD if probable estimable
• DISCLOSE in footnote if reasonably possible
• DO NOTHING if remotely probable
• How are they abused?
• Underestimate amount or probability

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What Are Some Analytical Symptoms of Liability
Fraud?

• Balances appear to be too small
• Purchase Returns Allowances seem too large
• Unearned Revenues, payroll taxes, payroll
  deductions, accrued liabilities, warranty
  balances appear to be too small

Compare with Prior Period Balances
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What Symptoms Appear in Documents?

• Large purchases recorded at the beginning of the
  period
• Photocopied records instead of originals
• Strange differences between balances
  confirmations
• Not recorded timely

• Unsupported or unauthorized balances
• Last minute adjustments
• Missing records
• Denied access to records, facilities, vendors or
  people

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What Are Some Other Clues to Liabilities Fraud?
?Unrecorded Liens ?No payments to Govt. ?No
Payroll Withholdings ?Capitalization of
Wages ?Interest with NO Recorded Debt
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Complete The Chart.

• Liability Account Balances
• Focus on changes in statement numbers
• Study Statement of Cash Flow
• Use horizontal analysis

• With Industry Competitors
• Compare statement results with those of similar
  companies
• Compare companys trends with those of similar
  companies

• Liability Relationships
• Examine changes in relevant ratios
• Use vertical analysis

• With Real-World Numbers
• Compare statement amounts with the assets they
  are supposed to represent

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What is a Recommended Process for Examining for
Liabilities Fraud?
Ask what kind of fraud could be occurring.
Identify what symptoms those frauds would
generate.
Determine whether those symptoms exist.
Follow up to determine if the symptom signals
fraud, or an abnormality caused by something else.
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List Ratios that Are Used to Detect These Types
of Fraud.

• Under recording Accounts Payable (A/P)
• Acid-test
• Current
• A/P to Purchases
• A/P to COGS
• A/P to Total Liabilities
• A/P to Inventory

• Under recording Accrued Liabilities
• Various Accruals to Number of days to accrue
  compared to same ratio in prior years
• Various Accruals to Related Expenses
• Under recording Unearned Revenues
• Unearned Revenue to Revenue

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List Ratios that Are Used to Detect These Types
of Fraud.

• Under recording Service Liabilities
• Warranty Expense to Sales
• Under recording Various Liabilities
• Interest Expense to Notes Payable
• Long-Term Debt to Stockholders Equity
• Various Types of Debt to Assets

• Total Liabilities to Total Assets
• Pension Expenses to Salary Expense
• Lease Expense to Total Fixed Assets
• Not Recording Contingent Liabilities
• Generally no ratios to help you, you must look
  for documentary evidence.

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Define Improper Capitalization or Expensing.

• Recording something as an asset when it should be
  expensed.
• This changes the time period when the expense is
  charged against income.

Computer Science Corporation (CSC)
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List Five Common Ways to Overstate Assets.
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List Some Ways Fixed Assets Are Overstated.
Record at Fair Market Value
Under Depreciate
Record Non-Existing Assets
Record Fully Depreciated Assets
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What Does Publicly Traded Mean?
Stocks the General Public Can Purchase
Stocks Not Traded on Regular Exchanges Are
Easily Mistated in Value
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List Some Symptoms of Asset Fraud.

• Deferred Interest
• Size of Deferred Charges
• Year-End Reclassification or JEs that reduce
  expenses increase deferred charges

Detect by Comparing Deferred Charges Ratios
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Discuss Define Inadequate Disclosure Fraud.
Creating or Misleading By Providing
Incorrect Information or Not Providing Information
Statements of Omission Statements of Commission
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How Are Footnotes Made Misleading?

• Missing
• Confusing
• Contingent Liabilities
• Contractual Obligations
• Significant Events

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Terms Match
Purchase something, one company by another
Mortgage
Long-term loan secured by real property
Acquisition
Rent asset, do not own, make periodic payments
Merger
Stocks, bonds and other non-cash assets
Lease
Combining two businesses into one business
Marketable Securities
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Terms Match
Asset that is not tangible, cant touch
Deferred Asset
Retirement benefits paid to former employees
Fixed Asset
Capitalized expenditure to be expensed in future
Intangible Asset
Property, Plant Equipment
Pension
Recording expenditure as an asset
Capitalization
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Terms Match
Assets are recorded at higher values than they
should be
Liability Frauds
Disclosure Frauds
Agreement to buy back something already sold
Issuing financial statements with inadequate
disclosure
Asset Frauds
Liabilities are understated
Repurchase Agreement