ACCT 410610: Forensic Accounting

1
ACCT 410/610 Forensic Accounting

• An NDSU course developed taught by
• Thomas A. Buckhoff, Ph.D., CFE, CPA
• Class Session 9 October 24, 2001

2
Quote for the Day

• Rarely do perpetrators save what they steal. They
  use the money to improve their lifestyles.
• Source Fraud, p. 172.

3
Quote for the Day 2

• The three indirect methods of proof can be used
  to show that a suspects expenses exceed his/her
  known sources of income.
• Source IRS text, p. 193.

4
Tip for the Day

• Avoid using the word investigation in
  connection with fraud examination work.
• The word tends to make all persons involved less
  willing to cooperate.

5
Agenda for Today

• Exercises
• Money Laundering
• Indirect methods of proof
• Jane and Joe Blow Exercise
• Guest Speaker
• Gary Preszler

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Exercise 10 Example of a Fictitious Vendor
Scheme

• Complete the Double Trouble Case Study on p. 7-2
  of the Student Workbook

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Instructions Part 1

• Read the newspaper article on p.
  7-3.
• How do you think this fraud was discovered?
• After considering this question, see next slide
  for answer.

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Part 1 Answer

• Investigative procedure
• Matched payments for invoices to receiving
  documents.
• Finding
• No receiving documents existed for numerous
  invoices approved for payment by Lisa Chaffey.

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Instructions Part 2

• Review pages 7-4, 7-5, and 7-6.
• Identify items that support the fraud theory that
  Fairmont Co. is a fictitious vendor.
• The case began with the money order.
• The other documents were among hundreds of items
  seized from the Chaffeys residence.

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Part 2 Answer

• A legitimate vendor would issue a company check
  rather than use a money order.
• Fictitious vendors generally list only a P.O. Box
  address.
• Paid for an answering service with another money
  order. Legitimate vendors rarely, if ever, use
  an answering service.

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Instructions Part 3

• Read the Case Synopsis beginning on p. 7-7.
• Identify the investigative procedures used to
  resolve this case.
• The total amount of the fraud loss was at least
  22,034 (14,239 7,795) as given on p. 7-3.

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Part 3 Answer

• Investigative procedures
• Interviewed various people.
• Examined phone directories.
• Matched invoices to receiving documents.
• Traced bogus invoices to person who approved
  them.
• Searched Chaffeys garbage.
• Searched Chaffeys residence.

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Reviewing Suspect Payments

• Review canceled checks
• Trace canceled checks to supporting documentation
  and investigate
• Discrepancies
• Unnumbered or sequentially unusual invoices
• Altered or photocopied documents

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Exercise 11

• Complete the Mary and John Crook - Part III
  exercise on p. 7-13 of the Student Workbook

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Instructions

• Complete all four parts of the exercise before
  proceeding to the next slide.

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Part I Surveillance

• Restaurant traffic does not appear heavy even
  though the business is doing extremely well
  financially.
• People are entering restaurant but do not appear
  to be using services.

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Part II Interview

• There are four employees.
• Do the employee records verify this?
• Customer traffic seems light.
• Compare this to reported sales for
  reasonableness.
• Mary Crook maintains the books.
• Do all business records match?
• John Crook has frequent visitors.
• Why are they there?

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Part III Business Records

• A review of the CRJ indicates
• Total cash receipts seems to be constant even
  when restaurant traffic is slow.
• Reconcile entries in the CRJ with cash register
  tapes and bank deposits.

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Part III Business Records

• A review of the CDJ indicates
• CK 278 to J. Reynolds
• Is this a legitimate expense?
• What was the service rendered?
• Trace to customer invoice and examine endorsement
  on canceled check.
• Six payroll checks were disbursed
• Interview revealed four employees.
• Review all payroll records and supporting
  documentation.

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Part IV Bank Records

• The bank statement indicates
• Deposits made on 3-07 and 3-24 do not correlate
  with journal entries.
• Examine corresponding deposit slips
• The J. Reynolds check was cashed
• Examine the endorsement
• Time cash withdrawals totaled 1,500
• Where did the cash go? Are there corresponding
  deposits in the Crooks personal accounts on these
  dates?

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Money Laundering

• The disguising of the existence, nature, source,
  ownership, location, and disposition of property
  obtained from a specified unlawful activity.

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Three Stages of Money Laundering

• Placement
• Most schemes are detected at this stage.
• Layering
• Integration
• Difficult to detect at the above two stages.

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Placement

• The illicit funds are placed into a financial
  institution. Methods
• Transport cash in suitcase out of country for
  deposit in offshore account.
• Break transactions down into smaller amounts to
  evade reporting requirements (i.e.,
  smurfing)
• Purchase cashiers checks, travelers checks, or
  money orders.

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Criminal of the Day

• Discussion on obtaining bank records
• Featured criminal
• Scott Stodghill, Smurf (an accomplice in a money
  laundering scheme)

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Layering

• After the funds have been placed, the launderer
  moves the funds around by using layers of
  financial transactions designed to confuse the
  audit trail.

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Integration

• Introducing the laundered money back into the
  economy in a manner that looks legitimate.
• The object of laundering is to convert cash into
  another asset.

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Favorite Businesses forLaundering Money

• Those that deal in large amounts of cash sales
• Bars/night clubs
• Casinos
• Restaurants
• Since real estate increases in value, it can be
  used to launder money.

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Money Laundering Example

• Interstate Business College (IBC)
• Born 1912
• Died 1998
• Cause of death Top management fraud
• Estimated fraud loss
• 1,000,000

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IBC Fraud Symptoms

• Extravagant lifestyle of owners
• Discrepancies in the records
• Excessive salaries of top managers
• Management by intimidation
• Financial statement anomalies
• Bankruptcy

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Video of Jensen home

• In February 1998, Tom Buckhoff--posing as a
  potential buyer of the Jensen home--entered the
  home and videotaped the contents.

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IBC Fraud Schemes

• Misappropriation of students financial aid
• SBA loan fraud
• Misrepresentation of their program
• Misappropriation of payroll taxes
• Credit card abuse

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IBC Charges Filed

• Loan fraud--SBA
• Mail fraud and wire fraud
• Mail and phone systems were used to
  misappropriate students financial aid
• Money laundering

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IBC Money Laundering

• How do the facts of this case support a money
  laundering charge?
• Answer
• The owners took the misappropriated money out of
  IBC in the form of excessive salaries.

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Indirect Evidence

• Evidence that the suspect lives beyond his or her
  means and must have had unexplained income is
  admissible in court.

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Indirect Methods of Proof

• Direct items of proof are not always available.
  Consequently, we must rely on indirect methods of
  proof
• Net worth
• Expenditures
• Bank deposits

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Basic Principle

• Money eventually shows up, either directly or
  indirectly, in the accounts, assets or
  expenditures of the recipient.

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The Financial Profile

• Objective is to discover what suspect
• Owns (assets)
• Owes (liabilities)
• Earns (income)
• Spends (expenditures)

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Disposition of Income

• Save it
• Increases assets
• Buy assets
• Increases assets
• Pay off debts
• Decreases liabilities
• Spend it
• Improves lifestyle

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Net Worth Method

• Unknown sources of funds identified by analyzing
  net worth increases
• Applied when significant changes in A L have
  occurred

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Keys to Net Worth Analysis

• Cash-on-hand
• Cash in banks
• Asset valuation
• Known expenses

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Net Worth Analysis Formula

• Increase in NW
• Known expenses
• Total NW increase
• - Known income
• Unknown income

• Assets
• - Liabilities
• Net Worth (NW)
• - Previous Yr NW
• Increase in NW

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Net Worth Method

• When using this method, be sure to
• Establish a reliable opening net worth.
• Investigate leads showing suspects innocence.

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Indirect Methods of Proof Example

• Jane and Joe Blow Matter
• Read background information on website link
  containing Excel spreadsheet.
• Do we have predication?

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Jane and Joe Blow Matter

• Estimate the Blows funds from unknown sources
  using the net worth method.
• Do not proceed to the next slide until you have
  completed Requirement 1.

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Net Worth Method Solution
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Expenditures Method

• Applied when significant changes in expenditures
  have occurred. Formula
• Total expenditures
• Minus Known sources of funds
• Equals Funds from unknown sources

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Jane and Joe Blow Matter

• Estimate the Blows funds from unknown sources
  using the expenditures method.
• Do not proceed to the next slide until you have
  completed Requirement 2.

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Expenditures Method Solution
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Expenditures Method Solution
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Indirect Methods of Proof

• After confronting the target with the funds from
  unknown sources, s/he will likely offer
  explanations.
• You must be ready to validate those explanations
  (i.e. rebut defenses).

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Rebutting Defenses

• Defense
• Claim of a prior cash hoard
• Rebuttal Show that the suspect
• Borrowed money
• Made installment purchases
• Incurred large debts
• Was delinquent on his accounts
• Had a poor credit rating
• Filed for bankruptcy

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Rebutting Defenses

• Defense
• Cash came from family or private loans
• Rebuttal Show that
• The alleged lender was incapable of generating
  the amounts lent.
• No documentation exists to support the alleged
  loan (e.g. no bank withdrawals)
• The alleged lender has no knowledge of the
  supposed loan.

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Guest Speaker

• Gary D. Preszler
• Former Commissioner (1986-2001)
• Department of Banking and
• Financial Institutions
• Topic
• Fraud within banks

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Fraudwise, LLC

• Specializing in fraud detection, investigation,
  and prevention consulting services
• Senior Investigators
• Thomas Buckhoff, Ph.D., CFE, CPA
• Thomas OHalloran, MBA, CFE, EA
• 2974 Southgate Drive
• Fargo, ND 58103-3524
• 701-282-8443
• www.fraud-wise.com