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Fraud Cases in Auditing

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CPAs responsibilities to detect fraud in audits, required approaches, types of financial statement frauds and specific case examples of different types of financial statement fraud

CPAs responsibilities to detect fraud in audits, required approaches, types of financial statement frauds and specific case examples of different types of financial statement fraud


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  • Auditing for Financial Statement Fraud January 25, 2005 Dr. Raymond S. Kulzick, CPA, CFE [email_address]
  • Auditing for Financial Statement Fraud January 25, 2005 Dr. Raymond S. Kulzick, CPA, CFE [email_address]
  • Auditing for Financial Statement Fraud January 25, 2005 Dr. Raymond S. Kulzick, CPA, CFE [email_address]
  • Transcript

    • 1. Auditing for Fraud – Cases and Applications
      • Presentation for
      • Miami-Dade Chapter - FICPA
      • June 23, 2009
      • Dr. Raymond S. Kulzick, CPA, CFE, CFF, CDFA, FCPA
      • St. Thomas University
      • Kulzick Consulting, PA
      • Information in this presentation is believed to be reliable at the time of the presentation; but the authors do not assume any responsibility for its use and it should not be relied upon as authoritative.
      • Illustrations are for educational purposes only and do not include all facts & circumstances.
    • 2. Ray Kulzick Kulzick Consulting, PA
      • Forensic Accounting
      • Divorce
      • Fraud
      • Business Damages
      • Data Analysis for Litigation
    • 3. Outline
      • Fraud
      • Audit & Accounting Standards
      • SAS 99 Required Approach
      • Understanding the Risks
      • Financial Statement Fraud
      • Cases & Examples
        • 5 major types of financial statement fraud
      • Conclusions
    • 4. Financial Statement Fraud
      • “Intentional misstatements or omissions of amounts or disclosures in financial statements designed to deceive FS users where the effect causes the FS not to be presented … in conformity with … GAAP.” – SAS 99
      • “We lie about what we owe and we lie about what we earn.” – Barry Minkow 1/05
    • 5. Misappropriation of Assets
      • “Theft of a entity’s assets.” – SAS 99
      • May lead to financial statement fraud if material, in which case SAS 99 covers.
        • Adelphia
        • Greater Miami Chamber of Commerce $1.9 million over 3 years
    • 6. Importance of Fraud
      • ACFE 2008 (U.S. including government)
        • Total fraud losses estimated at $994 billion
      • KPMG 2008 (U.S. including government)
        • 74% personally observed “misconduct”, 46% of a significant nature
      • PWC 2007 (40 countries)
        • 43% of companies had a significant loss in the last 2 years, averaging $2.4 million + $550 thousand post-fraud costs
      • E&Y 2008 (Global)
        • 23% had someone solicited to pay a bribe in last 2 years
      • Oversight Systems 2007 (U.S.)
        • 76% feel fraud is more prevalent today than it was in 2002
    • 7. Audit and Accounting Standards
      • SAS 99 – Consideration of Fraud in a Financial Statement Audit
      • SSAE 10 – Reporting on Internal Control
      • SSAE 15 – Internal Control w/FS Audit
      • SAS 104-111 – Risk Assessment Standards
        • Understanding Entity & Controls links to Risk Assessment links to Audit Procedures (110)
    • 8. Audit and Accounting Standards
      • SSARS 10 – Performance of Review Engagements
        • Inquiries to include fraud
        • Representation letter to include fraud
      • SSARS 1 – Compilation & Review of FS
        • For Compilations – CPA MUST:
          • Have a basic understanding of the company, its accounting system and its industry
    • 9. Current Economic Issues
      • January, 2009 – AICPA issued a audit risk alert on Going Concern Issues in the current environment.
      • March, 2009 – AICPA Audit Practice Bulletin:
        • “ The audit profession should continue to exercise vigilance and rigor under the current economic climate.”
        • Specific suggestions in Appendix, including fraud considerations
    • 10. 8 Steps for SAS 99
      • Discussion among engagement personnel
      • Obtaining the information needed to identify the risks of material misstatement due to fraud
      • Identifying risks that may result in a material misstatement due to fraud
    • 11. 8 Steps for SAS 99
      • Assessing identified risks after assessing and taking into account controls
      • Responding to the results of the assessment
      • Evaluating audit evidence
      • Communicating about possible fraud
      • Documenting the auditor’s consideration of fraud
    • 12. Understand the Risks - Business and Industry
      • What does the business do?
      • How does it do it?
      • How do competitors do it?
      • What is the competitive situation?
      • Who are the customers?
      • Why do they buy from this company?
      • Who are the vendors?
      • What are the vendor customs in this industry?
    • 13. Understand the Risks – External Trends
      • In the industry
      • Competitors strategies
      • In the macro environment
      • Vendors
      • Customers
    • 14. Understand the Risks – Likely Users and Uses
      • Investors?
      • Banks and lenders?
      • Surety companies?
      • Parent company?
      • Joint venture or other partners?
      • Options and/or bonuses?
      • Acquisitions?
      • Regulators?
      • Progress payments?
    • 15. FS Fraud Within Statements
      • Revenues
      • -COS
      • Gross margin
      • -Expenses
      • Operating income
      • -Interest & taxes
      • Net income
      • Current assets
      • +Fixed Assets
      • Total Assets
      • Current liabilities
      • +Long-term liabilities
      • Total liabilities
      • Equity
    • 16. FS Fraud Between Statements
      • Debits
      • Good
      • Assets
      • Bad
      • Cost of sales
      • Expenses
      • Credits
      • Good
      • Revenue
      • Equity
      • Bad
      • Liabilities
    • 17. Five Major Types of Financial Statement Fraud
      • Fictitious revenues
      • Timing differences
      • Concealed liabilities & expenses
      • Improper disclosures
      • Improper asset valuations
    • 18. 1-Fictitious revenues Enron
      • Traded gas and derivative contracts
        • “ Harshest” employee pay system – internal competition
        • 2000 huge increase in derivative holdings
        • Constantly growing earnings – met all projections
      • 100s of Special Purpose Entities used to hide massive amounts of debt and generate fictitious profits
        • Met “letter of the law” of GAAP at the time
        • Impact: debt became revenue
        • Minimal disclosure
      • Derivative holdings valued using in-house speculative methodology
        • Minimal disclosure
        • Impact: asset write-ups became trading profits
      • 2001 collapsed
    • 19. Rayco Construction Co
      • Built football stadiums
        • Decline in new contracts
        • EBITDA covenant in credit line
      • Decreased cost to complete estimates & shifted completed project costs to open projects
        • % of completion method
        • Costs remain same, revenue is increased
      • Not discovered
      • Following year, massive losses
        • Loans worked out, company recovered
    • 20. 2-Timing differences Medford Machining Co.
      • Custom machines to mfg firearms
        • Complex product, required customer acceptance
      • Booked revenue when shipped
      • Discovered in 2001 by auditor
        • Testing internal controls in revenue cycle
        • Shipping cut-off testing
      • $21 million restatement of 1999-2000
    • 21. Sunbeam Corp.
      • 1996 Chain Saw Al arrives
        • Overstates losses, creates reserves
      • 1997 produces $60m profit (claim $189m is fraud)
        • Reverses reserves
        • Bill and hold channel stuffing
        • Contingent sale of $11m of spare parts (cost $2 million)
          • Al reduces profit from $9 million to $6
          • AA agrees, “not material,” so OK
      • Late 1998, falls apart, SEC begins investigation
        • Dunlop pays $500k fine
        • AA pays $110 million settlement
      • 2001 Bankruptcy
    • 22. U. S. Foodservice (Ahold)
      • $700 million in vendor rebates booked before earned from 2000 to 2003
      • Deloitte did internal control audit in 2001
        • Found lack of internal controls on rebates
      • Deloitte external audit found in 2003
        • 13 vendor employees colluded & returned fraudulent confirmations
      • Part of $1.2 billion Ahold international fraud
      • Deloitte successfully defended based on 2007 Tellabs decision that narrowed 3 rd party liability in federal investor class action suits (2009)
    • 23. Krispy Kreme Doughnuts
      • Heavily reliant on growth of franchises
        • Sales dropped off in 2003
      • Wholesale customers doubled shipped last Friday & Saturday of 2004
      • PWC did not review heavy year-end shipments (and subsequent returns)
        • Whistleblower caused SEC investigation
      • PWC did later refuse to sign off on franchise buyback “profit”
    • 24. 3-Concealed liabilities & expenses Private Plumbing Industries, Inc.
      • Plumbing distributor
        • In 2000 squeezed by recession
      • Booked rebates from vendors early
      • Auditors caught
        • Amounts “not material,” but audited anyway
        • Analytics based on prior years percentage rebates revealed large increase
      • Result was loss versus claimed profit
    • 25. Worldcom
      • Major telecommunications company
        • Competitors profits dropping rapidly
        • Worldcom reports increasing profits
      • $3.8 billion in line costs capitalized in 2001
        • Payments to other co. for use of their lines
        • Had been doing since 1999
      • AA auditors did not investigate red flags
        • Costs ran over 50%, was 42% in 2001
        • Mgmt said sales mix had changed – no support
      • Whistleblowers took to SEC
      • AA settlement for $65 million
    • 26. Adelphia Communications
      • Cable television company
        • Public, but family controlled (4 on board)
      • Operated through over 200 subsidiaries
      • $2 billion+ debt in unconsolidated subsidiaries
        • Parent is guarantor
        • No disclosures
      • Deloitte clean opinions in 1999 and 2000
        • Recommended footnote for 2000, backed off
        • “ Suspended” 2001 audit, later fired
      • $167 million malpractice settlement
    • 27. CUC International, Inc.
      • Diversified services company
        • Numerous acquisitions
        • Entrenched management
      • $252 million fraud involving mismatch of deferred revenue and expenses
      • 1997 merged with HFS to form Cendant
      • Post-merger audit of CUC by former HFS management disclosed fraud
        • Stock dropped $14 billion in one day
        • Largest fraud at that date
      • Ernst settlement $335 million
        • Walter Forbes (chair) sentenced to12+ years and $3.27 billion
        • Kirk Shelton (vice chair) sentenced to 10 years and $3.27 billion
    • 28. Aurora Foods
      • $800 million manufacturer & marketer of branded foods
        • Duncan Hines, Mrs. Paul’s, Lender’s, etc.
      • IPO in July, 1998
      • Fraud began in mid-1998
        • Promotional credits not reflected in A/Receivable
        • $38m in 1998; $43m in 1999 1 st 3 quarters
        • Turned off computer system that generated these as credits on billings and changed to manual postings
      • Discovered by PWC in 1999 statements (Feb, 2000) – 10-Qs were not audited
      • Investigation by Deloitte
    • 29. 4-Improper disclosures Cardinal Health, Inc.
      • Drug wholesaler
        • Manufacturers cutting out wholesalers
        • Lawsuit by company against vitamin manufacturers
      • Booked anticipated legal settlements in 2000, 2001 and early 2002 as offsets to cost of sales
        • Journal entries
        • No disclosure, enabled them to meet analyst projections
      • E&Y did not discover (was successor to AA)
      • SEC opened an investigation in 2003, lawsuits followed
    • 30. 5-Improper asset valuations Prime Plumbing, Inc.
      • Plumbing Distributor & Retailer
        • 2 warehouses, 30 showrooms
        • Fraudulent inventory in showrooms
      • Auditors audited inventory only at warehouses for more than 5 years
        • 50% of inventory in showrooms
        • Individual showrooms deemed “not material”
      • 2001 auditors finally discovered
        • Obtained sq footage for each showroom
        • Analyzed inventory per sq foot
    • 31. Parmalat
      • International dairy products company
        • Based in Italy, rapid expansion
        • Many foreign subs losing money, high debt level
      • € 4 billion cash deposit in Cayman bank did not exist
      • Both Grant Thornton (1999 and earlier) and Deloitte (2000) issued clean opinions
        • Confirmation sent through company’s mail
        • Fraudulent confirmation accepted
      • Largest fraud in Europe to date
    • 32. Refuse Collection Services, Inc.
      • Wisconsin waste service company
        • 1997 acquired company in adjacent area
        • Recorded goodwill of $350,000
      • 1998 through 2001 the acquired division reported losses
        • Efforts to reduce losses were unsuccessful
        • Auditors accepted management’s forecasts and projections of future profits
      • Goodwill finally written off in 2002
    • 33. Mueller Microbrewery
      • Midwest brewery
        • Declining sales in 2001
        • Actual numbers would have violated loan covenants
      • Added $135,000 to fixed assets
        • Used journal entries crediting various expense accounts
        • Some in small assets, known to be “not material” in past audits
        • Some in a large addition
      • Auditor questioned missing support on large item
        • Accepted that papers must have been “lost”
      • Discovered following year by bank
    • 34. Brown Packaging Co.
      • Cardboard packaging to major manufacturers
        • Very cyclical business
      • Used long lives when times lean
        • e.g., 39 years for leasehold improvements
        • Short lives when times good, accelerated dep.
      • Audited during due diligence when sold in 2001
        • $5 million write-off on leaseholds
        • Additional $7 million on other assets
    • 35. John-Tee Plumbing Distributors
      • Plumbing distributor
        • Grew to 10 warehouses over 20+ years
      • Never wrote off or reserved for obsolete inventory
        • Auditors never tested for nor adjusted
      • New auditors
        • Observed, researched and documented all inventory
        • $ 500,000 write-off for obsolescence
    • 36. E. S. Bankest LLC
      • Miami factoring company
        • Joint venture created in 1998
        • Espirito Santo Bank & Orlansky brothers
      • $170m fraudulent receivables – main asset
      • BDO Seidman clean opinions 1998-2002
      • 2003 went into receivership
        • Receiver (Lewis Freeman)
        • Visited companies with large A/R
        • Either non-existent, related parties, or very small
      • $522 million malpractice award
        • Under Florida law, jury verdict cannot bankrupt a company - collectibility in doubt
    • 37. Conclusions
      • Materiality is not based on transactions
      • Management sometimes lies
      • Don’t audit something you don’t understand
      • Just because it isn’t consolidated doesn’t mean its not important
      • Look at the big picture – where’s the risk?
      • Do the financials “present fairly” to third party users?
    • 38.
      • Thank you!
      • Questions?
      • Ray Kulzick – 305.812.4998
      • Kulzick Consulting, PA
      • [email_address]
    • 39. Ray Kulzick Kulzick Consulting, PA
      • Forensic Accounting
      • Divorce
      • Fraud
      • Business Damages
      • Data Analysis for Litigation
    • 40.
      • Master of Accounting – 30 credits
        • Specialization in Forensic Accounting
        • Specialization in Tax
      • MBA – 42 credits
        • Specialization in Accounting
        • Joint JD degree program
      • MS in Management – 36 credits
        • Specialization in Management Accounting
      • Graduate Certificates – 12 credits
        • Forensic Accounting
        • Taxation
        • Management Accounting