Forensic and Investigative Accounting Test 2 ch3-5

Six legged stool - answer-well-functioning system of corporate governance composed of six groups: the board of directors, the audit committee, the top management team, internal auditors, external auditors, and certain governing bodies (e.g., SEC, AICPA, NYSE, and NASD) statement of financial concepts no 2 - answer-provides nine qualities and characteristics that make financial information useful for investors, creditors, analysts, and other users of financial information bill and hold strategy - answer-The company sold products to customers but held on to the shipments with an agreement to deliver the goods later. channel stuffing - answer-A company may engage in channel stuffing by offering large discounts or other inducements to a distributor/retailer to receive large orders late in the reporting quarter to increase their revenue. If the distributor has a side agreement that gives them the right to return any unsold inventory, these sales do not meet the revenue recognition in SAB No. 104 Howard M. Schilit's financial shenanigans - answer-Recording revenue before it is earned (sales on consignment, e.g., Cendant and Sunbeam). In 1997, Sunbeam offered deep discounts on gas grills in the fourth quarter under a classic "bill and hold" strategy. They booked the income and held the grills in their warehouses. For 1997, Sunbeam restated earnings by about $93 million. In another example, Qwest had 19 transactions where they booked income before receiving payments. The SEC calls this practice "channel stuffing." Creating fictitious revenue (false journal entries; almost 40 percent of earnings misstatements from 1995 to 1999 had to do with revenue recognition, and one-half of these involved complete fabrication, as with Kroger). Boosting profits with nonrecurring transactions (selling stock for a gain). Shifting current expenses to a later period (debit an asset account rather than expensing, e.g., Waste Management). In 1999, AMR changed the depreciation schedule from 20 to 25 years on some planes which reduced depreciation expense in 2000 by $158 million. WorldCom shifted at least $3.8 billion of line-cost expenses to its capital accounts over at least five quarters starting in 2001. So rather than $1.4 billion of reported profits in 2001, the company had a loss. Failing to record or disclose liabilities (Adelphia omitted at least $1.8 billion of debt from its balance sheet). Shifting current income to a later period (recognizing current revenues as deferred revenues). Shifting future expenses to an earlier period (expensing items that should be debited to an asset account, e.g., software costs). KPMG categories of fraud - answer-Employee, Management, External proving guilt pyramid - answer-pressure rationalization opportunity older fraud pyramid - answer- professor razaee - answer-Wrote the book on financial statement fraud developed the six legged stool theory COSO defines internal control - answer-a process, effected by an entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: Effectiveness and efficiency of operations, Reliability of financial reporting, and Compliance with applicable laws and regulations." fraud identifier to spot fraudsters - answer-large ego, substance abuse problems or gambling addiction, living beyond apparent means, self-absorption, hardworking/taking few vacations, under financial pressure (e.g., heavy borrowings), and sudden mood changes employee fraud - answer-stock theft misappropriation of assets Lapping check forgery expense account petty cash kickbacks loans/investments red flag for forensic accountants - answer-Look for aggressive revenue recognition policies (Qwest Communication, $1.1 billion in ). Beware of hockey stick pattern near the end of a quarter. Beware of the ever-present nonrecurring charges (e.g., Kodak for at least 12 years). Check for regular changes to reserves, depreciation, amortization, or comprehensive income policy. Related-party transactions (e.g., Enron). Complex financial products (e.g., derivatives). Unsupported top-side entries (e.g., WorldCom). Under-funded defined pension plans. Unreasonable management compensation. industry conditions risk factors - answer- operating and financial stability risk factor - answer- SEC to investigate specific companies - answer- Elements in the fraud triangle - answer-conditions corporate structure choice equitable remedy - answer-which permits a person to win a dispute against a corporation that a plaintiff does not have standing to sue under regular law. preventative control - answer-are first in line to prevent errors, omissions, or misappropriation of assets from occurring. This type of controls is more efficient (e.g., passwords, safes, fences, locks). detective control - answer-find errors or fraudulent incidents that escape the preventive controls. These controls are important when preventive controls are weak. For example, there are situations in which transactions are obtained from third parties, such as sales reports from franchisees or baggage claims reported by passengers at airports. corrective control - answer-are the actions taken to minimize further losses. They are there to correct errors, omissions, and frauds after detection. But internal controls can be broken, often by top executives. three types of control - answer-preventative, detective, corrective non fraudulent earnings management scheme - answer-is accomplished within the GAAP framework; whereas fraudulent earnings management does not follow GAAP (e.g., recording fictitious sales). The National Center for Continuing Education even offers a seminar on "How to Manage Earnings in Conformance with GAAP. Yet nothing gives greater fear to a corporate officer or investor than when there is a rumor about "an accounting problem." corruption - answer- round numbers - answer-look for net numbers, salaries etc KPMG 2016 survey - answer-of the percentage of frauds resulting in a loss of $1 million or more, 42 percent were perpetrated by purely internal fraudsters, 43 percent by groups of internal and external fraudsters, and 25 percent by external fraudsters. control risk - answer-Risk that a material error in the balance or transaction class will not be prevented or detected rises with weaknesses in the internal controls. The function of the effectiveness of the design and operation of internal controls. SAS No. 99 pyramid - answer-of external and internal variables affecting the entity that might (a) create incentives/pressures for management and others to commit fraud, (b) provide the opportunity for fraud to be perpetrated, and (c) indicate a culture or environment that enables management to rationalize committing fraud. SAS No.99 PCAOB AS 2401 - answer-that auditors must plan and perform an audit to obtain "reasonable assurance" that the financial statements are free of material misstatements caused by errors or fraud. In the planning stage the audit team must discuss the potential for material misstatement due to fraud collapse of Enron - answer- inflate sales - answer-rising stock markets, pension fund investments can inflate the bottom line. Small changes in assumptions can make a huge difference in net earnings.