BNM - CFIP - handout 1

FORENSIC ACCOUNTING MODULE
CERTIFIED FINANCIAL INVESTIGATOR PROGRAM
BANK NEGARA MALAYSIA

Prof. Dr. Syed Noh Syed Ahmad, CA(M)
Handout 1 Fakulti Perakaunan
Universiti Teknologi MARA

4th – 18th March 2013
Akademi Kastam DiRaja Malaysia
Bukit Baru
Melaka
Forensic Accounting - Handout 1: CFIP 1

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Topics in Handout 1
• Overview of accounting
• Overview of reporting environment.
• What is forensic accounting? The fraud
triangle and basic theories of criminology
• Review of process of preparing financial
statements – Income Statement and
Balance Sheet
• Management decisions affecting the
bottom line

What is Accounting?
• An information system that provides reports
to stakeholders about the economic activities
and conditions of a business
• Art of classifying, recording and summarising
of financial events
• Art and science of recording business
transactions in a methodological manner so
as to show:
– the financial position
– the profit or loss of organizations


A Brief History of Accounting


• The first accounting book was written by
Luca Pacioli in a section of a book on
mathematics entitled “Summa de
Arithmetica, Geometrica, Propotioni et
Proportionalita”, (trans: "Everything about
Arithmetic, Geometry, and Proportions."
published in 1494 (printed on Nov 10, 1494!).

• This book was written as a digest and guide
to existing mathematical knowledge, and
bookkeeping was only one of five topics
covered.


• Ever since the book written by Luca
Pacioli, accounting practitioners in public
accounting, industry, and not-for-profit
organizations, as well as investors, lending
institutions, business firms, and all other
users for financial information are still
using the double entry system of
accounting as written by Luca Pacioli.


INTRODUCTION -
WHAT IS FORENSIC
ACCOUNTING


What is Forensic Accounting?
• Forensic means “Relating to, used in, or
appropriate for courts of law or for public
discussion or argumentation” (Am. Heritage Dictionary, 4 th

ed.)

• Accounting means, “a system that provides
quantitative information about finances”
(WordNet 2.0)

• Forensic accounting is the application of
accounting skills to provide quantitative
financial info. about matters before the
courts (ACFE).

• “In general, forensic accounting is the
application of a specialized body of
knowledge to economic transaction
analysis and reporting, suitable to the
purpose(s) of establishing accountability
and/or valuation, often in a court of law
or administrative proceeding.”
Journal of Forensic Accounting:


• Thus, the preceding explanations and
definitions clearly establish the fact that
“forensic accounting” has close ties with
the potential of the findings being used
in the court of law.
• It is not a specialised field of accounting
per se, but the integration of
accounting, legal knowledge and
investigative skills.

Focus of Forensic Accounting?
• The essential components of forensic
accounting include an attempt to piece
together or reconstruct a past event or
events using financial information where
that reconstruction is likely to be used in
some judicial proceeding (e.g., criminal
court, civil court, deposition, mediation,
arbitration, settlement negotiation, plea
bargaining).

Aspects of Forensic Accounting in
the Battle Against Financial Crime
• Forensic accounting has the potential to
be useful in all organisations investigating
amongst other things:
– Tax evasion and criminal wrong doings
– Compliance with laws and regulations
– Other criminal matters such as fraud, money
laundering, theft, asset misappropriations, etc.


Developing Forensic Accounting
Expertise
• In regulatory and law enforcement and taxation
agencies, expertise in forensic accounting is an
added skill that will enhance and complement
existing knowledge that the officers possess.
• Thus, in the process of developing expertise in
Forensic accounting, other skills and knowledge
are essential. Accordingly, these items are:


• Knowledge of the relevant laws
• Rules of Evidence
• Investigative competency
• Knowledge of fraud
• Interviewing and interrogation skills
• An understanding of the psychological
theories relating to criminal behaviour
• Communication and interpersonal skills
• IT skills


• The integration of these knowledge/
skills with accounting will result in a
powerful weapon in the fight against tax
evaders and defaulters, bribery and
other forms of corruption, corporate
scandals and other criminal activities.
• In the current situation, knowledge of
forensic accounting is no longer an
option but a critical element in the fight
against financial misdeeds.


Why Is Developing Expertise in
Forensic Accounting Important?
– Increasing sophistication of criminals in the public
and corporate sectors
– Bribery and other forms of corruption in the
corporate sector are on the increase
– Investigating and persecuting such offences
require specialised skills
– Part of the overall enhancing of the “core of
knowledge” of investigating officers who may not
be exposed to such investigations
– Enhancing the knowledge of the investigating
officers


KPMG Fraud Survey in
Malaysia (2004)is a major
 62% of respondents felt that fraud
problem for Malaysian business generally.
83% of respondents acknowledged
experiencing fraud in their organization. This
is an increase of 33% from the 2002 survey.
 36% of companies suffered total losses of
RM10,001 to RM100,000 to fraudulent
conduct in the survey period while 17%
suffered losses in excess of RM 1 million
 87% of the frauds were perpetrated internally
[non-management employees (69%) and
management employees (18%)]. This was a
decrease of 10% from 2002.

Year Cases Amount of Losses (RM mil.)
1992 4,386 153.08
1993 4,929 181.08
1994 4,229 153.84
1995 4,227 180.91
Commercial
Crime in 1996 4,809 238.59
Malaysia 1997 7,137 556.93
1998 10,390 4,600.00
1999 9,546 1,426.80
2000 9,931 575.46
2001 10,578 797.89
2002 10,857 1,125.60
2003 11,714 579.80
2004 9,899 836.29
Source: CCID, Bukit- Aman 1: CFIP
Forensic Accounting Handout 19

The Bad News!!!!
• In a survey (December 2005) by
PriceWaterhouseCoopers, involving more
than 3600 corporate officers in 34
countries, financial fraud increased 22%.
• Those who can quantify the losses, totaled
about US$2 billion and the average loss is
about US$1.7 per organisation


• The study, conducted in conjunction with Martin-
Luther University in Germany, revealed that
fraud was detected by chance in more than
33% of the cases, while internal audit detected
the fraud 26 percent of the time.
• Of those who committed the fraud in North
America, 60 percent were employees of the
defrauded company. Almost one-quarter of the
perpetrators were senior managers--the very
people required to sign off on financial
statements.


KPMG 2009 SURVEY – BRIEF
FINDINGS
• 49% of all respondents experienced at least one fraud
during the survey period with a total of 714 separate
fraud incidences being reported.
• The value of fraud reported in the survey period was
RM63.95 million. Not all respondents disclosed
information on the number of fraud incidents or the value
of fraud detected (15% of the 85 respondents who said
that they were victims of fraud were unsure of the
number of incidents whereas 53% were unsure of the
value of financial losses due to fraud). Hence, this
suggests that losses may be far bigger than the
disclosed amounts.


• Consistent with the 2004 survey, internally
perpetrated fraud (perpetrated by management
and non-management employees) accounted for
87% of the total reported fraud value of RM63.95
million.
• Theft of cash (39%), theft of inventory (31%),
fraudulent expense claims (26%) followed by
kickbacks (25%) were the most common types
of fraud perpetrated. Theft of physical assets
appeared to be a popular category of fraud
perpetrated among non-management level
employees and external parties. Management
level employees however are more prone to
commit theft of funds (outgoing).


• Overall most fraud was detected internally,
with internal controls (55%) being the most
common method followed by notification
by employee (33%), internal audit review
(30%), notification by customer/ supplier
(25%) and anonymous letter/ informant/
whistleblower (25%).
• Greed/ lifestyle (62%) and personal
financial pressure (39%) were cited as the
two most common motivations for fraud.


• 39% of respondents indicated that fraud “red
flags” (early warning signs or indicators that
fraud may have occurred) were not acted upon
by management.
• Only 22% of respondents felt that their
employees in their organization were adequately
trained to recognize fraud “red- flags”.
• Poor internal controls (56%) followed by
collusion between employees and third party
(45%) and poor ethical practices (39%) were the
three most important factors contributing to
major frauds.


• Only 54% percent of respondents
believed that their organization’s anti
fraud policies, procedures and
controls are adequate to
prevent, detect, and respond to fraud
incidences.
• 62% of organizations are providing a
means for employees to report
allegations and incidents of fraud and
unethical conduct of which only 49%
said that they offered anonymous
reporting to employees.

• The most common steps taken by companies to
mitigate the risks of fraud are reviewing and/or
improving internal controls (93%), establishing a
corporate code of conduct/ethics
(74%), increased role of audit committee (63%)
and preemployment screening (62%).
• Approximately 38% of respondents had
experienced unethical behavior during the
survey period with the most common
occurrences were management employee’s
conflict of interest (49%), falsely claiming sick
leave or absenteeism (46%) and conducting
business transactions in a manner which derives
an unwarranted personal advantage (32%).

The Good News
• A simple reason for the increase could be that
management, regulators, law enforcement
officers, boards of directors and auditors have
actually gotten better at detecting the fraud.
• "I think the investment in control systems is
paying off and detecting more crime, and I think
it remains to be seen whether that pays off in the
future," a spokesman of PCW said. This is
based on the findings the “nearly 80 percent of
companies polled, said they did not consider it
likely that they would suffer from financial fraud
over the next five years”.


CORRUPTION IN MALAYSIA


Malaysia’s Corruption Perception
Index

2012 2011 2010 2009 2008 2007 2006

4.9 4.3 4.4 4.5 5.0 5.2 4.9

Pejabat Bendahari UiTM 36
14 Feb 2013

STATISTIK OPERASI

37
Pejabat Bendahari UiTM
14 Feb 2013

Source: SPRM Laporan Tahunan 2010 38
38
http://www.sprm.gov.my/
14 Feb 2013

Ruj: Laporan Tahunan SPRM 20
39
14 Feb 2013

40
14 Feb 2013

41
14 Feb 2013

TINDAKAN TATATERTIB

42
14 Feb 2013

43
14 Feb 2013

Ruj: Laporan Bendahari UiTM
Pejabat Tahunan SPRM 20
44
14 Feb 2013

45
14 Feb 2013

What is Fraud?
• A simple explanation of fraud
There are two main methods of obtaining
things illegally: either physically force
(sometime the actual use of violence)
someone to give you what you want, or you
trick them out of their belongings. The first is
called robbery, and the second method is
fraud. Fraud always involve trickery and
deception.


• Fraud is deception that includes the following
elements (Albrecht, et. al):
1. A representation
2. About a material point
3. Which is false
4. And intentionally or recklessly so
5. Which is believed
6. And acted upon by the victim
7. To the victim’s damage


Why People Commit Fraud – The
Fraud Triangle
• Of the numerous ways and reasons why
people commit fraud, there are three
common elements common to all – these
elements were identified by one of the
pioneering researchers on fraud - Donald
Cressey. He introduced the concept of the
“Fraud Triangle”.


CRIMINOLOGY AND FRAUD
THEORIES


Classical Criminology
• Based on the concept of deterrence. It is
only the threat of punishment that will
deter a person from committing a crime,
based on the following concept:
– a person has the choice of choosing criminal
versus non-criminal behaviour.
– a person will choose a criminal behaviour if
the rewards are greater than the risk or work
required to acquire such rewards.


– A person may choose not to commit criminal acts
if he fears of society’s reaction to such acts.
– The stronger the society’s reaction against crime,
the more likely it is to influence behavior.
– There is no more effective crime-prevention
device than punishment if it is strong enough to
make crime unattractive.
• Based on this classical theory, under the
proper sets of circumstances, all persons
have the potential to be criminals – they do
not become so because of society’s reactions
to such acts and the fear of punishment.
• There are of course other theories of criminal
behaviour such as psychological,
sociological, etc theories. 1: CFIP
Forensic Accounting - Handout 51

Edwin H Sutherland: White Collar Crime

• The term “White collar crime” was first
introduced by a criminologist from Indiana
University (ahem! – I am an alumnus of this
august university – although too young to be his
classmate!), Edwin H Sutherland.
• In 1939, Sutherland defined white collar crime
as “a crime committed by a person of
respectability and high social stated in the
course of his occupation”. See how
“respectable” the corporate crooks (Madoff,
Skilling, Ebbers, etc appear to be before the
discovery of the frauds!!!).


Edwin H. Sutherland
• These crimes include:
– Criminal acts of corporations
– Individuals in corporate capacity
• Theory of differential association
– Crime is learned
– Not genetic
– Learned from intimate personal groups


• Thus, Sutherland rejected the notion that
attributed theft and fraud to either poverty
or genetics.
• Just like any other criminals, the white
collar criminals learned how to commit
crimes much like other persons learn other
things – the longer they are at it, the better
they became.


Donald R. Cressey
• His ground breaking research was
conducted in the 1940’s in the United
States. He interviewed 200 imprisoned
embezzlers

• The outcome of his research was:
– Identifying or classifying offender types; and
– Fraud Triangle


Cressey’s Offender Types
1. Independent businessmen
– “Borrowing”
– Funds really theirs
2. Long-term violators
– “Borrowing”
– Protect family
– Company cheating them
– Company generally dishonest


Cressey’s Offender Types
3. Absconders
 Take the money and run
 Usually unmarried, loners
 Blame “outside influences” or “personal
defects


Donald Cressey’s Fraud Triangle
• Of the numerous ways and reasons why
people commit fraud, there are three
common elements common to all – these
elements were identified by one of the
pioneering researchers on fraud - Donald
Cressey. He introduced the concept of the
“Fraud Triangle”.


The Fraud Triangle
Sometimes
this is called the
“Motive”

Perceived Opportunity


Fraud Triangle
• When all the elements come together, then
fraud will occur.
• The three elements of the fraud triangle are
interactive
• In order to reduce the occurrence of fraud, one
of the elements must be eliminated.
• Most of the efforts to reduce fraud are
concentrated on one of these elements:
opportunity.


Perceived Pressure
• Usually divided into four different types of
pressures:
1. Financial pressures
2. Vices
3. Work related pressures
4. Other pressures


Financial Pressures
• Greed
• Living beyond one’s means
• Others?


Vice Pressures
• Gambling,
• Others?


Work related pressures
• Fear of losing job
• Others?


Other pressures
• Pressure from family
• Others


Perceived Opportunity
• A Perceived opportunity to commit
fraud, to conceal it, or to avoid being
punished.
• The following list illustrates six factors
which increase opportunities for
individuals to commit fraud within an
organisation:
– Lack of control in organisations to prevent or
deter fraud (control factors)
– Inability to evaluate -performance
Forensic Accounting Handout 1: CFIP 66

–Failure to discipline or
prosecute perpetrators
–Lack of information
–Ignorance or apathy and
incapacity
–Lack of an audit trail

Rationalization
• Attempt to explain or justify the commitment of
fraud with perceived reasons even though these
reasons or justifications are not true.
• Examples are:
– The organisation owes it to me
– I am only borrowing the money and will pay it back
– Nobody will get hurt
– Everybody in the organisation do it, so I am no
exception
– Etc.

• Knowledge of the Fraud Triangle is an
important to understand the
circumstances under which fraud are
committed.
• Understanding of these aspects are
important especially when investigating
fraud – these factors could serve as a
guide in determining the suspects or
perpetrators of fraud.


W. Steve Albrecht
• 1940’s U.S.
• Analyzed 212 actual frauds

• Developed “Red Flags”
– Personal characteristics
– Organizational environment
• Fraud Scale


W. Steve Albrecht
Nine motivators of fraud
1. Living beyond means
2. Overwhelming desire for personal gain
3. High personal debt
4. Close association with customers
5. Pay not commensurate with job


W. Steve Albrecht
Nine motivators of fraud
6. Wheeler-dealer
7. Strong challenge to beat system
8. Excessive gambling
9. Family/peer pressure


The Fraud Scale
• Situational pressures
– Immediate problems with environment
– Usually debts/losses
• Perceived opportunities
– Poor controls
• Personal integrity
– Individual code of behavior


The Fraud Scale

Forensic Accounting - Handout 1: 74
CFIP

The 20/60/20 Rule
• No specific author for this theory, only
“forensic experts” who indicate that their
experience suggests that the general
population can be divided in three
categories:
– 20% would never commit a fraud.
– 60% would commit a fraud if the chance of
getting caught is considered low.
– 20% would seek to commit a fraud regardless
of the circumstances.

The GONE theory: Identifying potential
fraud perpetrators and situations
• The GONE theory (also coined by nameless
fraud “experts”) can be used to identify potential
fraudsters and circumstances which could
encourage the occurrence of fraud:
– G: Greed
– O: Opportunity to take advantage
– N: Need for whatever is taken
– E: Expectation of being caught or discovered is low.
• Could be used to identify personnel who exhibit
these characteristics and thus take proactive
actions to prevent fraud from happening.

Fraud theories by M. T. Biegelman
and J. T. Bartow (2006)
• The two authors consider the above theories of
fraud as “traditional” and have designed “some
theories of their own”.
• Although these “new” fraud theories may seem
“light-hearted and even whimsical” at first, the
authors opined that nevertheless, based on their
many years as fraud investigators, speak
“volumes” about how and why fraud is
perpetrated and all too often successful.
• So here goes!


Tip of the Iceberg Theory of Fraud
• When initially discovered, frauds is just a
small part of the actual amount of the
loss, but is just like the tip of the iceberg!
• The amount of actual loss is much larger
after a thorough investigation takes place


Potato Chip Theory of Fraud
• Committing fraud and getting away with it can
become addictive.
• Once a perpetrator succeeds at an
embezzlement, corruption, bribery, etc; it gets
harder and harder to stop that activity and even
branching out to new types of fraud.
• Greed and success in not getting caught
become addictive and the behavior
continues, which will eventually leads to the this type
WorldCom is an example of
downfall of these criminals. of criminal behavior.


Rotten Apple Theory of Fraud
• This “theory” relates to the personal characteristics of the
leaders of the organisations. Leaders who lack
characters and integrity and who turn to fraud and
abuse, can have a bad influence on people they lead:
such as in the case of employees who turn to fraud
because their managers were doing and getting away
with it.
• I would like to call it the “fish starts rotting from the head”
theory. I think I will contact the authors to give an Asian
variation of this theory!

ENRON is a good example of this
theory.


Low Hanging Fruit Theory of Fraud
• This refers to the lower risk but high occurrence
simple frauds such as purchasing
fraud, inventory theft and thus these frauds are
normally given less attention.
• Because of the uncomplicated nature of the
fraud, it would take a longer time until it is
discovered and by that time the damage could
be substantial.


Addition by Subtraction Theory of Fraud

• Refers to the benefits that an organisation
receives when it takes a proactive action to fraud
detection, investigation and a zero tolerance
towards fraudulent behavior by employees.
• Thus by removing an employee who has
committed fraud, a risk is removed and that
improves an organisation


Fraudster as Employee Theory of
Fraud
• Good and dedicated employees are assets of the
company and critical to the success of the business: they
are concerned with the well – being, future and
sustainability of the business.
• Fraudsters cold not be considered as employees of the
business as they are masquerading (pretending) to be
employees.
• As such, stern action should be taken against the
fraudsters as they cannot be considered as employees.


Approaches to Fraud
Investigation
• Two approaches:
– The types of evidence produce
– The elements of fraud
• According to Albrecht, et. al., most
investigators rely heavily on interviews


Evidence Square

Testimonial Documentary
Evidence Evidence

Physical Personal
Evidence Observation


Testimonial Evidence
• Testimonial evidence: Gathered from
individuals, and techniques used to gather
testimonial evidence includes interviewing,
interrogation and honesty tests.


Documentary Evidence
• Documentary evidence: evidence gathered from
paper, computers, and other printed or written
cources.
• Common investigative techniques include
document examination, public record searches,
audits, computer searches, net worth method
and financial statement analysis.
• Increasingly, corporate databases and e-mails
often are useful for these documentary evidence


Physical Evidence
• Physical evidence: Such as fingerprints,
stolen property and other tangible
evidence associated with dishonest acts.
• The gathering of such physical evidence
often involves forensic analysis by experts.


Personal observation
• Personal observation: involves evidence
that is sensed (seen heard, felt, etc) by the
investigators themselves.
• Involves techniques such as surveillance
and covert operations


Elements of Fraud

Conversion


Elements of Fraud
• Theft act investigative methods involve efforts to
catch the perpetrators in the act of
embezzlement or to gather information about the
actual theft acts.
• Concealment investigative methods involve
focusing on records, documents, computer
programs and other places where the
perpetrators try to hide their dishonest acts.
• Conversion investigative methods involve
searching for ways in which perpetrators spent
their assets.

TERIMA
KASIH

BNM - CFIP - handout 1

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