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Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
Detecting and Auditing for Fraud in Financial Statements Using Data Analysis
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Detecting and Auditing for Fraud in Financial Statements Using Data Analysis

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Webinar series from FraudResourceNet LLC on Preventing and Detecting Fraud Using Data Analytics. Recordings of these Webinars are available for purchase from our Website fraudresourcenet.com …

Webinar series from FraudResourceNet LLC on Preventing and Detecting Fraud Using Data Analytics. Recordings of these Webinars are available for purchase from our Website fraudresourcenet.com
This Webinar focused on fraud detection using data analytic software (Excel, ACL, IDEA)
FraudResourceNet (FRN) is the only searchable portal of practical, expert fraud prevention, detection and audit information on the Web.
FRN combines the high quality, authoritative anti-fraud and audit content from the leading providers, AuditNet ® LLC and White-Collar Crime 101 LLC/FraudAware.
The two entities designed FRN as the “go-to”, easy-to-use source of “how-to” fraud prevention, detection, audit and investigation templates, guidelines, policies, training programs (recorded no CPE and live with CPE) and articles from leading subject matter experts.
FRN is a continuously expanding and improving resource, offering auditors, fraud examiners, controllers, investigators and accountants a content-rich source of cutting-edge anti-fraud tools and techniques they will want to refer to again and again.

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  • 1. Detecting and Auditing for Fraud in Financial Statements Using Data Analysis January 30, 2013 Special Guest Presenter: Richard Cascarino, Copyright © 2013 FraudResourceNet™ LLC About Peter Goldmann, MSc., CFE  President and Founder of White Collar Crime 101 Publisher of White-Collar Crime Fighter Developer of FraudAware® Anti-Fraud Training Monthly Columnist, The Fraud Examiner, ACFE Newsletter  Member of Editorial Advisory Board, ACFE  Author of “Fraud in the Markets” Explains how fraud fueled the financial crisis. Copyright © 2013 FraudResourceNet™ LLC
  • 2. About Jim Kaplan, MSc, CIA, CFE  President and Founder of AuditNet®, the global resource for auditors  Auditor, Web Site Guru, Internet for Auditors Pioneer Recipient of the IIA’s 2007 Bradford Cadmus Memorial Award.  Author of “The Auditor’s Guide to Internet Resources” 2nd Edition Copyright © 2013 FraudResourceNet™ LLC About Richard Cascarino, MBA, CIA, CISM, CFE  Principal of Richard Cascarino & Associates based in Colorado USA  Over 28 years experience in IT audit training and consultancy  Past President of the Institute of Internal Auditors in South Africa  Member of ISACA  Member of Association of Certified Fraud Examiners  Author of Auditor's Guide to Information Systems Auditing Copyright © 2013 FraudResourceNet™ LLC
  • 3. Webinar Housekeeping This webinar and its material are the property of AuditNet® and FraudAware®. Unauthorized usage or recording of this webinar or any of its material is strictly forbidden. We will be recording the webinar and if you paid the registration fee you will be provided access to that recording within two business days after the webinar. Downloading or otherwise duplicating the webinar recording is expressly prohibited. Webinar will be recorded and will be made available within 48 hours. Please complete the evaluation to help us continuously improve our Webinars. You must answer the polling questions to qualify for CPE per NASBA. Submit questions via the chat box on your screen and we will answer them either during or at the conclusion. If GTW stops working you may need to close and restart. You can always dial in and listen and follow along with the handout. Copyright © 2013 FraudResourceNet™ LLC Today’s Agenda  Introduction: Fraud Statistics: The Growing Fraud Threat  Auditing for Fraud: Standards & Essentials  Where & How Financial Statement Fraud Occurs  Detection/Auditing/Investigative Techniques – Including Automation  Entity-Level Red Flags of Fraud  Prevention and Deterrence  Your Questions  Conclusion Copyright © 2013 FraudResourceNet™ LLC
  • 4. Fraud: The Big Picture According to major accounting firms, professional fraud examiners and law enforcement:  Fraud jumps significantly during tough economic times  Business losses due to fraud increased 20% in last 12 months, from $1.4 million to $1.7 million per billion dollars of sales. (Kroll 2010/2011 Global Fraud Report)  Average cost to for each incident of fraud is $160,000 (ACFE) Of Financial Statement fraud: $2 million  Approx. 60% of corporate fraud committed by insiders (PwC)  Approx. 50% of employees who commit fraud have been with their employers for over 5 years (ACFE) Copyright © 2013 FraudResourceNet™ LLC Financial Statement Fraud: The Big Picture  Victims of financial fraud are stakeholders with claims against the entity: shareholders, lenders, regulators.  Financial fraud occurs less frequently than asset misappropriation but the losses are substantially higher.  Source: ACFE 2008 Report to the Nation Copyright © 2013 FraudResourceNet™ LLC
  • 5. The Auditor’s Role  IPPF Standard 1210.A3  Internal auditors must have sufficient knowledge of…available technology based audit techniques to perform their assigned work Copyright © 2013 FraudResourceNet™ LLC IIA Guidance – GTAG 13 Internal auditors require appropriate skills and should use available technological tools to help them maintain a successful fraud management program that covers prevention, detection, and investigation. As such, all audit professionals — not just IT audit specialists — are expected to be increasingly proficient in areas such as data analysis and the use of technology to help them meet the demands of the job. Copyright © 2013 FraudResourceNet™ LLC
  • 6. Professional Guidance Copyright © 2013 FraudResourceNet™ LLC Accounting Fraud  Selling More (Overstating revenue)  Costing Less (Understating/not reporting expenses)  Owing More (Overstating debt to reduce taxes)  Owing Less (Understating debt to boost share price)  Inappropriate Disclosure (Depreciation/asset value, etc)  Other Miscellaneous Techniques (Concealment) Copyright © 2013 FraudResourceNet™ LLC
  • 7. Financial Statement Fraud Schemes  Falsification, alteration, manipulation of material financial records, supporting documents or business transactions  Material intentional omissions or misrepresentations of events, transactions, accounts or other significant information from which financial statements are prepared  Deliberate misapplication of accounting principles, policies and procedures used to measure, recognize, report and disclose economic events and business transactions  Intentional omission of disclosures or presentation of inadequate disclosures regarding accounting principles and policies and related financial amounts Jim Gravitt and Jennifer Johnson, “Recognizing Financial Statement Fraud” Copyright © 2013 FraudResourceNet™ LLC Accounting Fraud: Red Flags  Missing documents      Excessive voids or credits Increased reconciliation items Alterations on documents Duplicate payments Common names or addresses of payees or customers  Increased past due accounts  Unusual spikes in payables or receivables  Odd patterns in key ratios Copyright © 2013 FraudResourceNet™ LLC
  • 8. The Power of Automation Example: Interactive Data Extraction and Analysis  21 years young  Database limitations:  2.1 billion records (100,000 records for IDEA Express) depending on the operating system  1.8 Exabytes file size (Tera, Peta, Exa) (Quintillion)  Some facilities not available in IDEA (Server) Copyright © 2013 FraudResourceNet™ LLC Example: Orders Over Credit Limit Copyright © 2013 FraudResourceNet™ LLC
  • 9. Common Types of Financial Statement Fraud 1) Revenue Recognition Copyright © 2013 FraudResourceNet™ LLC Revenue Recognition Backdating agreements    Stock options and other time-sensitive valuation issues that may result in fraudulently high revenue or low cost basis Need for controls in recording contracts/sales, including independent verification of the terms of the agreement and contemporaneous recording of transactions when they are approved Need for in-house legal, corporate board approval Copyright © 2013 FraudResourceNet™ LLC
  • 10. Revenue Recognition Sham Sales  Falsify inventory records, shipping records, and invoices and record the fictitious transactions as sales  Company may pretend to ship the inventory and hide it from company auditors Copyright © 2013 FraudResourceNet™ LLC Sales to Fictitious Customers Copyright © 2013 FraudResourceNet™ LLC
  • 11. Revenue Recognition Channel Stuffing  Shipping excess merchandise to distributors  Right of return exists/ Side agreements  Need to examine conditions of sale, analyze sales returns during cutoff period/after year-end, review of sales and contract files to determine if side agreements exist Copyright © 2013 FraudResourceNet™ LLC Revenue Recognition Bill and Hold Schemes  Recording fictitious sales and shipping goods to third-party warehouse  Need to examine shipping documents and analyze real estate rental costs  Look for evidence of side agreements  Review inventory changes Copyright © 2013 FraudResourceNet™ LLC
  • 12. Revenue Recognition Holding Books Open    Failure to match revenues with related expenses in the period in which they were incurred (CA’s “35-day month) Examine cut-off procedures for month, quarter and yearend Need for oversight and approval controls in recording contracts/sales Copyright © 2013 FraudResourceNet™ LLC Revenue Recognition Not Recording Detailed Transactions on Sub-ledger    Overstating Sales and A/R Where sub-ledger does not reconcile to General Ledger control account Examine reconciliation and top-side journal entries Copyright © 2013 FraudResourceNet™ LLC
  • 13. Polling Question 1 A side agreement would NOT be a typical part of which of the following: Channel Stuffing B. Holding the Books Open C. Bill and Hold Schemes A. Copyright © 2013 FraudResourceNet™ LLC Common Types of Financial Statement Fraud 2. Management Estimates Copyright © 2013 FraudResourceNet™ LLC
  • 14. Management Estimates Allowance for Bad Debts     Altering underlying A/R aging to manipulate computation Refreshing of receivables by writing off aged A/R and booking new, fictitious sales Use of credit memos Analyze Bad Debt expense and Sales accounts, looking for similar levels of transaction activity for the same customers Copyright © 2013 FraudResourceNet™ LLC A/R Enquiries Copyright © 2013 FraudResourceNet™ LLC
  • 15. Management Estimates Overstatement of assets by:  Understating allowances for receivables  Overstating the value of inventory, property, plant, equipment, and other tangible assets,  Recording assets that did not exist Copyright © 2013 FraudResourceNet™ LLC Management Estimates Fraudulent Input from Sales or Credit Department on Credit Quality    Lack of independent review of customer’s creditworthiness Inadequate documentation in credit file Credit analyses should be performed by individuals who are independent of the sales process, periodic review of credit files Copyright © 2013 FraudResourceNet™ LLC
  • 16. Common Types of Financial Statement Fraud 3. Expense Manipulation Copyright © 2013 FraudResourceNet™ LLC Expense Manipulation Under-Accruing Expenses  Lack of monthly or quarterly reconciliation of accruals to actual amounts  Charging accrual “true-ups” to other, infrequentlyused accounts  Compare monthly accruals to actual expenses and cash disbursements, noting variations in the adequacy of accruals  Capitalizing expenses Copyright © 2013 FraudResourceNet™ LLC
  • 17. Expense Examination Copyright © 2013 FraudResourceNet™ LLC Polling Question 2 Overstating assets can be achieved by (Choose all that apply): A. Understating allowances for receivables B. Overstating the value of inventory, property, plant, equipment, and other tangible assets C. Recording assets that do not exist D. All of the above Copyright © 2013 FraudResourceNet™ LLC
  • 18. Expense Manipulation Not Recording Expenses  Paying unrecorded expenses must be offset by not paying other expenses  Need to ensure adequate segregation of duties in the receipt of invoices and the recording of expenses, review invoice file for past due invoices and collection notices Copyright © 2013 FraudResourceNet™ LLC Expense Manipulation Not Recording Detailed Transactions on Sub-ledger  Understating Expenses and A/P  Where sub-ledger does not reconcile to General Ledger control account  Examine reconciliation and search for unrecorded expenses Copyright © 2013 FraudResourceNet™ LLC
  • 19. Expense Manipulation Capitalizing Expenses  Moving expenses from the P&L to the Balance Sheet and amortizing them over an extended period  WorldCom – telecom line charges  Examine capitalized asset accounts for year-onyear changes Copyright © 2013 FraudResourceNet™ LLC Expense Manipulation Changing Inventory Valuation Methods  May result in lower COGS and higher sales margins  Review calculation of inventory valuation and related disclosures Copyright © 2013 FraudResourceNet™ LLC
  • 20. Expense Manipulation Manipulating Non-Cash Expenses  Changing depreciation and amortization methods  Review calculation of depreciation and related disclosures Copyright © 2013 FraudResourceNet™ LLC Detection and Investigation Techniques 4. Detection and Investigative Techniques For Auditors, Fraud Investigators, Legal Staff, HR and Senior Management Copyright © 2013 FraudResourceNet™ LLC
  • 21. Detection and Investigation Techniques  What are you looking for? (Avoid spinning your wheels).  Where are you going to find it?  Choose the best technique (interviewing, audit, CAAT’s)  Select the tool Copyright © 2013 FraudResourceNet™ LLC ASK THESE QUESTIONS…  Where are the weakest links in the system’s controls?  What deviations from conventional good accounting practices are possible?  How are off-line transactions handled and who has the ability to authorize these transactions?  What would be the simplest way to compromise the system?  What control features in the system can be bypassed by higher authorities?  What is the nature of the work environment? Copyright © 2013 FraudResourceNet™ LLC
  • 22. Tools and Techniques  Be Skeptical!!!!  Analytical Procedures  Other Investigative Techniques  CAATs Copyright © 2013 FraudResourceNet™ LLC BE SKEPTICAL!!!!!            Always request originals. Ask yourself whether transactions make sense. Have documents been altered? Look to see where the documents are maintained. Do employees have close personal relationships with vendors? Is there a lack of supporting documentation? Do background checks identify related parties and DBAs? Does an answer not make sense? Are you avoided more than usual? When asking a relatively simple question, are you unexpectedly referred to someone high up in the organization? Go with your gut! Copyright © 2013 FraudResourceNet™ LLC
  • 23. Analytical Red Flags  Increased scrap.  Excessive purchases.  Unexplained inventory shortages or adjustments.  Significant increase or decrease in account balances.  Cash shortages or overages.  Deviations from specifications. Copyright © 2013 FraudResourceNet™ LLC Polling Question 3 WorldCom’s massive accounting fraud was characterized PRIMARILY by: Not recording detailed transactions on subledger B. Not recording expenses C. Capitalizing expenses D. None of the above A. Copyright © 2013 FraudResourceNet™ LLC
  • 24. Analytical Procedures Range from simple to complex Identify trends or anomalies Four Key Steps: 1. Develop an expectation 2. Determine the acceptable deviation from the expected value 3. Compare the result of the analytical procedure to the expected value 4. Investigate and evaluate any significant differences Copyright © 2013 FraudResourceNet™ LLC Analytical Anomalies Strange Financial statement relationships such as: Increased revenues with  decreased inventory.  Increased revenues with  decreased receivables.  Increased inventory with  decreased payables.  Increased volume with  increased cost per unit. Copyright © 2013 FraudResourceNet™ LLC
  • 25. Data Analysis: Testing for Red Flags Financial Statement Analysis  Vertical – a/k/a “common-sized statements”  Analyzes each line as a % of its relevant total  Income items as a % of total revenue  Expenses as a % of total expense  Identifies disproportionate items  Identifies fluctuations between periods  Horizontal – a/k/a “time-series analysis”  Measures $ and % changes from period to period  Identifies fluctuations and seasonality Copyright © 2013 FraudResourceNet™ LLC Knowledge Discovery         Data Selection. Data Cleaning. Data Enrichment. Data Coding/Reduction. Data Mining. Interpretation/Reporting. Action. Measurement and Evaluation. Copyright © 2013 FraudResourceNet™ LLC
  • 26. Data Analysis - Testing for Red Flags Data Mining/Analysis  Using file interrogation software to examine underlying data     General Ledgers Vendor files Payroll A/P and A/R Copyright © 2013 FraudResourceNet™ LLC Other Investigative Techniques  Public Document Reviews & Background Investigations  Interviews of Knowledgeable Persons  Confidential Sources Copyright © 2013 FraudResourceNet™ LLC
  • 27. Entity-Level Red Flags Internal control gaps, deficiencies, weaknesses Business results that continually outperform expectations Management override of controls Rapid or significant turnover of resources, especially senior management or employees in key positions Employee, customer or vendor complaints Inadequate segregation of duties  Unusual end-of-month or end-of-quarter variations  High-level of related-party transactions  Systems are manual and/or decentralized  Repeated changes of independent public accountants  Continuous problems with various regulatory agencies  Disclosures of Investigations  Suspicion of illegal activities Copyright © 2013 FraudResourceNet™ LLC Prevention, Deterrence and Detection  Prevention  Deterrence  Detection  Tone at the top  Value system (“Code of Ethics / Conduct”)  Positive workplace environment  Hiring, promoting and retaining appropriate employees  Training and awareness programs  Confirmation / affirmation of Code of Conduct/Ethics  Ombudsman programs  Whistleblower programs  Incident response / case management processes  Investigative procedures  Discipline, prosecution and recovery guidelines  “Active” oversight by Board and/or Audit Committee  Identification and measurement of fraud risk (“fraud risk assessment”)  Processes &procedures to mitigate identified fraud risk  Effective internal controls at entity and process level  On-going monitoring activities  Computer-assisted audit techniques  Investigation of: – Fraud risk assessment and related measures – Code confirmation / affirmation process – Management’s involvement in financial reporting process and override of control – Process to receive, retain and treat complaints of fraud / unethical conduct – Internal and external audit effectiveness  Internal audit – Evaluation of adequacy / effectiveness of internal controls  Disciplinary examples Copyright © 2013 FraudResourceNet™ LLC – – – Internal control weaknesses / breaches Non-response to Code confirmation / affirmation Reported issues
  • 28. CAATs IDEA Copyright © 2013 FraudResourceNet™ LLC CAATs ACL Copyright © 2013 FraudResourceNet™ LLC
  • 29. Common Analytical Mistakes  Failure to maintain proper documentation  Failure to notify decision makers  Failure to control digital evidence  Failure to report incident in a timely manner  Underestimating the scope of the incident  No incident response plan in place  Technical mistakes:  Altering date and time stamps on evidence systems before recording them  Killing rogue processes  Patching the system back together before investigation  Not recording commands used  Using untrusted commands and tools  Overwriting evidence by installing tools Copyright © 2013 FraudResourceNet™ LLC Questions?  Any Questions? Don’t be Shy! Copyright © 2013 FraudResourceNet™ LLC
  • 30. Special Training Opportunities*  Sign up for one or more of our monthly Webinars with special individual pricing ($99 for one, $175 for two, $225 for three) or,  Sign up all your staff and they all earn CPE (must register and sign in with their work email address). Special group corporate pricing $300 for one Webinar or $500 for both or $750 for all three.  *Limited time offer and we reserve the right to restrict registrations based on our attendee limit. Copyright © 2013 FraudResourceNet™ LLC Thank You! Website: http://www.fraudresourcenet.com Jim Kaplan FraudResourceNet™ 800-385-1625 jkaplan@fraudresourcenet.com Peter Goldmann FraudResourceNet™ 800-440-2261 pgoldmann@fraudresourcenet.com Richard Cascarino Cascarino & Associates rcasc@rcascarino.com Copyright © 2013 FraudResourceNet™ LLC
  • 31. Upcoming Events for 2013 Copyright © 2013 FraudResourceNet™ LLC

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