Chapter 12REVENUE AND INVENTORY-RELATED FINANCIAL STATEMENT .docx

Chapter 12
REVENUE AND INVENTORY-
RELATED FINANCIAL STATEMENT FRAUDS
Short Cases
Case 3
After performing the analysis, the accounts that raise questions
are Accounts Receivable and Retained Earnings. The percentage
changes are shown in the following table:
2007
2008
Percent
Change
2009
Percent
Change
2010
Percent
Change
Cash
$1,000
$1,200
20.0%
$1,400
16.7%
$1,500
7.1%
A/R

250
375
50.0%
600
60.0%
900
50.0%
Inventory
600
700
16.7%
825
17.9%
975
18.2%
PP&E (net)
1,500
1,700
13.3%
1,800
5.9%
1,950
8.3%
Notes Rec.
500
500
0.0%
500
0.0%
500
0.0%
Tot. Assets
$3,850
$4,475
16.2%
$5,125

14.5%
$5,825
13.7%
A/P
$ 700
$ 900
28.6%
$1,000
11.1%
$1,100
10.0%
Other Liab.
200
300
50.0%
350
16.7%
425
21.4%
Notes Pay.
1,200
1,400
16.7%
1,500
7.1%
1,750
16.7%
Tot. Liab.

$2,100
$2,600
23.8%
$2,850
9.6%
$3,275
14.9%
Stock Out.
$1,000
$1,000
0.0%
$1,000
0.0%
$1,000
0.0%
Ret. Earn.
750
875
16.7%
1,275
45.7%
1,550
21.6%
Total Share. Equity
$1,750
$1,875
7.1%
$2,275

21.3%
$2,550
12.1%
Total Liab./
Share. Equ.
$3,850
$4,475
16.2%
$5,125
14.5%
$5,825
13.7%
The Accounts Receivables balances are most questionable
because of the huge jump from year to year. Those balances
would be even more suspicious if there had been a drop in
business incurred by most companies in the technology sector.
Case 6
The following are symptoms and schemes used in this case:
1. Funneling bank loans through third parties to make it look as
though customers had paid when they had not.
2. Deliberately providing “false or incomplete information” to
auditors and conspiring to obstruct the firm’s audits.
3. Factoring unpaid receivables to banks to obtain up-front cash.
Side letters that were concealed from the auditors gave the
banks the right to take the money back if they could not collect

from the company’s customers.
4. The bulk of the company’s sales came from contracts signed
at the end of quarters, so managers could meet ambitious
quarterly sales targets and receive multimillion-dollar bonuses.
One of the first questions that needs to be examined is how the
company explained the sudden growth in sales from hundreds to
millions. The auditors should have investigated this increase.
Also, the fact that most sales were recorded in the last days of
the quarter should have been investigated. The auditors should
have concluded that management had strong motivation to
commit fraud because executives were being paid high bonuses
based on sales volume.
As discussed in this chapter, the analytical symptoms and the
accounting or documentary symptoms, if understood and
analyzed by auditors, could have lead to earlier fraud discovery.
Case 7
1. One way to search for possible red flags of fraud would be to
determine if the market value of inventories is higher or lower
than reported inventory amounts. Doing this reveals the
following:
Reported 2010
Market Value
Finished goods inventory
$1,654,500
$2,400,000
(300 million × $.08)
(Approx. 300 million feet—2010)
Copper rod inventory

$2,625,000
$2,832,000
(5.9 million × $.48)
(Approx. 5.9 million lbs.—2010)
Plastics inventory
$ 224,500
$ 132,000
(1.1 million × $.12)
Market price of insulated wire (per foot)
$ 0.008
$ 0.009
Market price of copper rod (per lb.)
$ 0.480
$ 0.480
Market price of plastics (per lb.)
$ 0.120
$ 0.190
2. From this table, if you multiply the market prices by the
actual quantities of inventories in 2010, you can see that for two
of the three inventories, the amounts reported in the balance
sheet are much lower than what the market prices show.
Because inventory should be carried on the balance sheet at the
lower of cost of market, these amounts may be fine. However,
changes in percentages from year to year should be examined.
Since the market value is significantly less than the carrying
amount of plastics inventory, this difference should be
investigated, as it represents a possible fraud symptom.
Using vertical analysis results in the following:

2010
2009
Sales
$8,450,000
100.00%
$8,150,000
100.00%
Cost of goods sold
6,242,500
73.88%
6,080,000
74.60%
Finished goods inventory
1,654,500
19.58%
1,175,500
14.42%
(Approx. 300 million ft.—2010)
Copper rod inventory
2,625,000
31.07%
1,650,000
20.25%

Plastics inventory
224,500
2.66%
182,000
2.23%
Accounts payable (for inv. purchases)
450,000
5.33%
425,000
5.21%
We can see that even though Cost of Goods Sold has stayed
relatively constant as a percentage of sales, finished goods
inventory has increased as a percentage of sales. Copper Rod
Inventory increased dramatically as a percentage of sales as
well, but what is interesting is that Accounts Payable also
maintained the relatively constant percentage with sales. You
would expect to see an increase in Accounts Payable as
inventory levels increase, but that is not the case here. This
possible red flag demands further investigation.
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Chapter 12
1
Chapter 11
FINANCIAL STATEMENT FRAUD
Short Cases

Case 1
Most of the fraud symptoms in this case relate to management,
the board of directors, and relationships with others.
Management and the board of directors: The senior officers
were friends. They had a lot of power in the new company,
which allowed them to collude if needed. Their positions in the
company allowed them to influence decisions and override
internal controls as they wished. They owned a large percentage
of the common stock, so they had a personal motivation for the
stock price to be as high as possible. They comprised a large
percentage of the board of directors, so they were insiders.
Relationships with others: The fact that the president of the
local bank was appointed to the board of directors not only
represented a “grey” member in the board (because he had
loaned the company money), but it could also represent a
concern about how valid the transactions are between the
company and the bank. Is the bank giving the company
extremely lax credit terms or an unreasonably low interest rate?
Are the transactions with the bank arm’s length? One might also
be concerned about the company’s relationship with city
officials, who feel a strong motivation to keep this company in
town because it boosts the city’s economy, provides jobs, etc.
Case 2
1. In determining whether or not a good system of internal
controls would have prevented fraudulent backdating practices,
it is important to understand who the perpetrators were. Internal
controls are most effective in preventing or detecting employees
who commit fraud when acting alone. When collusion (two or
more people are involved), internal controls are less effective.
When top management and the directors are involved, as was
the case with option backdating, they can often “override”
internal controls. Internal control activities (procedures) such as
segregation of duties, proper authorizations, and so forth,
wouldn’t be nearly as effective in preventing this type of fraud
as would a good control environment (tone at the top.) While a
few of these firms’ backdating practices were caught by

auditors or outsiders, most backdating revelations have come
from companies themselves after thoroughly examining all
options granted in the past.
2. The question of why executives and directors would have
allowed this fraudulent practice is a tough one. Hopefully, in
most cases, the option backdating was known by only a few
people. Those individuals probably engaged in the practice
because of the elements of the fraud triangle: (1) they felt a
pressure to increase their compensation—greed, (2) they
perceived an opportunity to backdate without getting caught—
no one had been paying attention to option dating in the past,
and (3) they rationalized that it was okay—everyone else was
doing it. With respect to the rationalization, they were correct.
While everyone wasn’t doing it, lots of companies were. The
fact that many others are acting illegal doesn’t make it right.
3. A whistle-blower system allows individuals to call in
anonymously to report suspected violations. A whistle-blower
system would probably be the most effective way to catch this
kind of fraud because individuals who saw the dishonest acts
could report violations by company executives without fear of
reprisal because no one knows who the anonymous caller is.
Whistle-blower systems are most important where internal
controls can be overridden. The fact that a whistle-blower
system is in place helps prevent or deters dishonest acts.
Providing a way for everyone who could see fraud to easily
report that fraud significantly increases the likelihood that
dishonest acts will be reported.
Case 3
Below are some of the red flags that fraud may be occurring:
· Success since beginning operations
· Rapid growth in revenues
· Pressure to perform well for the IPO
· Increased commissions as a way to increase revenue
· Personal relationships between executives

· Change in auditors
· Dispute with auditor over revenue recognition accounting
· Infrequent board of director and audit committee meetings
· Close relationships between the board and management
· High level of stock options held by management
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Chapter 11
2
Chapter 10
INQUIRY METHODS AND FRAUD REPORTS
Short Cases
Case 1
Judd
Jim
1. Denial
Disbelief; lets it go
Dumbfounded; denial
2. Anger
Confrontation
“What right …”
3. Rationalization
Jim slipped up
Just doing his job
4. Depression
Feels sad
“The gig is up”
5. Acceptance
Friends with Jim

Admits guilt
Case 2
Because you may already have enough evidence to support your
claims against Damon, the first thing you should do is contact
the police and present to them the results of your investigation
and audits. You might prearrange a meeting with Damon and
record the discussion. You may want to have police officers
watch the discussion live. If you decide not to have police
involvement, Damon could deny the conversation or say that
you fabricated it. It is important to plan the interview carefully.
1. Introductory Questions: Because you already know Damon
through your father-in-law’s work, Damon should not be alerted
by your request for a private talk. Once the discussion has
started, you could make small talk initially but should keep it
brief.
2. Informational Questions: You could openly bring up the topic
of how cheap your father-in-law is and how you wish he would
pay more. After a comment like, “I bet it wouldn’t be hard to
find a little extra money laying around the office,” you could
ask Damon if he can think of any ideas of how to defraud the
company. You could ask other questions to gather more
information, but if Damon is not willing to open up you could
question him directly about the fraud.
3. Closing Questions: To verify the facts he had told you, it is
important to ask closing questions. If you want to close the
conversation, you could ask, “Do you know anyone else I could
talk to? Is there anything else I have forgotten to ask you that
would be relevant? If I need to talk to you again, would it be
okay?”
4. Assessment Questions: If Damon just does not seem to be
opening up to any of your questions, you could specifically
bring up some of the things that Damon has done. You could

say that you happened to see him commit fraud and you were
just wondering how he happened to pull it off without getting
caught. While asking about the frauds, you should bring up each
one specifically and watch to try to determine if Damon is
telling the truth.
5. Admission: Seeking Questions: If Damon opens up and feels
comfortable with you, you can ask him if he has ever done the
things he described or talked about previously. You will likely
need to admit to Damon that you have been tracking his frauds
and that he has taken a substantial amount of money. You might
tell him that you wanted to talk to him directly rather than
talking to your father-in-law because you are hopeful that you
will find an acceptable way to fix things. You should ask direct
questions, encouraging Damon to confess.
Before the interview, you should have prepared a written
confession for Damon to sign and it should be accessible in case
he admits to what he has done. You might have purposely
misprinted the amount taken to read $70,000 so that Damon will
notice the difference, change it to $50,000, and initial it. You
should be aware, however, that most perpetrators don’t keep
track of how much they steal and they always believe it is less
than they really took. Putting too large a number for the theft
could scare him into not signing.
Case 7
1. A good place to start would be checking personnel records
and company records to gather information about Jane. Next,
you could examine financial statement accounts to verify that
there is erratic activity. During hours when no one is at work,
you could examine debit and credit documents to ascertain their
purpose. Interviewing Jane’s coworkers and subordinates might
come next. Gathering public information about Jane’s spending
habits and performing a net worth analysis might be helpful.
Finally, you would interview Jane, especially if you have

sufficient evidence to confront her and obtain a confession.
Before you proceed too far, you should obtain the CEO’s and
legal counsel’s permissions for the investigation.
2. No. There are several reasons why you would not interview
Jane first. First, you would not want to alert Jane to the fact that
you are investigating because you would not want her to have a
chance to conceal the embezzlement. Second, you would not
want to cause any undue hardship or emotional stress for her
department or create future legal problems for the company.
Finally, in order to eventually seek a confession from Jane, you
would want to have as much evidence as possible to convince
her that she cannot hide her fraud any longer.
3. You would want to have as much evidence as possible when
you interviewed her and you would perform all other
investigative procedures before the interview. You would
explain to Jane that she should feel free to leave at any time but
that you have important information to present to her. You
would conduct the interview at a neutral location and make sure
that it was a surprise to Jane. You would state the allegations
clearly and indicate that Jane was the primary suspect. You
would use a direct confrontational style while using statements
of sympathy to seek a confession from Jane.
Case 8
1. John went through the predictable sequence of five reactions:
denial, anger, rationalization, depression, and acceptance.
a. Denial. When John first spoke of the fraud, he mentioned how
much he respected his boss. John seemed to screen out reality.
He did not respond well to questions, and he seemed
emotionally distant from the situation.
b. Anger. Later, John became angry. His anger was displayed by
his comments about his boss. He also displaced some anger
toward his innocent friend.
c. Rationalization. John tried to justify why his boss committed

the fraud. He cited his boss’s family life, work troubles, and
recent traumatic events. John even made the comment that he
might have done the same thing.
d. Depression. John displayed depression in several ways. He
blamed himself for what had happened and felt a sense of
embarrassment for what happened before his eyes.
e. Acceptance. John finally accepted the fact that the fraud
happened. He acknowledged that it occurred and volunteered his
assistance with the investigation. At this stage, John wanted to
help resolve the situation and move on.
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Chapter 10
1
Chapter 9
CONVERSION INVESTIGATION METHODS
Discussion Questions
1. Most investigations of conversion involve searching public
records and other sources to trace purchases of assets, payments
of liabilities, and changes in lifestyle and net worth.
2. When people enter into financial transactions, such as buying
assets, they leave tracks or “financial footprints.” Trained
investigators who know how to follow, study, and interpret
these tracks often find valuable evidence that supports
allegations of fraud.
3. Understanding how perpetrators convert and spend their
stolen funds is important for two reasons: first, to determine the
extent of the embezzlement, and second, to gather evidence that

can be used in admission-seeking interviews to obtain a
confession.
4. Public sources include many federal, state, and local agencies
that maintain public records in accordance with various laws.
These records include such databases as driver’s license
records, marriage records, property tax records, etc. Private
sources are comprised of non-governmental records and include
gas, electric, water, and other utility records, bank and
brokerage records, and other financial institution records.
Private sources include all sources other than federal, state, and
local agencies.
5. State, federal, and local public records contain valuable
information that is extremely helpful in fraud investigations.
Local courts maintain records on past law violators,
employment history, personal and physical information, and
prior charges. Federal sources, such as FBI records, contain
large databases that can be accessed by local law enforcement
agencies. State records, such as those of the Secretary of State,
contain valuable information, such as UCC filings.
6. The Internet includes many databases, public and private,
that can be accessed. By accessing information such as how
individuals have spent their money (e.g. purchased boats, real
estate, automobiles, etc.), investigators can determine the
approximate amounts an individual has spent and the amount of
assets he or she has. This information is helpful both to
determine a person’s net worth and also to compare the
spending with known sources of income to make a net worth
calculation of a possible perpetrator.
7. Net worth calculations are valuable because only assets and
reductions in liabilities that can be discovered enter into the
calculation. Net worth calculations tend to give a conservative
estimate of stolen funds. Because these calculations are

conservative, the stolen amounts are usually readily accepted as
evidence by courts. Additionally, they often facilitate
investigations in the obtaining of confessions from suspects.
8. Some of the more advanced techniques available when
searching for information on Google include searching by
phrase, minus search terms, domain restrictions, Google
Groups, cached results, and Google News.
9. Because the Internet contains so much information, it is often
difficult to conduct effective searches. The advanced techniques
help researchers conduct effective searches by allowing them to
search entire phrases, to narrow searches and avoid words not
associated with the search, and to get cached results as well as
search news events.
10. There are four types of information sources available to
investigators searching public records. They are government
sources, private records, online databases, and Internet
searches.
11. The Gramm-Leach-Bliley Act, passed in 1999, prohibits the
use of false pretenses to access the personal information of
others. It also allows financial institutions to sell customer
information unless customers have opted out. This act is both
restrictive and helpful to investigations. While preventing false
pretenses, it allows the investigator to get information from
financial institutions in more accepted ways. This is especially
useful since most customers do not opt out.
12. Trash investigation is the discovery of information by
looking through a person’s trash. This can be useful since many
perpetrators do not shred documents. In addition, software can
put shredded documents back together, and many documents are
still kept electronically on the computers where they were
created.

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Chapter 9
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Chapter 8
INVESTIGATING CONCEALMENT
1. Concealment is generally accomplished by manipulating
documentary evidence, such as purchase invoices, sales
invoices, credit memos, deposit slips, checks, receiving reports,
bills of lading, leases, titles, sales receipts, money orders,
cashier's checks, or insurance policies.
2. Primary aspects of documentary evidence include:
· Chain of custody of documents
· Marking of evidence
· Organization of documentary evidence
· Coordination of evidence
· Rules concerning original versus copies of documents
3. From the time documentary evidence is received, its chain of
custody must be maintained in order for it to be accepted by the
courts. Contesting attorneys will make every attempt to
introduce the possibility that the document has been altered or
tampered with.
4. Programs to help coordinate evidence include CaseMap,
CaseCentral, Zantaz, RingTail, and DatiCon. Programs that help
in link analysis include the Analyst’s Notebook from i2, Inc.
and Xanalys Link Analysis.
5. Documents contain extremely valuable information for
conducting fraud investigations. When faced with a choice
between an eyewitness and a good document as evidence, most

fraud experts would choose the document. Unlike witnesses,
documents do not forget, they cannot be cross-examined or
confused by attorneys, they cannot commit perjury, and they
never tell inconsistent stories.
6. Documentary evidence such as the manipulation of purchase
invoices, sales invoices, credit memos, deposit slips, checks,
receiving reports, bills of lading, leases, titles, sales receipts,
money orders, cashier's checks, or insurance policies provides
extremely valuable information when conducting an
investigation. It is important to obtain such information because
perpetrators, when faced with such information, are much more
likely to give a confession. Furthermore, documentary evidence
is usually a vital link in proving guilt when a confession is not
obtained.
7. Documents contain extremely valuable information for
conducting fraud examinations. Documents are some of the best
sources of evidence in court, and they provide solid evidence in
a case.
8. Discovery (statistical) sampling allows a fraud examiner to
generalize and make inferences from the sample to the
population. Many fraud cases involve large databases, and when
several examiners are involved in the sampling, the chance for
human error increases. However, with computers and
technology, examiners can quantify both risk and samples with
little or no human error.
9. The three most common ways that investigators can obtain
hard-to-get documentary evidence are subpoena, search warrant,
and voluntary consent.
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Chapter 8
2
Chapter 7
INVESTIGATING THEFT
1. Theft investigation methods help to investigate fraud because
they allow the investigator to determine specific facts about the
fraud such as how the fraud was perpetrated and how the fraud
was concealed. Three main methods are used to investigate theft
in suspected frauds. They include surveillance and covert
operations, invigilation, and physical evidence. Surveillance
and covert operations are used in three ways: stationary or fixed
point, moving or tailing, and electronic surveillance.
Invigilation is used to determine if fraud is occurring, while
physical evidence is used to analyze objects such as inventory,
assets, and broken locks.
2. Determining the existence of predication is the most
important factor to consider when deciding whether to
investigate a case of fraud. Predication is defined as
circumstances that would lead a reasonable prudent professional
to believe that a fraud has occurred, is occurring, or will occur.
Other important factors include:
a. Expected strength of evidence.
b. Exposure or amount that could have been taken.
c. The signal that investigation or noninvestigation will send to
others in the organization.
d. Risks of investigating and not investigating.
e. Public exposure or loss of reputation from investigating and
not investigating.

f. Nature of the possible fraud.
3. A vulnerability chart can be useful when coordinating
theories about a suspected fraud. A vulnerability chart
coordinates the various elements of the possible fraud,
including assets that were taken or are missing, individuals who
have opportunities to commit fraud, promising methods to use
in the theft investigation, concealment possibilities, conversion
possibilities, symptoms observed, pressures on possible
perpetrators, potential rationalizations for the fraud, and key
internal controls that had to be compromised for the theft to
occur.
4. A surveillance log is a detailed record used in an observation.
A surveillance log includes the date and time of observation, the
name of the observer, the names of corroborating witnesses, the
position from which the observation was made, its distance from
the scene, and the time the observation began and ended, along
with a detailed time log of all the movements and activities of
the suspect.
5. Invigilation is a condition where management imposes strict
temporary controls on an activity so that during the observation
period, fraud is virtually impossible. Management keeps
detailed records before, during, and after the invigilation
period. By comparing the activity during the three periods,
management can obtain evidence about whether fraud is
occurring.
6. Physical evidence, such as paints, stains, fingerprints, and
tire marks, can help determine who stole certain assets. For
example, by tracing the fingerprints on the safe to a certain
employee, we can determine who accessed the safe and if they
had authorization to do so.
7. The steps may vary from case to case, depending upon the
media being seized. However, the general pattern is:

a. Step1: After ensuring that you have the legal right to seize,
secure the device and perform initial tasks
b. Step 2: Clone the device and calculate a CRC checksum
c. Step 3: Search the device manually
d. Step 4: Search the device using automated procedures
8. If perpetrators suspect they are being investigated for fraud,
they could do two things that would affect the outcome of the
investigation: destroy or conceal important evidence and
completely stop their fraudulent acts so that they cannot be
caught in the act.
9. It is important to consult legal counsel to ensure that the
suspect’s legal rights will not be violated in the course of the
investigation, and that the evidence being obtained will be able
to be used in a court of law. It is important to consult with
human resources to ensure that company privacy policies are
being followed throughout the investigation, and that the
investigation will not cause problems with other employees.
10. The Fourth Amendment to the Constitution protects the right
of a person against unreasonable searches, and limits the extent
to which investigations can be conducted.
11. The fraud triangle plus inquiry approach to investigation
includes four things:
a. Theft investigative methods
b. Concealment investigative methods
c. Conversion investigative methods
d. Inquiry investigative methods
Potential benefits:
e. The CDs are free to download and use.
f. The included tools generally include very advanced tools.
g. The CDs can boot directly into the computer, bypassing
Windows passwords.

h. Since the tools mount drives in read-only mode, no tracks are
left in log files or file timestamps.
Potential drawbacks:
a. The tools are based on Linux and can be more difficult to use
than more user-friendly, non-open source solutions.
b. The tools do not have the precedence in court that EnCase
and FTK have.
c. The CDs are a combination of many different, stand-alone
utilities. EnCase and FTK are all-in-one solutions that do much
of the work for you. They are not nearly as user-friendly as non-
open source, proprietary solutions.
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Chapter 6
DATA-DRIVEN FRAUD DETECTION
Short Cases
Case 5
There are a couple of possibilities available to Bucket Corp.:
1. Commercial data-mining software: By running analyses of
Bucket’s purchasing trends with the various buyers, it would
quickly come to someone’s attention that Harris Lumber has
high prices and high-volume purchases. While this could have
something to do with the quality of Harris’s lumber, it merits
further investigation.
2. Statistical analysis: According to Benford’s Law, a higher
percentage of invoice totals should start with number 1 (about
30 percent), followed by number 2 (about 17 percent), and so
on. The numbers for Harris Lumber clearly do not follow this

trend, while the other three companies do follow this trend
much more closely. This is a pretty good indication that the
invoices for Harris may not be totally genuine. Bucket should
look further to see if there are any abnormal relationships
between Harris and Bucket’s purchasing agent.
Case 8
1. Based on a comparison of the sample data with Benford’s
Law, there could be a possible fraud problem. A much larger
sample is required to be certain that the troublesome patterns
are persistent, and additional tests such as querying addresses of
vendors or analyzing vendor volumes over the past few months
should be undertaken.
Case 10
1. Some areas of concern are the rapid growth of receivables
without a corresponding increase in inventory. Adding to this
concern is the increase in accounts payable. Normally, as
accounts payable increase, inventory should also increase.
2. Possible explanations for these trends exist. The company
could have had a change in credit policy, allowing for accounts
receivable and accounts payable to increase. Also, the
possibility exists that the company has sold or discarded
obsolete inventory to reduce the amount it carries on the books.
Case 11
Even though the pattern does not exactly follow a normal
Benford’s Law shape, it does not differ much from expectations.
The only digit that looks out of the ordinary is “4,” and testing
could be performed to determine if that is a problem. Most
likely, however, fraud is not occurring and no further
investigation is necessary.

2
Chapter 6
2
Chapter 5
RECOGNIZING THE SYMPTOMS OF FRAUD
1. With fraud, it is not always apparent that a crime has been
committed. Therefore, it is important that observers watch for
red flags, or symptoms, in order to detect fraud. Without fraud
symptoms, it would be very difficult to detect fraud.
2. When internal controls are absent or overridden, an
opportunity is created, and the risk for fraud increases greatly.
By focusing on the internal controls that are absent or
overridden, we can identify possible areas and suspects, helping
us to detect possible fraud.
3. Accounting symptoms or anomalies involve problems with
source documents, faulty journal entries, and inaccuracies in
ledgers. These also include any record, electronic or paper, that
is unusual.
4. Analytical symptoms or anomalies are procedures or
relationships that are unusual or too unrealistic to be believable.
They include transactions or events that happen at odd times or
places, or that include odd procedures, policies, or practices.
They also include transactions and amounts that are too large or
too small, that occur too often or too rarely, that are too high or
too low, or that result in too much or too little of something.
Basically, analytical anomalies are anything out of the ordinary.
5. Most people who commit fraud do so under financial

pressure. Sometimes the pressures are real; sometimes they
represent simple greed. Once perpetrators meet their financial
needs, however, they often continue to steal, using the
embezzled funds to improve their lifestyles. They buy new cars.
They buy other expensive toys, take vacations, remodel their
homes, or move into more expensive houses. Fraud investigators
can detect fraud by focusing on these changes in suspected
perpetrators’ lifestyles.
6. Research in psychology indicates that when people
(especially first-time offenders, as many fraud perpetrators are)
commit crimes, they are overwhelmed by fear and guilt. When
perpetrators feel this fear and guilt, they change their behavior.
For example, a nice person suddenly becomes mean or angry. Or
a person who normally has lots of patience no longer is patient
with anyone.
Although no particular behavior signals fraud, it is the changes
in behavior that signal possible fraud. By focusing on these
changes, we can identify possible perpetrators of fraud.
7. Tips and complaints are categorized as fraud symptoms rather
than actual evidence of fraud because many tips and complaints
turn out to be false. It is often difficult to know what motivates
a person to complain or provide a tip. Customers, for example,
may complain because they think they are being taken
advantage of. Employees may phone in tips for reasons of
malice, personal problems, or jealousy. Tips from spouses and
friends may be motivated by anger, divorce, or blackmail.
Therefore, tips and complaints must be treated with care and
initially only as symptoms of fraud, not as evidence of it.
Individuals must always be considered innocent until proven
guilty.
8. Theft is the actual taking of cash, inventory, information, or
other assets. Theft can occur manually, by computer, telephone,

or other electronic means.
9. Conversion has to do with selling stolen assets or converting
them into cash and then spending the cash. If the asset taken is
cash, conversion is the spending of the stolen funds.
10. Concealment involves the steps taken by the perpetrator to
hide the fraud. In concealment, financial records are altered,
cash or inventory is miscounted, or evidence is destroyed.
a. If you are an auditor, you are responsible to report internal
control weaknesses to the Board of Directors or management. If
the company is a public company then you will be required
under Sarbanes-Oxley Act, Section 404, to audit the internal
controls. The severity of the weakness will determine the extent
of your reaction to a control weakness. Auditing concepts such
as materiality come to play in this decision but that discussion
is beyond the scope of this text.
b. If you believe the coworker is exhibiting signs that he or she
has been committing fraud you might report this to someone in
the organization who can investigate it. Many companies have
whistle-blowing systems in place that would allow you to report
this activity anonymously. You might also investigate the
opportunities for this coworker to commit fraud. Perhaps there
is inadequate segregation of duties or other control weaknesses
that the company is not aware of.
c. If you are in a position to embezzle from the company then
you will want to notify someone above you of the control
weakness so that you are not tempted to take advantage of the
situation. You can present this information to your superior in
the spirit of improving the company’s controls and preventing
future problems.
Multiple Choice
1. b

2. c
3. e
4. a
5. a
6. d
7. d
8. d
9. c
10. d
11. b
12. a
13. b
14. c
15. d
16. d
17. b
Short Cases
Case 1
1. The business is at risk because there is no separation of
duties. Cal Smith, Jr. works the night shift alone and then

accounts for and deposits the money at the bank in the morning.
2. Possible symptoms:
· Cal has never missed a day of work.
· Cal feels he is overworked and underpaid.
· Numerous doughnuts are thrown away for over baking.
· Cal was hired because he was friendly; he is now often angry
and frustrated.
· Cal has not been getting very much sleep.
· Cal recently purchased the car of his dreams.
3. Possible steps to reduce opportunities for fraud:
· Have other employees work at night.
· Do not allow Cal to make the deposits or handle cash.
· Force Cal to take some time off periodically.
· Pay Cal more money so he does not feel overworked and
underpaid.
Case 2
1. It is possible that James could be committing fraud.
· Fraud symptoms:
· Outstanding bills need to be paid.
· Lawsuits are pending from lack of payment.
· James drives nice cars.
· James has a very expensive home.
· James will not update equipment.
· James is known for losing his temper.
· Many customers are complaining.
2. Most businesses experience customer complaints. While
customer complaints are common, they can be possible fraud
symptoms, especially if customers do not believe their accounts
or charges appear appropriate. Whenever tips or complaints are
received, they must be treated with care and considered as
possible fraud symptoms but not as actual evidence of fraud.

Case 3
Several symptoms of fraud exist. The first is the fact that the
ranch has a patented new breeding technique that can increase
the population from 20 to 100 steers in two years. If this is true,
why has it not been chronicled on TV or in newspapers? Next,
the business has just started, and companies with a short history
are not tried and tested by the business world. Performance
seems suspicious with the immediate growth and phenomenal
success. If it seems too good to be true, it probably is. The
location in Hawaii is also suspicious, since most people cannot
afford to fly to the islands and observe operations. The large
growth in assets and revenues, the pressure to invest quickly,
and the fact that investors have only 10 days after the initial
offering to invest are all possible signs of fraud. Furthermore,
the words “double your money,” “sure thing,” and “very
exclusive” should tip off any educated person to the possibility
of fraud.
Case 5
First, vendors with the same address are a symptom in the
source documents. Lack of the needed signatures is a sign of
weak internal controls or the overriding of controls. The
expensive stereo system could be a sign of an extravagant
lifestyle, and these symptoms could indicate the existence of
fraud.
Case 10
Although fraud could be occurring, there is no conclusive proof.
Several fraud symptoms do exist, but all of these symptoms
could have other possible explanations. You may want to
discuss possible symptoms identified in the case and even how
the students would proceed in investigating the symptoms. For
example, the missing receiving documents may be for goods
that were personal items but recorded as inventory or legitimate
business expenses. You could investigate this possibility by

looking at the other supporting documents for these purchases
including vendor invoices and/or cancelled checks. Also,
overcharging customers may be a means for John to take funds
out of the company. He may be refunding money when the
customers complain but keeping it when they don’t notice. You
could investigate this possibility by reviewing customer
complaints and ensuring that customers are sent monthly
statements for amounts due to the store.
2
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Chapter 5
2
Chapter 4
PREVENTING FRAUD
1. Three factors are crucial in creating a culture of honesty,
openness, and assistance: hiring honest people and training
them in fraud awareness; creating a positive work environment;
and providing employee assistance programs (EAPs).
2. Five methods that companies can use to reduce actual or
perceived opportunities for fraud are as follows:
a. Install good internal controls.
b. Discourage collusion, and alert vendors and contractors to
company policies.
c. Monitor employees, and install tip hotlines.
d. Create an expectation of punishment.
e. Proactively audit for fraud.

3. Clearly defined codes of ethics delineate between what is
acceptable and what is unacceptable. Having employees
periodically read and sign the company’s code of ethics not
only reinforces their understanding of what constitutes
appropriate and inappropriate behavior; it also underscores the
fact that their behavior is important to the company.
Expectations are clarified, and clear expectations reduce fraud.
Clearly specified codes also inhibit rationalizations, and, as
previously discussed, rationalization is an important element of
nearly every fraud.
4. The most widely recognized way to deter fraud is with a good
system of internal controls. Internal controls include a good
control environment, a good accounting system, and good
control procedures as well as good communication and
monitoring.
5. Much collusion can be prevented by simply enforcing
mandatory vacations or job transfers, because collusive fraud
develops slowly (it takes time to get to know others well enough
to trust that they will cooperate and not blow the whistle).
When organizations leave one employee in close contact with
the same vendors or customers for long periods of time, the risk
of individuals deciding to profit personally increases
dramatically.
6. Sometimes otherwise innocent vendors and customers are
drawn into fraud by perpetrators because they fear that if they
do not participate they will lose the business relationship. In
most cases, such customers or vendors have only one or two
contacts with the firm, and the person who requested illegal
gratuities or suggested other types of illegal behavior often
intimidates them. A periodic letter to vendors that explains the
organization’s policy of no gifts or gratuities helps vendors
understand whether company buyers and sellers are acting in

accordance with the rules. Such letters clarify expectations,
something that is very important in preventing fraud. Many
frauds are uncovered when, after receiving such a letter,
vendors express concern about their buying or selling
relationships.
7. People who commit fraud and hoard their proceeds are
virtually nonexistent. Perpetrators almost always use their
stolen money to support expensive habits. Organizations can
monitor their employees by paying close attention to the
enhanced lifestyles that result from these expenditures and by
listening for verbalized rationalizations.
8. Proactive fraud auditing is conducted by following four
steps: identifying risk exposures, identifying the fraud
symptoms for each exposure, building audit programs that
proactively look for symptoms and exposures, and investigating
identified symptoms.
9. Even with advances in technology, fraud is most commonly
detected through tips. A good whistle-blowing program is an
extremely effective prevention tool. When employees know that
colleagues have an easy, anonymous way to report suspected
fraud, they are more reluctant to commit fraud.
10. When placed in an environment of low integrity, poor
controls, loose accountability, or high pressure, people tend to
become increasingly dishonest. While a few people probably
will not become dishonest at any point (about 30%), a large
portion of the population will be influenced by negative stimuli
and eventually cave to dishonesty. In essence, this phrase
means that a lot of people have a point where if the payoff is
high enough, they will be dishonest.
11. Along with the standard interviewing, background and
reference checks, some institutions are now conducting credit

checks, checking employee’s fingerprints against law
enforcement records, drug testing, and pen-and-pencil honesty
tests.
12. The Pygmalion effect states that when expectations are set
below average, results will be substandard. This relates to fraud
in that if we expect people to be dishonest, they will often be
dishonest. However, if we create a culture of honesty and
expect employees to be honest, then employees will often be
honest.
Multiple Choice
1. e
2. e
3. e
4. b
5. d
6. c
7. a
8. c
9. b
10. c
11. d
12. b

13. b
Short Cases
Case 10
The chapter states that a major factor in preventing fraud is to
create a culture of honesty, openness, and assistance. In this
case, there was no openness or assistance. No one
communicated with this employee. Rather than assisting him,
they treated him poorly and talked down to him. Fraud is
usually high in this type of environment because employees see
the company and its owners as adversaries rather than
supporters.
Case 11
Jorge is a high risk for fraud because he is facing significant
financial pressures to repay his student loans and because of his
credit card debt. He is depressed, and has an alcohol problem,
all of which will add to the desperation that often leads to
employee fraud. An EAP could help Jorge deal with his
financial, substance abuse and psychological problems and help
him lead a financially healthy life. An EAP could help Jorge get
medical assistance for his depression, and he could also get
drug counseling for his alcohol problem. This assistance would
reduce the likelihood that Jorge would succumb to the
temptation to commit fraud.
Case 12
First, the program does not allow employees to feel like they
are giving anonymous tips. If they are just calling someone in
the office who is the fraud liaison, then that person may know
the potential whistle-blower, which would obviously discourage
employees from making calls. Many of them would fear
retaliation from blowing the whistle. Second, if the liaison is
involved in the fraud, there would be no one to call. Third,

putting a notice in the break room is not sufficient. People
must know about the program and be trained about how it
works. This lack of training would also create failure in the
program. Finally, top management must let employees know
that the program is important to them and the company by
frequently referring to the program.
Case 13
There are a number of techniques potential employers can use to
screen to make sure they are hiring honest employees. Some
mentioned in the book are background checks, reference checks,
drug tests, criminal records checks, matching potential
employees’ fingerprints against fingerprint databases and credit
checks. An extensive interview would also be helpful in trying
to assess the integrity of the potential employee.
Case 14
1. Hire honest people and provide fraud awareness training:
Even in a small business, you can establish hiring procedures
that will result in a more honest workforce. You may not be
able to perform extensive background checks, but you can at
least check references and perform other simple and relatively
inexpensive screening processes. Even if you don’t have the
resources to conduct lengthy fraud-awareness training seminars,
discussions at the time of hiring or through the distribution of
materials can provide new employees with information about
how to handle fraud and the expected results of committing
fraudulent behavior.
2. Create a positive work environment: Employees should be
aware that either you or another appointed employee is always
willing to listen to them with respect to reports of fraudulent
activities. No one should be afraid to come forward. You might
even create a means of anonymous reporting. This does not
necessarily need to include expensive hotlines. It can be

something as simple as a locked comment box. As well, it is
very important that you do not override controls. It may be true
that you will never rob your own company, but if your example
is one of ignoring controls, you open the door for your
employees to do the same.
3. Have a well-understood and respected code of conduct or
ethics: You should find a way to inform all employees about
what is expected of them with respect to fraudulent activities.
This will remove part of their ability to rationalize their actions.
4. Provide an employee assistance program: Fraud usually
results (at least in part) from pressures with which the
employees are faced. You should attempt to monitor and
mitigate these pressures by providing an alternative means for
employees to receive assistance.
5. Create an expectation that dishonesty will be punished: You
should always prosecute employees who steal from the
company. The publicity this causes shouldn’t harm the company
as much as the potential long-term effects that may ensue from
not punishing dishonesty; most people realize that fraud affects
all companies. In fact, your responsible actions against fraud
might instill confidence in others that your company is
addressing the problem in a healthy manner. Other employees
will be less likely to commit fraud if they know they will be
punished severely if caught. In the end, the savings will most
certainly outweigh the costs.
2
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Chapter 4
1

Chapter 3
FIGHTING FRAUD: AN OVERVIEW
1. Fraud prevention is important because it is the most cost-
effective way to reduce losses from fraud. Once fraud occurs,
there are no winners.
2. Creating a culture of honesty and high ethics helps to reduce
fraud in various ways. Management through its own actions can
show that dishonest, questionable, or unethical behavior will
not be tolerated. By hiring the right kind of employees,
management can select people who are less likely to rationalize
their illegal or unethical actions as acceptable. By
communicating expectations, management can give fraud
awareness training that helps employees understand potential
problems they may encounter and how to resolve or report them.
And by creating an honesty-driven culture, management can
help to develop a positive work environment. Research indicates
that fraud occurs less frequently when employees have feelings
of ownership toward their organization than when they feel
abused, threatened, or ignored.
3. Identifying sources and measuring risk means that an
organization needs a process in place that both defines areas of
greatest risk and evaluates and tests controls that minimize
those risks. Risks that are inherent in the environment of an
organization can often be addressed with an appropriate system
of control. Once risks have been assessed, the organization can
identify processes, controls, and other procedures that can
minimize risks. Appropriate internal systems include well-
developed control environments, effective accounting systems,
and appropriate control procedures.
4. Because most frauds increase dramatically over time, it is

extremely important that when frauds occur they be detected
early. Once a fraud has been committed, there are no winners.
Perpetrators lose because they suffer humiliation and
embarrassment as well as legal punishment. Usually, they must
make tax and restitution payments, and there are financial
penalties and other adverse consequences. Victims lose because
assets are stolen and they incur legal fees, lost time, negative
public exposure, and other adverse consequences. The
investigation of fraud can be very expensive. Organizations and
individuals that have proactive fraud prevention measures
usually find that those measures pay big dividends.
5. When fraud is suspected it is important to conduct a thorough
review in order to (a) avoid wrongly targeting innocent people;
(b) gather sufficient factual evidence about the suspected fraud;
and (c) ensure a complete report of all the facts and
circumstances, both incriminating and exonerating, is prepared.
6. The types of evidence produced while investigating fraud can
be classified into evidence square. The evidence square includes
testimonial evidence, documentary evidence, physical evidence,
and personal observation. Testimonial evidence includes
evidence gathered from interviews, interrogations, and honesty
tests. Documentary evidence includes evidence gathered from
paper, computers, and other written or printed sources. Physical
evidence includes fingerprints, tire marks, weapons, stolen
property, identification numbers or markers on stolen objects,
and other tangible evidences that can be associated with theft.
Personal observation includes evidence collected by the
investigators themselves, including invigilation, surveillance,
and covert operations.
7. The evidence square allows us to identify the different types
of evidence that can and should be gathered, to identify the
evidence gathered, and then to categorize possible evidence so
that it is easily understood and correlated with all other sources

of evidence in the investigation.
a. Surveillance – personal observation
b. Tiremarks – physical evidence
c. Honestytest – testimonial evidence
d. Interview – testimonial evidence
e. A computer hard drive – physical evidence (Some would
classify this aS documentary evidence.)
f. A financial statement analysis – documentary evidence
g. A paper report – documentary evidence
h. Identification numbers on vehicles – physical evidence
i. Audit of financial statements – personal observation (Some
would classify this as
documentary evidence.)
j. Check stubs – documentary evidence
k. Fingerprints – physical evidence
l. Backgroundchecks – documentary evidence (Some would
classify this as personal observation.)
m. Interview – testimonial evidence
8. One of the major decisions a company or fraud victim must
make when fraud is committed is what kind of follow-up actions
should be taken. Most organizations and other victims of fraud
usually make one of three choices: take no legal action, pursue
civil remedies, and/or pursue criminal action against the
perpetrators.
9. Civil proceedings seek to reclaim the assets stolen in the
fraud. Often, with employee fraud, the employee quickly
liquidates and spends the proceeds of the fraud. Thus, there is
usually very little to reclaim in a civil suit. However, when
fraud involving organizations occurs, civil actions are often
useful because those organizations have assets (deep pockets)
from which they can pay the damages.
10. Management often avoids taking legal action against fraud

perpetrators because of the legal cost and the bad publicity for
the company. They justify that the legal costs and time spent
are more than the value of what was stolen, and what was stolen
is less valuable than the company’s good reputation. They fail
to recognize that they are destroying the company’s culture of
honesty, and opening themselves up for future, potentially
larger, frauds.
Multiple Choice
1. c
2. d
3. b
4. a
5. a
6. b
7. d
8. c
9. d
10. d
11. d
12. d
13. d
14. a

15. d
16. a
17. a
18. c
19. d
20. d
21. c
22. b
Short Cases
Case 8
There are three follow-up alternatives available to organizations
once fraud has occurred: take no legal action, pursue civil
remedies, and/or pursue criminal action against the perpetrators.
Case 11
While the Men’s Warehouse has disregarded a commonly
recommended fraud prevention policy of background checks,
they have compensated for this by creating an extremely
friendly working environment, creating a culture of honesty.
Men’s Warehouse is consistently ranked in the Fortune© list of
“100 Best Places to Work,” people feel ownership of the
company they work for, and thus do not steal from it. As a
result,, Men’s Warehouse has created a culture of honesty in a
nonstandard way.

Case 12
Prior to the policy change, employee fraud was not seen as a
serious issue, and prosecutions were unlikely. The general
message was that nothing serious will happen to you if you
commit fraud (fraud was acceptable), and so it proliferated. But,
creating a policy that would essentially prosecute everyone
involved in fraud (minimizing these bad-news reports to the
CEO), it was clear that fraud would not tolerated. As a result,
fraud within the organization decreased.
Case 13
Jamie needs to understand that most fraud perpetrators have no
past history of fraud, and so seemingly “good” people are
sometimes involved in fraud. Since fraud requires
“confidence,” it is usually those you trust most who are in the
best position to commit fraud. By not taking action Jamie is
putting in jeopardy the culture of the organization; this destroys
the culture of honesty that could exist if it was well known that
all fraud would be handled seriously.
Case 14
1. The management of this company seems too relaxed. They
did not provide for an independent check of the accounting
records and cash. They created an easy opportunity for Mary to
embezzle.
a. There was an inadequate segregation of duties in the
company. Peter Jones should have been assigned to do some of
Mary’s duties so that there was a reduced opportunity for
embezzlement.
2. The company should have paid more attention to internal
controls, both preventive and detective. Mary had no
accountability to anyone, and no one ever checked her work.
Consistent communication could have been one of the effective

ways of reducing the fraud. This would have helped identify and
remind the employees of what is expected of them by the
company. They could have also required a written and signed
statement that stated the possible punishment for committing
fraudulent acts.
Periodically, XYZ’s management should have asked Peter Jones
to take care of Miller’s books while she was required to take
vacation time. This would have helped detect the fraud at its
early stages. Additionally, it might have prevented the fraud,
since Mary would have known that someone else would be
checking her work.
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Chapter 3
1
Chapter 2
WHY PEOPLE COMMIT FRAUD
1. Research shows that anyone can commit fraud. Fraud
perpetrators usually cannot be distinguished from other people
on the basis of demographic or psychological characteristics.
Most fraud perpetrators have profiles that look like those of
honest people. In other words, the types of people who commit
fraud are ordinary people, just like you and me.
2. People can be motivated to commit fraud because of financial
pressures, vices, or because of work-related pressures. As well,
perpetrators of fraud can be motivated by a perceived

opportunity to commit fraud and the ability to rationalize that
what they are doing is not wrong. Their motivations are usually
combined into the fraud triangle of perceived pressure,
perceived opportunity, and rationalization.
3. The fraud triangle includes three elements that almost always
must be present in order for someone to commit fraud: a
perceived pressure, a perceived opportunity, and some way to
rationalize the fraud as acceptable. The fraud triangle is
important because it helps us to determine the motives, reasons,
and opportunities that someone had in committing fraud. By
using the fraud triangle, we can better focus on areas in an
organization that will help us detect and prevent fraud.
4. The fraud scale illustrates the relationship between the three
elements of the fraud triangle. It shows that perceived pressure,
perceived opportunity, and rationalization are interactive. In
other words, the greater the perceived opportunity or the more
intense the perceived pressure, the less rationalization it takes
to motivate someone to commit fraud. Likewise, the more
dishonest a perpetrator is, the less opportunity and/or pressure it
takes to motivate fraud.
5. Many types of pressures motivate someone to commit fraud.
They include financial pressures, vices, work-related pressures,
and other types of pressures. Financial pressures include greed,
living beyond one’s means, high bills or personal debt, poor
credit, personal financial losses, and unexpected financial
needs. Vices include addictions, such as gambling, drugs,
alcohol, and extramarital relationships. Work-related pressures
include feeling overworked or underpaid.
6. The controls that prevent and/or detect fraudulent behavior
have to do with providing deterrence to those who are thinking
about committing fraud. Having an effective control structure is
probably the single most important step that organizations can
take to prevent and even to detect fraud. There are five

components in a company’s control structure: the control
environment, risk assessment, information and communication,
control procedures or activities, and monitoring.
7. Many factors provide opportunities for fraud including the
inability to judge the quality of performance; failure to
discipline fraud perpetrators; lack of access to information;
ignorance, apathy, and incapacity; and lack of an audit trail.
8. Nearly every fraud involves the element of rationalization.
Most perpetrators are first-time offenders who would not
commit other types of crimes. Rationalizing helps minimize the
perceived dishonesty of their acts. Common rationalizations
include:
· The organization owes me.
· I am only borrowing the money—I will pay it back.
· Nobody will get hurt.
· I deserve more.
· It’s for a good purpose.
· We’ll fix the books as soon as we get over this financial
difficulty.
· Something has to be sacrificed.
When interviewed, most fraud perpetrators say things like, “I
intended to pay the money back. I really did.” They are sincere.
In their minds, they rationalize that they will repay the money,
and since they judge themselves by their intentions and not by
their actions, they do not see themselves as criminals.
9. Jim Bakker rationalized his actions by convincing himself
that the PTL network had a good purpose and that he was

helping others. Bakker believed that any money he received
would directly or indirectly benefit his followers. He had
numerous pressures, including greed, selfishness, and a lust for
power, and Bakker was in a position of trust. As with most
people in positions of trust, he had numerous opportunities to
commit fraud.
10. Dr. Sam Waksal committed fraud by transferring shares into
his daughter’s trading account and then having her trade in his
company’s stock (insider trading). Because he had insider
information, he understood that it would be unethical for him to
make trades. However, he rationalized that if he had his
daughter make the trades, rather than himself, then his actions
would be legal and ethical.
Later on, when explaining his actions, Waksal said the
following: “I could sit there and think that I was the most
honest CEO that ever lived. And, at the same time, I could
glibly do something and rationalize it because I cut a corner,
because I didn’t think I was going to get caught. And who
cared? Look at me. I’m doing “X,” so what difference does it
make that I do a couple of things that aren’t exactly kosher?”
Waksal’s rationalization allowed him to have a long history of
ethical lapses, reckless behavior, and embellishing the truth. He
had been dismissed from a number of academic and research
positions for questionable conduct, for example. One former
colleague said “cutting corners for Sam was like substance
abuse. He did it in every aspect of his life, throughout his entire
life.”
11. Power is defined as the ability to influence someone else.
When a fraud takes place, the conspirator has the desire to carry
out his or her own will—influence another person to act and do
as the perpetrator wishes—regardless of resistance.

12. Fraud perpetrators use power to influence and persuade
individuals to participate in fraud. Fraud perpetrators can get
potential co-conspirators to join the fraud by promising a
reward or benefit (reward power), by following the orders of a
person who is in a position of authority (legitimate power), by
making the potential recruit feel fear for not joining the fraud
scheme (coercive power), or through deceiving someone
because the potential recruit has a lack of knowledge (expert
power). Finally, perpetrators can get potential perpetrators to
join the scheme through the influence of a relationship (referent
power).
Multiple Choice
1. b
2. d
3. c
4. a
5. d
6. d
7. c
8. e
9. b
10. a
11. b

12. c
13. c
14. b
15. b
16. e
17. e
18. c
19. c
20. b
Short Cases
Case 1
1. Authorization. The managers of the stores should follow the
authorization policy and review all requests for large amounts
of credit and the approval of new credit customers.
2. Segregation of duties and independent check on performance.
A second individual, preferably someone not in the accounting
department, should perform the bank reconciliation.
3. Segregation of duties and/or independent checks. With
respect to separation of duties, various functions should be
assigned to different people. If two separate individuals
performed the record keeping and physical handling of
inventory, the opportunity for theft would be greatly reduced.
With respect to independent checks, test counts of his record
keeping could be performed.
4. Adequate document and records. A well-designed document
should be formatted so that it can be handled quickly and
efficiently.

Case 3
1. The company lacks good control activities or procedures.
Mainly, it lacks segregation of duties, a good system of
authorizations, independent checks, physical safeguards, and
documents or records. Helen was allowed to sign the payment
voucher for services rendered, and she was also allowed to sign
for all voucher payments less than $10,000.
2. Helen was a trusted employee. The company also lacked good
control activities. To perpetrate the fraud, all she had to do was
continue to process the checks to the terminated vendor and
sign the vouchers.
3. The fraud would have been detected if the company had
possessed a good internal audit department, combined with
security or loss prevention programs. A good accounting system
would have helped in the discovery of the fraud and would have
made it difficult for Helen to conceal.
Case 5
1. The company should implement independent checks and
segregation of duties controls. The accountant should not be
posting to the General Ledger, paying the bills, and signing the
checks. The CEO or someone else should sign the checks. Also,
the accountant’s work should be reviewed for errors and fraud
by an independent source. The accountant should be prosecuted
civilly and criminally for mail fraud, embezzlement, and money
laundering. In addition, it would be a simple task to have the
auditors run a computer analysis on the addresses of vendors to
look for companies with the same addresses.
2. The company should implement segregation of duties
controls. The warehouse manager should not be able to both
receive returned items and issue the credit memos. The accounts
receivable department should create credit memos, which are
then taken to the warehouse where additional goods can be

issued. In addition, another worker must process returned
defective merchandise. Both the manager and the worker should
sign off. The warehouse manager should be prosecuted, and his
son should spend more time in the gym.
3. A system of authorizations should be implemented. The board
should not allow the CEO to fire his employees and rehire them
as contractors. The accountant who prepares payroll records
should notice this problem. In addition, if the CEO prepares
payroll records, there is also no segregation of duties. The CEO
should be prosecuted for tax fraud and money laundering.
4. Authorization and segregation of duties controls should be
implemented. The accounts payable clerk should not have
custody of the supplies she purchases. Supplies should be
logged into a warehouse and then distributed as needed. The
accountant should also independently record the clerk’s
activities. She should not be able to sign checks.
Case 7
1. Joel has many opportunities to commit fraud. He is a trusted
friend of the family. At the restaurant, there is no segregation of
duties, system of authorizations, independent checks, or
physical safeguards to prevent Joel from committing fraud.
2. An increase in revenues accompanied by a decrease in profits
may signal a possible fraud. The changed profit margin ratio
(net income/revenues) is a possible symptom of fraud.
3. In this case, as in most cases, a few simple controls could
substantially reduce the opportunities for fraud. For example,
Bob and Tom could install an automated register into which all
sales would be recorded. They could have mystery shoppers eat
at the restaurant and pay in cash in order to see if the receipts
were recorded. They could make the deposits and reconcile the
bank account themselves.

4. Possible answers might be:
· Segregation of duties—do not allow Joel to do everything he
is doing.
· System of authorizations.
· Independent checks.
· Physical safeguards—such as automated registers.
Case 9
A couple of possibilities may explain the rationalization
element of the fraud triangle. First, since many of the clients
were expatriates working outside the United States, there may
have been rationalization on the part of Hammond and FCS that
it was okay to sell them high-yield investment schemes because
they couldn’t follow the stock market on a daily basis. The
second possibility is that Hammond knew that the accounts were
or might be misleading, false, or deceptive. Although he may
have thought this, if the other two factors are present, it is easy
to rationalize that even though they may be false, they also may
be real or genuine. Instead of looking at the situation
objectively, he probably rationalized the possibility of it being a
legitimate opportunity.
Case 11
1. Yes, it is a fraud to charge the company for personal lunches
that you submit as business expenses. Fraud is often defined by
the rules of an organization, and charging the company for
personal expenses is intentionally not following the rules.
2. In this example, all three elements of fraud may be present:
pressure, opportunity, and rationalization. The opportunity to
commit fraud is high, and certainly rationalization is present. It
is difficult from the limited facts to know whether a pressure is
present.

3. How one responds to the mentor is a subjective answer. If the
new employee was aware that such charges represented fraud,
she should decline to participate and let the mentor know that
she does not agree with charging lunches against company
policy. Additional steps could be taken to notify supervisors
and suggest that they further educate company personnel
regarding company policies.
Case 13
1. Lauersen could have felt some pressure to make fertility
treatments affordable for his patients.
2. Lauersen perceived that the insurance company did not check
carefully on the types of surgeries performed, and therefore it
was easy for him to lie about the surgeries.
3. Lauersen may have felt that he was helping women who could
not afford to have children. This was the primary factor in his
decision to commit fraud.
4. Lauersen could have recommended different insurance
companies that covered fertility surgeries. Or, to help maintain
his and his clients’ integrity, he could have recommended
adoption services for those patients unable to afford fertility
surgeries.
Case 15
1. Joe had several financial pressures: his wife just had a fourth
child; they had just purchased a new home; and he had
experienced a severe drop in commissions earned. His
opportunity arose from the fact that the company had poor
internal controls over petty cash. Shortages were usually written
off. Joe’s rationalizations could have been that his thefts were
only temporary; the company owed him more money; or he
worked hard and deserved the money.

2. The company could have prevented the fraud from occurring
by having better controls over the petty cash. For example, the
company could have had one person be the petty cash custodian
requiring anyone with a need for petty cash to go through that
person. There should also have been periodic reconciliations of
the petty cash fund.
� CBSNews.com, “Sam Waksal: I Was Arrogant,” 6 October
2003, <www.cbsnews.com/stores/2003/10/02/60
minutes/main576328.shtml>, accessed on May 22, 2004.
16
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