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Detecting Financial Frauds: Insights from Forensic Accounting

Explore methods and red flags for detecting revenue, inventory, liability, and other asset frauds through forensic accounting. Understand the importance of disclosure fraud detection for transparent financial reporting.

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Detecting Financial Frauds: Insights from Forensic Accounting

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  1. Today’s Topics • Revenue Frauds • Inventory Frauds • Liability Frauds • Other Asset Frauds • Disclosure Frauds FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  2. General Detection Model • Period to period account balance analysis • Period to period relationship analysis • Comparison with industry averages • Comparison with physical assets • General horizontal and vertical analysis FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  3. Revenue Frauds • Shenanigans #1 and #2 • Tables pps. 403-405 • Revenue cycle • Sell goods or services • Estimate collectibility • Returns • Write-offs • Collect cash FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  4. Revenue Fraud Detection • Detection • Accounting anomilies • Ratios (p.408) FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  5. Inventory Frauds • Shenanigan #4 • Tables pps. 416-417 • Inventory cycle • Purchase inventory • Returns • Payment • Sell inventory • Write offs • Estimate or count inventory • Value inventory FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  6. Inventory Fraud Detection • Detection • Statement of cash flows • Comparison with physical assets • Ratios (p.421) FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  7. Liability Fraud • Shenanigan #5 • Table p. 449 • Liability cycle • Purchase goods and services • Incur accruals • Sell goods and services • Borrow money • Payments on account • Assess contingencies FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  8. Liability Fraud Detection • Types • Understatement • Unearned revenue • Omission of debt and contingencies • Detection • Accounting anomilies • Ratios (p.455) FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  9. Other Asset Fraud • Shenanigan #4 • Chart-p. 458 • Table-p. 464 • Types • Overstatement • Improper capitalization • Understated write offs FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  10. Other Asset Fraud Detection • Detection • Accounting anomilies • Ratios (pps. 465-469) FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  11. Inadequate Disclosure Fraud • Misrepresentation • Company and its products • Via financial reports • Via footnote disclosures FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  12. Disclosure Fraud Detection • Detection • KTT • Questions on pps. 473-477 • Use common sense • Compare footnotes • Vigorous use of inquiries • Go outside the box! • Fraud Buster Ratio • (NI - CFO)/Total Assets; should approach zero • Condition worsens as result grows FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  13. Financial Fraud Detection • KTT is the key • Note audit related procedures C12 & C13-Appendix A • Use the Fraud Exposure Rectangle • Management & Directors • Background, motivation & influence • Company relationships • Obligations, related party transactions & compliance • Nature of organization & industry • Financial results & operations • GAAP, attitude FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  14. Shenanigan #4-Expense Shifting with Assets…Think WorldCom • Technique #1: • Capitalizing normal operating costs-AOL • Technique #2: • Shift of expenses to earlier period due to accounting change-Snapple • Technique #3: • Slow amortization (somewhat subjective)-Orion Pictures • Technique #4: • Failing to write-down impaired assets-Lockheed • Technique #5: • Reducing asset reserves-Lucent FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  15. Shenanigan #4Red Flags • Changes in capitalization policy pre-IPO • Late accounting change announcements FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  16. Shenanigan #5-Liability Games…Failure to record or understatement • Technique #1: • Failure to record-intentional or unintentional • Technique #2: • Reducing liabilities by changing assumptions-tax provisions and reserves • Technique #3: • Questionable cookie jar reserves-Chainsaw Al Dunlap and Sunbeam Corporation • Technique #4: • Sham rebates-rebate used to reduce COGS • Technique #5: • Early revenue recognition versus revenue received in advance FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

  17. Transparency is Key • Are the #s telling the story or making the story? • Is the company managing the business or managing the #s? • What is, is? versus What is. Is! • Recall SFAC #1, now #8 • Improved decision making • Insight into future cash flows • Resource information FORENSIC ACCOUNTING - BA124 – Spring 2015 Slide 18-1

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