Forensic Accounting and Financial Statement Fraud, Volume II: Forensic Accounting
Performance
Copyright © Business Expert Press, LLC, 2019.
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First published in 2019 by
Business Expert Press, LLC
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Business Expert Press Financial Accounting, Auditing and Taxation Collection
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Printed in the United States of America.
Abstract
Forensic accounting is gaining considerable attention as a rewarding and exciting
field of accounting. Forensic accountants perform both fraud and nonfraud
services. The organization of the book provides maximum coverage and flexibility
in choosing the amount and order of materials on forensic accounting and financial
statement fraud (FSF) theory, education, and practice. This book is organized into
two volumes; each volume can be utilized separately or in an integrated form. The
first volume, entitled “Fundamentals of Forensic Accounting” consists of five
chapters presenting a road map for various fraud and nonfraud services performed
by forensic accountants. The second volume, entitled “Forensic Accounting
Performance,” consists of five chapters addressing fraud and nonfraud forensic
accounting practices and performance. Chapter 1 discusses roles and processes of
forensic accounting. Chapter 2 describes forensic accounting techniques. Chapter 3
describes roles and responsibilities of corporate gatekeepers including forensic
accountants in creating a corporate culture of integrity and competency in
preventing and discovering financial statement fraud. Chapter 4 presents
challenges and opportunities in forensic accounting in the areas of litigation
consulting and expert witnessing. Chapter 5 discusses emerging issues in forensic
accounting.
Keywords
forensic accounting; financial statement fraud; fraud examination; expert
witnessing; litigation consulting; skill sets of forensic accountants; professional
standards; codes of professional conduct; fraud and non-fraud forensic accounting
services; corporate governance; antifraud policies and practices; challenges of
forensic accounting; digital forensics; emerging issues in forensic accounting
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Contents
Preface
Acknowledgments
Roles and Processes of Forensic Accounting
Forensic Accounting Techniques
Role of Forensic Accountants in Corporate Governance and in Detecting and
Preventing Fraud
Challenges and Opportunities in Forensic Accounting
Emerging Issues in Forensic Accounting
About the Author
Index
Preface
Financial statement fraud (hereafter, FSF) is a severe threat to investor confidence
in financial information and thus capital markets. Reported financial scandals by
high-profile companies (Enron, Global Crossing, Qwest, WorldCom, Parmalat) and
ethical debacles in corporations have eroded investor confidence and public trust in
corporate America, its corporate governance, financial reporting, and audit
functions. These scandals and related FSF reinvigorated interest in education and
practice of forensic accounting and financial statement fraud examination. Forensic
accounting is gaining considerable attention because the American Accounting
Association (AAA) has added a new educational and research section on “Forensic
Accounting,” the Securities and Exchange Commission (SEC) has strengthened its
FSF divisions and trained its staff in the area of forensic accounting and financial
statement fraud, all international public accounting firms have established a
forensic accounting department, and forensic accounting and fraud examination is
becoming one of the fundamental components of business school’s curriculum in
recent years.
This book presents a comprehensive framework of the theory and practice of
forensic accounting investigation and FSF examination in two volumes. The
purpose of this book is to present a comprehensive primer of forensic accounting in
areas of fraud and nonfraud services. At present, headlines have again been
dominated by the investment Ponzi schemes and credit crunch scandals. Banks
have been hit by record levels of fraud over the past several years, and the situation
is likely to get worse as the full impact of the credit crunch unfolds. In such
increasingly unstable economic and litigious environment, there has been
significant growth in the demand for and interest in forensic accounting services.
During the 2007–2009 global financial crisis, the focus on financial statement
fraud prevention and detection become more important as regulators, investors,
and companies seek better understanding of corporate malfeasance and
misconduct.
In this book, forensic accounting is defined as the practice of rigorous data
collection and analysis in the areas of litigation support consulting, expert
witnessing, and fraud examination. Furthermore, forensic and investigative
accounting services range from expert report preparation to appearing in the
witness box, and from carrying out a fraud investigation to interviewing witness
and securing evidence. As a rapidly growing area within the accounting profession,
forensic and investigative accounting has gradually been recognized by
professionals and academics. Forensic accounting is viewed as one of the most
secured career tracks. There appears to be a gap between forensic and investigative
accounting practice and education given that there is only a limited number of
forensic accounting modules/courses offered within accounting and business
curricula in universities worldwide. This book is intended to develop an awareness
and understanding of the main themes, perspectives, frameworks, and issues
pertaining to forensic and investigative accounting. This book provides
practitioners, academics, and students with the knowledge and the professional and
personal skills in technical, analytical, and communication areas to equip them to
become successful forensic accountants with adequate knowledge in FSF
examination.
The two volumes of this book present the essential and fundamental aspects,
structure, theory, and practice of forensic and FSF, with a keen focus on a holistic
approach in forensic accounting and fraud investigation. These two volumes should
assist forensic accountants and fraud examiners with adequate knowledge and tools
in effectively performing fraud and nonfraud forensic accounting services. Anyone
who participates in the preparation of financial reports or uses financial
information in making financial decisions should be interested in this book.
Specifically, corporations and their executives, the boards of directors and audit
committees, internal and external auditors, accountants, governing bodies, users of
financial statements (investors, creditors, pensioners), business schools, other
professionals (attorneys, financial analysts, bankers), forensic accountants, and
Sincerely,
<PRESIDIO_ANONYMIZED_PERSON>
January 15, 2019
fraud examiners will benefit from this book.
Zabihollah (Zabi) Rezaee
January 15, 2019
Acknowledgments
I acknowledge the Securities and Exchange Commission, the Public Company
Accounting Oversight Board, the American Institute of Certified Public
Accountants, the Big Four Accounting Firms and Corporate Governance
Organizations, American Accounting Association, American Certified Fraud
Examiner, and other forensic accounting organizations for permission to quote and
reference their professional standards and other publications.
The encouragement and support of my colleagues at the University of Memphis are
also acknowledged. Especially, three of my graduate assistants, Mr. Charles Bell,
Mr. Matthew Cantin, and Mr. Jon Paul Squitieri for providing invaluable
assistance. I thank the members of the Business Expert Press team and S4Carlisle
Publishing Services for their hard work and dedication in editing the book,
including, Scott Isenberg, Mark Bettner, Michael Coyne, and Premkumar
Narayanan.
My sincere thanks are due to my family, my wife Soheila, and my children Rose and
Nick. Without their love, enthusiasm, and support, this book would not have come
to fruition when it did.
CHAPTER 1
Roles and Processes of Forensic
Accounting
Executive Summary
Forensic accountants are often hired to investigate allegations of wrongdoing such
as financial statement fraud (FSF), employee fraud, misappropriation of assets,
misrepresentation of financial information, kickbacks, bribery, conspiracy, inside
trading, valuation disputes, and money laundering, among other forensic
accounting services. It is important for forensic accountants to understand the role
of evidence, methods of gathering sufficient and competent evidence, evaluate
evidence, reach conclusions, communicate findings, make recommendations, and
testify before courts. This chapter discusses the roles of forensic accountants and
processes of forensic accounting, including the types of evidence (i.e., direct and
circumstantial), evidence-gathering procedures, evidence assessment, conclusions,
opinions, recommendations, and testimony.
Introduction
Forensic accountants gather evidence by conducting evidence-gathering
procedures, evaluate evidence in terms of sufficiency and competency, use evidence
in forming opinions, communicate their opinions, make recommendations, and
testify in courts about their opinions. This chapter presents fundamentals of
forensic accounting in performing fraud and nonfraud services by examining the
types of evidence (e.g., direct, circumstantial, testimonial, physical, and
documentary), rules of evidence, methods of gathering and evaluating evidence,
and reaching evidence-based conclusions. The expertise of forensic accountants is
in higher demand than expected in the areas of expert witnessing, litigation
consulting, and fraud investigation, because the advancement of technology has
augmented the specialized skills of forensic accountants. The increasing prevalence
of fraud justifies the growing demand for and interest in forensic accounting.
The Role of Forensic Accountants
Forensic accountants, also known as investigative auditors or forensic auditors, are
professionals that are usually employed to investigate financial and nonfinancial
matters owing to a dispute, fraudulent, or imminent legal proceedings. Effective
performance of forensic accounting services require gathering of a huge amount of
both structured (e.g., general ledger or transaction data) and unstructured data
(e.g., e-mail, voice, or free-text fields in a database), together with an increasing
amount of nontraditional data sources such as third-party watch lists, news media,
free-text payment descriptions, e-mail communications, and social media. Data
analytics with the use of Big Data has been employed by forensic accountants to
transform unstructured data into useful, structured, and relevant information for
decision making in performing forensic accounting services. Forensic accounting
services are often performed by individuals, with multidisciplinary knowledge and
experience in accounting, technology, criminology, psychology, and laws, who are
professionally skeptical in asking the right questions, utilizing data science and data
management expertise to translate questions into meaningful analytics and use
systems and information technology (IT) infrastructures.
Individuals performing forensic accounting services are often working with
professionals that are considered to have certifications such as the Certified Public
Accountants (CPA), Certified Forensic Accounting Credential (CFAC), Certified
Fraud Examiner (CFE), Forensic Certified Public Accountant (FCPA), Certified in
Financial Forensics (CFF), and Certified Valuation Analyst (CVA), among others.
These certifications enhance forensic accountants’ competency, skill sets, and
reputation. The new AICPA proposed standards, released in December 2018,
1
classify forensic accounting engagements as services provided by members for
“investigation” or “litigation”. The investigation engagements are services
performed to reach a conclusion regarding concerns of wrongdoing in which the
CPA performs necessary procedures to collect, analyze, evaluate, or interpret
evidence on the merits of the concerns. The litigation engagements are actual or
potential litigation services performed in connection with the resolution of disputes
between parties in which the engagement does not need to be formal and may
include alternative dispute resolution forum.
Forensic accountants should obtain sufficient understanding of how to plan and
prepare for a forensic engagement, including considerations of whether to accept an
engagement, defining the terms of the engagement, working with attorneys,
identifying and managing resources, planning the engagement, and conducting the
investigation. Accepting an engagement is an important step in the process of
performing forensic accounting services. Forensic accountants base their opinion
on the evidence gathered during their investigation. For example, a fraud
investigation is the process of examining allegations of fraud, gathering convincing
evidence, and reaching a resolution on the basis of evidence, reporting, testifying,
and detection and prevention. Evidence is used as the foundation of a fraud
examination, which is the basis for reaching conclusions. The evidence needs to be
thorough, sufficient, competent, and credible in nature for the investigation to be
appropriate. The sufficiency of the evidence is a matter of quantity about how much
evidence is enough. The competency of the evidence is a matter of quality regarding
whether the evidence is persuasive and credible.
The two main types of sufficient and competent evidence are documents and
witness statements. The evidence should be evaluated and used as a basis for
forming an opinion and writing a report. The report details the investigative process
and the findings from the evidence used. Information often included in fraud
reports are activities of the perpetrator(s), findings, and suggestions for
improvement. Forensic accounting reports should be submitted to the interested
parties. After the report has been issued, forensic accountants may be required to
testify in court regarding the report and its findings. When testifying, the forensic
accountant must take an oath to be honest and clear in communication and
opinion. The effective planning for fraud and nonfraud forensic accounting
services requires that forensic accountants understand the scope, type, and motives
of fraud explained in the following sections.
Fraud Models
The nature, scope, and drivers of fraud can be defined in many ways, including the
fraud triangle. The fraud triangle was initially conceptualized by Donald Cressey
(1953) and consists of three components—incentive, opportunity, and
rationalization. Fraud occurs when there are pressures or incentives to engage in
fraud, opportunities to commit the fraud, and there is a rationalization for the
actions taken; these can either be real or simply perceived by the fraudster. The
American Institute of Certified Public Accountants (AICPA) issued the Statement of
Auditing Standards No. 82 (SAS No. 82) and then SAS No. 99, “Consideration of
Fraud in a Financial Statement Audit” in 2002, which promotes the fraud triangle
as a theoretical framework in the investigation of FSF. The fraud diamond was later
developed by Wolfe and Hermanson (2004) who added “capability component” as
the fourth dimension of the fraud diamond. The fraud diamond model includes
incentives/pressures, opportunities, rationalization, and capability. The fraud
pentagon model consists of five components—pressures/incentives, opportunity,
capability, rationalization, and accountability. The inclusion of
enforcement/compliance was introduced by Hossain, Mitera, and Rezaee (2016).
Exhibit 1.1 (Panels A, B, and C) presents all three models—fraud triangle, diamond,
and pentagon—and they are further explained in the following paragraphs.
Exhibit 1.1
Models of Fraud
Panel A: Fraud Triangle
2
3
4
5
6
7
8
Panel B: Fraud Diamond
Panel C: Pentagon Model of Financial Reporting Fraud
Incentive is the motivation driven from conflicts of interest or a perceived pressure
on individuals to commit FSF. In a corporate setting, incentive is typically
examined in the context of operational/financial characteristics and as a motivating
factor for management to adopt aggressive accounting policies and practices.
Opportunity describes the conditions or corporate culture and environment that
would allow management to commit FSF, which is often examined in the context of
corporate governance effectiveness, adequate regulatory reforms, and vigorous
enforcement of laws, rules, and regulations. Rationalization is a process by which
management justifies its action in committing FSF and it can be addressed through
psychological effects or mistakes in judgments in assessing the consequences of
compromising ethical values or committing wrongdoings. Whereas incentive has
been examined through the existence of internal and external pressures on
management to achieve earnings targets or beat analyst earnings forecast and
opportunity has been investigated through board and audit committee effectiveness
and audit quality, rationalization has been difficult to examine because it is not
easily measured.
To commit fraud, the fraudster must have adequate knowledge of the accounting
systems and how they interact. Alongside the fraud models are four conditions that
increase the likelihood of a person committing fraud; they are pressing financial
need, opportunity, reasonable justification, and a lack of moral principle. The most
serious of these aforementioned conditions is the lack of moral principle. This
fraudster sees nothing wrong with committing fraud and will often continue to
commit fraud as long as the opportunity is present. The conditions of people likely
to commit fraud and all the fraud models have overlapping themes. The
opportunity to commit fraud usually comes from a lack of or ineffective internal
controls. Ineffective controls include the ability to override activities, no password
constraints, and no preventions against collusion. If there is a strong separation of
duties and multiple checks for areas with higher inherent risk, it is harder to
commit fraud and easier to identify fraud. Rationalization, or justification, can stem
from a real or perceived slight against the employee. It can also be rationalized by
the employee by perceiving that the act is not actually stealing from the company.
Also, the employee thinking that he or she is not hurting anyone or will be able to
pay back the money before it is been noticed is also popular rationalization. This is
important for forensic accountants to consider, so they can adequately examine the
situations they are involved.
The pentagon model of financial reporting fraud (FRF) consists of five components:
pressures/incentives, opportunity, capability, rationalization, and accountability
through enforcement and compliance with all applicable laws, rules, and
regulations. FRF occurs for a wide variety of reasons, more so when motives
combine with opportunities. Corporate strategy to meet or beat analysts’ earnings
forecasts pressures management to achieve earnings targets. Managers are
motivated, in most cases, by pressure and reward when their bonuses are tied to
reported earnings. This may induce managers to adopt accounting techniques that
may often result in misreported earnings. Companies are more likely to engage in
FRF when their actual earnings are predicted to fall short of certain thresholds. In
such a situation, managers have incentives and pressures to manipulate earnings
and engage in FRF by exercising their accounting discretion/flexibility available
within the bounds of accounting standards. This is more likely when the benefits of
manipulating earnings outweigh the associated costs and risks imposed by the
adverse consequence of such frauds being detected.
The accountability element of the pentagon model of FRF is an extension of the
fraud triangle model. All three factors—opportunity, incentive, and rationalization
—must be in place for fraud to occur, and fraudsters must be able to commit fraud.
Although the above-mentioned fraud elements deal with FRF prevention and
detection, the accountability component is more relevant for FRF deterrence. The
deterrence of FRF can be achieved when fraudsters realize that they will pay for the
crime either through capital punishment or alternative severe criminal and civil
penalties. The fifth component of FRF deterrence—“prevention and detection”—is
accountability measured by effective compliance and vigorous enforcement of
antifraud policies and procedures as well as severe punishment of fraud predators.
Rezaee and Kedia (2012) present the following antifraud policies, procedures, and
best practices of corporate gatekeepers, including the board of directors,
management, internal auditors, and external auditors.
The board of directors should establish the “tone at the top” by promoting
competent and ethical behavior throughout the organization, effectively evaluating
management performance and compensation as related to risk assessment, and
vigilantly overseeing the financial reporting process and internal control system in
preventing and detecting FRF. Management must design and implement an
effective financial reporting process and internal control system while establishing
a proactive approach to deter, prevent, and detect FRF. Internal auditors should
provide both assurance and consulting services to their organization in the areas of
operational efficiency, risk management, internal controls, financial reporting,
antifraud, and governance processes. External auditors should provide reasonable
assurance that financial reports are free from material fraud by integrating forensic
procedures and fraud risk into audit strategies and tests and establishing open and
frank dialogue with the board, audit committee, and management about the
organization’s vulnerability to fraud.
FRF occurs for a wide variety of reasons, including when motives combine with
opportunity. Corporations’ strategies to meet or exceed analysts’ earnings forecasts
pressure management to achieve earnings targets. Managers are motivated and
rewarded by achieving or exceeding target earnings, which can lead managers to
choose accounting principles that may result in the misrepresentation of earnings.
Companies are more likely to engage in FRF when quality and quantity of earnings
are deteriorating, management has incentives and pressures to manipulate
earnings, opportunities to engage in FRF exist, and management can have
rationalized that the benefits outweigh the associated costs calculated using the
probability and consequences of detection.
9
Economic incentives are common in FRF, even though other types of incentives
such as psychotic, egocentric, or ideological motives may play a role. Pressure on
management to meet analysts’ earnings forecast may give them the perception that
their only option is to manipulate earnings. Management evaluates the opportunity
for earnings manipulation and the benefit of earnings management in terms of the
positive effect it will have on the company’s stock price against the possible cost of
consequences of engaging in FRF and the probability of detection, prosecution, and
sanction.
Antifraud roles and responsibilities of corporate gatekeepers are important because
FRF is typically committed at the level of the top management team rather than
lower management or employees. Senior executives are primarily responsible for
fair presentation of financial statements, whereas the board of directors oversees
the financial reporting process and auditors (external and internal) provide
assurance regarding the reliability of financial reports. Both the 1999 and 2010
reports of Committee of Sponsoring Organizations of the Treadway Commission
(COSO) find senior executives’ involvement in the high majority of FRF cases (i.e.,
83 and 89 percent, respectively). When management has incentives to meet
financial targets through earnings management and the opportunities to override
internal controls exist, senior executives may engage in FRF as further explained in
the next section.
Misstatements
Any material misstatements can result in fraud. Management fraud is a deliberate
action by the management to mislead users of financial statements through
preparation of materially misstated financial reports. These deliberate
misstatements or omissions of amounts or disclosures of financial statements
attempt to deceive users of financial statements, including shareholders, creditors,
governments, and other stakeholders. There are two types of misstatements that
can mislead investors and other users of financial statements. These two
misstatements are “fraudulent financial reporting” and “misappropriation of assets”
accompanied by misleading financial information. There are many types of fraud
schemes including occupational fraud, in which employees defraud their employer,
FSF, in which management defraud users of financial statements, and other frauds,
including vendor fraud, supplier fraud, customer fraud, and digital fraud.
Fraudulent Misstatements
There are many ways in which misstatements can occur, and fraudulent financial
statements can be committed, including (1) fictitious revenues, (2) timing
differences, (3) concealed liabilities and expenses, (4) improper disclosure, (5)
improper asset valuation, and (6) earnings management.
Fictitious Revenues
This scheme is used to overstate revenues during periods of financial distress and
duress or to improve outlook for a given period. There are several ways of recording
fictitious revenues, including false journal entries, inaccurate sales to existing
customers, sales to fake customers, and round tripping. False journal entries
typically take the form of a debit to accounts receivable and a credit to sales. This
method is often supported by internally generated phony supporting documents to
mislead auditors. Also, if other journal entries are not created to offset the
imbalance created, auditors will easily identify the misbalanced accounting
equation. Fictitious revenues can also be recorded by inaccurately accounting for
sales to existing customers or by claiming sales to fake customers. Both schemes
involve the forgery of documentation to support the fraudulent distortion of the
financial statements. Forgery would be committed on documents such as sales
invoices, shipping documents, and purchase orders. Similar to other revenue
schemes, patterns exist, such as revenue at the end of a period, customers outside of
the industry, and increasing sales with a drastic decrease in cost of goods sold. The
same fraud detection techniques used under revenue recognition fraud can be used
for this scheme too. Round tripping occurs when a transaction proves to be of little
benefit but is recorded as if it were beneficial. According to the 2018 Report to the
Nations by Association of Certified Fraud Examiners (ACFE), FSF schema had the
greatest median loss at $975,000 per incident.
10 11
12
13
14
•
•
•
Timing Differences in Revenue and Expense Recognition
The timing differences in revenue and expense recognition include the following
schemes:
Not matching revenues with expenses: The
effect of this error overstates the net
income of the company in the period in
which the sales were recorded and
understates net income when the expenses
are reported.
Early revenue recognition: The result of
this not only leads to statement
misrepresentation but also can serve as a
catalyst to further fraud.
Recording expenses in wrong period: The
motivation of doing this comes from the
pressures to meet budget projections and
goods and lack of proper accounting
controls.
Timing difference fraud, also known as cut-off fraud, includes the recognition of
revenues before they were earned, postponing the recording of expenses and
liabilities, and shipping merchandise to customers before the sale is approved or
finalized. Under generally accepted accounting principle (GAAP), revenue is
recognized when they are realized or realizable, when goods change ownership, or
when services are rendered. The company could also keep the books open after the
accounting period ends to accumulate more sales. The purpose behind these forms
of fraud is, much like the previous form, to improve the apparent financial position
of the company to encourage stock purchases, increase the availability of debt
funding and decrease its cost, and to meet analyst forecasts of sales and net income.
If the company of interest is avidly seeking funding through equity or debt, this
could be a sign to carefully examine it for the aforementioned forms of fraud.
Forensic accountants can uncover most forms of timing difference fraud by
sampling a selection of transactions from the sales journal and inspecting the credit
terms, comparing shipping documents and invoices for discrepancies, comparing
invoice prices with published or established sales prices, or by simply verifying
major sales. Forensic accountants can also look for increased shipping costs or
decreased expenses near the end of the accounting period, indicating an irregularity
that requires further assessment.
Concealed Liabilities
Concealed liabilities, as the name suggests, involve hiding certain obligations from
investors and the public to improve the apparent health of the company’s balance
sheet similar to special purpose entities that were created by Enron to hide
liabilities. Liabilities can be concealed by either hiding their existence or creating
fictitious journal entries indicating that they have been paid down or paid off
15
completely. A key component of financial health of a business is the leveraging of
debt to generate returns. However, there is a delicate balance of debt-to-equity in
every industry and it is not uncommon for businesses to be overburdened by debt.
If this is the case, management may hide certain debt obligations that harm buy-ins
to the company or reduce access to additional debt borrowing.
Companies that are in poor financial health, because of exorbitant amounts of debt,
are likely suffocated by fixed costs associated with debt financing. If a company,
struggling to pay bills as they become due, does secure additional debt funding by
concealing liabilities, it only makes the fixed cost burden greater, thus making their
financial position even more precarious than before. Liabilities could also be shifted
from short term to long term to improve working capital figures, consequently
increasing the apparent liquidity of the company. Liquidity, or solvency, is a key
metric evaluated by creditors when making the decision to lend company money.
Misclassification of the term of liabilities can be identified by identifying debt that
was reclassified near the company’s fiscal year-end or in interim financial
statements submitted to creditors with the purpose of obtaining additional debt
funding.
Improper Disclosure
The disclosure of financial and nonfinancial is crucial and often required by law
such as SOX Act of 2002, SEC regulations and accounting standards. Disclosed
information may include footnotes, nonfinancial key performance indicators
(KPIs), and other important items located in public reports that could have an
adverse effect on the company’s financial position. Disclosure schema include
failure to disclose related party transactions, asset impairments, liabilities, and
material departures from GAAP. Fraudulent behavior may frequently arise when
the disclosures are manipulated to exclude pertinent information, mentioned
earlier. This is often done by management to hide data that may dissuade investors
from investing. If a subsequent event occurs after the balance sheet date but before
the statements are filed, public companies are required to disclose the information
if it is material.
The Sarbanes–Oxley (SOX) Act addresses many issues with disclosures to increase
investor confidence in the accuracy and completeness of financial information of
reporting by public companies. It has been noted by many experts that potential
fraud schema can arise from the strict requirements of the SOX Act. Although less
common, it is also possible that disclosures include fictitious or overstated benefits.
For example, disclosing a harmful significant transaction in a positive manner to
deceive investors, when the effect on the company’s financial health will be
negative, is considered as fraud.
Improper Asset Valuation
Valuation is the act of determining the intrinsic value of an asset. Improper asset
valuation often involves the overstatement of an asset’s value, positively skewing
earnings. The primary areas where improper asset valuation occurs are inventory,
accounts receivable, and business combinations. Inventory can be overstated by
falsifying physical count, and inflating its cost, among others. Accounts receivable is
typically manipulated by either recording fictitious and related transactions in the
accounts receivable, failure to write off uncollectible accounts, or manipulation of
allowances for doubtful accounts. When a company acquires another business, it
typically revalues its assets. The company could choose to falsely write up the assets
to increase total asset value.
There are several reasons for overvaluation fraud to occur. First, financial ratios are
often used by investors to evaluate company performance. If the ratio is below the
industry average or poor in comparison to previous years, investors are less likely to
buy into the company. Also, certain debt covenants might be contingent on the
company maintaining certain financial ratios. If the company falls below a
contractually agreed-upon threshold, the creditor has the right to recall the debt
and demand repayment in full. Management may intentionally overinflate assets to
make ratios such as return on assets (ROA) appear better. Second, when more
investors buy into a company, upper management may receive a bonus or the value
of stock they own could increase. This is another incentive to erroneously report an
asset’s or group of assets’ value(s).
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17
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Earnings Management
Earnings management is defined as a process of managing earnings to achieve the
desired or targeted earnings. It can be done legitimately in creating sustainable
performance, or in manipulating earnings. Earnings manipulation can be achieved
by using accounting techniques to produce financial reports that present an overly
positive view of a company’s business activities and financial position. Although
accounting rules and standards often require management to make judgment calls,
earnings management takes advantage of the gray areas of these standards and
rules to inflate revenue and assets and manipulate liabilities and expenses.
Earnings management needs to be properly monitored after being implemented in
a business. There are currently many methods a business can use to evaluate
earnings. The methods usually fall under the purview of U.S. GAAP and therefore
comply with accounting standards. These methods include inventory flow (e.g.,
first-in-first-out (FIFO), last-in-first-out (LIFO), and cost method), timing
principles, estimates, and classification of earnings. These methods can conflict
under certain circumstances and be used by management to manipulate earnings.
For instance, when a company has financial statement items that are non-GAAP,
they are excluded from earnings management. The reason for this is that the
reconciliation of non-GAAP to GAAP standards can cause earnings management to
become inaccurate and, in turn, a poor methodology for running a successful
business.
In summary, material misstatements in financial reporting can be classified into
several categories. The first and most common scheme is the intentional
manipulation of financial reports by management as discussed earlier. The second
most common is the timing differences in revenue and expense recognition. The
third category is concealed liabilities. The forth category is improper disclosures.
The fifth category is improper asset valuation. The Public Company Accounting
Oversight Board (PCAOB) released Auditing Standard (AS)2401 in 2003 and made
amendments to the standard in 2015, which outlines the importance of this audit
function when detecting FSF. During the audit, the auditor looks for fraud during
financial statement analysis by assessing the risk of material misstatement and
using the audit risk (AR) to establish the level of acceptable materiality and
detection risk. The lower the acceptable detection risk to the auditor, the more the
procedures required to verify the validity of audit evidence. On December 15,
2012, Au-C section 240 became effective. This standard, established by the AICPA,
is similar in nature to AS 2041 released by the PCAOB. It requires the auditors to
consider the possibility of management committing FSF. The standard also lays out
auditor’s responsibilities, requirements, and objectives.
Asset Misappropriation
The most commonly used method for concealing liabilities/expenses is through
liability/expense omissions because it is easy not to record liabilities and expenses,
which makes it more difficult to discover the related fraud. Perpetrators of liability
and expense omissions often plan to conceal their fraud until it can be compensated
with future sources of income. For example, by increasing the sale price in the
future when the omitted expenses can be recorded. These types of fraud can be
prevented through effective internal controls and can be discovered through
abnormal changes in accounts payable by recording unusual transactions in the
postfinancial statement date.
Fraud can be committed by intentionally overstating inventory by falsely increasing
inventory value and decreasing cost of goods sold. The fraud perpetrator can
conduct the fraud of overstating inventory. An effective inventory internal control
system using just-in-time and perpetual system can prevent fraudulent inventory
overstatements. Four types of tools to discover fraud include inventory physical
counting, review of accounts receivable, aging report, and analytical procedures.
Inventory counting involves using inventory scanners, physical counts, and
inventory logs to compare estimated count with actual inventory count. Massive
discrepancies can indicate inventory fraud. Accounts receivable is an account used
to measure sales that have been completed but of which payment has not been
received yet. Reviewing accounts receivable can determine if sales were recorded
when the transaction(s) were not completed. An aging report is a methodology
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applied to accounts receivable that determines “how long” or the useful life of
account receivable. The older the receivable, the less likely it is to be collected and
thus, more allowance for uncollectible/doubtful accounts should be considered.
Analytical procedures allow for in-depth analysis of factors that can impact
inventory, cost of goods sold and accounts receivable.
Asset misappropriation, usually pertaining to occupational fraud, involves the theft
or misuse of the organizations’ assets and can be conducted by any employee,
including management and even nonemployees. However, employees are usually
the perpetrator of asset misappropriations, whereas management typically engage
in FRF, including asset misappropriations. The four current classifications of asset
misappropriation are cash schemes, accounts receivables, inventory, and fixed
assets schemes. These are discussed in the following paragraphs.
Cash schemes include skimming, larceny, and fraud cash payments. Skimming is
defined as removing cash from company hands before it enters into the record
books (accounting software). This fraudulent behavior often affects the
revenues/sales account and checkbooks. Cash larceny is the theft of money from an
employer without consent of the employer and the intension to give back. Lastly,
fraudulent cash payments occur when an employee (usually in a management
position) disburses cash to others unrelated to the business dealings. Examples of
this type of scheme include payroll alterations, check forgery, and unrelated
business expense reimbursement. This type of scheme is also the most prevalent
form of asset misappropriation.
Accounts receivable is also subject to varying degrees of fraudulent behavior. The
types of schemes prevalent to accounts receivable are lapping, made-up receivables,
and posting unnecessary credits. First, lapping is recording a payment twice or
recording another payment after the money was already received. Relating to
fictitious sales mentioned in the previous paragraph, fictitious accounts receivables
are only created to match phony and fake sales account. The reason for this is most
businesses use the accrual accounting system, which records a debit to receivable
and credits sale revenue when a revenue transaction has occurred not when a cash
collected. Finally, the improper use of discounts, returns, and allowance for
uncollectible accounts is often misused. An employee can manipulate an account as
it was written off and then pocket the money for personal use.
Inventory fraud schemes happen in many types and sizes of retail and
manufacturing companies, particularly in big warehouses of various businesses.
The most common schemes are inventory theft, selling scrap, and use of inventory
for one’s personal use. The final category of asset misappropriation is fixed asset
schema. This is the manipulation of a company’s property, plant, and equipment,
usually for personal use or gain. Theft of smaller equipment such as drills,
hammers, and other lightweight objects is frequent.
Employee Fraud and Theft
Employee fraud is committed by employees other than owners and executives.
Employees are much more likely to commit fraud according to ACFE’s 2016 Report
to the Nations. The median loss attributed to employee occupational fraud was
$65,000, the median loss for managers was $173,000, and the median loss for
owners/executives was $703,000. The reason for the high disparity in the dollar
amounts is due to executives being able to bypass and control functions of the
corporation, allowing them higher opportunities for fraudulent activity. The losses
were also attributable more to males than to females. Out of the 2,410 cases
analyzed by the ACFE, males contributed a median loss of $187,000, whereas
females contributed only $100,000. In the past 3 years, there was about 10
percent increase in median loss for females and a 6.5 percent decrease for males.
When comparing positions held in the company, the gender breakdown between
males and females matches the overall losses stated earlier. Owners and executives
of both genders were more likely to steal more from the company. When fraud is
broken down by schema, males engaged in FSF and corruption, whereas females
engaged more in asset misappropriation. For both genders, as age increased, so did
the frequency of fraud. Also, the higher the level of education, the more likely an
employee is to commit fraud. Overall, 82.5 percent of perpetrators are never
punished for their actions.
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A key component to analyze regarding employee fraud is the method of detection
used. The three most common detection methods were tips, management reviews,
and internal audits with the average of 36.55 percent, 13.6 percent, and 15.3
percent, respectively. Across the regions of the United States, South Africa, Asia-
Pacific, and Latin America and the Caribbean tips were the highest surveying in at
37 percent, 37.3 percent, 45.2 percent, and 36.9 percent, respectively. The average
for all four regions is 39.1 percent. Management reviews in all four regions, polled
in at 14.3 percent, 10.2 percent, 13.1 percent and, 17.1 percent, respectively, for an
average of 13.68 percent. Lastly, internal audit detection across all four regions
sampled at 14.1 percent, 16.2 percent, 15.8 percent, and 19.8 percent,
correspondingly, for an average of 16.48 percent. These methods differed between
size of firm, confession, management review, and surveillance. Larger firms
preferred tips and internal audit, whereas smaller firms favored external and minor
internal activities such as external audits.
Employee fraud can be prevented and detected in many ways as follows:
Sound code of conduct: A proper and
effective code of conduct for employees
promotes a corporate culture of integrity
and competency. The code of conduct
should provide guidelines for ethical
behavior and accountability.
The ACFE states in their Code of Ethics
that any illegal activity or activity that leads
to a conflict of interest between parties is
strictly prohibited. This standard adheres
strictly to professionalism, which is a
positive quality associated with one’s
business career. It is also important for a
CFE to remain a confidant in all times
throughout his or her career. Accounting
ethics strongly supports the foundational
pillar of accountability and
confidentiality.
Implementing an effective system of
internal control and establishing a system
of checks and balances in preventing
employee fraud: An effective system of
internal control should prevent, detect, and
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correct any errors, irregularities, and fraud.
Policies and procedures in observing
employee’s behavior: Employees tend to be
more ethical when they know there is an
accountability system that monitors their
behavior and actions without invading
their privacy.
Identifying and Gathering Evidence
Evidence identification, gathering, and evaluation during legal matters and
independent investigations are crucial. This section discusses various services that
can be performed by forensic accountants and the type of evidence they need to
gather to effectively support their decisions to be able to defend in the court of law.
Forensic accountants need to know where evidence (paper and electronic) can be
found and how it should be evaluated and processed. For example, more credible
and persuasive materials need to be gathered for fraud allegations regarding
revenue manipulation because the majority of FSF cases involved improper revenue
recognition even though revenue manipulation could be the most expensive form of
earnings management. Revenue manipulation is the most common type of FSF,
even though it can be very costly because of the higher likelihood of receiving
comment letters from the Securities and Exchange Commission (SEC), short
interest, restatements, increased audit fees and unfavorable audit reports,
litigation, investigations, sanctions by regulators and standard setters, and negative
market reactions.
Management is also responsible for cash flows generated from operating, financing,
and investment activities because cash flows determine stock prices, firm valuation,
and debt-service capacity, eventually influencing costs of capital. Manipulation of
cash flows from operations is most common. For example, management can
manipulate cash flow by classifying operating leases as capital expenditures that
could shift the payments from the operating section of the cash flow statement to
the investing section.
Rules and Types of Evidence
Evidence can be defined as things, matters, or issues—physical, verbal, or electronic
—that can be relevant in an investigation to support assertions, propositions, or
factual statements. The rule of evidence is whether a case is held before a judge or a
jury or whether it is presented in court. There are two general categories of
evidence. First, the direct evidence that provides the existence of a fact under
investigation without any need for inferences or presentation of any other facts.
Circumstantial evidence is the evidence that requires an inference on the basis of
indirect evidence. Each of these two categories of evidence can be further classified
into testimonial, demonstrative, and real evidence.
Testimonial evidence is an oral declaration of fact or a written statement by witness
that is used in trial. This witness could be involved in the subject of litigation, to an
extent, or could be an expert witness hired to provide credible testimony regarding
a matter requiring specialized knowledge. These witnesses are typically subject to
cross-examination by the opposing side. The aim of the cross-examination would be
to discredit the individual’s testimony or credibility within the circumstances of the
case.
Demonstrative evidence, by definition, includes all evidence that is not substantive
or testimonial in nature. This form of evidence is often meant to demonstrate or
represent testimonial evidence in a physical form and is only admissible when it
precisely mirrors the witness’s testimony. Examples of this type of evidence are
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pictures, charts, and objects that can be used in litigation to support the case.
Demonstrative evidence can be immensely useful when testimonial evidence is
complex in nature, because it can provide a visual representation of the facts that
can be more easily understood by a jury.
Real, or physical, evidence simply relates to any object used in trial and litigation. It
is similar to demonstrative evidence in the sense of its physical nature; however,
this form of evidence is not generated from testimony. Real evidence can include an
alleged murder weapon, narcotics, fingerprints, clothing, or any material object
used to prove or disprove an issue in a trial. An important concept relating to real
evidence is its chain of custody. This describes the chronological possession of the
evidence, aiming to reduce the chance of admitting tampered or contaminated
evidence into the trial.
Evidence-Gathering Procedures
Forensic accountants perform a variety of investigative, litigation, and expert
witnessing services for their clients that range from a simple asset valuation to a
more complex fraud and dispute investigation. Regardless of the type and
complexity of the engagement, forensic accountants should do the following steps
of planning and preparation, evidence gathering and evaluation, and conclusions
and communication.
Planning and Preparation
Forensic accountants should plan the engagement by deciding to accept the
engagement, evaluate the client, obtaining an understanding of the engagement
case, assess their resources and ability to perform the service, and the commitment
to do thorough investigation. The decision to accept the client is extremely
important, particularly in the case of expert testimony and requires proper
negotiation and understanding of the scope of forensic accounting services.
Forensic accountants should obtain either verbal or written agreement from their
client before performing the service. Terms of the agreement should be specified in
the engagement letter. During the planning stage, forensic accountants should
consider the factors that increase the likelihood of FSF. These factors should be
addressed and considered in planning an investigation absolute power, greed,
incompetence, capability, pressures/incentives, opportunity, collusion, and lack of
proper business codes of conduct. Factors that may decrease the possibility of FSF
are effective corporate governance; compliance with applicable laws, rules,
regulations, and standards; effective internal controls; and tone at the top.
Gathering Evidence, Reporting, and Court Proceedings
After the engagement has been planned, the forensic accounting team must gather
evidence. In the current forensic landscape, there are various procedures that can
be used to gather sufficient, accurate, reliable, and timely evidence. These
procedures include testing controls, which can be used to identify security
loopholes, and analytical procedures to conduct trend or comparative analysis. This
will enable accountants to detect paradigms or cycles on a business using advanced
computer techniques and software, interviewing, and reconciliations. The
aforementioned processes will allow enough evidence to be gathered to report to
the client. The report includes the fraud scheme and information supporting the
schema. This report is used in court proceedings as evidence to determine the guilt,
or lack therefore, of the defendant.
Evidence-Gathering Methods
Brainstorming Sessions
Mind-mapping, open-ended, computer-mediated, and strategic reasoning are the
four types of brainstorming techniques, according to the Tennessee Society of CPAs
(TSCPA). These methods each involve the forensic team holding meetings to
create means to interact with fraud. Opened-ended brainstorming involves
practitioners selecting an arbiter that allows the free flow of ideas. A notetaker is
present and is not allowed to participate in the discussion. This technique has a
shortcoming though; not all ideas may be heard because of time constraints and
number of individuals speaking per session. In relation to fraud, this technique is
frequently cited has discovering fraud risk factors at a higher rate.
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Computer-mediated brainstorming is the use of a computerized environment to
simulate face-to-face interaction via electronic transmissions. Examples of this
technique include telecommunications, Skype, and Blue Jeans. Electronic data
transmission allows quicker exchange of information when compared with other
methods. It also allows for anonymous transfer of information, if necessary. Mindmapping
is real-time diagramming placing the discussion title in the center and
major elements branch from the center. This approach is evidence of the use of
visualization technologies, which are becoming more prevalent as data sizes
increase (Big Data). Both computer-mediated and mind-mapping uses software
such as XMind, iMindMap, and StormBoard to host these visualizations and
communication networks. Lastly, strategic reasoning evaluates how managers
commit fraud. This perspective enables auditors to think in the shoes of
management when conducting an audit and looking for fraudulent behavior.
Red Flag Identification
Red flags are defined the early symptoms that would indicate a higher risk of
potential fraud or intentional misstatement of financial statements. Forensic
accountants can assess fraud by focusing on using fraud risk factors, “red flags,” to
assess the overall risk of fraudulent financial reporting as suggested in SAS No.
99. In this approach, the forensic accountant identifies the presence or absence of
certain red flags and then assesses the risk of fraud. To facilitate the use of red flags,
various decision aids have been developed, such as checklists, regression models,
and expert systems. One major limitation of current red flag approaches is that they
are developed to assess the overall fraud risk without considering the impact of
fraud schemes that are used by management to perpetrate and conceal fraud.
A checklist consists of a list of potential red flags that the auditor can use to assess
fraud risk. Various decision aids have been developed, including checklists,
regression models, and expert systems to facilitate the use of red flags. A checklist
consists of a list of potential red flags or sympathies that forensic accountants can
use to assess fraud risk. Checklists are the most common decision aid for forensic
accountants. One major drawback of the checklist is that it ignores the structure
and interrelations between fraud risk factors.
Examples of red flags checklists of FSF are:
Personal financial pressure
Vices (e.g., drugs, alcohol, or gambling)
Extravagant lifestyles
Real or imagined grievances against
company
Related parties
Increased stress
Internal pressures
Red flag lists are often used to spot and warn about fraudulent activity by degree of
severity. A red flag is defined as a circumstance that is outside the norm. There are
several categories of red flags that can enable forensic accountants to identify and
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detect errors, irregularities, and fraud. These categories include:
Employee red flags: Can be identified by
changes in expenses, turnover, working
overtime frequently, or lack of separation
of duties. For example, if an employee buys
a Porsche not affordable with the salary
made in the position held, this is an
employee red flag.
Management red flags: Signs include
noncompliance with accounting standards
and policies, lack of internal control
environment, too many bank accounts,
decisions made by a select few managers,
too many year-end transactions, or
nonresponses and waiver of auditors
suggested adjustments and closing entries.
Change in behavior red flags: This category
can apply signs including borrowing money
from coworkers, excessive drinking or
other negative habits, carrying unusually
large amounts of cash, overworking, or
gambling beyond reasonable means.
Statistics have been released that enable forensic accountants and auditors to
search for specific red flags. An overwhelming 42.1 percent of occupational fraud
violations are committed by employees and 61 percent of fraudulent actions were
perpetrated by males. Despite these statistics to help narrow down red flags, 88
percent of individuals who commit fraud are never caught by the legal system.
Regression Models
The most common regression models are linear and logistic. Different model
selections can be used with these regression types, including backward, forward,
and stepwise. Regressions are often used to perform statistical analysis on data sets,
in which relationships among input and target variables must be discovered. There
are many software providers that produce software that aids in regression
modeling. An example of regression software is SAS Enterprise Miner.
A logistic regression model can be used in fraud detection by analyzing a company’s
financial information in a model to identify irregularities and anomalies for further
inspection. For example, the timing of a company’s journal entries could be
examined using a linear regression model, where the relationship between number
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of journal entries of a specific category and time are analyzed. If the number of
journal entries in specific accounts with a high propensity for fraud increases
drastically at year-end, forensic accountants would be alerted to closely inspect that
specific account for potential fraud. A predictive model can be used in a similar
fashion by using historical data to project certain financial ratios. If the projected
ratios are drastically different from the ratios on financial statements, that would be
an indication for the auditor to see if the over- or underperformance caused by
fraud.
Expert System Aids
Expert system aids are commonly computer-based design consultation systems that
verify completeness, consistency, and accuracy of transactions or events. These
computer-based expert system aids are often used to mimic the decision-making
process and reasoning capabilities of the human mind. Forensic accountants can
use expert system aids to increase the efficiency and accuracy of their work. Expert
systems mimic the auditors’ and forensic accountants’ professional judgment to
arrive at similar conclusions as the human. These systems are fed large amounts of
test data and professional knowledge and reduced to “if-then” rules to build a basis
for decision making and analysis. As expert systems have progressed over time,
they are capable of processing increasingly complex issues and providing thorough
solutions, similar to that of a human expert. The benefit of expert systems from a
fraud detection standpoint is that forensic accountants are able to analyze 100
percent of the data in the area of interest to detect anomalies, in a significantly
shorter amount of time.
Analytical Procedures
Analytical procedures are techniques used by forensic accountants and auditors in
gathering and evaluating evidence by studying plausible relationships between
financial data and their link to nonfinancial data. Analytical procedures can be an
effective tool for forensic accountants in all phases of an investigative engagement,
including the planning phase of deciding on the extent and types of tests, in
substantive testing of gathering and evaluating evidence, and in the overall review
of an investigation in justifying results and opinions. Like auditors, forensic
accountants can perform analytical procedures during the planning stage of the
investigation to enhance understanding of the client’s business and to assist in
planning the nature, timing, and extent of their testing. During the planning stage,
analytical procedures are typically performed by comparing financial data with
nonfinancial data and developing expectation for the investigation. Forensic
accountants’ expectations should be developed through a comprehensive
understanding of the client and its industry and knowledge of the client’s financial
and internal control systems. Forensic accountants may use several sources of
information to develop expectations, including financial information from prior
periods, nonfinancial information (client standing in the industry with peers,
management style, and integrity), anticipated results (budgets or forecasts),
information on the industry in which the client operates, and the relationships of
financial information with nonfinancial information.
Financial ratios are often used to detect FSF. Research from the past 30 years has
shown that specific ratios are more useful at fraud detection than others. The ratios
of total debt-to-total assets (TD/TA), total liabilities-to-total assets (TL/TA), total
debt-to-equity (TD/E), current assets-to-current liabilities (CA/CL), and working
capital-to-total assets (WC/TA) have proven to be most effective in establishing
relationship among financial data. Managers have more incentives to commit FSF
when liquidity is low, and that the above-mentioned ratios aid in determining
liquidity of a business. Financial ratios are typically classified into profitability,
solvency, and operating ratios that enable forensic accountants to detect financial
anomalies and items that are out of norm.
Scanning is an eye-open approach looking for unusual items and is considered as
analytical procedure that relies on the professional judgment, which has been
developed through education and work experience, to identify suspect items during
an audit or a forensic investigation. These can include overstated or understated
accounts, new accounts, and balances that are high or too low in comparison with
the industry average. A combination of financial ratio analyses, scanning, and
time-series analyses can enable forensic accountants to identify unusual items and
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anomalies. For example, if a company has historically grown 5 percent annually,
managers could be under pressure to misstate financial statements if the internally
expected growth is less than 5 percent. Additionally, analyst projections can
exacerbate the pressure felt by management, as often when the consensus of analyst
projections is not met, the company is punished by the market with a fall in stock
price. A comparison of financial data with nonfinancial KPIs such as budgets can
assist forensic accountants to establish benchmark for assessing management
expectations and incentives.
Financial reporting analysis techniques can help detect FSF. The first is vertical
analysis for analyzing the relationships between the items on an income statement,
balance sheet, or statement of cash flows by expressing components as percentages.
This method is often referred to as “common size” financial statement analyses. In
the vertical analysis of an income statement, net sales are assigned 100 percent; for
a balance sheet, total assets are assigned 100 percent. All other items in the
financial statements are expressed as a percentage of these numbers. It is the
expression of the relationship or percentage of component part items to a specific
base item. Vertical analysis emphasizes the relationship of statement items within
each accounting period. These relationships can be used with historical average to
determine statement anomalies.
The second type is horizontal analysis, also known as “trend analysis,” to determine
changes (increase/decrease) in a series of financial data over a period of time
expressed as either an amount or a percentage commonly over several years. The
third type is ratio analysis, which is the study of relationship among financial items.
Traditionally, financial statement ratios are used in comparison to an entity’s
industry average or other norms in identifying red flags of FSF.
Benford’s Law
Benford’s law, founded by Simon Newcomb, uses the occurrence of digits to show a
trend. The law compares the actual frequency of the digits in a data set, using a
digit-by-digit approach. This output is compared with the expected occurrence to
find holes in data. The deviations in the frequency are then investigated. For
example, a forensic accountant may use Benford’s law to spot fraud in an assigned
case. The forensic accountant uses the standard Benford curve to identify an area
for further investigation.
A Benford curve resembles an exponentially decreasing function, as it increases
toward the y-axis and decreases as it moves away. Benford’s law states that the
number 1 will be the leading digit in a set of numbers approximately 30 percent of
the time and the following numbers have a proportionally less chance of appearing
as a leading number, relating to their respective order. A comparison between
actual results and expected results can be analyzed simply by comparing graphs of
the two. If the actual results do not approximately line up with the Benford curve,
further investigation is needed. If a forensic accountant examines a large data set
and finds that the number 1 is the leading digit only 8 percent of the time, it could
be an indication that the data set is not genuine and fraud could be present.
Artificial Neural Networks
Artificial neural networks (ANNs) are computer scientists’ attempts in mimicking
the thought process of a human brain in technology, which has proven success in
detecting and preventing credit card fraud. The revolutionary feature of ANNs is
their ability to model linear and nonlinear relationships, learn these relationships
directly from the data being used, and apply them to future situations.
Consequently, ANNs can be used as a tool in fraud detection, such as creating
expectations for account balances that can be compared with actual balances.
Previously used fraud detection systems would determine fraudulent events on the
basis of a predetermined and static pattern; however, ANNs can gauge a
transaction’s variance from the pattern to determine a more accurate determination
if the transaction is fraudulent.
Forensic Data Analytics
Data analytics is the process of identifying, mapping, cleaning, examining,
analyzing, and converting a set of raw data into formatted and useful information
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4.
5.
for decision making. This process is often conducted using specialized systems and
software. Business organizations have increasingly used data analytics processes,
techniques, and technologies as a decision aid to make more-informed business
decisions. In recent years, Big Data analytics are employed to study and investigate
large amounts of data to discover patterns, correlations, and other insights in the
database as descriptive, predictive, or prescriptive modeling and analyses. Forensic
data analytics help organizations by preemptively preventing fraud, improving
internal controls, improving the regulatory and compliance environment, and
controlling the degree of fraud reactively. Forensic data analytics provide forensic
accountants with the predictive tools to deter FSF and establish fraud-protection
solutions rather than attempting to manage damage after it has occurred. The
concept of Big Data and data analytics has been around for many years to capture
and transform huge data into a set of manageable and useful information for
decision making. Forensic accountants can use Big Data and data analytics to:
Discover patterns among data.
Connect the dots in discovering fraud.
Store large amounts of data.
Analyze new sources of data.
Effectively and efficiently, discover fraud.
The application of Big Data and data analytics to forensic accounting is currently at
an early stage of initiation and development and forensic accountants have taken a
scattershot approach in addressing capabilities of Big Data in identifying patterns
in financial and nonfinancial information in annual and quarterly financial reports,
management discussion and analysis (MD&A), and management earnings forecast.
Forensic analytics is powerful enough to be used singularly, or alongside the
practices of investigations, audits, and process review, and with such a large
amount of data flowing in, forensic data analysis can be used to transform raw data
into intelligible information. It is expected that Big Data will grow bigger, and
thus, forensic accountants should proactively search for patterns, including
irregularities in Big Data, and assess and manage their risk profile in detecting
fraud.
Forensic accountants can use Big Data, which has the capability to store huge
amounts of data, and data analytics, the algorithms through which data are
transformed to information, as valuable evidence. The use of both Big Data and
data analytics is changing the way forensic accountants gather and assess evidence
in their investigation and in discovering fraud. This affects planning, evidence
gathering, and reporting phases of a forensic investigation. During the planning
phase, forensic accountants should make sure to adopt some of the new tools that
enable them to take full advantage of Big Data and data analytics. Forensic
accountants should change their way of making decisions to take advantage of
analytics. Building a foundation of Big Data and data analytics into the
investigation process is now possible because of the new tools available. Forensic
accountants have a wider set of options to use computerized-assisted investigation
tools and techniques to perform descriptive and predictive analytics on Big Data in
detecting fraud and providing early signals of fraud. The scale and complexity of Big
Data, however, requires advanced levels of analytical skills by forensic accountants
for data mining, deriving algorithms, and predictive analytics.
In summary, analytical procedures with the use of ratio analysis is the most
conventional approach used in detecting fraud, despite its subjectivity in selecting
the ratios that are likely to indicate fraud. Data mining is another technique that
can discover the implicit, previously unknown and actionable knowledge and
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include techniques such as logistic regression, neural networks, decision trees, and
text mining. Time-series and regression analyses can be used to identify critical risk
factors, financial and nonfinancial, and develops a regression model combining
these factors to predict fraud. Expert systems, by incorporating judgment of
auditors during the fraud risk assessment process, perform better than checklists or
regression models.
Conclusion
In performing forensic accounting services of fraud investigation, expert
witnessing, and litigation consulting, forensic accountants investigate allegations of
wrongdoing such as FSF, employee fraud, kickbacks, bribery, conspiracy, inside
trading, valuation disputes, and money laundering, among other forensic
accounting services. It is important for forensic accountants to understand the role
of evidence, methods of gathering sufficient and competence evidence, evaluate
evidence, reach conclusions, communicate findings, write a report, make
recommendations, and testify before courts. This chapter discusses fundamentals of
forensic accounting, including types of evidence (i.e., direct and circumstantial),
evidence-gathering procedures, evidence assessment, risk assessment, internal
control evaluation, reach conclusions, express opinions, make recommendations,
and testimony by the court.
Action Items
Rules of evidence determine whether
evidence is permissible into various types
of judicial and administrative proceedings.
Evidence is all things, matters, and issues
relevant to the matter under investigation.
Evidence can be direct or circumstantial,
physical, documentary, and verbal.
Evidence-gathering procedures are all
methods of gathering sufficient and
competent evidence.
Evidence should be used in forming an
opinion and reaching conclusions.
Recommendations should be made on the
basis of evidence gathered and opinion
expressed.
Endnotes
Ernst and Young (EY). 2016. Global Forensic Data Analytics Survey 2016. Shifting into
Higher Gear: Mitigating Risks and Demonstrating Returns.
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18.
http://www.ey.com/gl/en/services/assurance/fraud-investigation---dispute-services/eyshifting-
into-high-gear-mitigating-risks-and-demonstrating-returns
(http://www.ey.com/gl/en/services/assurance/fraud-investigation---dispute-services/ey-shifting-into-high-gearmitigating-
risks-and-demonstrating-returns), (accessed January 4, 2017).
American Institute of Certified Public Accountants (AICPA). 2018. Exposure Draft:
Statement on Standards for Forensic Services No. 1 (SSFS 1). Available at
https://www.aicpa.org/interestareas/forensicandvaluation/resources/standards/exposuredraft-
statement-on-standards-for-forensic-services.html
ACFE. 2018. Planning and Conducting a Fraud Examination.
http://www.acfe.com/uploadedFiles/Shared_Content/Products/Books_and_Manuals/2018
%20US%20FEM%20Sample%20Chapter.pdf
(http://www.acfe.com/uploadedFiles/Shared_Content/Products/Books_and_Manuals/2018%20US%20FEM%20Sample
%20Chapter.pdf), (accessed December 10, 2017).
D. Cressey. 1953. Other People’s Money: A Study in the Social Psychology of Embezzlement
(Glencoe, IL: Free Press).
American Institute of Certified Public Accountants (AICPA). 1997. Consideration of Fraud
in a Financial Statement Audit. SAS No. 82 (New York, NY: AICPA).
AICPA. 2002. Statement on Auditing Standards (SAS No. 99): Consideration of Fraud in a
Financial Statement Audit (November) (New York, NY: AICPA).
D.T. Wolfe, and D.R Hermanson. 2004. “The Fraud Diamond: Considering the Four
Elements of Fraud”, The CPA Journal 74, no. 12, pp. 38–42.
M. Hossain, S. Mitra, and Z. Rezaee. October, 2016. “Can Capital Punishment Deter
Financial Reporting Fraud,” Advances in Financial Planning and Forecasting (AFPF), pp.
15–25.
Z. Rezaee, and B. Kedia. 2012. “The Role of Corporate Governance Participants in
Preventing and Detecting Financial Statement Fraud,” Journal of Forensic and Investigative
Accounting 4, no. 2, pp. 176–205.
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 1999.
Fraudulent Financial Reporting: 1987–1997, an Analysis of U.S. Public Companies (New
York, NY: AICPA).
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 2010.
“Fraudulent Financial Reporting: 1998–2007: An Analysis of U.S. Public Companies.”
www.coso.org (http://www.coso.org)
Wells, J.T. 2001. “Follow Fraud to the Likely Perp,” Journal of Accountancy 191, no. 3, pp.
91–94.
https://www.journalofaccountancy.com/issues/2001/mar/followfraudtothelikelyperp.html,
(accessed September 11, 2018).
J. Ahmad, D. Jansen, and J.J. Frank. May, 2003. “Common Financial Statement Fraud
Schemes,” Yale
University.http://faculty.som.yale.edu/shyamsunder/FinancialFraud/Frank-Common
%20Financial%20Fraud%20Schemes%207May%2003v1.doc
(http://faculty.som.yale.edu/shyamsunder/FinancialFraud/Frank-Common%20Financial%20Fraud%20Schemes%207May
%2003v1.doc)
ACFE. 2018. Report to the Nations. https://www.acfe.com/rttn2016/costs.aspx
J.T. Wells. 2001. “Timing Is of the Essence,” Journal of Accountancy.
https://www.journalofaccountancy.com/issues/2001/may/timingisoftheessence.html,
(accessed September 12, 2018).
ACFE. 2018. Common Financial Statement Frauds. https://brisbaneacfe.org/library/thirdparty-
fraud/common-financial-statement-frauds/
Deloitte. 2009. Sample Listing of Fraud Schema.
https://www2.deloitte.com/content/dam/Deloitte/in/Documents/risk/Corporate
%20Governance/Audit%20Committee/in-gc-fraud-schemes-questions-to-considernoexp.
pdf, (accessed September 13, 2018).
ACFE. 2016. Financial Transactions and Fraud Schemes.
http://www.acfe.com/uploadedFiles/ACFE_Website/Content/review/examreview/12-
accoutning-concepts.pdf (http://www.acfe.com/uploadedFiles/ACFE_Website/Content/review/examreview/12-
accoutning-concepts.pdf), (accessed September 13, 2018).
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
J. Ronen, and V. Yaari. 2008. Earnings Management: Emerging Insights in Theory,
Practice, and Research. https://link.springer.com/content/pdf/10.1007%2F978-0-387-
25771-6.pdf
PACOB. 2015. AS 2401: Consideration of Fraud in a Financial Statement Audit.
https://pcaobus.org/Standards/Auditing/Pages/AS2401.aspx
AICPA. 2012. AU-C Section 240.
https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-
00240.pdf
ACFE. 2011. Introduction to Fraud Examination.
https://www.acfe.com/uploadedFiles/Shared_Content/Products/Self-Study_CPE/intro-tofraud-
exam-2011-extract.pdf
ACFE. 2016. Report to the Nations on Occupational Fraud and Abuse.
http://www.acfe.com/rttn2016.aspx (http://www.acfe.com/rttn2016.aspx), (accessed March 14,
2018).
Ibid.
Ibid.
Ibid.
ACFE. 2016. Report to the Nations. https://www.acfe.com/rttn2016/docs/2016-report-tothe-
nations.pdf, (accessed October 21, 2017).
ACFE. 2017. ACFE Code of Professional Ethics.
http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Code-Of-
Ethics.pdf (http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Code-Of-Ethics.pdf),
(accessed October 21, 2017).
Cornell. Legal Information Institute. https://www.law.cornell.edu/
Ibid.
ACFE. 2016.
ACCA. 2018. Forensic Auditing. http://www.accaglobal.com/us/en/student/exam-supportresources/
professional-exams-study-resources/p7/technical-articles/forensicaccounting.
html (http://www.accaglobal.com/us/en/student/exam-support-resources/professional-exams-studyresources/
p7/technical-articles/forensic-accounting.html)
Tennessee Society of CPAs (TSCPA). June, 2015. Conducting Effective Fraud
Brainstorming Sessions. https://www.tscpa.org/docs/default-source/default-documentlibrary/
cpe_fraudbrainstorm_mayjune2015.pdf?sfvrsn=2
Ibid.
Ibid.
AICPA. 2002.
T.P. DiNapoli. n.d. Red Flags for Fraud.
https://www.osc.state.ny.us/localgov/pubs/red_flags_fraud.pdf
SAS. 2017. How It Works. https://www.sas.com/en_us/insights/analytics/predictiveanalytics.
html
L.M. Smith. 1994. “Accounting Expert Systems,” The CPA Journal Online.
http://archives.cpajournal.com/old/16458936.htm (http://archives.cpajournal.com/old/16458936.htm),
(accessed September 17, 2018).
AICIPA. 2017. AU-C Section 520: Analytical Procedures.
https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-
00520.pdf
R. Kanapickiene, and Z. Grundiene. 2015. The Model of Fraud Detection in Financial
Statements by Means of Financial Ratios. https://ac.els-cdn.com/S1877042815059005/1-
s2.0-S1877042815059005-main.pdf?_tid=8312b854-0b54-11e8-a8c5-
00000aab0f26&acdnat=1517932004_f34c411fb7391be5aef7c5d940699e39
J.C. Collins. April 1, 2017. “Using Excel and Benford’s Law to Detect Fraud,” Journal of
Accountancy. https://www.journalofaccountancy.com/issues/2017/apr/excel-and-benfordslaw-
to-detect-fraud.html
43.
44.
45.
46.
47.
Ibid.
R. Patidar, and L. Sharma. September 18, 2018. “Credit Card Fraud Detection Using Neural
Network,” International Journal of Soft Computing and Engineering.
https://pdfs.semanticscholar.org/0419/c275f05841d87ab9a4c9767a4f997b61a50e.pdf
Ernst Young. 2013. Forensic Data Analytics.
https://www.ey.com/Publication/vwLUAssets/EY_-_Forensic_Data_Analysis/
$FILE/Forensics-Data-Analytics.pdf
Ibid.
C.E. Hogan, Z. Rezaee, R.A. Riley, and U.K. Velury. 2008. “Financial Statement Fraud:
Insights from the Academic Literature,” AUDITING: A Journal of Practice and Theory 27,
pp. 231–52.
CHAPTER 2
Forensic Accounting Techniques
Executive Summary
Forensic accountants use accounting and auditing techniques as well as the legal
rule of evidence during their investigation and the preparation of reports. Forensic
accountants should assess the risk of unfavorable events that can lead to the
occurrences fraud. Forensic accountants also evaluate the internal controls to
ensure they are adequate and effective in responding to the related risks. This
chapter presents the role of forensic accountants in risk assessment, internal
control evaluation, and implementation of investigative techniques in gathering
sufficient and competent evidence to support their opinions.
Introduction
Organizations of all sizes, types, and complexities are experiencing many risks that
should be assessed and managed through effective risk management systems.
Forensic accountants can be hired to assist management in the organization’s risk
management system and internal controls. Internal controls are a set of control
activities designed to prevent, detect, and correct errors, irregularities, and fraud
that may enter the business processes. Forensic accountants can also be hired to
assist management with internal control design, implementation, and assessment.
Forensic accountants can use their technical skills with their skeptical attributes in
employing a risk-based approach in performing assessment of controls over their
company’s operational effectiveness, reliability of financial reports, and compliance
with applicable laws, rules, and regulations. This chapter presents the role of
forensic accountants in risk assessment, control evaluation, and investigation
techniques in performing fraud and nonfraud forensic accounting services and in
the preparation of their reports.
Risk Management
Business organizations are facing many risks from operational to financial,
compliance, reputational, and cybersecurity. These risks, their effective assessment
and management, and related internal controls affect the operational effectiveness,
reliability and credibility of financial statements and compliance with applicable
laws, rules, regulations and standards. Management is primarily responsible for
risk assessment and management that affect business operations, compliance and
the integrity and reliability of financial statements. Forensic accountants can
provide assurance to the audit committee and management on the managerial
process designed to manage the risks and minimize their impacts on operations,
financial reporting, and performance achievements. The primary role of forensic
accountants is to provide assurance on the processes designed to manage risk,
implement effective internal controls, and produce reliable financial statements.
Forensic accountants focus more on effective risk assessments and use a risk-based
approach in their investigation coverage by: (1) identifying and assessing risk: (2)
adopting a process approach to risk assessment and planning; (3) leveraging prior
assessment results; (4) aligning risk assessments with management risk appetite;
(5) coordinating with other risk management groups including internal and
external auditors; (6) assessing the entire risk management profile of their
organization, including risks related to financial reporting, operations, strategy, and
information technology; (7) prioritizing risk management categories in terms of
their threads to their organizations’ sustainable performance; (8) working with
senior management and the audit committee in the assessment process to address
risks and minimize their effects; (9) establishing a risk-based internal audit plan on
the basis of an enterprise-wide risk management assessment; and (10) formulating
opinions and communicating findings to the audit committee, management, and
other applicable stakeholders.
•
•
•
Forensic accountants can also conduct fraud risk assessment and management.
Fraud risk management includes proper corporate governance measures (tone at
the top), policies and procedures for risk identification, assessment, fraud
prevention, fraud detection, and fraud investigation. Fraud risk management
consists of identification and assessment of inherent risk, control risk, and
detection risk in the context of the fraud triangle of incentives/pressures,
opportunities, and rationalization.
Forensic accountants can use the audit risk (AR) model developed by external
auditors. The goal of an auditor is to conduct the audit of financial statements in a
manner that results in minimal AR. As such, Public Company Accounting Oversight
Board (PCAOB) Auditing Standard (AS) No. 8, Audit Risk, focuses on an auditor’s
consideration of AR when auditing financial statements.
The PCAOB AS No. 8 highlights:
Audit risk (the risk that the auditor
expresses and inappropriate audit opinion
when financial statements are materially
misstated)
Risk of material misstatement (the risk
that financial statements are materially
misstated)
Detection risk (the risk that procedures
performed by the auditor will not detect an
existing misstatement that may be material
singularly or in combination)
The AR model often used by external auditors is an appropriate approach that
forensic accountants can utilize in gathering evidence about fraud risk. The AR
model is not intended to be a mathematical mode as certain minimum standard
should apply in all situations pertaining forensic accounting services. The
specification of risk model is different for forensic accountants as they investigate
fraud. Forensic accountants can use the AR model to justify the means of gathering
evidence sufficient, competent, and credible evidence. In the auditing literature and
authoritative statements, the AR model is specified in four components as follows :
AR = IR × CR × DR.
Audit risk (AR) is the risk that the auditor issues an inappropriate audit opinion or
fails to modify the opinion on materially misstated financial statements, for
example, issuing an unqualified opinion on such statements. For forensic
accountants this can be defined as an “investigative risk” of making wrong
investigative decision. The ultimate goal is to assess, manage and minimize this AR
for external auditors or investigative risk for forensic accountants.
Inherent risk (IR) is the risk of the susceptibility of an assertion to material
misstatements in the absence of proper internal controls. It is the risk that material
misstatements enter the financial reporting process because of ineffective corporate
governance, lack of management integrity, or relative risk relevant to individual
accounts. Management is primarily responsible for managing and controlling the
IR; however, the auditor’s responsibility is to assess this risk and its impact on the
1
2
audit plan. Given that forensic accountants are skeptical and searching for incidents
of fraud, the IR is always high and, in many cases, closer to 100 percent. For
forensic accountants this IR is the risk that errors, irregularities, noncompliance
and fraud have occurred.
Control risk (CR) is the risk that internal controls fail to prevent, detect, and correct
material misstatements caused by error, irregularities, noncompliance and fraud.
Management is responsible for establishing and maintaining an adequate and
effective internal control structure to prevent errors, irregularities, noncompliance
and fraud on a timely basis. The auditor’s responsibility is to assess the CR and
determine its impact on audit planning of internal control over both financial
reporting and financial statements. Forensic accountants also assess internal CR
with a keen focus on that fraud and nonfraud incidents could occur and were
undetected by the internal control system.
Detection risk (DR) is the risk that audit procedures fail to discover material
misstatements, given that they have entered the financial reporting process and
they went undetected by the internal control structure. The auditor is primarily
responsible to manage and control the DR by designing and implementing an
effective audit strategy. DR can be classified into analytical procedures risk, which
is the risk that analytical procedures fail to detect material misstatements, and
substantive tests of details risk, which is the risk that substantive tests fail to detect
material misstatements that are not detected by internal controls and analytical
procedures. For forensic accountants, this DR is very important as they often
defend they work and decisions under the court system. Forensic accountants are
responsible to assess, manage and minimize DR to the level of acceptance in the
court of law.
Forensic accountants should modify the above AR model by integrating the three
elements of the fraud triangle, namely pressures/incentives, opportunities, and
rationalization into all three components of IR, CR, and DR. Forensic accountants
should combine all three risk components with three elements of the fraud triangle.
For example, forensic accountants in assessing the IR should consider fraudsters’
incentives, opportunity, and rationalization. This integrated risk model for forensic
accountants focuses on conventional risk elements and fraud components and
should be an effective approach in assessing fraud risk. Exhibit 2.1 shows
integration of fraud triangle with the risk model.
Exhibit 2.1
Fraud Risk Assessment: Integration of Risk and Fraud Components
1.
2.
The Committee of Sponsoring Organizations of the Treadway Commission (COSO)
released its “Fraud Risk Management Guide” in September 2016, which suggests a
comprehensive monitoring and assessment approach in managing fraud risk
including FSF by all corporate gatekeepers from the board of directors to
management, internal auditors, external auditors, and others such as forensic
accountants. The guide details processes in programs that aid organizations in
detecting and managing fraud risk and reduce fraud incidents.
Forensic accountants should assist their client organization to implement fraud risk
assessment and management consisting of the following fraud risk management
components:
Develop an effective fraud governance
process
The development of effective fraud
governance process is the first and most
important step in engaging all corporate
gatekeepers from the board of directors to
executive and auditors. The effectiveness of
corporate governance structure determines
the robustness of risk assessment and
management. A strong corporate
governance system often includes an
appropriate tone at the top and strong
ethical leadership, systems of internal
control, and a culture that promotes the
ethical and moral over profits. These will
be discussed in the next three steps.
Establish effective and efficient antifraud
culture
3
3.
4.
The establishment of effective and efficient
antifraud policies and procedures is
essential in ensuring fraud deterrence,
detection, prevention, and correction.
Boundaries must be set on what fraud is
acceptable. For instance, the report notes
that many companies have an issue
distinguishing between high-level and lowlevel
fraud, and therefore, punish them the
same. After developing such a framework,
the employees of the organization will be
able to combat fraud effectively.
Develop, implement, and maintain
effective preventive, detective, and
corrective fraud control activities. Fraud
control activities must be developed in
response to the assessed fraud risk. Proper
control activities should be designed,
effectively implemented, and compliance
be demanded.
Implement accountability for alleged
perpetrators by taking swift action in
response to allegations of fraud and fraud
perpetrators. Properly responding to fraud
is equally important to detecting it. To
conduct a well-rounded forensic
investigation, a balanced team is required.
This team is required to follow due care to
preserve all evidence while using it to
achieve the appropriate result. The types of
evidence are discussed earlier in this
chapter.
4
5
Exhibit 2.2 summarizes the five fraud risk management principles suggested in the
2016 COSO report in two columns of fraud risk management components and
principles. The last column presents the relevance and implication of fraud risk
management components and principles for forensic accountants.
Exhibit 2.2
Fraud Risk Management Components and Principles
1.
2.
3.
4.
5.
1.
2.
3.
4.
1.
2.
3.
1.
2.
3.
Components Principles
Relevance to Forensic
Accounting
Integrity and ethics
Board independence
Management oversight
Employees align with
culture
Employees are
responsible for actions
Control environment High integrity and ethical
standards are good
practices when investigation
fraudulent behavior.
Identify objectives
Risk assessment of
objectives
Potential for fraud
Assess impact to
internal control system
Risk assessment Forensic accountants
investigate many fraud
schemes including asset
misappropriation, fictitious
revenues, and insider
trading.
Align control with
objectives
Technology to achieve
objectives
Establish policies
regarding internal control
Control activities Corporate governance
systems and principles.
Select correct data to
support internal control
Communicate
information regarding
internal control
procedures
Information and
communication
Forensic accountants must
often consult with internal
control and accounting
professional before and
during litigation to gather
sufficient evidence for trial
proceedings.
Internal Controls
Internal control is a process that provides a reasonable assurance that errors,
irregularities, and fraud are prevented, detected, and corrected. Section 404 of SOX
and PCAOB AS No. 2 and No. 5 encourage accountants and auditors to focus on
compliance-driven controls in assisting management in the preparation of reports
on internal control over financial reporting (ICFR). Section 302 of SOX requires
quarterly management certifications of both financial statements and financial
reporting controls, whereas Section 404 requires annual management assessment
of the effectiveness of the design, implementation, and operation of ICFR. Although
management’s responsibilities for compliance with both Sections 302 and 404
cannot be delegated or abdicated, forensic accountants can considerably assist
management in fulfilling their compliance responsibilities.
Many companies, to comply with the requirements of Section 404 and AS No. 2 on
management reporting on internal controls, turned to their forensic accountants for
documentation of the effectiveness of both design and operation of their ICFR.
Management is primarily responsible for the design, implementation, and
maintenance of ICFR, and forensic accountants provide assurance and opine on
internal control. Forensic accountants in assisting management with internal
control assessment should maintain their objectivity and independence according
to their charter and properly communicate with the audit committee. The extent of
forensic accountant’s involvement with Sections 302 and 404 depends on the
company’s accounting function, resources, funding, personnel qualifications, and
considerations.
Forensic accountants are well positioned to make recommendations to
management regarding the design, implementation, and maintenance of effective
internal controls and expressing an opinion on internal control by: (1) developing
and maintaining an internal control system that is adequate and effective in
managing risks; (2) improving the efficiency and effectiveness of risk management
processes and controls; (3) reviewing entity-level controls relevant to the company’s
integrity and ethical values, management’s philosophy and operating style,
organizational structure, human resources policies and procedures, competence
and integrity of personnel, and assignment of authority and responsibility; (4)
challenging management’s decisions pertaining to internal control where
appropriate; and (5) facilitating improvements in the internal control structure.
Investigative Techniques
Forensic accounting is viewed as a practice of providing fraud and nonfraud
services in the areas of accounting, business, finance, management, marketing,
criminology, and law by using digital forensics, technology, science, and
investigation techniques. The following sections present some of the investigative
techniques that are being used by forensic accountants.
Deposition and Testimony
1.
2.
Communication with
external entities about
internal controls (e.g.,
external auditors)
Evaluation of internal
control
Communicate findings
pertaining to deficiencies
to appropriate staff
Monitoring activities Forensic accountants are
often required to discuss
findings with upper
management and all
individuals involved in the
current litigation
proceedings.
6
Forensic accountants can be hired as an expert witness and/or consultants in
litigation cases. Both consultants and testifying experts provide clarifying expert
opinions; however, some key differences between the two exist. Consultants can be
retained for their expertise and guidance in areas applicable to the case, assuming
the client is able to fund the retainer fees of the consultants. Because of the nature
of consultants, they are not eligible to be deposed, and thus have a high degree of
confidentiality with clients. Unlike consultants, testifying experts cannot be
retained and could possibly be subpoenaed for deposition. Testifying experts can
provide similar services as consultants; however, their confidentiality is not as
adamant as consultants because they can be legally required to provide information
to the opposing counsel. Testifying experts, however, can deliver their expert
testimony directly to the jury and judge, which could be advantageous in certain
scenarios.
Testifying experts typically provide their opinion surrounding the facts of a case in
two forms, testimony and deposition. Testimony is delivered via a witness in court,
in front of the judge and jury, while a deposition is provided out of court, and is
typically inadmissible into court unless the party admits to an act against selfinterest,
subsequent testimony contradicts the deposition, or the witness is
unavailable during the trial. Both testimony and deposition are communicated as a
declaration of fact or solemn statement. When in the process of being deposed or
providing testimony, it is important to be in contact with the attorney to ensure all
the necessary information is understood and documentation is possessed. It is
imperative to know the full extent of facts established during a deposition, as
contradicting it can destroy the individual’s credibility. Often, an attorney will not
ask a witness a question in which they already do not know the answer to,
emphasizing the importance of in-court testimony consistent with deposition.
Federal Rules of Evidence
The Federal Rules of Evidence were developed in 1975 and pertain solely to U.S.
federal courts. In December 2016, the U.S. court system released an updated set of
rules and was presented by the House of Representatives. The University of
Cornell maintains an up-to-date website regarding these rules. The Federal Rules of
Evidence has a total of 11 articles. Articles are sections of rules that are broken
down categorically. For example, article IV covers relevance and article VI discuss
witnesses.
In relation to forensic accounting, articles III, VI, and VII are of importance.
Because of the nature of forensic practice, most cases accountants are involved are
civil trials. Under article III, presumptions must be made. These presumptions
include the defendant defending against the accusation and the plaintiff keeping the
burden of proof. Article VI relates to witnesses. Within this article, rule 608 and
rule 610 are most important to the forensic accounting profession. Similar to audit
and financial accounting, forensic practitioners must be objective and impartial in
the cases presented in court.
The best practices guide for forensic accountants suggest compliance with all
applicable rules, regulations and standards as well as professional codes of
conducts. Within rule 608, the federal government set standards for truthful action.
A witness can be attacked for lack of character. This can damage the forensic
accountant when called upon to present convincing evidence to the jury. Rule 610
revolves around religious beliefs. The rule states that if an individual has certain
ties to religion, the evidence presented by said individual cannot be discriminated
against on that basis. It is also important to consider rule 801 before testifying in
court, because an improper understanding of the two can destroy credibility and
even dismiss the witness entirely, potentially severely damaging the position of the
appointing counsel. Rule 801 defines hearsay as a statement not made while
testifying in court for the express purpose of proving the truth of the matter of fact.
More importantly, it provides that a statement is not hearsay if it inconsistent with
previous testimony under oath. If this occurs, statements previously regarded as
hearsay will be admissible into court.
Aiding and Abetting
Aiding and abetting is known as asking another professional to commit a crime, and
if convicted, results in the individual potentially being punished as a principal
7
8
9
10
11
12
perpetrator. According to the Department of Justice (DOJ), there are four main
components to this theory. First, the person being accused intended to assist in a
crime. Second, the accused underlie the offense. Third, the accused aided in the
offense, and fourth, that the offense was committed. For instance, if an employee
aids a boss in committing fraud in any way, this is considered aiding and abetting.
Each of these four components is discussed in detail.
The first component, involving the accused individual, requires a committed crime
to be determined before the pursuit of a verdict. Second, the accused must have
acted with intent of the standalone crime or offense; in other words, the act must be
punishable in and of itself as a crime. Third, the accused is required to be actively
involved in perpetration of the offense. For example, if accused aided a business in
fraudulent misrepresenting financial performance, this would be an example of
aiding and abetting. Lastly, the offense must have been committed; otherwise a
crime would have not taken place. In the prior example, the fraudulent reporting
would be the crime committed.
To ultimately be convicted of aiding and abetting, the burden of proof is on the jury
to find beyond a reasonable doubt that the individual in question intentionally
aided and abetted the crime throughout all essential stages. Also, it must be proved
beyond a reasonable doubt that the defendant was associated with the criminal
venture and purposely assisted with the criminal activity with the purpose of aiding
the success of the criminal act. To be associated with a criminal venture requires the
defendant to share criminal intent with the principal perpetrator of the act.
Conducting Effective Interviews
Many of the professional standards provide guidance for forensic accountants to
conduct effective interviews. Forensic accountants need answers to questions to
satisfy the requirements of the investigative plan and engagement contract; they
will get those answers from various employees and those outside of the client
organization. Employees who are being interviewed will often be nervous and
intimidated by forensic accountants or they may try to hide relevant and important
information from forensic accountants. In many cases, forensic accountants are
aware of wrongdoing in advance of the interview, or they may discover during the
interview that the employee is trying to hide some important information. When
conducting an interview, forensic accountants should have eye contact with
interviewees and observe their body language and behavior rather than simply
taking notes and checking off a list. Forensic accountants should be a good listener
and observer and digest things that are said and things that are not said. Forensic
accountants should follow up with more questions when there are confusing
answers and when questions are addressed differently.
Forensic accountants’ skills and confidence with the interview process may affect
the interviewees’ willingness to participate in the interview process and provide
candid answers. While, deceptions by interviewees are difficult to identify, skilled
forensic accountants may improve the quality and quantity of the interview process.
Forensic accountants can adjust the interview process on the basis of background
information obtained leading into the interview. In this case, the interview is simply
being conducted for affirmation or clarification of what is already known to forensic
accountants. Interviewees may voluntary reveal new information, which is relevant
to the case under investigation. In this case, forensic accountants should be very
encouraging and receptive of receiving, analyzing, and following up on the
information.
The main purpose of an interview is to gather as much of relevant and reliable
information as possible to either conform the information known to forensic
accountants or learn new information not previously available. The interview
should be conducted in a collegial and congenial manner and not threatening to the
interviewee and should start with welcoming greetings (a handshake), exchange of
business cards, soft and short questions, and then proceed with harder,
controversial and tough questions. The more the interviewees feel being respected
and treated fairly by forensic accountants, the more likely they will be cooperative
and forthcoming with information or answers. Again, forensic accountants should
start with soft and nonthreatening questions, encouraging the interviewees to
participate fully and truthfully in the interview process. The use of checklist is a
good practice to ensure all relevant questions being asked and sufficient
13
14
evidence/information being gathered. However, looking at the checklist constantly
and asking questions from the checklist is not a good practice.
Forensic accountants should be proactive in asking questions and engaging and
active listener, allowing the interviewee to thoroughly answer the questions without
interrupting. Forensic accountants should look at the checklist toward the end by
making sure all relevant questions are being asked. Forensic accountants may want
to end the interview by thanking the interviewee and genuinely asking “are we
missing any things” or “what else we have not discussed” or “do you have anything
else to share.” These open-ended questions are important parts of the interview
process and often add more relevant information. The interview should end with a
handshake, exchange of business cards (either at the beginning, or toward the end),
and encouragement to follow up through e-mails or telephone calls.
Forensic accountants should be skeptical of possibility of deceptive behaviors on
the part of interviewees. Some follow-up questions or asking similar questions in
different ways enable forensic accountants to better understand and identify truth
from deception. Different interrogation techniques can be used to get truthful
statements from wrongdoers who may attempt to hide or lie about the truth to
protect themselves or others.
Interrogation is different from interview in the sense that the main purpose of
interview is obtain as much of relevant and reliable information as possible to
either conform the information known to forensic accountants or learn new
information, whereas interrogation often starts with an accusation or a
confrontation with the employee about the wrongdoing acts or behavior. However,
the interrogation process may result in an emotional denial by both truthful and
untruthful individuals that attempt to defend themselves. The interrogation often
relies on emotional and other pressures intended to convince and make a guilty
person to admit to their wrongdoings. However, less direct and nonconfrontational
interrogation method that enables the interrogator to discuss a variety of things
with the subject before making any accusations can be more effective in discovery
the truth.
The interrogator may present exception reporting, handwriting analysis, video
review, or other relevant evidence in starting the interrogation process to alleged
guilty subject and encourage them to admit to the wrongdoing. It is typical that the
subjects that worry about being caught have a fear of confessing to their
wrongdoing that may result in embarrassment, termination, restitution, or even
prosecution. Thus, interrogators should never offer clemency or make any false
promises to a subject while showing empathy and understanding. The interrogator
should be ready to accept and record the admission of guilt or the denial of
wrongdoing at any point in the interrogation without forming an opinion or judging
the wrongdoing. Best practices of interrogation suggest that the integrator should
acknowledge that admission, showing genuine empathy, and be nonjudgmental.
The interrogator’s goal is to get the subject to admit or deny the wrongdoing and
explain how and why it happened and get the whole confession out at once.
Preparing a Report
Understanding the reporting requirements and professional standards that are
required aids in creating an effective, accurate, and sustainable report. There are
three primary reports issued by fraud examiners—fraud examination proposals,
fraud policy reports, and fraud examination report. The proposal is sent to the party
in need of the examiner’s expertise and includes details such as techniques to be
used, fees, and a disclaimer that existing fraud might not be uncovered. The policy
report identifies and describes differences between established internal controls
and what occurs. The fraud examination report is the most important report of the
three and will be discussed in the following paragraphs.
Typically, after evidence of an occurrence of fraud has been found, the forensic
accountant must analyze the evidence and present it to the appropriate individual
in the form of a report. The rough draft of the report begins after all evidence has
been thoroughly analyzed and observations have been derived from it. The report
should explain the processes used to uncover the alleged fraud, the findings of these
processes, and recommendations to prevent this issue from occurring in the future.
The report itself details everything the forensic accountant does in preparing the
15
16
•
•
•
•
1.
2.
3.
report and its issuance. The report also is required to be presented concisely so that
the average individual can comprehend its contents. This is essential because if the
alleged fraud is found to be true, various parties could read or use the report
(internal users, lawyers, judges, juries, attorneys, witnesses, etc.).
Reports can be reported in writing or orally; however, it is important for the fraud
examiner to keep documentation of the report if possible. The contents of a fraud
report usually include a letter to the appropriate level of management and law
enforcement, an executive summary, and various forms of supporting
documentation (interviews, various company records, statements of individuals
involved or with knowledge of the fraud, etc.), supporting the examiner’s
conclusion. The report itself is typically considered confidential, because it could
lead to criminal and/or civil penalties.
Conclusion
Forensic accountants in performing fraud and nonfraud services often assess risks
and evaluate internal controls designed in response to the risks. Forensic
accountants can also be hired to assist organizations’ in their risk management and
internal control systems. Internal controls are a set of control activities designed to
prevent, detect, and correct errors, irregularities, and fraud that may enter the
business processes. Forensic accountants can be hired to assist management with
internal control design, implementation, and assessment. Forensic accountant can
use their investigative techniques to assess operational effectiveness, reliability of
financial reports, and compliance with applicable laws, rules, and regulations. This
chapter presents risk assessment, control evaluation, and investigation techniques
used by forensic accountants in performing fraud and nonfraud forensic accounting
services and in the preparation of their reports.
Action Items
Assess risks that may cause unfavorable
outcomes.
Evaluate the adequacy and effectiveness of
internal control activities and processes in
achieving the intended objectives.
Use investigative techniques in gathering
sufficient and competent evidence.
Base your opinion on the evidence
gathered.
Endnotes
PCAOB. 2010. AS 1101: Audit Risk.
https://pcaobus.org/Standards/Auditing/Pages/AS1101.aspx
Z. Rezaee, and R. Riley. 2009. Financial Statement Fraud: Prevention and Detection (2nd
ed., Hoboken, NJ: John Wiley & Sons, Inc.).
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 2016. Fraud
Risk Management Guide. https://www.coso.org/documents/COSO-Fraud-Risk-
Management-Final-92816.pdf
17
18
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
Chartered Institute of Management Accountants. 2016. Fraud Risk Management: A Guide
to Good Practice.
http://www.cimaglobal.com/Documents/ImportedDocuments/cid_techguide_fraud_risk_
management_feb09.pdf.pdf
(http://www.cimaglobal.com/Documents/ImportedDocuments/cid_techguide_fraud_risk_management_feb09.pdf.pdf)
Ibid.
Public Company Accounting Oversight Board (PCAOB). 2007. Audit Standards (AS) No. 2:
An Audit of Internal Control over Financial Reporting Performed in Conjunction with an
Audit of Financial Statements. https://pcaobus.org/Rulemaking/Docket008/2004-03-
09_Release_2004-001_Release.pdfndard_2.pdf
M.J. Smith. 2015. Effective Depositions and Courtroom Testimony.
http://rolfeshenry.com/Uploads/files/Effective%20Deposition%20and%20Courtroom
%20Testimony.pdf (http://rolfeshenry.com/Uploads/files/Effective%20Deposition%20and%20Courtroom
%20Testimony.pdf)
Cornell Law School. n.d. Deposition. https://www.law.cornell.edu/wex/deposition,
(accessed October 2, 2018).
Ibid.
Committee on the Judiciary. December 1, 2016. Federal Rules of Evidence.
https://judiciary.house.gov/wp-content/uploads/2013/07/Evidence2016.pdf
Cornell Law School. December 1, 2015. Federal Rules of Evidence.
https://www.law.cornell.edu/rules/fre
Ibid.
United States Department of Justice. n.d. Elements of Aiding and Abetting.
https://www.justice.gov/usam/criminal-resource-manual-2474-elements-aiding-andabetting
C. Doyle, U.S. Congressional Research Service. 2014. Aiding, Abetting, and the Like: An
Overview of 18 U.S.C. 2.. https://fas.org/sgp/crs/misc/R43769.pdf, (accessed October 2,
2018).
Wicklander-Zulawski & Associates. 2015. History. http://www.w-z.com/about-wicklanderzulawski/
history/ (http://www.w-z.com/about-wicklander-zulawski/history/)
ACFE. 2018. Sample Fraud Examination Documents. http://www.acfe.com/acfetwocolumn.
aspx?pageid=6764&terms= (http://www.acfe.com/acfe-twocolumn.aspx?pageid=6764&terms=)
ACFE. 2014. Planning and Conducting a Fraud Examination.
https://www.acfe.com/uploadedFiles/Shared_Content/Products/Books_and_Manuals/201
5%20Sample%20Chapter.pdf
Ibid.

CHAPTER 3
Role of Forensic Accountants in
Corporate Governance and in
Detecting and Preventing Fraud
Executive Summary
Forensic accountants work with various corporate governance participants
including the board of directors, management, auditors, legal counsel, and law
enforcement officials. Corporate governance plays an important role in improving
the reliability, integrity, and quality of financial reports and ensuring that they are
free from material misstatements whether caused by error or fraud. Financial
scandals at the turn of the twenty-first century (e.g., Enron, WorldCom, and Global
Crossing, among others) and the 2007 to 2009 global financial crisis suggest
existence and persistence of financial statement fraud (FSF) and beg the questions
of where corporate gatekeepers were to prevent further occurrences of FSF.
Corporate gatekeepers including the board of directors, executive, internal auditors,
and external auditors and forensic accountants play an important role in
preventing, detecting, and correcting FSF. This chapter describes the roles and
responsibilities of forensic accountants in corporate governance and in preventing,
discovering, and correcting FSF.
Introduction
Forensic accountants work with many corporate governance participants, federal
and state regulators, and law enforcement officials. Financial statement fraud (FSF)
incidents are real, and their threats have significantly increased the uncertainty and
volatility in the markets, which results in adverse effect on investor confidence
worldwide. The FSF incidents prevent investors from receiving meaningful
financial information to make sound investment decisions. Effective corporate
governance plays an important role in addressing these incidents. Corporate
governance has transformed from focusing on the agency theory of ensuring
management works for the best interests of shareholders to a compliance process in
the post-Sarbanes–Oxley (SOX) Act of 2002 intended to combat FSF to a business
strategic imperative in recent years promoting business sustainability, corporate
accountability, and social responsibility. The demand for ever-improving and
effective corporate governance for business organizations is a global trend in recent
years. However, the role of corporate gatekeepers and corporate governance
participants in preventing and detecting FSF has not been sufficiently addressed in
the literature. The 2010 Committee of Sponsoring Organizations (COSO) report
emphasizes the importance of the corporate governance research and its relation to
FSF. This chapter presents the role of forensic accountants in corporate
governance and in preventing, detecting, and correcting FSF.
Financial Statement Fraud
FSF has become daily press reports challenging the corporate governance and
accountability of public companies as well as professional responsibilities and
integrity of these companies’ board of directors, senior executives, and auditors.
FSF is defined in several authoritative standards and reports as a deliberate
misstatement or omission of amounts or disclosures of financial statements to
deceive financial statement users, including investors and creditors. The AICPA, AU
Section 240, Para. 11, defines FSF “as an intentional act by one or more individuals
among management, those charged with governance, employees, or third parties,
involving the use of deception that results in a misstatement in financial statements
that are the subject of an audit.” Alleged high-profile incidents of FSF, committed
by large companies such as Enron, Global Crossing, Waste Management, Sunbeam,
Lucent, MicroStrategy, KnowledgeWare, Raytheon, Cendant, and Rite Aid, to name
1
2 3
4
just a few, have received considerable attention of the investing public, regulators,
and the accounting profession. FSF has cost investors more than $100 billion
during the wave of financial scandals at the turn of the twenty-first century.
FSF has been one of the most dominating news cycles in the past several decades
from Enron and WorldCom in 2001 to Madoff, Stanford Financials, and Satyam
recently. There have been many FSF cases that have undermined the integrity and
reliability of financial reports and have contributed to significant damages to
reputation and economic losses. FSF has eroded investor confidence in the quality,
usefulness, and reliability of financial statements. The collapse of Enron and
WorldCom, among others caused by FSF, resulted in erosion of investor confidence
that encouraged Congress to respond by passing the SOX Act of 2002. The
existence and persistence of FSF continues to contribute to the financial uncertainty
and market volatility, which prevent global investors from receiving meaningful
financial information to make sound investment decisions.
Incidents of FSF have continued to increase even after the passage of the SOX Act
of July 2002, which was intended to combat financial fraud. The 2010 Committee
of Sponsoring Organizations of the Treadway Commission (COSO) report found
347 cases of FSF from 1998 to 2007 compared with 294 fraud incidents from 1987
to 1997 with an increase of 18 percent. The COSO report indicates that key areas
in which fraud occurs and the causes of fraud. Along with this increase in total
cases, the dollar amount of fraud also increased across the spectrum.
Misappropriation was 120 billion in 300 cases (mean of 300 million per fraudulent
event) in the 2010 study compared with the 1987 to 1998 study where the mean was
$25 million. These events occurred when the average revenues were 100 million
and 16 million, respectively.
The COSO report indicates that top management teams (e.g., chief executive officer
[CEO], chief financial officer [CFO], treasurer, controller, and other top executives)
were involved in 89 percent of reported cases from 1998 to 2007 compared with 83
percent in the 1987 to 1997 study. Of the top executives that were sent to trial, 20
percent were sent to jail and 60 percent were found guilty. As a result of these
outcomes, it was discovered that the most common means of fraud were revenue
recognition and overstatement of financial accounts, particularly assets and
capitalizations. These frauds caused a decline in stock prices, loss in public trust,
and often lead companies to file for bankruptcy. When the company is not
effective in generating sustainable performance, the management is under more
pressure to manage earnings. Opportunities to engage in FSF are higher when the
company is not doing well financially and unable to invest in effective corporate
governance and internal controls. Emerging corporate governance reforms,
securities laws, and best practices are intended to identify and minimize potential
conflicts of interest, incentives, and opportunities to engage in FSF.
FSF occurs for a wide variety of reasons, including when motives combine with
opportunity. Corporations’ strategies to meet or exceed analysts’ earnings forecasts
pressure the management to achieve earnings targets. Managers are motivated or,
in most cases, rewarded when their bonuses are tied to reported earnings, which
can lead managers to choose accounting principles that may result in the
misrepresentation of earnings. Companies are more likely to engage in FSF when
quality and quantity of earnings are deteriorating, management has all incentives
and pressures to manipulate earnings, opportunity to engage in FSF exist, and
management can rationalize that the benefits outweigh the associated costs
calculated using the probability and consequences of detection.
Economic incentives are common in FSF, even though other types of incentives
such as psychotic, egocentric, or ideological motives may play a role. Pressure on
management to meet analysts’ earnings forecast may force management to
manipulate earnings. Opportunities to engage in FSF are higher when the company
is not doing well financially and unable to invest in effective corporate governance
and internal controls in designing and maintaining proper antifraud policies and
practices. Emerging corporate governance reforms, securities laws, and best
practices are intended to identify and minimize potential conflicts of interest,
incentives, and opportunities to engage in FSF. Management evaluates the
opportunity for earnings manipulation and the benefit of earnings management in
terms of the positive effect it will have on the company’s stock price against the
possible cost of consequences of engaging in FSF and the probability of detection,
5
6
7
8,9
10
11
•
•
•
•
•
•
•
•
•
•
•
•
prosecution, and sanction.
Some of the prevailing reasons for the occurrences of FSFs are as follows:
Poor internal controls
Management override of internal controls
Collusion between employees and third
parties
Collusion between employees or
management
Lack of control over management
Poor or nonexistent corporate ethics policy
Ineffective corporate governance
Forensic accountants’ responsibilities concerning FSF are as follows:
Consideration of fraud risks and their
implications for fraud investigation
Examination of journal entries and other
material adjustments (manual, postclosing)
Review of accounting estimates for bias—
individually and in aggregate (retrospective
review)
Evaluation of the business rationale for
significant unusual transactions
Evaluation of current and prior year
uncorrected misstatements
•
•
•
•
•
•
•
•
•
•
•
•
•
Search for smaller misstatements over
larger ones
Evaluate employee moral
Interviewing possible perpetrators of FSF
Gather sufficient evidence before making a
case regarding FSF
The use of professional skepticism
including a questioning mind and critical
evaluation of the evidence
Forensic accountants by virtue of their independence, expertise, and knowledge are
expected to discover FSF. However, they are several reasons why forensic
accountants may fail to discover FSF. Among those reasons are:
Over-reliance on client representations
Lack of awareness or failure to recognize
that an observed condition may indicate a
material fraud
Inability to connect dots
Lack of proper attention to red flags
Lack of experience
Personal relationships with clients
Not being skeptical
More specifically, forensic accountants may fail to discover FSF for the following
reasons:
Failure to exercise professional skepticism
in evaluating whether fraud risk factors
•
•
•
exist. Forensic accountants may fail to
evaluate with requisite professional
skepticism whether information obtained
during the investigation reflects risk factors
for fraud.
Failure to gain an understanding of the
client’s industry and business.
Failure to understand the rationale for and
reasons behind unusual transactions.
Forensic accountants may fail to
adequately consider the fraud risks
associated with or ascertain the business
rationale for certain unusual expenses
identified in company documents,
including expenses incurred and earnings
generated. Forensic accountants should
consider the business rationale for
transactions outside of the normal course
of business and assess whether the
rationale suggests that the transaction was
entered to engage in fraudulent financial
reporting or to manage earnings or to
conceal the misappropriation of assets.
Failure to appropriately respond to risk
factors that arise during the course of the
investigation. Forensic accountants may
fail to reassess the risk of material
misstatement that caused FSF, despite
becoming aware of transactions and
related information that warrant
heightened scrutiny, including information
•
•
•
•
regarding earnings management and
information contrary to management
representations.
Failure to pay attention to fraud symptoms
and reassess whether the red flags
necessitated a change in the nature, timing,
or extent of investigative procedures to
obtain additional and/or more reliable
audit evidence.
Failure to conduct a thorough retrospective
review of significant accounting estimates
and fair value determinations. Forensic
accountants may fail to perform or ensure
the performance of the review process and
use the performance review in assessing
FSF risk. The retrospective review provides
the auditor with additional information to
assess whether there is possible bias in the
current year’s estimate.
Forensic accountants should perform a
retrospective review of significant
accounting estimates and fair value
estimates to assess whether there is
evidence of management bias in the
judgments and assumptions of fair value
determinations.
Failure to connect dots. Materiality should
not be an issue for forensic accountants as
any insignificant matter may lead forensic
accountants toward discovery of material
misstatements caused by FSF. The ability
•
•
•
•
•
•
to connect right dots comes with
experience and by creative and critical
thinking of forensic accountants.
Failure to pay attention to illegal acts and
violations of applicable laws, rules, and
regulations. When forensic accountants
become aware of an illegal act in
conjunction with refusal to restate the
financial statements should reassess fraud
risk and possibility of FSF.
Failure to gather sufficient, competent, and
credible evidence, particularly for asset
valuation and ownership.
Failure to address management
assumptions for account balance estimates.
Failure to challenge management
responses to issues raised during the
investigation.
Failure to understand and have proper
interpretation of U.S. generally accepted
accounting principles (GAAP) and
International Financial Reporting
Standards.
Failure to conduct proper and adequate
investigation planning. Forensic
accountant should prepare an investigation
program tailored to the client’s accounting
and internal control systems.
1.
2.
3.
4.
5.
Enron fraud case is presented to highlight an important role that corporate
gatekeepers are playing in preventing and detecting fraud. Enron Corporation was
once (2001) the seventh largest public company in the United States, and in the
next year was the largest company to ever declare bankruptcy in U.S. history. In less
than a year, Enron went from being considered one of the most innovative
companies of the twentieth century to being the most corrupted and fraudulent
company. FSF committed by Enron Corporation is estimated to cause a loss of
about $70 billion in market capitalization to investors, creditors, employees, and
pensioners. Its investors lost billions of dollars, directors paid penalties, executives
were indicted and subsequently convicted, employees lost their job and pension
investment, the auditor (Andersen) was demised, and regulators and standard
setters were blamed for not providing early warning signals of potential business
failure. Enron is one example of vast FSF cases that undermine the integrity of
financial reporting process and the safety, efficiency, and soundness of the financial
markets.
FSF has become daily press reports challenging the corporate responsibility,
accountability, and integrity of major companies as their executives (CEO and CFO)
are being accused of cooking the books. Occurrences of FSF by high-profile
companies have raised concerns about the integrity, transparency, and reliability of
the financial reporting process and have challenged the role of corporate
governance in preventing and detecting FSF. Exhibit 3.1 presents a list of highprofile
cases of FSF that have proved to be detrimental to sustainability of public
companies and caused risks to the efficiency and safety of the financial markets.
Exhibit 3.1 reveals that common themes of reported FSF are as follows:
Lack of transparency and disclosures on
complex financial products, including
subprime loans, structured finance, offbalance
sheet transactions, and credit
derivatives.
Lack of accountability, because the
financial companies were not responsible
through market discipline or by regulators.
Lack of governance and oversight by those
responsible for overseeing corporate
governance, financial reporting, audit
activities, and risk management.
Lack of effective engagement of
“gatekeepers” including the board of
directors, legal counsel, and internal and
external auditors.
6.
7.
8.
9.
10.
Lack of effective analysis by credit rating
agencies.
Conflicts of interest and conflicting
incentives for corporate directors, officers,
and auditors to maximize their interests at
the investors’ expense.
Opportunities to engage in earnings
manipulations and focus on short-term
performance.
Incentive structure driven by fees and a
process linked to short-term performance
rather than sustainable performance.
Lax regulatory environment created by
regulators’ attempt to follow the
“principles-based” regulatory process used
in other countries.
Market discipline cannot and should not be
a substitute for sound, cost-effective, and
efficient regulations.
Exhibit 3.1
Reported Financial Statement Fraud
Company Allegations Reported Date
Adelphia
Communications
Founding Rigas family collected
$3.1 billion in off-balance sheet
loans backed by Adelphia;
overstated results by inflating
capital expenses and hiding
debt.
April 2002
AOL Time Warner As the ad market faltered and
AOL’s purchase of Time Warner
loomed, AOL inflated sales by
booking barter deals and ads it
sold on behalf of others as
July 2002
revenue to keep its growth rate
up and seal the deal. AOL also
boosted sales via “round-trip”
deals with advertisers and
suppliers.
Arthur Andersen Shredding documents related to
audit client Enron after the SEC
launched an inquiry into Enron.
November 2001
Bristol-Myers Squibb Inflated its 2001 revenue by $1.5
billion by “channel stuffing,” or
forcing wholesalers to accept
more inventory than they can
sell to get it off the
manufacturer’s books.
July 2002
CMS Energy Executing “round-trip” trades to
artificially boost energy trading
volume.
May 2002
Duke Energy Engaged in 23 “round-trip”
trades to boost trading volumes
and revenue.
July 2002
Dynegy Executing “round-trip” trades to
artificially boost energy trading
volume and cash flow.
May 2002
El Paso Executing “round-trip” trades to
artificially boost energy trading
volume.
May 2002
Enron Boosted profits and hid debts
totaling over $1 billion by
improperly using off-the-books
partnerships; manipulated the
Texas power market; bribed
foreign governments to win
contracts abroad; manipulated
California energy market.
October 2001
Freddie Mac The firm understated earnings
for 2002. The fine was $125
million.
December 2002
Global Crossing Engaged in network capacity
“swaps” with other carriers to
inflate revenue; shredded
documents related to accounting
practices.
February 2002
Halliburton Improperly booked $100 million
in annual construction cost
overruns before customers
agreed to pay for them.
May 2002
Homestore.com (http://HomeInstfolraet.cinogm )sales by booking barter
transactions as revenue.
January 2002
Kmart Anonymous letters from people
claiming to be Kmart employees
allege that the company’s
accounting practices intended to
January 2002
mislead investors about its
financial health.
Merck Recorded $12.4 billion in
consumer-to-pharmacy copayments
that Merck never
collected.
July 2002
Mirant The company said it may have
overstated various assets and
liabilities.
July 2002
Monsanto Improperly accounted for
rebates that affected financial
statements. Was fined $80
million.
February 2016
Nicor Energy, LLC, a
joint venture between
Nicor and Dynegy
Independent audit uncovered
accounting problems that
boosted revenue and
underestimated expenses.
July 2002
Parmalat Europe’s biggest bankruptcy
(around 14 billion pounds) due
to falsifying accounting
information. The responsible
party, Calisto Tanzi, served 10
years in prison.
September 2003
Penn West Exploration Four years of overstated profits
equating to $5 billion.
July 2014
Peregrine Systems Overstated $100 million in sales
by improperly recognizing
revenue from third-party
resellers.
May 2002
Qwest Communications
International
Inflated revenue using network
capacity “swaps” and improper
accounting for long-term deals.
February 2002
Reliant Energy Engaging in “round-trip” trades
to boost trading volumes and
revenue.
May 2002
Toshiba Overstated profits by 738 million
pounds over a 6-year period.
July 2015
Tyco Ex-CEO L. Dennis Kozlowski
indicted for tax evasion. SEC
investigating whether the
company was aware of his
actions, possible improper use
of company funds and relatedparty
transactions, as well as
improper merger accounting
practices.
May 2002
Source: SEC: Securities and Exchange Commission. CFTC: Commodity Futures Trading
Commission. DOJ: U.S. Department of Justice.
http://www.forbes.com/home/2002/07/25/accountingtracker.html
(http://www.forbes.com/home/2002/07/25/accountingtracker.html)
There are many reasons why FSF may occur. These reasons fall under the three
categories—conditions, corporate structure, and choice (3Cs) —which explain
motivations, opportunities, and rationalizations for the commission of FSF.
Conditions provide motivations and opportunities for perpetrators to engage in
FSF. FSF will occur when the benefits to perpetrate outweigh the associated costs.
Pressures on corporations to meet analysts’ earnings forecasts play an important
role in the commission of FSF. Management evaluates the benefits of overstating
earnings and assets and/or understating liabilities and expenses in terms of a
positive effect on the company’s stock price against the costs and consequences of
committing FSF and the probability of detection, prosecution, and sanction.
Exhibit 3.2 presents several FSF studies and cases that highlight the existence and
persistence of fraud cases. Corporate structure can create an environment that
increases the likelihood of the occurrence of FSF. Given that FSF is typically
committed by the top management team (i.e., more than 80 percent committed by
top executives, CEOs, and CFOs), one would expect incidences to occur most in an
environment characterized by irresponsible and ineffective corporate governance.
The characteristics and attributes of the corporate governance structure, most likely
to be associated with FSF, are aggressiveness, arrogance, cohesiveness, loyalty,
trust, control ineffectiveness, and gamesmanship. Aggressiveness and arrogance
can be signified by the company’s attitude and motivations toward being the world’s
leading company or exceeding analysts’ earnings expectations by cooking the books.
Cohesiveness, gamesmanship, and loyalty attributes create an environment that
increases the likelihood of cooking the books and subsequent cover-up attempts
and decreases the probability of whistle-blowing. Trust and control ineffectiveness
can cause monitoring mechanisms (e.g., oversight functions, audit functions, and
internal control structure) to be less effective in preventing and detecting fraud.
Exhibit 3.2
Summary of Recent Fraud Studies and Cases
WorldCom Overstated cash flow by booking
$3.8 billion in operating
expenses as capital expenses;
gave founder Bernard Ebbers
$400 million in off-the-books
loans.
March 2002
Xerox Falsifying financial results for 5
years, boosting income by $1.5
billion.
June 2000
Valeant Overstated sales by $50 million. March 2016
1.
2.
1.
2.
1.
2.
COSO Report Business Fraud Survey KPMG Survey
Financial pressures were
important contributory
factors for the commitment
of financial statement fraud
(FSF).
Nearly 15% reported
management
misappropriation as the
greatest fraud risk to their
organization.
Medical insurance
claims fraud had the
greatest average cost
per incident followed
by FSF.
12
13
a b c
Sources in the order of presentation in the table, from left to right, are:
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 1999.
“Fraudulent Financial Reporting: 1987-1997, an Analysis of U.S. Public Companies.”
The Institute of Management and Administration (IOMA) and The Institute of Internal
Auditors (IIA). 1999. “Business Fraud Survey.” http://www.theiia.org (http://www.theiia.org)
KPMG. 1999. “1998 Fraud Survey.” http://www.kpmg.com (http://www.kpmg.com)
3.
4.
5.
6.
7.
8.
9.
10.
3.
4.
5.
6.
3.
4.
5.
6.
Top executives (e.g.,
CEOs and CFOs) were
commonly involved in FSF.
The majority of alleged
FSF were committed by
small companies.
Boards of directors and
audit committees of the
fraud companies were
weak and ineffective.
Adverse consequences for
fraud companies were
bankruptcy, significant
changes in ownership, and
delisting by national stock
exchanges.
Cumulative amounts of
FSF were relatively
significant and large.
More than half of the
alleged FSFs involved
overstatement of revenues.
Most FSF were not
isolated to a single fiscal
period.
About 55% of the audit
reports issued in the last
year of the fraud period
contained unqualified
opinions.
Majority of the sample
fraud companies (56%)
were audited by a Big
8/Big5 auditing firm.
About 60% of the
respondents reported their
department’s fraud risk
analysis process as being
reactive in nature.
The majority of
respondents (72%)
reported that their
organizations did not have
fraud detection and
deterrence program in
place.
The majority of the
respondents (68%)
reported that they never
felt pressured to
compromise the adherence
to their organization’s
standards of ethical
conduct.
The majority of the
respondents reported their
organization’s external
auditors as being
ineffective in preventing
and detecting fraud.
The majority of the
respondents believed that
more budget should be
devoted to fraud-related
activities and training in
their internal audit
department.
FSF resulted in an
average loss of $1.24
million per incident.
Poor internal controls
and management
override of controls
were considered as the
two most conditions for
occurrence of fraud.
Various types of
collusion were cited as
important causes of
fraud.
Personal financial
pressures were
considered as
important red flags
signaling the possibility
of fraud occurrence.
Suggested fraud
prevention and
detection strategies
are: effective internal
controls, the tone at
the top, training
courses in fraud
prevention and
detection, a corporate
code of conduct, and
ethics training.
1.
2.
1.
2.
1.
2.
Ernst & Young Survey Wells Fargo Volkswagen
More than 20% of the
respondents were aware
of fraud in their workplace.
Nearly 80% would be
willing to turn in a
colleague thought to be
committing a fraudulent
act.
Employees became
aware of an exploit in the
Wells Fargo system,
allowing them to open
fraudulent accounts.
(Opportunity)
A hostile work
environment was created
by Corporate Leadership
when they aggressively
raised the goals of
The CEO and five other
executives were indicted
in federal court on
charges of wire fraud and
conspiracy.
The CEO himself was
charged with four felony
counts including:
a
b
c
a b c,d
Ernst & Young. 2002. “American Works: Employers Lose 20 Percent of Every Dollar to
Work Place Fraud.” http://www.ey.com/global/content.nsf/us/Media_-_Release_-_-8-05-
02.doc (http://www.ey.com/global/content.nsf/us/Media_-_Release_-_-8-05-02.doc)
Morang, S.C. 2016. “Big Frauds,” Fraud Magazine. http://www.fraudmagazine.
com/article.aspx?id=4294994748 (http://www.fraud-magazine.com/article.aspx?id=4294994748)
Wolff-Mann, E. 2018. “VW Emissions Scandal,” Yahoo Finance.
https://finance.yahoo.com/news/vws-emission-scandal-goes-beyond-corporate-lies-
180304829.html
Shepardson, D. 2018. “Ex-Volkswagen CEO Winterkorn Charged in U.S. Over Diesel
Scandal,” Yahoo Finance. https://finance.yahoo.com/news/ex-volkswagen-ceo-winterkorncharged-
194713779.html
Source: IRS.GOV (http://IRS.GOV). 2018. “Examples of Corporate Fraud Investigations Fiscal
Year 2017.”https://www.irs.gov/compliance/criminal-investigation/examples-of-corporatefraud-
investigations-fiscal-year-2017 (http://www.irs.gov/compliance/criminal-investigation/examples-ofcorporate-
fraud-investigations-fiscal-year-2017)
3.
4.
5.
6.
3.
4.
a.
b.
c.
3.
Employees lose a
staggering 20% of every
dollar earned to some
type of workplace fraud.
Most frequently
committed frauds are
theft of office items,
claiming extra hours
worked, inflating expense
accounts, and taking
kickbacks from suppliers.
Women are more likely
than men to report
fraudulent activities.
Older employees were
more likely to be willing to
report fraudulent activities
than younger employees.
employees and
decreased incentive pay.
(Pressure)
“Either you are moving
up or moving out.”
Employees were afraid
that they would lose their
jobs. (Rationalization)
Internal controls were
weak. The article gives
the example that an
employee in San
Francisco and the other in
Chicago could both use
the same gap in internal
controls to make the fake
accounts.
Conspiracy to defraud
the United States
Wire fraudc.
Violating the Clean Air Act
Employees were said to
present PowerPoint slides
to the CEO and other
management providing an
explanation as to how the
software worked, thus
refuting claims of
ignorance.
M.E. Zukerman & Co.
(MEZCO) Nick’s Roast Beef HBO
a
b
c
d
FSF has been a contributing factor to the 2007 to 2009 global financial crisis,
resulting in a global economic meltdown, and has threatened the efficiency,
liquidity, and safety of both debt and capital markets. These financial crises have
substantially increased volatility and uncertainty in financial markets and have
adversely affected investor confidence and public trust worldwide. Choice provides
management with the flexibility to use its discretion to either choose ethical
business strategies of continuous improvements of both the quality and quantity of
earnings, or to engage in illegitimate earnings management schemes of cooking the
1.
2.
3.
4.
5.
6.
7.
1.
2.
3.
4.
5.
6.
1.
2.
3.
4.
5.
Zukerman intended to
evade income taxes by
neglecting to report the
sale of a petroleum
products company he
owned through a
subsidiary.
The oil company sold for
$130 million and
corporate income taxes
due amounted to $33
million.
Zukerman directed tax
preparers to generate
income tax forms for
himself, his wife, and
other family members that
claimed millions of dollars
in total in fraudulent
deductions and expenses.
Zukerman directed
corporate funds to pay for
domestic employees.
Zukerman fraudulently
claimed charitable
contribution deductions
totaling $1 million for the
years 2009 and 2011 and
then purchased 240 acres
on a small island off the
coast of Maine. This
purchase was allegedly
for conservation purposes
but was instead for the
benefit of himself and his
family.
Zukerman provided false
documentation and
information during three
separate audits to hide
his actions.
Zukerman was
sentenced to 70 months
in prison, 3 years of
supervised release, and
ordered to pay
$37,547,951 in restitution.
Boston, MA: Nicholas
Koudanis skimmed
approximately $6 million
in cash receipts from the
business over 6 years
and neglected to report
this on his business or
personal tax returns.
From 2008 to 2013 coowners
Nicholas
Koudanis and Nicholas
Markos skimmed over $1
million in cash receipts
each year and did not
report the income on their
personal or corporate
returns.
Each week the coowners
divided the cash
receipts, determined how
much to deposit into
business accounts and
report on their tax returns,
how much to pay
suppliers and employees,
and how much to keep for
themselves.
The bookkeeper Eleni
Koudanis (wife) provided
some of the false income
information to their tax
preparer, and their son
Steven Koudanis
generated the false cash
register receipts used
during an IRS tax audit of
the business.
By the end of 2014,
Nicholas and Eleni
Koudanis accumulated
$1.6 million in cash in
their home safe.
Nicholas Koudanis was
sentenced to 24 months
in prison, 2 years of
supervised release, and
ordered to pay restitution
of $2,042,366. His wife
was sentenced to pay the
same and given 1-year
probation. His son was
sentenced to 1-year
house arrest and ordered
to pay $151,240 to the
IRS.
Jennifer Choi was
responsible for
scheduling hairstyling,
wardrobe, and make-up
for HBO actors. She set
up a company called
Shine Glossy, LLP, that
she used to submit
fraudulent invoices to
HBO for the
aforementioned services
allegedly provided to the
actors.
Through the Shine
Glossy company, Choi
submitted approximately
300 fraudulent invoices
that led HBO to pay out
approximately $940,000.
Choi also used a car
service for herself, her
family, and friends to the
tune of $63,000 that she
billed to HBO without
authorization.
Choi didn’t file federal
income tax returns for
2011, 2013, and 2014
despite earning hundreds
of thousands of dollars
those years. She also
greatly under-reported
income when she did file
for 2010, and 2012.
Choi was sentenced 30
months in prison and had
to pay $1,285,742 in
restitution.
1.
2.
3.
4.
books to show earnings stability or earnings growth. Management may be
motivated to engage in FSF when (1) its personal wealth is closely associated with
the company’s performance through profit sharing, stock-based compensation
plans, and other bonuses; (2) management is willing to take personal risks for
corporate benefit (e.g., risk of indictment and civil or criminal penalties); (3)
opportunities for the commission of FSF are present; (4) there is a substantial
internal and external pressures to either create or maximize shareholder value; and
(5) the probability of FSF being detected is perceived by management to be very
low.
FSF may involve the following schemes :
Falsification, alteration, or manipulation of
material financial records, supporting
documents, or business transactions.
Material intentional omissions or
misrepresentations of events, transactions,
accounts, or other significant information
from which financial statements are
prepared.
Deliberate misapplication of accounting
principles, policies, and procedures used to
measure, recognize, report, and disclose
economic events and business
transactions.
Intentional omissions of disclosures or
presentation of inadequate disclosures
regarding accounting principles and
policies and related financial amounts.
The Association of Certified Fraud Examiners (ACFE) estimates that business
organizations lose about 5 percent of their revenues to fraud each year, which can
exceed $3.5 trillion worldwide. This is just the direct economic losses resulted
from FSF. Other fraud costs are legal costs, increased insurance costs, loss of
productivity, adverse impacts on employees’ morale, customers’ goodwill, suppliers’
trust, and negative stock market reactions. An important indirect cost of FSF is the
loss of productivity owing to dismissal of the fraudsters and their replacements.
Although these indirect costs cannot possibly be estimated, these costs are typically
more than the direct money and assets losses and they should be taken into
consideration when assessing the consequences of FSF. Exhibit 3.3 shows a list of
global FSF, their description, consequences and accountability. These FSF cases
underscore the detrimental effects of global fraud and individual perpetrators and
their accountability.
Corporate Governance and Fraud
14
15
Corporate governance has evolved as a central issue within regulators and public
companies in the wake of recent global financial crisis. Companies have recently
undergone a series of corporate governance reforms aimed at improving the
effectiveness of their governance, internal controls, and financial reports. Effective
corporate governance promotes accountability, improves the reliability and quality
of financial information, and prevents financial reporting fraud. Poor corporate
governance adversely affects the company’s potential, performance, financial
reports, and accountability and can pave the way for business failure and financial
reporting fraud. Corporate governance measures of the oversight function assumed
by the board of directors, managerial function delegated to management, internal
audit function conducted by internal auditors, and external audit function
performed by external auditors are vital to the quality of financial information. An
increasing number of alleged FSF and earnings restatements by high-profile
companies has caused lawmakers (e.g., Congress), regulators (e.g., Securities and
Exchange Commission [SEC]), and the accounting profession (e.g., AICPA and
Institute of Internal Auditors [IIA]) to address the role of corporate governance as
well as the integrity and quality of the financial reporting process and audit efficacy.
Exhibit 3.3
Summary of Global Financial Statement Fraud
The Enron debacle, caused by the alleged commission of FSF, has raised concerns
regarding a lack of vigilant oversight function of its board of directors and audit
committee in effectively overseeing Enron’s financial reporting process and audit
functions. Corporate governance is viewed as interactions among participants in
managerial functions (e.g., management and top executives), oversight functions
(e.g., the board of directors and the audit committee), audit functions (e.g., internal
auditors and external auditors), monitoring functions (e.g., lawmakers, regulators,
SEC, and standard setters), and user functions (e.g., investors, creditors, and
employees). Corporate governance framework determines the organization’s
corporate governance culture, structure, mechanisms, and compliance, as well as
the roles and responsibilities of all corporate governance participants. The
framework also determines how organizations fulfill their roles and responsibilities,
as well as being held accountable through corporate reporting and assurance.
Corporate governance has garnered considerable attention in the wake of the 2007
to 2009 global financial crisis and is now emerging as a central issue for regulators
and public companies. Large public companies have recently undergone a series of
regulatory reforms resulting from legislation imposed by the U.S. Congress (e.g.,
SOX Act of 2002 and Dodd-Frank Act of 2010), new regulations from the SEC,
listing standards of national stock exchanges, and best practices of investor
activism. Corporate governance measures are designed to protect shareholders and
other stakeholders’ interests by limiting opportunistic behavior of managers who
control their interests. Corporate governance measures including proper antifraud
policies and practices are intended to protect investors from receiving fraudulent
financial information.
One of the key responsibilities of corporate governance participants is to ensure the
quality, integrity, reliability, and transparency of financial statements and provide a
reasonable assurance that they are free from any misstatements caused by errors or
fraud. Proper antifraud policies and practices improve the effectiveness of
corporate governance and thus reliability of financial statements.
Corporate governance reforms in the past two decades are intended to improve the
effectiveness of corporate governance in preventing, deterring, detecting, and
correcting FSF. Corporate governance is a process affected by legislations, legal,
regulatory, contractual and market-based mechanisms, measures, and reforms, as
well as best practices to create sustainable shareholder value while protecting the
interests of other shareholders. This definition implies that there is a dispersed
ownership structure, and thus the role of corporate governance measures is to
protect shareholders and other stakeholders’ interests by limiting opportunistic
behavior and self-dealing practices of management who controls their interests.
Under the U.S. dispersed ownership system, it is highly possible that management
has incentives and opportunities to engage in short-term earnings management and
quarterly FSF.
Corporate governance is about leadership and accountability for (1) setting a tone at
the top promoting integrity and competency throughout the organization; (2)
improving efficiency and effectiveness of operations to compete in the global
markets; and (3) producing accurate, complete, and transparent financial and
nonfinancial information. Thus, the main responsibilities of corporate governance
participants and corporate gatekeepers are to ensure the quality, integrity,
reliability, and transparency of financial statements in providing a reasonable
assurance that they are free from material misstatements caused by errors or fraud.
Antifraud Policies and Practices
Corporate governance and its participants play an important role in designing,
maintaining and implementing adequate and effective antifraud policies. These
policies are intended to to protect investors from receiving fraudulent financial
information. Thus, effective corporate governance in strengthening antifraud
policies and practices promotes accountability, improves the reliability and quality
of financial information, enhances the integrity and efficiency of the capital market,
and improves investor confidence. Poor corporate governance adversely affects the
company’s potential, performance, financial reports, and accountability and can
pave the way for business failure, fraudulent public financial information,
inefficiency in capital markets, and loss of investor confidence. Proper antifraud
policies and practices improve the effectiveness of corporate governance and thus
reliability of financial statements. As described in Exhibit 3.4, antifraud policies and
practices can prevent and detect FSF. These antifraud policies and practices are
classified into preventing, detecting, and correcting corporate governance measures
influenced by all corporate gatekeepers including the board of directors and the
audit committee, management, internal auditors, and external auditors. The board
of directors as representative of all stakeholders (investors, employees, society) has
a fiduciary duty to protect their interests and ensure that their decisions
(investment, employment) are not affected by misleading financial information.
16
17
The effectiveness of the board oversight function depends on directors’
independence, due process, authority, resources, composition, qualifications, and
accountability. Senior executives consisting of the CEO and CFO are responsible for
managing the company and its resources and operations, as well as certifying the
accuracy and completeness of financial reports. The effectiveness of the managerial
function depends on the alignment of management’s interests with those of
shareholders and ensuring reliability of financial reports. Internal auditors are
regarded as the first defence against fraudulent activities, providing both assurance
and consulting services to the company in the areas of operational efficiency, risk
management, internal controls, financial reporting, antifraud, and governance
processes. External auditors are also expected to discover and report FSF. Exhibit
3.4 presents strategies, policies, and procedures in preventing, detecting, and
correcting FSF.
Several strategies can be established to prevent, detect, and correct FSF. The
following are the examples of these strategies: (1) establishment of a responsible
corporate governance, vigilant board of directors and audit committee, diligent
management, and adequate and effective internal audit functions; (2) utilization of
alert, skeptical external audit function, responsible legal counsel, adequate and
effective internal control structure, and external regulatory procedures; and (3)
implementation of appropriate corporate strategies for correction of the committed
FSF, elimination of the probability of its future occurrences, and restore confidence
in the financial reporting process. FSF occurs when one strategy or a combination
of these strategies are relaxed because of self-interest, lack of due diligence,
pressure, over-reliance, or lack of dedication. The opportunity of occurrence of FSF
is significantly increased when these strategies are inadequate and ineffective.
Exhibit 3.4
Financial Statement Fraud: Prevention, Detection, and Correction
1.
2.
3.
4.
Source: Rezaee, Z. 2002. “Internal Auditors’ Roles in Prevention, Detection, and
Correction of Financial Statement Fraud.” Internal Auditing 17, no. 3, pp. 13–20.
High-profile FSF incidents in recent years have raised serious concerns about the
following: (1) the role of corporate governance participants and corporate
gatekeepers including the board of directors and audit committees, executives, and
auditors in preventing and detecting FSF; (2) integrity, competency, and ethical
values of corporate gatekeepers; and (3) ineffectiveness of internal and external
audit functions in detecting and reporting FSF. Incidents of FSF are harmful to
companies and their gatekeepers in many ways including the following:
Undermining the reliability, quality,
usefulness, transparency, and integrity of
public financial information, which has
detrimental effects on the efficiency of the
financial markets.
Jeopardizing the integrity, quality, and
objectivity of the auditing profession,
which adversely affect its reputation and
relevancy.
Diminishing the confidence of investors
and public trust on financial information.
Resulting in substantial litigation costs as
public companies and their auditors are
being sued for alleged FSF.
5.
6.
7.
8.
9.
Destroying careers of those engaged in
FSF, such as corporate directors and
officers banning of serving on the board of
directors of any public companies or
auditors being barred from practice of
public accounting.
Causing bankruptcy or loss of substantial
economic losses by public companies for
the alleged FSF.
Encouraging regulatory intervention
including the passage of SOX in 2002.
Regulatory agencies (e.g., the SEC)
considerably influence the financial
reporting process and related audit
functions.
Causing destructions in the normal
operations and performance of companies
for alleged FSF.
Raising serious doubt about the efficacy of
financial statement audits and quality of
audit and assurance services.
Prevention and detection of FSF is the responsibility of all corporate governance
participants and those involved with financial statements’ supply chain. These
individuals are members of the board of directors including the audit committees,
management, internal auditors, external auditors, the SEC, and users of financial
reports.
The existence of responsible and effective corporate governance, consisting of a
vigilant and active board of directors, an effective audit committee, and adequate
and effective internal audit function, discovers the intended FSF and prevents its
occurrence. When FSF is prevented at this stage, the financial information will not
be misleading. However, ineffective and irresponsible corporate governance, along
with the gamesmanship attitude of corporate governance, would fail to prevent the
deliberate FSF perpetrated by management. Management may operate in its own
self-interests rather than the interests of stakeholders. Lack of adequate and
effective corporate governance (e.g., internal control) may create opportunities for
management to appoint the board of directors, auditors, and the audit committee
and offer the monetary incentive of their continued employment. This potential for
moral hazard causes a fiduciary conflict of interest in the sense that management
18
can bend the board of directors, the audit committee, and auditors to its will.
Management may act honestly but incompetently in managing the corporate affairs.
This causes management to be ineffective in creating shareholder value. In this
case, the board of directors should exercise its oversight authority of replacing the
current management team.
The board of directors and its representative audit committee should oversee the
following: (1) the integrity, quality, transparency, and reliability of the financial
reporting process; (2) the adequacy and effectiveness of internal control structure
in preventing, detecting, and correcting material misstatements in the financial
statements; and (3) effectiveness, efficacy, and objectivity of audit functions. Enron,
WorldCom, and Global Crossing debacles indicate that many boards of directors are
not good caretakers. Boards are theoretically elected to act as the shareholders’ eyes
and ears to ensure creation of shareholder value.
Boards are elected to hire executives (e.g., top management team) and drive their
performance through the carrot (higher executive compensation) and the stick
(compensation cuts and termination). However, lack of due diligence by the board
of directors creates opportunities for management to engage in FSF. The board of
directors and audit committee of Enron are coming under sharp criticism for
allowing the use of special-purpose entities (SPEs) to overstate earnings and
understate liabilities. Some directors and audit committee members are even being
accused of “insider trading” for making misleading statements about the company’s
prospects and selling more than $1 billion worth of stock during the last 3 years
before the Enron crisis.
A significant portion of Enron’s success was built on an elaborate foundation of
smoke and mirrors with much of its success proved to be scam and resulted from
questionable business practices. In 15 years, Enron grew from inception to
America’s seventh largest corporation, employing more than 21,000 persons in
more than 40 countries. Although the fall of Enron was because of a failed business
model and spin-off ventures in water, international energy brokerage, and
broadband communications, Enron’s demise began when investors became aware
of off-balance sheet partnerships and SPEs that hid billions of dollars of losses. One
of the major techniques to facilitate the deception was Enron’s executives’ use of
more than 1,500 SPEs and partnerships to achieve off-balance sheet treatment of
assets and liabilities. Some of these transactions essentially involved Enron
receiving borrowed funds that were made to look like revenues, without recording
liabilities on the company’s balance sheet.
In many cases, Enron personnel held personal stakes in these related-party entities,
reaping profits in addition to their Enron compensation. For example, Enron
admitted that Andrew Fastow, Enron’s CFO, earned more than $30 million from
his positions in the partnerships. In 2001, Enron found itself in real trouble when,
simultaneously, the business deals underlying these transactions went sour and its
stock price plummeted. Debt holders began to recall the loans owing to Enron’s
diminished stock price, and the company found its business sustainability and
accounting positions increasingly problematic to maintain. Public disclosure of
diminishing liquidity, questionable management decisions, and unsustainable
business practices and performance destroyed the public trust and investor
confidence that Enron had established within the business community. This caused
hundreds of trading partners, clients, and suppliers to suspend doing business with
the company, its shareholders selling their shares, and bondholders recall their
loans, which ultimately lead to its downfall.
Corporate Gatekeepers Role in FSF
The existence of responsible and effective corporate governance, consisting of a
vigilant and active board of directors, an effective audit committee, responsible
management, proper audits and adequate and effective internal audit function can
prevent, detect and correct FSF. When FSF is prevented at this stage, the financial
information will not be misleading. However, ineffective and irresponsible
corporate governance, along with the gamesmanship attitude of corporate
governance, would fail to prevent the deliberate FSF perpetrated by management.
Management may operate in its own self-interests rather than the interests of
stakeholders. Results of a survey indicates that the majority of the respondents
(about 82 percent) believe that future demand for and interest in corporate
governance will increase, supporting that current initiatives toward promoting
corporate governance by policymakers, regulators, businesses, and educators
worldwide. This survey also shows that (1) financial scandals and crisis galvanize
more demand for and interest in effective corporate governance; and (2) corporate
governance participants and thus corporate gatekeepers should ensure the quality,
integrity, reliability, and transparency of financial statements; (3) effective
corporate governance promotes accountability and improves the reliability and
quality of financial information; and (4) effective corporate governance reduces
FSF.
Antifraud Role of the Board of Directors
A vigilant board of directors that proactively oversees strategic decisions,
management’s plans, decisions, and actions as well as compliance with all
applicable laws, rules, regulations, standards, and best practices can be very
effective in achieving good governance and protecting stakeholders from receiving
misleading and fraudulent financial reports. The primary responsibility of the
board of directors is the appointment of the CEO and approval of the appointment
of other senior executives (top management team) to run the company for the
benefit of its shareholders. Boards of directors have experienced unprecedented
challenges and opportunities in the post-SOX era, and some boards still struggle to
find the proper balance between engaging in the strategic decisions of overseeing
managerial decisions and actions and ensuring compliance with applicable laws,
rules, regulations, and standards and preventing financial scandals and crises. In
the aftermath of the global financial crisis of 2007 to 2009, it is expected that the
boards of directors engage more proactively in the oversight function, especially in
an ever-increasingly complex business environment, the governance practices,
strategic priorities in dealing with global economic and political uncertainties,
financial crises, fraud, and the potential risk of cybersecurity.
The boards of directors are primarily responsible to protect investor interests and
ensure that they are not receiving misleading financial information that may affect
their investment decisions. A survey suggests that the board of directors can
effectively fulfill its fiduciary duties of ensuring published financial statements are
free from material misstatements caused by errors and fraud by (1) supervising the
implementation of antifraud measures, including deterrence, prevention, and
detection; (2) setting a tone at the top promoting ethical and competent behavior
throughout the organization; (3) assessing management performance and
compensation and its relevance to fraud risk assessment; (4) overseeing the audit
performed by independent auditors in discovering material financial
misstatements; (5) overseeing proper design and effective implementation of
antifraud policies and procedures; (6) overseeing the financial reporting and
internal control processes; (7) considering feedback received from the independent
auditors; and (8) including at least one financial expert in the audit committee to
improve financial expertise of the committee in overseeing financial reports,
internal controls, and the audit process.
Improving corporate governance and enhancing reliability of financial statements
are receiving significant attentions from lawmakers, regulators, the financial
community, standard-setting bodies, and the accounting profession. This welldeserved
attention stems from a variety of reasons, including widely publicized
business failures, high-profile alleged FSF committed by big corporations, lack of
vigilant oversight functions by the board of directors and audit committee,
irresponsible management, inadequate governance structure, and ineffective audit
functions. The increasing interest in and demand for more responsible and effective
corporate governance have provided a unique and timely opportunity for the audit
committee to improve its oversight function.
The corporate culture of integrity, competency, resilience, responsiveness,
transparency, accountability, and value-adding philosophy can play an important
role in the continuous improvements and sustainable performance and business
success. Because directors’ fiduciary duty and loyalty are to the shareholders,
directors should set the tone at the top in promoting a healthy corporate culture
and reliable financial reports free of material errors, irregularities, and fraud to
protect the interests of shareholders and create shared value for all stakeholders.
The main failure of Enron’s directors and officers (D&O) was violation of fiduciary
duty of protecting interests of shareholders and other stakeholders (e.g., employees,
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•
•
suppliers, customers, government, and society). During the first week of January
2001, the revelry and celebration was an Enron event when Kenneth L. Lay,
longtime chairman and chief executive, said the company would take on a new
mission: Enron would become “the world’s greatest company.”
The Enron board “waived” the company’s own ethics code requirements to allow
the company’s officers to serve as general partner for the partnerships used as a
conduit for much of its business. Directors ignored the duty of good faith and full
disclosure. There is no evidence that when Enron’s CEO told the employees that the
stock would probably rise that he also disclosed that he was selling stock. Moreover,
the employees would not have learned of the stock sale within days or weeks, as is
ordinarily the case. Only the investigation surrounding Enron’s bankruptcy enabled
shareholders to learn of the CEO stock sell-off before February 14, 2002, which is
when the sell-off would otherwise have been disclosed. Essentially, the concern
with a fiduciary’s appearances is on the basis of the fiduciary’s implicit role in
assuring that the company will observe the spirit as well as the letter of the law. The
fiduciary duty is to protect stakeholders not to violate through the waiver of the
company’s own ethical code.
Directors are usually subject to liability exposure under state and federal law. State
law imposes on directors the fiduciary duties of obedience, loyalty, good faith, and
due care. Breaches of these mandatory duties can result in litigations against
directors where the court determines the nature and extent of directors’ liability. It
is very rare that outside directors serving on board committees come under scrutiny
and investigations by federal authorities for their decisions on the board. However,
the three outside directors of Mercury Interactive Corp. who served on both its
compensation and audit committees and signed off on the alleged illegal and
intentional backdated options are under investigation by the SEC. The SEC, in
June 2006, advised these directors that it was considering filing a civil complaint
against them regarding their involvement and approval of manipulated stock
options grants. It would be the first time that all the members of the
compensation and audit committees could face civil charges, if the SEC decides to
take further action against these directors for conduct that did not even happen in
high-profile scandals of Enron and WorldCom.
In the WorldCom settlement case, 12 of the company’s outside directors agreed to
pay $24.75 million from their personal funds; in the Enron case, 10 of the outside
directors agreed to pay $13 million in personal contributions. Agreements reached
for personal contributions in these two cases may have profound and
unprecedented implications for and effects on the determination of future directors’
personal liability. Many have argued that the existing securities litigation trend will
have a chilling effect on recruiting outside directors and maintaining existing
directors who face the exposure of losing personal assets. The consensus is that in
these two cases, the board of directors in general and outside directors, failed to
effectively discharge their oversight responsibilities and acquiesced entirely to the
company’s CEO and thus did not prevent corporate wrongdoings. The signal sent by
Enron, WorldCom, and subsequent personal contributions is that as the guardians
for protecting investors’ interests, directors will be held accountable and personally
liable when they allow fraud and violations of securities laws to be committed by
their company’s management.
The Enron and WorldCom cases were rare situations of outside directors suffering
liability. In both companies:
Outside directors’ oversight responsibility
was not adequately fulfilled.
Even though they were not directly
engaged in fraudulent activities, they sold
their shares of the company during a time
when share prices were high due to the
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•
•
•
fraud.
The potential liability cost exceeded
available directors and officers (D&O)
insurance.
Outside directors were collectively wealthy.
Plaintiffs were either motivated to force
directors to disgorge profit gained from
fraudulent financial activities they failed to
prevent and detect or they wanted to send
the clear message to outside directors that
they could be held personally liable for
failing to effectively discharge their
oversight responsibilities.
Antifraud Role of Management
The board of directors of public companies as representative of shareholders
appoints the management team heading by the CEO and other members, including
the CFO, controller, treasurer, and other officers to run the company. Management,
under the oversight direction of the board of directors, is primarily responsible for
all managerial functions, including the development and execution of corporate
strategies, safeguarding resources, ensuring effective and efficient operations,
promoting reliability of financial reports, and ensuring compliance with all
applicable laws, rules, regulations, standards, and best practices to create long-term
and sustainable shareholder value.
Management consisting of the CEO and CFO is responsible for managing the
company for the best benefit of shareholders and ensuring they receive accurate,
complete, and reliable financial information in making investment and voting
decisions. The effective discharge of this responsibility requires management to
produce reliable, transparent, and accurate financial statements free of material
misstatements caused by errors and fraud. Results of a survey show that antifraud
policies, procedures, and practices of management should ensure the following: (1)
the adoption of a proactive approach in addressing fraud deterrence, prevention,
and detection; (2) the design, implementation, and maintenance of sound financial
and effective internal control systems; (3) preparation of reliable financial
statements free of material misstatements caused by errors and fraud; and (4)
design and implementation of effective antifraud policies and procedures.
Compliance with both the spirit and the requirements of applicable rules,
regulations, and laws, including legal, regulatory, and tax and accounting rules, is
one of the primary responsibilities of management. The focus of the investing
community and the financial markets will continue to be on a public company’s
financial performance; however, recently companies’ social responsibility
performance has also started to receive attention. Laws, rules, and regulations have
recently increased significantly in response to the emerging global competition,
which has reshaped financial and capital markets structure worldwide to provide
adequate protections for global investors. The globalization of capital markets and
the demand for investor protection in response to financial scandals worldwide
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(e.g., Enron, WorldCom, Parmalat, and Ahold) also require consistency and
uniformity in regulatory reforms and corporate governance practices, and thus
proper compliance with them.
The global competitive nature of U.S. capital markets is driven by tougher
regulatory reforms in protecting investors. According to the Corporate Fraud Task
Force’s 2008 Report to the President, the Department of Justice charged 34
defendants during its 4-year investigation of the Enron collapse. Twenty-six of the
thirty-four were former Enron employees. The CEO, Jeffrey Skilling, and the CFO,
Andrew Fastow, were among those receiving prison sentences. Kenneth Lay,
Chairman of the Board, was found guilty but died while awaiting an appeal
opportunity. Lea Fastow, wife of Andrew Fastow, was sentenced to 1 year in prison
for her role in filing tax returns that did not include some of the ill-gotten gains
from her husband’s schemes.
Antifraud Role of Internal Auditors
Internal auditors are the first defence against fraudulent financial activities by
assisting management to achieve operational efficiency and effectiveness, proper
risk management, internal controls evaluation, financial reporting certifications,
and antifraud and governance policies and procedures. Results of a survey suggest
that internal auditors should assist management in (1) developing and maintaining
sufficient skills to identify the indicators of fraud; (2) implementing and monitoring
the established antifraud policies and procedures; (3) adopting proactive approach
in detecting employees’ fraud and FSF; (4) using a risk-based audit methodology in
assessing fraud risk; and (5) planning audits in accordance with industry standards,
and where applicable, obtain audit committee (or the board of directors)
approval.
Internal auditors are integral parts of corporate governance and their expertise in
internal control is on the front line in preventing, detecting, and correcting FSF.
Internal auditors are viewed as a first-line defence against fraud because of their
knowledge and understanding of internal control structure and the business
environment. Internal auditors’ responsibilities for detecting, investigating, and
reporting FSF are stated in their standards SIAS No. 3. Recently, the IIA, in its
position paper presented to the U.S. Congress, states “Internal auditors, the board
of directors, senior management, and external auditors are the cornerstones of the
foundation on which effective corporate governance must be built.” The IIA also
recognizes that internal auditors are an active participant in corporate governance,
yet an independent observer of that process.
Internal auditors play an important role in ensuring a responsible corporate
governance and a reliable financial reporting process and an effective system of
internal controls by assisting their organization in (1) improving the quality,
integrity, reliability, and transparency of financial information; (2) preventing,
detecting, and correcting FSF; (3) assisting management to fulfill its financial
reporting responsibilities; (4) ensuring the adequacy and effectiveness of internal
control structure; and (5) cooperating with outside auditors to improve audit
efficacy. Andersen conducted both the external and internal audits of the bankrupt
Enron, which possibly created conflicts of interest that ultimately impaired
Andersen’s objectivity and integrity.
Internal auditors should identify red flags that signal the possibility of fraud,
investigate symptoms of fraud, and report the detected fraud or its possibility of
occurrence to appropriate authorities within their organization, such as top
executives, the audit committee, and the board of directors. The following
suggestions can enhance the active role of internal auditors in the financial
reporting process, and thus, their role in preventing, detecting, and correcting
FSF :
Assist their organization to implement the
10 principles of corporation governance
endorsed by the IIA.
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2.
3.
4.
5.
6.
7.
Regular meetings between the chief audit
executive (CAE) and the audit committee
regarding the financial reporting process.
Establishment of a consolidated financial
statement audit function consisting of the
audit committee, internal auditors,
external auditors, and top management
team periodically assessing the quality,
reliability, and integrity of financial
reporting process.
Close cooperation and coordination of the
work of external auditors with internal
auditors through an integrated audit
planning process consisting of the
exchange of audit plans, programs,
findings, and reports.
A requirement that internal auditors report
their audit findings related to financial
statement preparation, especially when
there are symptoms of the possibility of
FSF, to the audit committee or the board of
directors.
Reporting to applicable regulatory agencies
or even the shareholders upon failure of
the audit committee to act on FSF findings
of internal auditors.
Enhancing the status of internal auditors
as a part of corporate governance through
the higher-level reporting relationship,
more access to the audit committee, career
8.
9.
10.
11.
12.
development plans for necessary
experience, training and knowledge, and
sufficient resources.
Assessment of the adequacy and
effectiveness of the internal control
structure in general and internal controls
over the financial reporting process in
particular.
Evaluation of the quality of financial
reporting process, including the review of
both annually and quarterly financial
statements filed with the SEC and other
regulatory agencies.
Participation with the audit committee and
external auditors in reviewing
management’s discretionary decisions,
judgment, selection, and accounting
principles and practices as related to the
preparation of financial statements.
Assessment of the risks and control
environment pertaining to the financial
reporting process by ensuring that
financial reporting risks are identified, and
related controls are adequate and effective.
Review of risks, policies, and procedures
and controls pertaining to the quality,
integrity, and reliability of financial
reporting, including related-party
transactions, partnerships, mergers and
acquisitions, information systems risks,
13.
14.
and off-balance sheet financial
instruments.
Monitoring compliance with the
company’s code of corporate conduct to
ensure that compliance with ethical
policies and other related procedures
promoting ethical behavior are being
achieved. The tone set by management
encouraging ethical behavior can be the
most effective factor in contributing to the
integrity and quality of the financial
reporting process.
Continuously assessing their organization
susceptibility to frauds including
occupational fraud and FSF, reviewing
managerial programs and controls to
address such risks, and ensuring that the
established programs and controls are
adequate and effective in mitigating or
exacerbating the identified fraud risks.
A close working relationship between the audit committee and internal auditors can
improve the effectiveness of corporate governance. First, the independence and
objectivity of internal auditors can be strengthened when they report their findings
and opinions directly to the audit committee. Second, the prestige and status of
internal auditors can be enhanced when they work with management at all levels
while being accountable to the audit committees. Third, internal auditors can be of
a significant assistance to audit committees to effectively fulfill their oversight
duties in functions such as financial reporting, internal controls, risk management,
external audit, whistle-blowing, ethics, and taxes.
Internal auditors’ reports should (1) disclose all relevant information about the
effectiveness of the organization’s corporate governance; (2) focus on its
sustainability performance in all areas of economic and financial, social, ethical,
governance, and environmental activities; (3) provide transparent financial and
nonfinancial information on key performance indicators (KPIs) and their impacts
on all stakeholders; and (4) assess the organization’s responsiveness to the needs of
all of its stakeholders.
Antifraud Role of External Auditors
FSF has been and continues to be the focus of the auditing profession. During the
1890s, external auditors viewed the detection of fraud, in general, and FSF as the
primary purpose of the financial audit. The auditing profession had moved from
1.
2.
3.
4.
acceptance of fraud detection as a primary purpose to the expression of an opinion
on fair presentation of financial statements during the twentieth century. The
accounting profession has initially addressed the external auditor’s responsibility
for FSF detection in SAS No. 82 and SAS No. 99 titled Consideration of Fraud in a
Financial Statement Audit. SAS No. 82, which is superseded by SAS No. 99,
required the independent auditor to consider a broad range of fraud risk factors in
assessing the risk of occurrences of FSF and to use this assessment in audit
planning to detect fraud.
The Auditing Standards Board (ASB) of the AICPA, by issuing SAS No. 99, attempts
to clarify, but not to expand, the auditor’s responsibility to detect and report FSF.
SAS No. 99 states “The auditor has a responsibility to plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement, whether caused by error or fraud (emphasis
added).” SAS No. 99 makes it clear that the auditor’s responsibility for detecting
fraud is framed by the concepts of reasonable, but not absolute, assurance and
materiality and subject to cost/benefit decisions inherent in the audit process.
However, although auditors are not expected to detect all employees’ frauds, the
public expects auditors to detect material FSF perpetrated by management with the
purpose of misleading investors and creditors. Independent auditors provide
reasonable assurance that financial statements are not materially misstated, and
therefore, they are free of material errors, irregularities, and fraud. This level of
assurance is given in an audit report on the basis of an audit of financial statements.
SAS No. 99 states that “absolute assurance is not attainable and thus even a
properly planned and performed audit may not detect a material misstatement
resulting from fraud.” SAS No. 99 requires auditors to (1) approach every audit
with professional skepticism; (2) discuss among the audit team members regarding
the risks of material misstatement caused by fraud; (3) identify fraud risk and
management incentives, opportunities, and ability to rationalize occurrence of
fraud; and (4) design audit tests responsive to the risks of fraud. SAS No. 99
requires that auditors place an increased emphasis on discovering FSF.
Although SAS No. 99 is not suggesting any changes to the auditor’s current
responsibilities for detecting fraud in a financial statement, it provides new
guidelines, concepts, and requirements to aid auditors in fulfilling those
responsibilities.
These guidelines
describe fraud and its characteristics;
discuss the need for auditors to exercise
professional skepticism in conducting
financial audits;
require auditors to discuss among the audit
team members regarding the risks of
material misstatement caused by fraud;
require auditors to obtain competent and
sufficient evidence to identify risks of
material misstatement caused by fraud
through inquiring of management,
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5.
6.
a.
b.
c.
7.
8.
performing analytical procedures, and
considering fraud risk factors;
identify fraud risk factors and assess these
risk factors by considering the client’s
programs and controls;
require auditors to respond to the results of
the risk assessment by:
determining its overall effect on how the
audit is conducted;
considering its impact on the nature,
timing, and extent of the auditing
procedures to be performed; and
performing certain procedures (e.g.,
examining journal entries and other
adjustments, reviewing accounting
estimates and unusual transactions) to
further address the likelihood of
occurrence of fraud involving management
override of controls;
require auditors to evaluate audit evidence
indicating the likelihood of financial
misstatements caused by fraud and their
implications for fair presentation of
financial statements;
provide guidance regarding auditors’
communicates about fraud to
management, the audit committee, and
others; and
9. describe appropriate documentations of
auditors’ consideration of fraud.
The 2010 inspection reports of the Public Company Accounting Oversight Board
(PCAOB) indicate that audit failures of detecting financial misstatements including
FSF have contributed to 2007 to 2008 financial crisis. External auditors failed to
perform their gatekeeping responsibility of protecting investors from receiving
misleading financial reports by (1) not challenging the assumptions of valuation
models used in estimating fair value assets; (2) not considering risk assessment of
off-balance sheet transactions; and (3) not providing early signal of financial
difficulties and going concern. Auditing standards (SAS Nos 88 and 99, 2002)
define independent auditor responsibility in rendering an unqualified opinion is to
express reasonable assurance that the audited financial statements are free from
material misstatements, whether caused by error or fraud. Results of a survey
indicate that external auditors can reduce the likelihood of FSF by (1) performing
risk-based audit tests; (2) discussing FSF with the board, audit committee, and
management; (3) integrating fraud risk into audit strategies, plans, and procedures;
and (4) performing forensic and investigative audit procedures to detect FSF when
there is likelihood of allegation of fraud. External auditors main concern is with
material misstatements in the audited financial statements by reducing the
information risk of be misleading and fraudulent.
Enron’s collapse and related audit failures caused loss of reputation, trust, and
confidence in Big 5 accounting firm, Andersen, LLP. News about charges of
inappropriate destruction of documents at the Andersen office in Houston, which
housed the Enron audit and the subsequent unprecedented federal indictment,
resulted in the demise of Andersen. Andersen’s clients quickly lost confidence in the
auditing firm, and by June 2002, more than 400 of its largest clients had fired the
firm as their auditor, leading to the sale or desertion of various pieces of Andersen’s
U.S. and international practices. On June 15th, a federal jury in Houston convicted
Andersen on a felony count of obstructing the SEC’s investigation into Enron’s
collapse. Although the Supreme Court later overturned the decision in May 2005,
the reversal came nearly 3 years after Andersen was essentially out of business.
Shortly, after the June 15, 2002 verdict, Andersen announced it would cease
auditing publicly owned clients by August 31. Therefore, like Enron, in less than a
year Andersen went from being one of the world’s largest and most respected
auditing firms into oblivion.
Andersen was regarded as the watchdog and moral voice of the auditing profession
in the United States for many years before its demise in 2002, caused by the
conviction of obstruction of justice. Although later the Supreme Court overturned
Andersen’s initial U.S. District court conviction, it did not help Andersen to retain
its severely damaged reputation. The Supreme Court decision did not save
Andersen and did not change the perception that Andersen “was a victim of its own
self-indulgence.” Nonetheless, a series of audit failures of Sunbeam, Waste
Management, and Enron, among others, were devastating to investors and caused
the public distrust of Andersen as it paid more than 500 million between 1997 and
2001 to settle claims of audit failures, looking the other way, and not reporting the
discovered FSF.
Auditors must be skeptical, alert, professional, inquisitive, and understand the
public trust in their profession and why they are licensed to serve as auditors. Their
role is to lend credibility to published financial statements and provide reasonable
assurance that financial statements fairly reflect underlying business realities,
substance, financial conditions, and results of operations. SAS No. 99 defines
skepticism as
an attitude that includes a questioning mind and a critical assessment of audit evidence. The
auditor should conduct the engagement with a questioning mind that recognizes the
possibility that a material misstatement due to fraud could be present, regardless of any past
experiences with the entity and regardless of the auditor’s belief about management’s
honesty and integrity.
Every publicly traded company has a right to be audited under the law. However, an
audit is not an entitlement for receiving a clean or unqualified audit opinion. Some
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1.
2.
companies should not receive standard unqualified opinions until they clean up
their act by providing objective, high-quality, reliable, and transparent financial
statements. Auditors must be alert to management overriding controls, resulting in
fraudulent financial reporting and misappropriation of assets.
The following suggestions can help the accounting profession to narrow the
expectation gap:
Existing auditing standards require
auditors to provide reasonable assurance
that financial statements are free from
material misstatements, whether caused by
errors or fraud. This level of reasonable
assurance is not well defined and means
different things to different people.
Investors view reasonable assurance as a
high-level assurance and wish to hold
auditors responsible for all errors,
irregularities, and fraud threatening the
integrity of financial statements. Auditors,
on the other hand, in recognizing the
limitation of financial audits (e.g.,
management override, test basis, and use
of estimates), can only provide a
reasonable assurance which is less than
absolute assurance. The accounting
profession should clearly define what
constitutes “reasonable assurance” in order
to narrow the perceived expectation gap.
Given the credibility issues and expectation
gap facing the accounting profession, it is
important that investors have confidence
in regulators (SEC) and standard-setters
(the PCAOB and AICPA) in protecting
investors from receiving misleading
financial statements. The AICPA, the
leading advocate for the view of CPAs and
3.
4.
5.
the PCAOB, the watchdog of the
accounting profession, should be more
active in addressing the perceived trust gap
and ways to narrow this gap. Only more
training in forensic techniques can bridge
this credibility gap.
The accounting profession should promote
the use of an integrated audit for all
entities, public and private companies, and
for profit and not-for-profit organizations.
An integrated audit approach is the audit
of both internal control over financial
reporting and financial statements. Under
an integrated audit, auditors test the
adequacy and effectiveness of the design
and operation of internal controls as well
as audit of financial statements. An
effective and efficient integrated audit can
improve integrity, reliability, quality, and
transparency of financial statements.
Participation in local community activities,
especially activities of colleges and
universities. Public accounting firms of all
sizes (Big 4 and non-Big 4) should get
more engaged in the development of the
accounting curriculum with a keen focus
on antifraud and forensic accounting.
Expansion of auditing and accounting
services to clients assist them to ensure the
integrity and reliability of their financial
reports. Examples of these services are
•
•
•
•
•
•
•
antifraud training for management, boards
of directors, and audit committees.
Reasons auditors fail to detect FSF are as follows:
Over-reliance on client representations
Lack of awareness or failure to recognize
that an observed condition may indicate a
material fraud
Lack of experience
Personal relationships with clients
Insufficient professional skepticisms
Inadequate use of IT and data analytics
Lack of focus on FSF discovery
Short Sellers Role in Discovering Fraud
Short sellers as sophisticated investors and in looking after their investments also
act as gatekeepers in preventing, detecting, and correcting irregularities, and errors
and fraud. However, auditors’ efficacy and incentives in discovering and reporting
FSF may be different from those of short sellers in the sense that auditors are
concerned with fair presentation of financial statements and provide reasonable
assurance that these statements are free from material misstatements, whether
caused by errors or fraud, whereas short sellers search for financial challenges that
influence short interest. Short sellers, through their private search and information
processing skill, can identify firms with financial challenges and take actions before
public disclosure of such information, and thus public disclosure of such challenges
has no value relevant to short sellers. Short sellers tend to target firms with
financial challenges, including irregularities, red flags of financial reporting fraud,
and reported material weaknesses in their internal controls, top executive
resignations, and auditor changes, and can obtain information faster than other
traders before such information is publicly disclosed and reflected in stock prices.
Short sellers play an important role in the financial market and their incentives in
targeting firms with financial challenges, including misstatements caused by fraud.
Forensic Accountants Role in Discovering Fraud
Forensic accountants combine accounting knowledge with investigative skills.
Using this skill set, forensic accountants lend litigation support and conduct
investigations in accounting settings. They are responsible for performing forensic
research to trace funds and identify assets for recovery, conducting forensic analysis
of financial data, and preparing forensic accounting reports from any financial
findings. Forensic accountants are responsible for finding a resolution for fraud
allegations. This means performing a myriad of tasks including aiding in the
prevention and detection of white-collar crime, collecting evidence (physical and
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2.
3.
4.
5.
verbal testimony), writing reports, and testifying to their findings. Because of the
important role the forensic accountants play, their knowledge base includes whitecollar
crime, money laundering, insurance claims, GAAP or generally accepted
auditing standards (GAAS) violations, telemarketing fraud, check kiting, contract
and procurement fraud, asset misappropriation, securities fraud, FSF, bankruptcy
fraud, credit card fraud, embezzlement, financial data analysis, evidence integrity
analysis, computer application design, damage assessment, tracing illicit funds,
locating hidden assets, due diligence reviews, forensic intelligence gathering,
accounting procedures, legal system and its procedures, regression analysis, and
computer applications. They must possess the skill to write reports of high import
as well as reliably testify as an expert witness, and their abilities must include
interpersonal communication verbal communication, written communication, and
attention to detail, analytical, integrity, objectivity, independence, and credibility.
The common ways forensic Accountants assist business organizations in
performing forensic accounting services are:
Assist managers and audit committee
(board of directors) with the aspect of
deterrence, prevention, and detection
processes (i.e., directly or through the
participation with internal or independent
auditors)
Provide input into management’s
assessment of fraud risk
Help to cultivate an appropriate antifraud
environment
Assist the audit committee and board
assesses susceptibility to management
override and collusion
Resolve allegations or suspicions of fraud
Certified Fraud Examiners passing the CFE Examination requires expert knowledge
of fraudulent financial transactions, legal elements of fraud, fraud investigation,
and criminology and ethics. In the investigation step of the fraud examination
process, individuals working in the public and private sectors are key. Public-sector
investigators work at the federal, state, or local level as police detectives, federal
special agents, and anything in-between. Private-sector investigators work in the
field of loss prevention, internal or external fraud analysis, and as independent or
agency private investigations.
Specific job positions for the public sector include state and local police, police
detective, crime scene investigator, district attorney investigator, attorney general,
state bureau of investigation, Security and Exchange Commission, Homeland
Security, U.S. Immigration and Customs Enforcement (ICE), Transportation
Security Administration (TSA), U.S. Customs and Border Protection (CBP),
Department of Justice, Federal Bureau of Investigation (FBI), Criminal Division,
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Civil Division, Central Intelligence Agency (CIA), Bureau of Alcohol Tobacco and
Firearms (ATF), and the Drug Enforcement Administration (DEA).
The knowledge required of a public-sector investigator is white-collar crime,
organized crime, financial crime, bribery and corruption, money laundering,
counterfeiting, fraudulent documents, and credit card fraud. Much like a forensic
accountant, an investigator should be proficient in the skills of writing reports and
testifying in court, but they must also conduct surveillance, collect evidence,
conduct interviews, record examination, and utilize computers. Important abilities
required of public-sector investigators are attention to detail, ability to function in
stressful situations, alert to surroundings, understanding of associated risks,
honesty, sound judgment, integrity, responsibility, fairness, compassion,
leadership, accountability, and adaptability.
Specific job positions for private-sector investigators include loss prevention,
private investigator, internal fraud analyst, and external fraud analyst. The
knowledge required of a public-sector investigator is the same as that of the publicsector
accounting along with the addition of loss prevention and counterfeiting.
They must have the skills to conduct surveillance, collect evidence, conduct
interviews, record examination, writing reports, and utilize computers. The abilities
required of private-sector investigators are attention to detail, functioning in
stressful situations, being alert to surroundings, understanding associated risks,
honesty, having sound judgment, high integrity, being responsible, and a having a
strong judge of character.
Antifraud Role of Market, Regulators, and Standard Setters
Limitations in GAAP are at least partly to blame for Enron executives’ ability to hide
debt, keeping it off the company’s financial statements. These technical accounting
standards lay out specific “bright-line” rules that read much like the tax or criminal
law codes. Some observers of the profession argue that by attempting to outline
every accounting situation in detail, standard-setters are trying to create a specific
decision model for every imaginable situation. However, very specific rules create
an opportunity for clever lawyers, investment bankers, and accountants to create
entities and transactions that circumvent the intent of the rules while still
conforming to the “letter of the law.” SPEs were never intended to provide safe
harbor to keep assets and liabilities out of a company’s accounting records. In
contract, for an SPE’s assets and liabilities to be treated as “off-balance sheet,”
Enron needed to maintain at least a 3 percent ownership in the SPE and the
remaining debt, and equity investors needed to have their investment capital at
risk.
Enron structured the transactions so that it virtually guaranteed the investors’
positions. As such, the SPE and its related assets and liabilities should have been
consolidated as part of Enron. Because the SPEs were not consolidated, Enron’s
risk remained hidden by a veil of deception in the form of the SPEs. When Enron’s
guarantees came to light during 2001, the market’s trust in Enron’s ability to deliver
as a market maker evaporated. Even more interesting was that Enron executives
had significant financial stakes in some of these SPEs and personally reaped huge
income from that ownership. For example, Michael Kopper, a Fastow assistant, is
reported to have made at least $12 million and Andrew Fastow, CFO, more than
$30 million on their related party investments in Enron off-balance sheet entities.
Enron created four SPEs in 2000. As part of the initial capitalization of these SPEs
and a series of ongoing transactions, Enron issued its own common stock in
exchange for notes receivable. At the time, Enron increased notes receivable (an
asset) and shareholders’ equity to reflect these transactions. However, GAAP
generally requires that notes receivable arising from transactions involving a
company’s capital stock be presented as deductions from stockholders’ equity and
not as assets. Enron has indicated that they overstated both total assets and
shareholders’ equity by $172 million owing to a transaction first reported in the
financial statements for the quarter ended June 30, 2000, and by an additional
$828 million owing to a transaction first reported in the quarter ended March 31,
2001. Even with these accounting mistreatments, Enron was demonstrating signs
of impending financial troubles. In the first and second quarter of 2001, Enron
reported negative cash flows from operations in contrast to reporting operating
earnings. Regulations and standards that are cost-effective, efficient, proactive, and
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43
scalable provide framework and guidelines for business organizations in developing
sound business and accounting systems to prevent, detect, and correct FSF, and
proper guidelines for forensic accountants and auditors to discover and report FSF.
Market Correction Mechanisms
Market can play an important role in preventing and detecting FSF by demanding
full and fair disclosure of financial information of the listed public companies.
Financial analysts, following public companies for compliance with listing
standards pertaining to full and fair disclosures and revealing non-compliance, can
cause a substantial reduction in stock prices. Any market correction mechanism for
disclosure of fraudulent activities can be detrimental to companies. The capital
market can monitor and punish fraud-prone companies through negative stock
reactions to fraud disclosures. These negative stock reactions usually get the
attention of the board of directors in replacing management and establishing
effective corporate governance measures to correct fraud. However, in many fraud
cases including the Enron case, by the time that the market reacts to undisclosed
and disclosed frauds, these fraud companies are already bankrupt or on their way to
becoming insolvent.
Academic studies, by using “fraud-on-the-market theory,” find that on average
stock prices are negatively affected by the disclosure of FSF. The question is
whether the market price is fraudulently being distorted, suggesting that stock
prices are different from what they would have been in the absence of such
disclosure. The fraud-on-the-market theory suggests that in an efficient market,
stock prices reflect all available public information including misstatements caused
by FSF, presumably at the disclosure time of FSF. However, the securities market
may not be aware of occurrences of FSF before public disclosure, and thus their
effects are not embedded in stock prices. It is also possible that stock prices are
distorted by disclosures of FSF. A combination of the fraud-on-the-market theory
and the bad news concealing theory derived from the agency problem suggests that
there is an information asymmetry between management and shareholders that can
motivate management to engage in FSF that may affect stock prices According to
the fraud-on-the-market theory, the stock price reflects all information, including
the misstatement caused by fraud. Therefore, if an investor can show that the
purchased stock was priced much higher because the market price did not reflect
the fraud when the fraud was not disclosed to the market, the investor has the
grounds for a class-action lawsuit.
There is nothing wrong with markets failing to fulfill their task of leveling the
playing field between buyer and seller. Such market failures are in fact how many
entities make their money through patents (temporary monopolies) and the use of
expertise that is not universally available (competitive advantage). Nonetheless, the
types of market failures that ignore the rights of others and endanger the credibility
of all legitimate transactions have detrimental effects on business and market
sustainability. The most common form of market failure is information
asymmetries known to business decision makers (management) and not properly
disclosed to investors. Thus, this unfairness information asymmetry exceeds simple
competitive advantage and is a threat to the rights of investors and to the effective
functioning of the free market system. An obvious example of this market failure is
the use of “off-balance sheet,” SPEs, and other related party entities by Enron with
the intention to hide liabilities and exaggerate earnings. When an entity acts as a
market marker, optimally, the market maker has no ownership positions in the
assets and liabilities being traded; instead, the market maker assists willing buyers
and willing sellers meet in an effective, efficient, and low-cost manner. The trouble
with Enron was that in many of its markets, it was a counterparty to the
transaction. Enron’s inventory of energy and other assets also created enormous
debt. Enron used about five hundred SPEs and thousands of questionable
partnerships for the structure transactions to achieve off-balance sheet treatment of
assets and liabilities. Enron used SPEs to borrow directly from outside lenders,
often supplying its own credit and stock guarantees. When outside investors
became suspicious of the value of the SPEs, Enron offered its own stock as
collateral.
In the natural gas market, Enron provided and charged for stability, marketing
stable financial contracts to its customer by combining of options, swap, and similar
financial instruments. The problem at Enron was that many of their contracts were
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45
custom and did not have a ready market. Custom contracts without a market are
difficult to value. The alternative was that Enron valued these contracts through
computer models, a process known as mark-to-model. The immediate advantage is
that Enron could put a positive spin on its earnings. But the end result was: Enron
not only started to believe that mark-to-model earnings were real, but also
“manipulated the models to its advantage.” The capital market is expected to
discipline underperformed and unethical companies through extensive sales of
shares of these companies and lack of investor confidence that causes substantial
declines in stock prices. Exhibit 3.5 shows Enron’s stock decline during the Enron
debacle in 2001.
Antifraud Role of Regulators
The SECs have several divisions related to fraud and regulatory enforcement. Under
the purview of the Financial Reporting and Audit Task Force, the team investigates
violations related to financial information and disclosure. The SEC’s Financial
Reporting and Audit Task Force is also responsible for fraud detection through use
of real-time analysis, running systems designed to detect fraud, and using experts
to pinpoint and properly address fraudulent behavior. This task force
communicates its findings with several offices, including the Chief Accountant,
Economic and Risk Analysis, and Corporate Finance.
Exhibit 3.5
The Microcap Fraud Task Force, created in 2010, joined several different
operations in the enforcement and examined functions of the SEC. Research and
investigative techniques are used on only microcap securities. Microcap securities
have a capitalization value between $50 and $300 million. As a result, the task
force is concerned about a specific set of actions, people, and firms and develops
strategies on the basis of this optic. Elisha Frank and Michael Paley are currently in
charge of this task force.
The previously mentioned task forces were created to discover fraud. The SEC uses
these groups to find fraud, but there is a general process that the agency follows. An
investigation is opened first, then proceedings occur, and then finally is
investigated, enforced and then closed. When opening an investigation, the SEC has
two methodologies to choose from. The first method occurs when a Matters Under
Inquiry (MUI) is translated into an investigation. When a MUI becomes
investigative, the SEC has determined that a MUI is no longer applicable given the
conclusions of the analysis. Second, an investigation may be opened when no MUI
is present.
To open an investigation, several questions must be considered about the validation
of evidence, the resources used, and the conduct in which the investigation will be
done. The investigations are required to be administered to benefit the public and
investors in the public sector. As a result, the SEC needs to be thorough in the
processes leading up to investigation closure. Factors that should be contemplated
when deciding whether to close an investigation are: the seriousness of the conduct
and potential violations, the staff resources available to pursue the investigation,
the sufficiency and strength of the evidence, the extent of potential investor harm if
an action is not commenced, and the age of the conduct underlying the potential
violations. Once the decision is made to close an investigation, there are several
steps that a staff must take, including checking with the Freedom of Information
46
47
48
49
1.
2.
Act Office (for instructions of retention and disposition of case files), preparing a
closing recommendation, preparing the files for disposition, and generating and
sending the proper termination notices. However, should a case result in
enforcement action, it can’t be closed until all enforcement actions in the case are
completed. This mandates a final judgment/commission order and that all ordered
monetary relief be accounted for.
SEC enforcement actions are taken against firms that are identified as having
violated the financial reporting requirements of the Securities Exchange Act of
1934. The SEC Enforcement Manual provides guidance to employees about the
handling of complaints, tips, and referrals (leads) received concerning violations of
SEC requirements. The SEC obtains leads for investigation from several sources: (1)
public complaints and tips; (2) the reporting requirements of federal, state, and
local law enforcement agencies under the Bank Secrecy Act; (3) the enforcement
staff of the Public Company Accounting Oversight Board; (4) the enforcement of
“blue sky laws” by state securities regulators; (5) complaints and other information
from members of Congress on behalf of constituents whom they represent; and (6)
trading-related referrals from domestic self-regulatory organizations (SROs).
Antifraud Education
Effective antifraud policies and programs should be designed to prevent and detect
fraud. Antifraud programs should deter, prevent, and detect all variations of fraud,
from misrepresenting financial information to misappropriating assets and
employee fraud. Effective antifraud programs should also address the antifraud role
of corporate governance participants. Entities of all sizes are susceptible to both
employee fraud (e.g., theft and embezzlement) and management fraud (e.g.,
manipulation of financial reports). Effective antifraud programs—focusing on fraud
awareness and education in the workplace environment, whistle-blowing policies
and procedures of encouraging and protecting employees to report suspicious
behavior, adequate internal control procedures designed to prevent and detect
fraud, and conducting surprise audits—can significantly reduce fraud.
The demand for and interest in ethics and corporate governance and antifraud
practice and education has significantly increased in the post-SOX era. Ethics and
corporate governance have transformed from a compliance process to a business
strategic imperative—yet, many have expressed concern over the corporate
governance and ethics education, as well as the training provided in an effective
antifraud program. Antifraud policies and programs should address corporate
culture, control structure, and fraud procedures.
Corporate culture: Corporate culture
should create an environment that sets an
appropriate tone at the top that promotes
ethical behavior and reinforces antifraud
conduct, demanding “doing the right thing
always.” The corporate culture provides
incentives for everyone in the company,
from directors to officers and employees, to
act competently and ethically.
Control structure: An effective control
structure should eliminate opportunities
for individuals to engage in fraudulent
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51
3.
activities. Section 404 of SOX, SEC rules,
and PCAOB AS No. 5 all underscore the
importance of internal controls in the
prevention and detection of fraud.
Antifraud procedures: Adequate fraudrelated
procedures should be developed
and performed to ensure prevention and
detection of potential fraud.
Conclusion
Entities of all sizes and types are susceptible to both employee (e.g., theft and
embezzlement) and management fraud (e.g., manipulating financial reports).
Effective antifraud programs and procedures should be designed to prevent and
detect fraud. Antifraud programs should deter, prevent, and detect all variations of
fraud, from misrepresenting financial information to misappropriating assets and
employee fraud. Effective antifraud programs should address the role of corporate
governance participants including the board of directors, executives and auditors in
preventing and detecting fraud. This chapter provides insights on the role of
corporate governance participants in antifraud policies and procedures. Corporate
culture should create an environment that sets an appropriate tone at the top,
promoting ethical behavior, reinforcing antifraud conduct, and demanding “doing
the right thing always.” It provides incentives for everyone in the company to act
ethically. Control structure should eliminate opportunities for individuals to engage
in fraudulent activities. Antifraud procedures are necessary to ensure prevention
and detection of potential fraud.
The collapse of Enron, WorldCom, and Global Crossing, among others, caused by
the alleged FSF has encouraged organizations to place more emphasis on corporate
governances, information systems, and internal control in generating online and
real-time, reliable, relevant, and transparent financial information. The internal
audit function is an important component of corporate governance and the first line
of defence against FSF. The three-factor model consisting of conditions, corporate
structure, and choice discussed in this chapter should assist internal auditors and
forensic accountants to identify symptoms and red flags that may indicate the
occurrence of FSF, assess the identified symptoms and opportunities, and notify the
appropriate authorities within their organization for investigation of the possibility
of FSF.
FSF occurs when one or a combination of antifraud strategies presented in this
chapter are relaxed owing to self-interest, lack of due diligence, pressure, overreliance,
or lack of dedication. The opportunity of occurrence of FSF is significantly
increased when antifraud strategies are inadequate and ineffective. The opportunity
to engage in FSF increases as the organization’s control structure weakens, its
corporate governance becomes ineffective, and its audit efficacy deteriorates. One
important lesson learned from Enron’s collapse is the relevance and importance of
a proactive, responsible, and vigilant corporate governance, including internal and
external audit functions in ensuring the quality, integrity, transparency, and
reliability of the financial reporting process. As an active participant in corporate
governance and front-line combatants in the recent struggle against occupational
fraud, corporate abuse, and FSF, forensic accountants must play an important role
in improving the quality and quantity of public financial information.
Action Items
•
•
•
1.
2.
3.
4.
5.
6.
7.
8.
Establishment of responsible corporate
governance, vigilant board of directors and
audit committee, diligent management,
and adequate and effective internal and
external audit functions to prevent, detect,
correct, and report FSF.
Utilization of alert, skeptical external audit
function, responsible legal counsel,
adequate and effective internal control
structure and external regulatory
procedures, and forensic accounting to
combat fraud.
Implementation of appropriate corporate
strategies for correction of the committed
FSF, elimination of the probability of its
future occurrences, and restore confidence
in the financial reporting process.
Endnotes
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 2010.
Fraudulent Financial Reporting: 1998–2007: An Analysis of U.S. Public Companies.
www.coso.org (http://www.coso.org)
American Institute of Certified Public Accountants (AICPA). 2002. Statement on Auditing
Standards No. 99: Consideration of Fraud in a Financial Statement Audit. Available at
https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-
00316.pdf
National Commission on Fraudulent Financial Reporting. 1987. Report of the National
Commission on Fraudulent Financial Reporting.
https://www.coso.org/Publications/NCFFR.pdf
American institute of Certified Public Accountants (AICPA). 2017. Consideration of Fraud
in a Financial Statement Audit. AU-C Section 240.
https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-
00240.pdf
Z. Rezaee. 2002. Financial Statement Fraud: Prevention and Detection (New York, NY:
John Wiley & Sons).
Z. Rezaee, and R. Riley. 2009. Financial Statement Fraud: Prevention and Detection (2nd
ed., Hoboken, NJ: John Wiley & Sons, Inc.).
Ibid.
COSO. 1987. The Report of the National Commission on Fraudulent Financial Reporting
(Washington, DC: COSO).
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
COSO. 2010. The Report of the National Commission on Fraudulent Financial Reporting
(Washington, DC: COSO).
COSO. May, 2010. “Fraudulent Financial Reporting 1998-2007.”
https://www.coso.org/Documents/COSO-Fraud-Study-2010-001.pdf
Ibid.
Z. Rezaee. 2002.
Ibid.
Z. Rezaee. 2002. “Internal Auditors’ Roles in Prevention, Detection, and Correction of
Financial Statement Fraud,” Internal Auditing 17, no. 3, pp. 13–20.
Association of Certified Fraud Examiners (ACFE). 2016. Report to the Nations on
Occupational Fraud and Abuse. http://www.acfe.com/rttn2016.aspx
(http://www.acfe.com/rttn2016.aspx), (accessed March 14, 2018).
Z. Rezaee. 2018. Corporate Governance in the Aftermath of the Global Financial Crisis
(four volumes, New York, NY: Business Expert Press).
Z. Rezaee. 2007. Corporate Governance Post-Sarbanes-Oxley. Hoboken, NJ: John Wiley
&Sons.
Rezaee and Riley. 2009.
Z. Rezaee, and B. Kedia. 2012. “The Role of Corporate Governance Participants in
Preventing and Detecting Financial Statement Fraud.” Journal of Forensic and Investigative
Accounting 4, no. 2, pp. 176–205.
Ibid.
Ibid.
E. Dash. August 27, 2006. “Who Signed Off on Those Options?” The New York Times.
Available at https://www.nytimes.com/2006/08/27/business/yourmoney/27mercury.html
Ibid.
Ibid.
A.P. Lebowitz. August 3, 2005. “The WorldCom Directors Settlement: The Lead Plaintiff’s
Perspective,” NAPPA Report 9.
Ibid.
Ibid.
Ibid.
Institute of Internal Auditors (IIA). 1985. Statement of Internal Auditing Standards No. 3:
Deterrence, Detection, Investigation and Reporting of Fraud (Altamonte Springs, FL: IIA).
IIA. April 8, 2002. “Recommendations for Improving Corporate Governance.” A Position
Paper Presented by the IIA to the U.S. Congress. http://www.theiia.org/ecm/guide-pc.cfm?
doc_id=3602 (http://www.theiia.org/ecm/guide-pc.cfm?doc_id=3602)
Z. Rezaee. 2002. “Internal Auditors’ Roles in Prevention, Detection, and Correction of
Financial Statement Fraud,” Internal Auditing 17, no. 3, pp. 13–20.
American Institute of Certified Public Accountants (AICPA). 1997. Statement on Auditing
Standards No. 82: Consideration of Fraud in a Financial Statement Audit. Available at
https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-
00240.pdf
AICPA, 2002.
Ibid.
Public Company Accounting Oversight Board (PCAOB). 2011. Looking Ahead: Auditor
Oversight. http://pcaobus.org/News/Speech/Pages/04042011_DotyLookingAhead.aspx
(http://pcaobus.org/News/Speech/Pages/04042011_DotyLookingAhead.aspx)
Ibid.
AICPA, 2002.
38.
39.
40.
41.
42.
43.
44.
45.
46.
47.
48.
49.
50.
51.
P.K. Jain, A. Jain, and Z. Rezaee. 2016. “Value-Relevance of Corporate Social Responsibility:
Evidence from Short Selling,” Journal of Management Accounting Research 28, no. 2, pp.
29–52.
ACFE. n.d. Career Path—Forensic Accountant. http://www.acfe.com/career-path-forensicaccountant.
aspx#job (http://www.acfe.com/career-path-forensic-accountant.aspx#job), (accessed July 7,
2018).
Certified Fraud Examiner, Fraud Detection Services, Fraud Auditor. 2003.
http://www.ltplanning.com/audit.htm (http://www.ltplanning.com/audit.htm), (accessed June 25,
2018).
Ibid.
ACFE. n.d. Career Path—Public-Sector-Investigator. http://www.acfe.com/career-pathpublic-
sector-investigator.aspx (http://www.acfe.com/career-path-public-sector-investigator.aspx), (accessed
June 26, 2018).
ACFE. n.d. Career Path—Private-Sector-Investigator. http://www.acfe.com/career-pathprivate-
sector-investigator.aspx (http://www.acfe.com/career-path-private-sector-investigator.aspx),
(accessed June 26, 2018).
L.A. Bebchuk, and A. Ferrell. 2014. “Rethinking Basic,” The Business Lawyer 69, no. 3, pp.
671–97.
Ibid.
Security and Exchange Commission (SEC). 2013. SEC Announces Enforcement Initiatives to
Combat Financial Reporting and Microcap Fraud and Enhance Risk Analysis. Available at
https://www.sec.gov/news/press-release/2013-2013-121htm
Ibid.
SEC. 2017. Securities and Exchange Commission Division of Enforcement—Enforcement
Manual. https://www.sec.gov/divisions/enforce/enforcementmanual.pdf
Ibid.
Ibid.
Securities and Exchange Commission. 2017. Enforcement Manual. Office of Chief Counsel.
https://www.sec.gov/divisions/enforce/enforcementmanual.pdf
CHAPTER 4
Challenges and Opportunities in
Forensic Accounting
Executive Summary
High-quality financial information is the lifeblood of capital markets, and that
lifeblood can be adversely affected by the existence and persistence of financial
statement fraud (FSF). Forensic accounting has made impressive progress in the
past two decades in the aftermath of financial scandals at the turn of the twentyfirst
century and the 2007 to 2009 global financial crisis. Forensic accounting has
moved to the center stage of accounting as the most challenging, exciting, and
rewarding field of accounting. This chapter presents emerging issues in forensic
accounting in the areas of litigation consulting, expert witnessing, valuation, and
fraud investigation.
Introduction
Forensic accounting has evolved in the past decade as primarily a fraud
investigation to the full pledged nonfraud accounting and investigative activities.
There are still many challenges in forensic accounting, and this chapter presents
these challenges and the related opportunities. Challenges presented in this chapter
are forensic accountants’ involvement with risk assessment, cyberattacks, corporate
governance, and information technology (IT). This chapter also presents emerging
issues in fraud and nonfraud forensic accounting services.
Forensic Accounting Challenges and Opportunities
Forensic accounting fraud and nonfraud services are challenging and rewarding.
Owing to advancements in technology, forensic accountants need improved skills to
properly and accurately use IT, Big Data, and data analytics to improve the
effectiveness of their forensic accounting services. Analytical skills are often used to
tackle Big Data, which is becoming more prevalent in businesses, particularly in
larger firms. Specific skills include database manipulation and slice and dice. These
techniques are IT-related, because the accounting field is moving toward data
analytics, data mining, and manipulation of data instead of codifying data. Owing
to this advancement in technology, forensic accountants’ job opportunities are
increasing. According to Association of Chartered Certified Accountants (ACCA),
the rise of corporate governance is leading to increasing demand. Corporate
governance measures are designed to hold corporate gatekeepers accountable and
to oust unethical and illegal business practices. Forensic accountants investigate
these practices and aid in the trail process during litigation procedures.
The rise of emphasis on corporate governance is a direct result of recent wellknown
fraud cases such as Enron and WorldCom, among others. Fraud cases
presented in previous chapters suggest that ineffective corporate governance has
contributed to the existence and persistence of financial statement fraud (FSF).
Forensic accountants understand that fraud happens from an ineffective corporate
governance, insufficient internal controls, and improper regulations and standards.
Forensic accountants often advocate for open communication, established
oversight, and a set of rules that punish the guilty to solidify corporate governance.
If fraud happens, often because of failures in corporate governance, forensic
accountants will review financial statements, identify red flags and areas of high
risk for fraud potential, and follow red flags to fraudulent behavior.
Forensic Accounting Opportunities
Forensic accountants have provided a variety of fraud and nonfraud services,
including FSF investigation, litigation consulting, expert witnessing, and valuation,
1
2
3
1.
among other services. These services have contributed to the success of businesses
and individuals as well as the accounting profession. Many professional
organizations, particularly the Big 4, have established expertise and market niche in
forensic accounting. Deloitte has a project deliver analyst position, which requires
assistance with federal investigations, anti-money laundering (AML) compliance,
support tasks, and analysis of fraud, whereas KPMG, PwC, and EY have similar
positions. In the government sector, the Tennessee Bureau of Investigation (TBI)
has forensic services divisions located in Nashville, Knoxville, and Memphis, in
which employees investigate crime scenes, respond to violent crime, and examine
medical material. The Committee of Sponsoring Organizations of the Treadway
Commission (COSO) released its “Fraud Risk Management Guide” in September
2016, that encourages engagement of all corporate gatekeepers including the board
of directors, management and internal and external auditors, legal counsel, and
forensic accountants in FSF risk assessment and management.
The Securities and Exchange Commission (SEC) has recently taken three initiatives,
namely, the Financial Reporting and Audit Task Force, the Microcap Fraud Task
Force, and the Centre for Risk and Quantitative Analytics to investigate and combat
FSF. Forensic accounting practices are exciting and rewarding. The forensic
accounting field is experiencing rapid growth. The rise of technology has increased
the number of jobs and requirements for forensic accountants. The ACFE released a
global study in 2017 that showed a 31-percent increase in compensation when a
forensic accountant obtains a Certified Fraud Examiner (CFE) certification. The
average annual salary for a forensic accountant, according to Glassdoor statistics, is
$80,464.
Challenges for Forensic Accountants
Forensic accountants are facing many challenges in successfully performing their
professional services. The most prevailing challenges for forensic accountants are in
the areas of fraud investigation, risk assessment, and corporate governance, among
others, addressed in this section.
Financial Fraud Investigation
FSF is defined in previous chapter as deliberate misstatement or omission of
amounts or disclosures of financial statements to deceive financial statement users,
particularly investors and creditors. There is a variety of FSF schemes as discussed
in the previous chapters. The motivation to commit FSF not only comes from
pressures that are placed on management to succeed but also comes from
departmental budget requirements including income and profit goals. FSF is
harmful in many ways; for example it :
Undermines the reliability, quality,
transparency, and integrity of the financial
reporting process. An increasing number of
financial restatements and recent
enforcement acts by the SEC against big
corporations (e.g., Enron, WorldCom,
Xerox, ImClone, Global Crossing, Qwest,
Halliburton, Bristol-Myers, Tyco, Dynegy,
Adelphia Communications, and Computer
Associates) for alleged FSF has severely
undermined the public confidence in the
veracity of financial reports.
4
5
6
7
8
9
10
2.
3.
4.
5.
Jeopardizes the integrity and objectivity of
the auditing profession, especially auditors
and auditing firms. Andersen, one of the
Big-5 CPA firms, during the past several
months, has dismantled its international
network and allowed offices to join rival
firms. The jury’s guilty verdict of
obstruction of justice effectively ended
Andersen’s audit practice.
Diminishes the confidence of the capital
markets, as well as market participants, in
the reliability of financial information. The
capital market and market participants,
including investors, creditors, employees,
and pensioners, are affected by the quality
and transparency of financial information
they use in making investment decisions.
Makes the capital market less efficient.
Auditors reduce the information risk that
may be associated with the published
financial statements and thus make them
more transparent. The information risk is
the likelihood that financial statements are
inaccurate, false, misleading, biased, and
deceptive. By applying the same financial
standards to diverse businesses and by
reducing the information risk, accountants
contribute to the efficiency of our capital
markets.
Adversely affects the nation’s economic
growth and prosperity. Accountants are
6.
7.
expected to make financial statements
among corporations more comparable by
applying the same set of accounting
standards to diverse businesses. This
enhanced comparability makes business
more transparent, the capital markets
more efficient, free enterprise system
possible, and the economy more vibrant
and prosperous. The efficiency of our
capital markets depends on receiving
objective, reliable, and transparent
financial information. Thus, the accounting
profession, especially practicing auditors,
plays an important role in our free
enterprise system and capital markets.
However, Enron, WorldCom, and Global
Crossing debacles cast some doubt that the
role of accountants can be compromised.
Results in huge litigation costs.
Corporations and their auditors are being
sued for alleged FSF and related audit
failures by a diverse group of litigants,
including class action suits by small
investors and suits by the U.S. Department
of Justice. Investors are also given the right
to sue and recover damages from those
who aided and abetted securities fraud.
Destroys careers of individuals involved in
FSF such as top executives being barred
from serving on the board of directors of
any public companies or auditors being
barred from practice of public accounting.
8.
9.
10.
Several senior executives of Adelphia
Communications were arrested on July 24,
2002, for allegedly committing fraud by
stealing hundreds of millions of dollars
from the battered cable company and
engaging in financial shenanigans.
Causes bankruptcy or loss of substantial
economic losses by the company engaged
in FSF. WorldCom, with $107 billion in
assets and $41 billion in debt, finally filed
for Chapter 11 bankruptcy protection on
July 21, 2002. WorldCom’s bankruptcy is
the largest U.S. bankruptcy ever, almost
twice the size of Enron.
Encourages regulatory intervention.
Regulatory agencies (e.g., the SEC)
considerably influence the financial
reporting process and related audit
functions. The current perceived crisis in
the financial reporting process and audit
functions has encouraged lawmakers to
establish accounting reform legislation
(Sarbanes–Oxley [SOX] Act of 2002). The
SOX Act will drastically change the selfregulating
environment of the accounting
profession to a regulatory framework
under the SEC oversight function.
Causes destructions in the normal
operations and performance of alleged
companies. Alleged FSF of Enron,
WorldCom, Global Crossing, and Adelphia
11.
12.
•
•
•
has caused these high-profile companies to
file bankruptcy, and their top executives
have been fined and, in some cases,
indicted for violation of Securities Acts.
Raises serious doubt about the efficacy of
financial statement audits. The financial
community is demanding that high-quality
audits and auditors should improve their
audit effectiveness and efficacy to produce
the needed assurance.
Erodes public confidence and trust in the
accounting and auditing profession. One
message that comes through loud and clear
these days in response to the increasing
number of financial restatements and
alleged FSF is that the public confidence in
the financial reporting process and related
audit functions is substantially eroded.
The COSO released its “Fraud Risk Management Guide” in September 2016, which
suggests a comprehensive monitoring and assessment approach in managing fraud
risk, including FSF by all corporate gatekeepers from the board of directors to
management, internal auditors, external auditors, and others such as short sellers
and forensic accountants. All corporate gatekeepers play an important role in
preventing, detecting, and correcting FSF, as depicted in Exhibit 4.1.
FSF is intentional wrongful acts by management to mislead shareholders and other
stakeholders by presenting materially misstated financial reports. This type of fraud
is intentionally committed to benefit the company to the detrimental of
shareholders or engaging in fraud against the company involving misappropriation
of assets. The elements of fraud are as follows:
A false representation of a material nature
Knowledge that the representation is false
or reckless disregard for the truth
(Scienter)
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Reliance on the false representation by the
victim
Financial damages are incurred (to the
benefit of the perpetrator).
The act was intentional.
The important element of management and occupational fraud is the intent and
knowingly engaging in fraud. Although “intent” is an element of fraud, the presence
of “intent” is difficult to prove in fraud cases by “direct” evidence. Thus, forensic
accountants usually focus on other three elements of fraud, as depicted in Exhibit
4.2. The three elements are “The Act,” “The Conversion,” and “The Concealment”
that are the metrics used by forensic accountants in analyzing corporate fraud. The
“Act” is usually the theft or engaging in FSF. The “Concealment” usually involves
efforts to conceal the “Act.” “Conversion” is when the fraudsters convert the assets
to their own benefit. The Act involves the actual perpetration of fraud, for example,
taking cash or the misappropriation of assets. Conversion involves converting
business resources for personal use and/or transferring the business and its
resources to others. Concealment involves the actions and steps taken by the fraud
perpetrators to hide fraud by destroying documents and evidence, changing the
business structure, and altering financial records.
Exhibit 4.1
Financial Statement Fraud: Functions, Actions, and Consequences
Exhibit 4.2
Elements of Fraud as Proxies for Intent/Scienter/Knowledge of Wrongdoing (Dimond
of Fraud Actions)
Source: This Dimond of fraud actions is developed based on the original triangle of
characteristics of the crime by Albrecht, S., C.O Albrecht. C. C.C Albrecht. 2006. Fraud
Examination, 2 Edition, Thompson, South Wetern, Canada.
Digital Forensics
Digital forensic is the merging area of practice for forensic accountants that create
both challenges and opportunities for them. Particularly, digital analysis can serve
as an effective tool in identifying material errors and irregularities and detecting
fraud. Digital forensics, including computer forensics and network forensics, is a
digital data analytics technique used in investigating and analyzing evidence in
online computer networks. There are multiple types of software that can be used to
analyze digital data. An example includes the Forensic Toolkit, which often is called
the FTK. The FTK is produced by ACCESSDATA, which is a forensic service firm
founded in 1987 to help clients address fraud using its software. The toolkit itself
has been ported over to mobile and e-technology platforms to further its mobility.
According to Grant Thornton, a modestly sized accounting firm, the use of FTK is
prevalent in its offices. In terms of software function, it locates evidence and then
analyzes the location it originated from. The evidence is stored in a central database
making it easy to access. Along with ease of accessing, having a central database
reduces cost of maintenance. For more information pertaining to the forensic
toolkits functionality and Grant Thornton’s opinion on the software, please visit
accessdata.com (http://accessdata.com).
Benford’s law, one of the most commonly used techniques, is used in digital
analysis. In applying the Benford’s law, a forensic accountant could extract the first
number from a dataset using the “Left” function in excel, and then execute a
“Sumif” function to calculate the percentage of numbers that begin with 1–9. In a
normal dataset, there will be more 1’s than 2’s, 2’s than 3’s, 3’s than 4’s,
consecutively. Other digital analysis techniques include:
Searching for duplicate transactions, searching for rounded amounts, and performing ratio
analysis in which the ratio of the highest value to the lowest (maximum/minimum), the ratio
of the highest value to the next highest (maximum/second highest), and the ratio of the
current year to the previous year are analyzed.
The importance of digital forensics is ever increasing in the current business
environment, because companies are moving toward a reduced, or paperless
environment. A byproduct of this shift is an increasing proportion of digital to
nondigital evidence. A fraud examiner proficient in digital forensics can recover
seemingly deleted documents, e-mails, files, programs, and so on, by having
proficient knowledge of a computer’s registry. This change in environment works in
the favor of the fraud examiner because, previously, if a paper file and its backups
were destroyed the file would be gone. However, in computerized systems it is
much more difficult to delete all traces and backups of a file owing to the sheer
amount of storage possibilities. Digital fraud is growing as e-commerce strategies
are becoming more common business practices, and thus digital fraud perpetrators
are fined for engaging in digital fraud transmitting by means of wire, radio, or
television communication in interstate or foreign commerce, any writings, signs,
signals, pictures, or sounds for the purpose of executing such scheme or artifice.
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Big Data and Data Analytics
IT advances (e.g., cloud, social media, and analytics) enable organizations to have
an unprecedented amount of structured, semi-structured, and unstructured data.
The emergence of “high-volume, high-velocity, and high-variety” information that
can be processed electronically to facilitate decision making is usually described as
Big Data. Big Data has also received common acceptance and practical application
in the business community. For example, more than 98 percent of all stored
information is electronic, compared with about 25 percent of such information,
which was digital in 2000. Because traditional rules-based relational database
techniques, such as matching, sorting, filtering, and query design, often result in
false positives or missed fraud detection opportunities, forensic accountants
nowadays incorporate data visualization, predictive analytics, behavior analytics,
content analytics, social network analysis, geo-spatial analytics, and numerous
advanced antifraud techniques.
Forensic accountants are now able to obtain a huge amount of both structured (e.g.,
general ledger or transaction data) and unstructured data (e.g., e-mail, voice, or
free-text fields in a database), together with an increasing amount of nontraditional
data sources such as third-party watch lists, news media, free-text payment
descriptions, e-mail communications, and social media. As a result, forensic
accountants use advanced technological tools in the investigation. For example,
forensic accountants use social media and web monitoring, voice searching and
analysis, visualization, and reporting tools. There is a shortage of forensic
accountants who possess Big Data/analytical skills and are able to use sophisticated
analytical tools to effectively and accurately identify potential risks and proactively
search for irregularities and assess and manage their risk profile. The growing
demand and inadequate supply of Big Data professionals raises the question
whether there is adequate training related to Big Data at the
undergraduate/graduate level in the forensic accounting education. The integration
of Big Data into the forensic accounting and business curriculum supports the
market demand in these two areas and keeps the business curriculum aligned with
the practices.
The following examples illustrate the use of Big Data (analytics) in the forensic
accounting practice. First, when forensic accountants investigate fraud, corruption,
or bribery cases, they take industry-specific norms or regulations into consideration
and use keyword phrases to identify potential frauds. Second, by utilizing historical
activities or transaction data, forensic accountants can use predictive modeling and
other advanced analytics to detect suspicious and anomalous transactions, highrisk
events, or potential fraudulent behaviors or activities. Third, by mining across
multiple sources of databases (e.g., customer or third-party databases), forensic
accountants can use entity resolution algorithms to identify hidden relationships,
addresses, and aliases and investigate conflicts of interest, fake identities, or
sanctioned individuals/entities.
Fourth, forensic accountants use social network analytics to detect hidden
relationships, bogus vendors, or fake bank accounts when they analyze both
structured and unstructured data in the format of visuals and links from social
media. Fifth, a large amount of unstructured text data is available from the free-text
field of journal entries, payment description, expense details, e-mails, social media,
documents, presentations, and hard drives of individual employees or the
organizations. Forensic accountants use text mining or text analytics with heuristic
rules and statistical techniques to discover the sentiments and conceptual meanings
of large amounts of text data, which help to identify potential frauds or
noncompliance in the organization. Finally, besides traditional simple spreadsheets
or static charts and graphs, forensic accountants use data visualization techniques
and interactive dashboards to present evidence in an easy-to-understand manner.
Data analytics has the potential to significantly improve the effectiveness and
efficiency services performed by forensic accountants. Data analytics have been
used by accountants and auditors for many years, and forensic accountants should
use more advanced data analytics in identifying red flags, patterns of errors,
irregularities, and fraud. Data warehousing and data mining techniques are the
process of identifying and analyzing patterns in massive datasets to predict future
norms. Data mining is the process of exploring large datasets to discover patterns
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2.
3.
and predictive analytics through use of algorithms. This process has been
exaggerated through the many prevalent software. The most popular software
includes Microsoft SharePoint, Dundas BI, and IBM Cognos Analytics. Data
warehousing is a database linking relationships to queries. Data warehouses are not
used to process transactions, and it uses historical transaction data to consolidate
useable data to be analyzed.
Forensic accountants use the above-mentioned techniques during investigations.
For data mining, Dundas BI can be used to analyze data. This software can provide
real-time data analysis and can use visualizations to aid in easy understanding of
complex data. According to the Dundas website, dashboards can be combined with
data and exported into different business applications. The applications include
Microsoft SharePoint and HTML5. Microsoft SharePoint is used to create websites
for businesses. The website can use HTML5, which is the latest evolution of
HTML and is a markup language that allows the usage of documentation.
Forensic accountants can use these powerful tools during investigations to
articulate important data through visualizations that are easy to understand.
The use of analytical procedures as substantive evidence gathering requires that
forensic accountants pay attention to underlying relationships and develop a
precise and independent expectation of the account balance and related risks (i.e.,
the inherent and control risk). If there are any unexpected differences, they should
be assessed and their impacts be evaluated. Analytical procedures provide indirect
evidence and as such draw auditor attentions to things out of norm, irregularities,
and red flag symptoms. In the case that an explanation for the abnormalities cannot
be obtained, forensic accountants should perform other procedures to gather
sufficient evidence that the abnormalities were not caused by a misstatement.
Analytical procedures can be particularly effective for assertions in which potential
misstatements are not apparent or where evidence is not available. When higher
levels of assurance are required, analytical procedures should be applied to more
predictable relationships. Relationships involving transactions subject to
management discretion and those pertaining to balance sheet are less predictable
by nature.
Scholars have used a wide range of data sources, well-developed core analytics
capabilities, and integration of the Internet of things (IoT) and artificial intelligence
(AI) into processes to improve their engagement and interactions with customers.
The following are the advantages of using data analytics:
Competitive advantage from analytics
continues to grow as more than half (59
percent) of executive report their company
is using analytics to gain a competitive
advantage.
Analytics is driving customer engagement
because the most analytically mature
organizations are twice as likely to report
strong customer engagement as the least
analytically mature organizations.
Analytically mature organizations use more
data sources to engage customers.
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4. Sharing data can improve influence with
customers and other groups.
EY conducted a Global Forensic Data Analytics Survey in 2018. The survey
focused on technological advancement and its effect on businesses. As technology
advances, the risk profile of business changes. The most important risks affecting
firms today are data privacy and cybersecurity, at a 40 percent increase and 38
percent, respectively. However, the effectiveness of forensic data analytics on fraud
risk management reveals that for the largest category, internal investigations has 50
percent of respondents claiming that the FDA method is somewhat effective. This is
indicative of a lack of connection between fraud risk profile, fraud risk management
of the profile, and the use of forensic data analytics to mitigate the inherent risks of
technology. In practice, it is important for forensic accountants to use the
necessary skills to work in the era of technological era.
Corporate Governance Challenges
Corporate governance has evolved as a central theme for public companies in the
aftermath of the 2007 to 2009 global financial crisis. In today’s global environment,
business organizations are under scrutiny and profound pressures from lawmakers,
regulators, the investment community, and their diverse stakeholders to accept
accountability and responsibility for their corporate governance effectiveness and
financial reporting process. Corporate governance is a process (journey) of
managing corporate affairs to create shareholder value while protecting interests of
other stakeholders. Corporate governance can strengthen the safety, efficiency,
depth, and liquidity of capital markets and reliability of public financial
information. Effective corporate governance ensures strong investor protection,
giving rise to high-quality financial reports, which enables investors to make sound
investment decisions. Forensic accountants can investigate corporate irregularities,
illegal acts, and fraud as well as prevent, discover, and correct them to improve the
reliability of financial reports used by investors.
Sound investment decisions by investors improve efficiency of capital markets that
results in economic prosperity and growth for the nation. Corporate governance has
been transformed from simply a routine set of compliance requirements to a
strategic business imperative. The integrity, reliability, and transparency of
financial reports is a function of corporate governance effectiveness. Corporate
governance measures and practices have become a mandate for both public and
private firms, regardless of their size, type, or location. No longer is corporate
governance just seen as one of many compliance requirements. Today, good
corporate governance measures and procedures are being actively integrated into
the corporate culture, business model, and the environment of companies across
the country and around the world to ensure accountability and sustainability.
Corporate gatekeepers are the focal point of these efforts and the conduits of
company information to shareholders, management, customers, suppliers,
financiers, government, and the community.
Competition among global capital markets can be healthy in producing an adequate
level of protection for investors through the right balance of corporate governance
and regulatory reforms. Corporate governance functions constitute an important
element of the corporate governance structure. There are seven essential corporate
governance functions: oversight, managerial, compliance, internal audit, advisory,
external audit, and monitoring. A well-balanced implementation of these seven
interrelated functions produces effective corporate governance, reliable financial
reports, and credible audit services. This integrated approach underscores and
reaffirms the primary goal of corporations to create sustainable shareholder value
while protecting the interests of other stakeholders. Given that the primary purpose
of any business, particularly public companies, is to create substantial and enduring
value, the goal of corporate governance is to ensure that all participants are working
to achieve this goal.
The seven interactive functions should be properly integrated into the overall
corporate culture, business environment, and corporate strategy and accountability.
Three of these seven functions, however, are essential to the achievement of
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sustainable and long-term corporate performance. These corporate governance
functions are the oversight function assumed by the board of directors, the
managerial function delegated to management, and the monitoring function
exercised by shareholders. Effective corporate governance should develop a right
balance between the achievement of short-term targets and long-term sustainable
performance. To effectively fulfill their fiduciary duties, corporate governance
participants should lead from the front and by example in managing the
organization for the best interests of its stakeholders. Corporate governance should
create an appropriate balance of power-sharing that:
provides shareholder democracy in freely
electing directors (e.g., the majority voting
system).
enables the board of directors to make
strategic decisions and oversee and consult
with management without micromanaging.
empowers management to run the
company.
The participants in the corporate governance process are the board of directors,
executives, stakeholders/shareholders, and gatekeepers, including internal
auditors, external auditors, financial analysts, legal counsel, financial advisors, and
regulators. Forensic accountants can provide consulting services to all corporate
governance participants from the board of directors to management and internal
and external auditor and legal counsel in effectively discharging their fiduciary
duties. Forensic accountants in investigating corporate misconduct, irregularities,
fraud, and illegal acts can improve the effectiveness of corporate governance.
Forensic accountants can provide a wide range of services to corporate governance
participants, including anticorruption compliance, forensic technology
investigation, fraud prevention, and dispute services. Compliance services aid in the
minimization of risk associated with manipulation of laws, regulations, and
corporate governance. Fraud perpetrators often commit fraud on the occupation
and management level, so strict compliance is necessary for those positions.
Compliance minimizes risks by testing internal control, enhancing policies
regarding corporate governance and fraud risk management, and correcting fraud
loopholes. Compliance services are usually linked with investigations.
Investigations can vary in subject, but usually revolve around management and
employees.
Whistleblowing Program, Policies and Procedures
Much of fraud is being discovered through unanimous tips from employees,
customers, suppliers, and others. The audit committee of public companies is
responsible for overseeing the establishment and enforcement of whistle-blower
programs in compliance with the requirements of SOX and SEC-related rules.
SOX created the opportunity for confidential and anonymous submissions of
complaints by requiring that the company’s audit committee establish procedures
for receiving, recording, retaining, and treating such complaints. Section 301 of
SOX requires audit committees of public companies to establish effective programs
and procedures for handling the concerns and complaints of whistle-blowers.
Pursuant to the passage of SOX, concerned employees are enabled to report
financial and accounting irregularities as well as fraud without undue fear of
suffering demotion, suspension, harassment, threats, loss of job, or any other form
of retribution.
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To implement provisions of SOX pertaining to whistle-blowers effectively, public
companies should establish whistle-blower programs and procedures that enable
employees to report suspected incidents of misconduct anonymously. These
programs and procedures encompass establishing an effective hotline with a tollfree
number and the capability to accept collect calls, a fax number, a regular mail
address or post office box, and a confidential website. Anonymous reporting
channels may be particularly useful in encouraging the reporting of wrongdoing by
organizational members because anonymity should minimize personal “costs” of
reporting, such as retaliation and other potential penalties. A benefit of such
channels is that employees often discover FSF before other monitors (e.g., internal
auditors, external auditors, and/or regulators) and, consequently, often can inform
the organization earlier than others.
The past decade, particularly the post-SOX period, provides a better understanding
of what whistle-blowers are and the important role they can play in preventing,
reporting, and correcting corporate corruption, fraud, and financial malfeasance.
Whistleblowers at Enron (Sherron Watkins) and WorldCom (Cynthia Cooper)
prove that they are often the brightest, best qualified, most courageous, and most
committed employees in organizations who risk their employment and life for
speaking out about wrongdoings. Sections 301 and 806 of SOX and SEC-related
rules require (1) the audit committee to establish procedures for the receipt,
retention, and treatment of complaints received by the company relevant to
accounting, internal accounting control, or auditing matters as well as confidential
and anonymous submission by employees of concerns regarding questionable
accounting or auditing matters; and (2) that the company provide whistle-blower
protections for its employees who willingly report evidence of fraud or violations of
securities laws. SOX and the SEC do not require any specific procedures for
whistle-blower programs and procedures and give flexibility to the listed companies
and their audit committees to establish whistle-blower programs and procedures
that are suitable for and tailored to their particular situations.
The SOX of 2002 and SEC-related rules require that the audit committee establish
and maintain appropriate whistle-blower programs for the receipt, process, and
retention of complaints regarding internal control accounting and auditing
matters. Such programs must establish procedures and mechanisms that
encompass the confidential and anonymous submission of concerns on
questionable accounting and auditing matters by employees. The SEC requires that
the audit committee establish specific mechanisms tailored and suitable to the
company’s circumstances and needs for whistle-blower programs. The whistleblowing
program must be established in compliance with both the SOX of 2002 and
the Dodd–Frank (DOF) Act of 2010. Section 301 of the SOX contain whistleblowing
provisions that require the audit committee to establish policies and
procedures regarding the receipt, retention, and treatment of complaints about
violations of accounting and auditing standards, and Section 806 prohibits
retaliations against whistle-blowers.
Section 806 of the DOF of 2010 provides protections for whistle-blowers in
securities fraud cases and has directed the SEC to establish rules regarding
confidential and anonymous submissions of violations of security laws and conduct
of fraudulent and unethical activities by public companies. Whistleblowers are
protected and rewarded for informing the SEC of corporate wrongdoings. Forensic
accountants can assist the audit committee to assess the effectiveness of the
whistle-blowing policies, procedures and practices. Forensic accountants can also
be source of information for the SEC in investigating and enforcing its whistleblowing
processes.
Sustainability Reporting and Assurance and Forensic Accountants
Business sustainability has garnered considerable attention in the wake of the
recent global financial crisis and is now emerging as a central issue for regulators
and public companies. In particular, business sustainability focuses on protecting
interests of all stakeholders from shareholders to creditors, employees, customers,
suppliers, government, environment and society. Thus, effective sustainability
performance is expected to better align interests of management with those of all
stakeholders and better protect them from receiving fraudulent financial
information. Thus, effective sustainability performance improves sustainable
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financial health, corporate governance, quality of financial information, enhances
the integrity and efficiency of the capital market, and improves investor confidence.
Poor sustainability performance adversely affects corporate governance, the
company’s potential, performance, financial reports and accountability and can
pave the way for business failure, fraudulent public financial information,
inefficiency in capital markets and loss of investor confidence. The important
question address in section is “Do firms that issue sustainability report engage less
in FSF and what forensic accountants can do to prevent and detect FSF in the
context of sustainability reporting and assurance?”
The holistic and comprehensive definition of sustainability reporting is the process
of disclosing information relevant to both financial and nonfinancial key
performance indicators (KPIs) for all five areas of multiple bottom line
performance: economic, governance, social, ethics, and environmental (EGSEE).
Sustainability disclosures affect financial reporting quality in several ways. First,
sustainability reporting reduces incentives for focus on short-term performance of
manipulating earnings to meet analysts’ earnings forecast. Second, sustainability
reporting focuses on improving corporate governance which will reduce
opportunities to engage in fraudulent financial activities. Third, sustainability
disclosures reduce information asymmetry which improves quality of financial
reports. Forensic accountants are capable of assisting business organizations in
avoiding short-termism phenomenon, combatting fraudulent activities and
minimizing information asymmetry.
The number of public companies worldwide that disclose sustainability
performance information has increased significantly to more than 15,000, and
today, most European companies are now disclosing their sustainability
performance information. The reliability and credibility of these integrated
sustainability reports need to be assured by assurance providers and forensic
accountants can provide assurance on the integrated sustainability reports. To
integrate sustainability into corporate culture, strategic planning and business
environment forensic accountants can assist management in establishing and
implementing anti-fraud policies and procedures consisting of:
Defining sustainability shared value
creation in the organization
Identifying and assessing the positive and
negative impact of trends shaping the
organization’s five EGSEE.
Identifying non-financial metrics on nonfinancial
dimensions of sustainability
performance (governance, social, ethical,
and environmental)
Linking non-financial sustainability
performance metrics to the sustainable
financial success of the business.
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Preparing integrated sustainability reports
reflecting both financial and non-financial
information.
Obtaining assurance on sustainability
reports from external assurance providers
including forensic accountants.
Forensic Accountants and Internal Control Reporting
Traditionally, organizations have reported their performance on economic affairs
and their only focus on financial results has become complicated, irrelevant, and
less value-relevant to all stakeholders including shareholders. Firm performance is
measured not only by financial income, but also by the mechanisms in which
business success and sustainability is measured in terms of non-financial
sustainability key performance indicators pertaining to environmental, social,
governance, and ethical activities. Public companies play an important role in
disseminating useful, reliable, relevant, and transparent financial/quantitative and
nonfinancial/qualitative information to the financial markets. Public companies are
now not only report their financial statements but also the process of preparing
financial statements in the context of reporting their internal control over financial
reporting (ICFR).
The reliability of financial statements, the effectiveness of ICFR, and the efficacy of
audits of both financial statements and ICFR under integrated financial and
internal control reporting (IFICR) are vital if public companies are to attract
investors and build confidence in the capital markets. Many provisions of the
Sarbanes–Oxley Act of 2002 (SOX) pertain to financial reporting, including
Sections 302 and 404, which require public companies’ management (CEO, CFO)
to certify financial statements and report on the effectiveness of the company’s
ICFR and require auditors to attest to and report on both financial statements and
ICFR. Section 302 requires that the audit committee oversees the work of
management and the independent auditor as related to ICFR. The audit
committee’s oversight of Section 404 is essential, as mandatory ICFR is becoming
an integral part of financial reporting. The effectiveness of the IFICR depends on
the vigilant oversight function of the board of directors, particularly the audit
committee, the responsible and accountable managerial function of senior
executives, the credible external audit function of the independent auditor, and the
objective internal audit function of internal auditors.
IFICR reports are expected to reduce the information risk that financial
information is misleading, biased, incomplete, inaccurate, or fraudulent. In this
context, audits reduce financial information asymmetries between management
and shareholders and thus help investors to make more informed decisions that in
turn make the capital markets more efficient and add to the nation’s economic
prosperity. Management is ultimately and directly responsible for the reliability and
quality of all internal and external financial reports including IFICR. Internal
auditors assist management in the proper assessment, documentation and
reporting of IFICR. External auditors lend more credibility to IFICR by providing
reasonable assurance on the effectiveness of internal controls and the reliability of
financial statements. Companies of all sizes and types worldwide benefit from an
effective IFICR. Proper preparation and reporting of IFICR requires public
companies to obtain:
Management certification of financial
statements in certifying reliability,
completeness, and accuracy of financial
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statements.
Management certification of the
effectiveness of internal control over
financial reporting.
Audit report providing reasonable
assurance that financial statements are free
from material misstatement whether
caused by error or fraud and an opinion
that financial statements are prepared
inconformity with applicable accounting
standards.
Audit report on the effectiveness of
internal control over financial reporting.
Audit committee review and approval of
both management and auditor reports on
financial statements and internal control
over financial reporting.
The board of directors’ declaration that
management and auditor reports on
financial statements and internal control
over financial reporting be filed with
regulators and disseminated to
shareholders.
Forensic accountant can adopt new approaches to assessing risks and controls.
Forensic accountants can monitor how technological innovation is changing
businesses and their corresponding changes to risks and controls. Forensic
accountants can deliver new value by implementing and creating digital tools for
internal control risk assessment and management. Changes in the risk
environment, technological advancements and increasing regulatory pressure have
created new opportunities for forensic accountants to develop new capabilities in
internal control reporting.
Forensic Accountants and Antifraud Program and Plan
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The persistence of this fraud is still a significant concern for the business
community and the accounting profession and has eroded investor confidence in
corporate reports. From Enron and WorldCom in 2001, to Madoff and Satyam in
2009, Olympus in 2011 and Volkswagen in 2015, over the past decade, financial
reporting fraud has been a dominant news item. There has been ample evidence
that financial reporting fraud has undermined the integrity and quality of financial
reports and has contributed to substantial economic losses. Since the passage of the
SOX Act, which was primarily intended to combat financial reporting fraud, there
are more incidents of FRF. Companies of all types and sizes are susceptible to
employee fraud including embezzlements, thefts, and misappropriations of assets
as well as Financial Reporting Fraud (FRF), or “cooking the books,” to show a rosy
picture of the company so that it appears more attractive to investors than it really
is.
Financial reporting fraud can occur in situations where there are unexplained
accounting anomalies, unusually rapid revenue or profit growth, weak internal
controls, and aggressive financial actions by senior management, among other
things. The very viability of the business as well as the safety of financial markets in
general are threatened when the existence and persistence of FRF go undetected.
Financial reporting fraud can be detected with effective corporate governance,
which includes effective antifraud policies and programs by the board of directors,
management, and auditors. Effective antifraud programs, focusing on fraud
awareness and education in the workplace environment, whistle-blowing policies
and procedures of encouraging employees to report suspicious behavior without
fear of reprisals, adequate internal control procedures designed to prevent and
detect fraud, and conducting surprise audits are all examples of actions that the
board of directors, management, and other corporate gatekeepers can take to
significantly reduce FRF. Forensic accountant can assist public companies to
prevent and detect FRF and to minimize its detrimental effects by:
Assessing existing antifraud programs and
controls, establish effective fraud
prevention and detection policies and
procedures, and communicate with the
audit committee and independent auditors.
Conducting a fraud risk assessment
process to identify the company’s risks and
establish related control activities to
effectively prevent and detect fraud.
Evaluating and testing the design and
operating effectiveness of internal controls
to prevent and detect fraud.
Standardizing the processes for fraud
incident investigation and remediation and
enable prompt responses to allegations or
suspicions of fraud.
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Establishing antifraud programs and
controls relevant to both financial
reporting fraud and occupational fraud.
Establishing antifraud deterrence;
prevention, detection, and correction
mechanisms driven from the corporate
culture of setting an appropriate tone at
the top; promoting competent and ethical
behavior and reinforcing antifraud
conduct; and demanding to do the right
thing always.
Forensic Accountants and Enterprise Risk Management
Enterprise risk management (ERM) has recently received considerable attention
from public companies, the business community, and the accounting profession.
Financial scandals of the early 2000s and recent world events, including the
September 11, 2001 terrorist attacks and recent cyberattacks, have generated more
interest in the issue of overall ERM. Natural disasters, such as hurricanes,
earthquakes, and floods, require companies to design adequate and effective
disaster recovery plans and assess their risk of occurrence and their consequence on
operations. Companies should conduct risk assessment periodically to identify
potential risks and design appropriate controls to mitigate their adversarial
impacts. The board of directors, particularly the audit committee, should oversee
the company’s ERM, and both internal and external auditors should be involved in
assessing risks of natural disasters and the protection of important electronics and
other information.
The board of directors should oversee the company’s risk appetite and access timely
information on current and emerging material risk exposures and risk response
strategies, and should implement effective risk management processes. Forensic
accountants can assist public companies and their boards of directors to effectively
fulfill their oversight of risk assessment and management as stated below:
Establishing a risk compliance board
committee by delegating all responsibilities
to such board committee.
Making the entire board of directors
responsible for risk oversight;
Combination of the first two alternatives by
making the whole Board responsible along
with delegation of specific roles and
•
•
responsibilities to Board committees.
COSO releases frequent reports regarding the effectiveness of the ERM framework
on financial statements. In May 2010, the official COSO report was released, which
provided details about key fraudulent events. The study found that most companies
that committed fraud had assets around $100 million and of which executive
management was involved in approximately 90 percent of cases (347 cases total).
Of these cases, the most common fraud schemes were recognizing revenue at the
improper time and manipulation of assets and expenses. Forensic accountants
can assist in design and implementation of the ERM that detects and prevents FSF.
Forensic Accountants and XBRL-Generated Financial Reports
Extensible business reporting language (XBRL) is an application of extensible
markup language (XML) in business and financial reporting. XBRL is now
commonly accepted as the electronic method of business and financial reporting
worldwide. XBRL tools, techniques, and taxonomies have been developed by the
XBRL International Steering Committee available at the XBRL website
(www.xbrl.org (http://www.xbrl.org)). XBRL enables computer systems to assemble data
electronically in instance documents, retrieve data directly from XBRL instance
documents, and convert data into human-readable financial reports. In 2004, the
SEC established a voluntary XBRL filing program under its Electronic Data
Gathering, Analysis, and Retrieval (EDGAR) system. The Federal Deposit Insurance
Corporation (FDIC) has implemented an XBRL filing system for all its banks, and
European financial institutions are using XBRL in more than 25 countries.
In the United States, both regulators (SEC) and standard setters (FASB, PCAOB)
have taken initiatives to address online real-time financial reporting using the
XBRL format and electronic or continuous auditing. Recently, the SEC has
promoted XBRL voluntary reporting and provided a faster review for companies
using XBRL. It is expected that XBRL taxonomies for different industries will be
further developed, and the use of the XBRL format will gain more momentum. A
move toward the global acceptance of XBRL for electronic business and financial
reporting requires auditors to provide assurance by conducting an integrated audit
on XBRL-generated financial statements. An important issue for regulators (SEC),
standard setters (FASB, PCAOB), public companies, and the accounting profession
is to decide whether to require public reporting on XBRL-generated financial
statements and internal control reports at a point in time (periodic filing report
dates, quarterly Form 10-Q, or annual Form 10-K) or on a real-time basis.
Companies, however, should use XBRL-generated financial statements and related
internal controls on a real-time basis for internal purposes.
Forensic accountant can assist in an integrated audit of periodic XBRL-generated
financial statements and internal controls, which requires investigation of the
following:
Internal controls over XBRL taxonomy, the
tagging of data, preparation of the instance
documents, the integrity of the tagged data,
and the consistent application of both
taxonomy and the tagged data.
The effectiveness of both the design and
operation of XBRL internal controls,
including authorization procedures and
selection of the appropriate taxonomy and
40
•
•
1.
2.
3.
4.
tagged data in producing financial
statements.
The XBRL instance documents to ensure
the integrity and reliability of XBRLgenerated
financial statements and
comparability of data contained in the
instance documents and the audited
financial statements.
XBRL-generated financial statements in
conformity with the selected XBRL
taxonomy.
Conclusion
Forensic accounting has advanced as one of the most demanding and rewarding
areas of accounting practices, including fraud examination, anticorruption and
antibribery, business valuation, litigation support, expert witnessing, and
cybersecurity. This chapter presents challenges and opportunities in providing
fraud and nonfraud forensic accounting services. Forensic accounting is a
rewarding and exciting career with much opportunities for advancements and
requirements for a balanced skill sets in technical, analytical, and communication
education and practice.
Action Items
Forensic accounting career is exciting and
rewarding.
Opportunities in forensic accounting are
abundant.
Forensic accounting challenges are
significant.
Demand for and interest in fraud and
nonfraud forensic accounting services are
expected to continue.
Endnotes
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
Journal of Accountancy. 2015. “Big Data Case Study: What Forensic Accountants Need to
Know.” https://www.journalofaccountancy.com/issues/2015/mar/forensic-accounting-bigdata-
case-study.html, (accessed September 9, 2018).
Association of Chartered Certified Accountants (ACCA). March 1, 2017. Demand for
Forensic Accountants Is Growing.
https://www.accaglobal.com/us/en/member/member/accountingbusiness/
2017/03/practice/forensic-accountants.html, (accessed September 24, 2018).
M.L. Bhasin. January, 2017. “Integrating Corporate Governance and Forensic Accounting: A
Study of an Asian Country.” International Journal of Management Sciences and Business
Research 6, no. 1.
Deloitte. 2018. Forensic Accountant.
https://jobs2.deloitte.com/us/en/job/DELOA003X225127/Forensic-Accountant
Tennessee Bureau of Investigation. 2018. Forensic Services Division.
https://www.tn.gov/tbi/divisions/forensic-services-division.html
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 2016. Fraud
Risk Management Guide. https://www.coso.org/documents/COSO-Fraud-Risk-
Management-Final-92816.pdf
Securities and Exchange Commission (SEC). May, 2013. SEC Announces Enforcement
Initiatives to Combat Financial Reporting and Microcap Fraud and Enhance Risk Analysis.
https://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171624975#.UubI41NM
Gih
ACFE. 2017. Compensation Guide for Anti-Fraud Professionals.
http://www.acfe.com/compguide-2017.aspx (http://www.acfe.com/compguide-2017.aspx)
ZipRecruiter. 2018. Forensic Accountant Salary.
https://www.ziprecruiter.com/Salaries/Forensic-Accountant-Salary
Z. Rezaee, and R. Riley. 2009. Financial Statement Fraud: Prevention and Detection (2nd
ed., Hoboken, NJ: John Wiley & Sons, Inc.)
COSO. 2016.
ACCESSDATA. 2017. Forensic Toolkit. https://accessdata.com/products-services/forensictoolkit-
ftk
Ibid.
C. Gomes da Silva, and P.M.R. Carreira. May, 2013. Selecting Audit Samples Using
Benford’s Law. AUDITING: A Journal of Practice & Theory 32, no. 2, pp. 53–65.
R.D. Cannon. 2006. “Computer Forensics for the Fraud Examiner,” ACFE.
http://www.acfe.com/article.aspx?id=4294967651 (http://www.acfe.com/article.aspx?id=4294967651)
Board of Governors of the Federal Reserve System. 2016. Credit and Liquidity Programs
and the Balance Sheet.
http://www.federalreserve.gov/monetarypolicy/bst_riskmanagement.htm
(http://www.federalreserve.gov/monetarypolicy/bst_riskmanagement.htm)
Gartner. 2014. IT Glossary. http://www.gartner.com/it-glossary/?s=big+data
(http://www.gartner.com/it-glossary/?s=big+data), (accessed July 31, 2017).
L. Crumbley, L. Heitger, and S. Smith. 2015. Forensic and Investigative Accounting (7th ed.,
Chicago, IL: Commerce Clearing House).
Ernst and Young (EY). 2016. Global Forensic Data Analytics Survey 2016.
http://www.ey.com/gl/en/services/assurance/fraud-investigation—dispute-services/eyshifting-
into-high-gear-mitigating-risks-and-demonstrating-returns
(http://www.ey.com/gl/en/services/assurance/fraud-investigation%E2%80%94dispute-services/ey-shifting-into-highgear-
mitigating-risks-and-demonstrating-returns), (accessed July 12, 2017).
Ibid.
Oracle. n.d. What Is Data Mining?
https://docs.oracle.com/cd/B28359_01/datamine.111/b28129/process.htm#DMCON002,
(accessed September 27, 2018).
Oracle. n.d. Data Warehousing Concepts.
https://docs.oracle.com/cd/B10501_01/server.920/a96520/concept.htm, (accessed
September 27, 2018).
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
Dundas. n.d. Dundas BI Product Features. https://www.dundas.com/dundas-bi/features,
(accessed September 27, 2018).
Microsoft. n.d. What Is SharePoint? https://support.office.com/en-us/article/what-issharepoint-
97b915e6-651b-43b2-827d-fb25777f446f, (accessed September 27, 2018).
W3. 2017. HTML 5.2. https://www.w3.org/TR/html52/, (Accessed September 27, 2018).
Public Company Accounting Oversight Board (PCAOB). “AU Section 329A—Analytical
Procedures,” PCAOB. https://pcaobus.org/Standards/Archived/Pages/AU329A.aspx
S. Ransbotham, and D. Kiron. January, 2018. “Using Analytics to Improve Customer
Engagement,” MIT Sloan Management Review. http://sloanreview.mit.edu/analytics2018
(http://sloanreview.mit.edu/analytics2018)
Ibid.
EY. 2018. Global Forensic Data Analytics Survey 2018.
https://assets.ey.com/content/dam/ey-sites/ey-com/global/topics/assurance/assurancepdfs/
ey-global-fda-survay.pdf, (accessed September 25, 2018).
Ibid.
BDO. 2018. Forensic Accounting & Investigations.
https://www.bdo.com/services/business-financial-advisory/forensics-andinvestigations/
overview-(1), (accessed September 25, 2018).
Sarbanes-Oxley Act of 2002. Section 301. http://www.sarbanes-oxley.com/section.php?
level=1&pub_id=Sarbanes-Oxley (http://www.sarbanes-oxley.com/section.php?level=1&pub_id=Sarbanes-
Oxley)
Ibid.
Sarbanes-Oxley Act, 2002. Securities and Exchange Commission (SEC). April 9, 2003. SEC
Final Rule: Standards Relating to Listed Company Audit Committees. Release Nos. 33-
8220; 34-47654. http://www.sec.gov/rules/final/33-8220.htm (http://www.sec.gov/rules/final/33-
8220.htm)
Ibid.
Ibid.
SOX 2002. Section 406.
Dodd–Frank Act of 2010.
Z. Rezaee. 2015. Business Sustainability: Performance, Compliance, Accountability and
Integrated Reporting (Sheffield, UK: Greenleaf Publishing Limited).
NC State University. May 3, 2010. COSO Fraud Study 2010.
https://erm.ncsu.edu/library/article/coso-fraud-study
1.
CHAPTER 5
Emerging Issues in Forensic
Accounting
Executive Summary
Existence and persistence of high-profile financial statement fraud (FSF) can be
detrimental to the integrity and soundness of the financial markets and adversely
affect the quality and reliability of public financial information. Forensic
accountants are well-trained and equipped to detect FSF, and thus contribute to the
improvement in quality and reliability of financial reports. This chapter presents
emerging issues and challenges in fraud investigation, including revenue
recognition, fair value estimation, collusion and conspiracy, bribery and money
laundering, and cyberattacks.
Introduction
Forensic accounting has advanced as a rewarding and exiting profession with a
focus on fraud and nonfraud investigation. The area of fraud investigation has
made significant progress in the past decade. However, there are still many
opportunities and challenges in forensic accounting as presented in this chapter.
Forensic accounting job opportunities have increased sustainability. Technological
advances enable forensic accountants to use Big Data and data analytics in
performing digital forensics. Challenges presented in this chapter are forensic
accountants’ practices in areas of proper revenue recognition, fair value estimation,
bribery, money laundering, Ponzi schemes, collusion, and cybercrimes.
Fraud Investigation Challenges
This section presents many challenges associated with fraud investigation
dimension of forensic accounting practices.
Forensic Accountants and Revenue Recognition
Revenue manipulation is the most common type of fraud, even though it can be
very costly because of litigation, restatements, unfavorable audit reports, increased
audit fees, negative market reactions, and investigations and sanctions by SEC. Any
recorded revenues that do not meet the following three criteria can be alleged as
fraudulent and fictitious:
The recorded revenues do not meet the
definition of revenue as defined in
Financial Accounting Standards Board
(FASB) Concepts Statement 3 as “actual or
expected cash inflows (or the equivalent)
that have occurred or will eventually occur
as a result of the enterprise’s ongoing
major or central operations during the
period.”1
2.
3.
They are not measurable and/or cannot be
reliably measured.
They are not verifiable or cannot be easily
verified.
In summary, firms have incentives to manipulate revenues, even though the cost of
revenue manipulation may be high. Knowing the characteristics of firms that will
take the chance of getting caught is important as investors, auditors, and regulators
determine the riskiness attached to particular types of firms. Looking specifically at
revenues and the attempts by managers to increase earnings through revenue
manipulations contributes to earnings management findings by looking at the
costliest form of earnings management and the characteristics of firms that are
willing to suffer the high costs of this type of manipulation. These costs include
litigation by shareholders, investigation and sanctions by the SEC, restatements,
unfavorable audit reports with increased audit fees, and negative market reactions.
In summary, empirical evidence from lawsuits, SEC enforcement actions,
restatements, and audit fees show that revenue manipulations can be the costliest
form of earnings management, which leads to the importance of determining the
characteristics of firms that are willing to take the risks of these significant costs by
manipulating revenues. The high costs associated with these firms increase the
importance of these characteristics to auditors, regulators, and investors so that
they can more easily determine the firms that may be tempted to increase earnings
through revenue manipulations.
There are several methods of engaging in fictitious revenues. The most common
method is to use fake or phantom customers in recoding fictitious revenue. The
second method is to use legitimate customers and intentionally alter or inflate
invoices reflecting higher amounts or quantities than actually sold. Forensic
accountants can assist public companies to detect and prevent improper revenue
recognition.
Fair Value Estimation
The goal of fair value accounting is to enable companies to choose whether or not to
invest by showing not what the asset cost in the past, but what it would cost to buy
today. The subprime scandals of 2008 can be attributed to many factors, including
the improper application of fair value estimates by the real estate appraising
industry. The conflicting interest between real estate appraisal firms and real estate
brokerage firms provided incentives and opportunities for the appraisals to provide
fair value estimates above and beyond reasonable and realistic fair value to get
financing needs to close the deal. Banks had all the incentives and opportunities to
get the highest fair value estimates to provide subprime loans to customers and
then sell the mortgages to mortgage buyers such as Freddie Mac and Fannie Mae,
quasi-government corporations established to buy up mortgages from banks. The
other factor is banks’ securitization vehicles of variable interest entities (VIESs) or
special-purpose entities (SPEs). The appropriate tone set at the top by management
regarding corporate culture within which financial reports are produced is vital to
the integrity of financial reporting process. When the tone set at the top is lax,
fraudulent financial reporting is more likely to occur and cannot be prevented.
The Financial Accounting Standards Board (FASB) has recently promoted the
implementation of fair value principles, with no set definition for fair value. SFAS
157 defined fair value as the exchange price in an orderly transaction between
market participants to sell an asset or transfer a liability in the market in which the
reporting entity would transact for the asset or liability. The focus is on the exit
price, which is the price that would be received to sell the asset or paid to transfer
the liability. SFAS 157 did not require any new fair value measurements but did
provide guidance for determining the fair values of assets and liabilities and
required the disclosure of information about the following: (1) the use of fair value
to measure assets and the extent to which companies measure assets and liabilities
at fair value; (2) the information used to measure fair value; and (3) the effect that
2
1.
2.
fair value measurements have on earnings.
SFAS 157 also established a three-tiered framework for measuring fair value and
dictated that the fair value of all assets and liabilities be disclosed into one of the
following categories on the basis of inputs. It does, however, provide the methods
for developing it. According to Financial Accounting Statement 157, information
relating to the development of fair value is classified into three tiers. Level 1 inputs
include prices for identical assets selling in active markets. Examples of Level 1
inputs include “US government and agency securities, foreign government debt,
listed equities, and money market securities.” Level 2 inputs are defined as
observable information on similar assets that are actively trading. Some types of
Level 2 inputs are “corporate bonds (investment grade, high yield), mortgagebacked
securities, bank loans, loan commitments, less liquid listed equities,
municipal bonds, and certain over-the-counter derivatives.” Level 3 inputs are
unobservable information that has been either calculated or estimated and should
have the least bearing on defining the fair value of the asset. The use of the fair
value method for asset valuation is an attempt by the SEC and FASB to increase the
transparency and relevance of accounting information. Forensic accountants
should use accounting and auditing guidelines in estimating fair values of assets
and liabilities in performing valuation and economic dispute services.
Collusion and Conspiracy
Fraud often occurs because of collusion among fraudsters. Collusion can occur
between executives and the board of directors and other corporate gatekeepers to
mislead investors. Forensic accountants can be hired to discover collusions and
conspiracy that cause fraudulent activities. Forensic accountants should ask very
detailed questions to figure out whether a hint of wrongdoing is present. These
questions are particularly addressed to finance and accounting-related sections of
the company. The reason for this is the day-to-day responsibilities and ultimate
preparation of financial data is left with these sections, and the CEO and CFO
simply must approve the statements. If forensic accountants decide that the
answers to the questions are suspicious, the team should discuss the issues with the
board and other members of the management, especially executives. Forensic
accountants can use red flags to detect collusion. Common red flags include errant
payments, change in behavioral patterns, and drastic changes in financial statement
accounts. Collusion can also be conveyed by whistle-blowing, auditing, and
electronic systems.
Money Laundering
Money laundering can be defined as obtaining money from illegal activity but
passing it off as having been obtained from sources of legal and legitimate business
transactions. Money laundering is the means by which criminals, as a necessity,
disguise the origin of their money so that they may avoid the risk of prosecution.
Whoever transports, transmits, or transfers a monetary instrument or funds from a
place in the United States to or through a place outside the United States or to a
place in the United States from or through a place outside the United States as
follows:
with the intent to promote the carrying on
of specified unlawful activity; or
knowing that the monetary instrument or
funds involved in the transportation,
transmission, or transfer represent the
proceeds of some form of unlawful activity
and knowing that such transportation,
transmission, or transfer is designed in
3
4
5
3.
whole or in part; and
to conceal or disguise the nature, the
location, the source, the ownership, or the
control of the proceeds of specified
unlawful activity.
To accomplish the above-mentioned, money laundering usually falls into the three
stages of placement, layering, and integration. Placement occurs when unlawfully
obtained money is put into financial institutions. Layering occurs when layers of
complex transactions are used to separate the unlawfully obtained money from
their origin. Integration occurs when legitimate transactions are used to disguise
unlawfully obtained money as legitimately obtained money.
To combat these stages, anti-money laundering efforts such as Suspicious Activity
Reports (SARs) and Form 8300 have been put into place. SARs require financial
institutions to fill out a form that brings to the IRS’ attention deposits that may be
irregular, or seem to intentionally avoid crossing the $10,000 threshold that would
require Form 8300. Form 8300 requires that deposits of $10,000 and above be
reported to the IRS. Money laundering has a corrosive effect on a country’s
economy, government, and social well-being. The practice distorts business
decisions, increases the risk of bank failures, takes control of economic policy away
from the government, harms a country’s reputation, and exposes its people to drug
trafficking, smuggling, and other criminal activity.
The National Money Laundering Strategy was published by the U.S. Department of
the Treasury, in 2000, which dictates the required government actions upon those
committing money laundering. These actions include identifying the seven highrisk
areas, known as High-Risk Money Laundering and Financial Crimes Areas
(HIFCAs), a local grant program to fund the pursuance of fraud cases in this
schema. A crime map is present in the financial crimes enforcement network
website. The seven regional areas of high risk are California northern district,
California southern district, the Southwest border, Chicago, New York, Puerto Rico,
and South Florida. Each region lists specific counties or cities that have swaths of
money laundering. In the Northern California district, San Francisco, Santa Cruz,
and Napa are a few locations to monitor. Outside of the area map, the bill itself lists
several ways to develop a framework to combat fraud. A creation of support
program in high crime areas, interconnect between federal, state, and local law
enforcement, and administration of grants to assist in operations are main
components of the bill. Forensic accountants are well-trained and have skill sets
necessary to investigate money laundering.
Bribery
The Foreign Corrupt Practices Act (FCPA) of 1977 discussed in previous chapters
made it illegal for U.S. companies to bribe foreign official and political parties for
the purpose of advancing their business. The FCPA regulates all business conducted
in the U.S. markets, regarding of country of origin. Unlike other cases of fraudulent
behavior, both the public and the government feel it is necessary for companies to
take direct responsibility for the occurrence of bribery. Forensic accountants can be
employed to assess compliance with provisions of the FCPA in detecting and
preventing corporate bribery.
In detecting bribery, risk assessment procedures, and forensic accountants can
identify risk factors that may constitute the presence of bribery and fraudulent
behavior. These factors include previous findings, internal control weaknesses,
timing differences, geographic location, and management policies. The list of
factors can be found in the source attached here. After concluding that fraud may
be present, substantive procedures are performed to address these risk factors. The
accountant must design a strategy that can be used to change the nature and extent
of further investigation. Tests are then conducted to find out specifics about
6
7
8
9
10
11
12
detected bribery. These tests include examination of contracts, transactions, and
fees; FCPA compliance; and contributions. After, the procedures have been
completed, the material needs to be prepared for court. Forensic accountants use
quantitative methods to measure that impact and usability of trial evidence in
litigation. The forensic accounting practice is gaining in popularity due to auditor’s
not being able to satisfy the demand of investors and stakeholders. This has created
an expectation gap that allows the growth of sophisticated fields, such as forensic
accounting.
Ponzi Schemes
Ponzi schemes, according to the Association of Certified Fraud Examiners (ACFE),
is an illegal activity that use new investors’ money to satisfy older investor’s
desires. “Ponzi” schemes promise high financial returns or dividends not available
through traditional investments. Instead of investing the funds of victims, the con
artist pays “dividends” to initial investors using the funds of subsequent investors.
The scheme generally falls apart when the operator flees with all the proceeds or
when a sufficient number of new investors cannot be found to allow the continued
payment of “dividends.” This type of fraud is named after its creator Charles Ponzi
of Boston, Massachusetts. In the early 1900s, Ponzi launched a scheme that
guaranteed investors a 50-percent return on their investment in postal coupons.
Although he was able to pay his initial backers, the scheme dissolved when he was
unable to pay later investors (FBI).
The best-known example of a Ponzi scheme was Bernie Madoff, a stockbroker who
committed the largest Ponzi scheme in ever, estimated at a value of approximately
$65 billion. Forensic accountants can assist in providing an early signal of Ponzi
schemes and other fraudulent activities. Ponzi schemes are enforced by the Federal
Trade Commission (FTC) and the SEC. Forensic accountants identify red flags in
Ponzi schemes. The red flags include pressure tactics, little to no segregation of
duties, and vows of high return and low risk. Red flags are used during
investigations to alert forensic accountants to potential fraud.
Fraud and Information Technology
Organizations of different types and size invest in information technology (IT) and
related resources to meet their goals and objectives. The ever-increasing use of IT
and block-chain platforms and computers in data processing and the application of
various enterprise systems have had significant effects on business processes and
internal controls and financial reporting processes. The potential IT failure and
associated business risk may cause organizations to misjudge or overlook the risk of
material misstatement if they do not understand IT systems and their potentials
and challenges.
Block-chain technology brings smart contracts, smarter supply chains, and the end
of identity fraud. Smart contracts create “if/then” contracts between a buyer and
seller. This results in one step of the selling process not being fulfilled until another
step has been verified. An example of this would be purchasing an item on eBay,
and having the money withdrawn from your account, but held in limbo until the
item in question has been marked shipped. Then the money is released to the seller.
This removes risk for the buyer in not receiving a product (service) and losing their
money as well as removing risk for the seller of not getting paid after delivering a
product (rendering a service).
When looking at supply chains, companies can fight fraud by verifying every part of
the process. For example, a diamond can be tracked from its place of origin to every
hand that touches it along the way, along with serial numbers, photos, details, and
documents of authenticity. As it pertains to fraud, block-chain can serve as a thirdparty
mediator of sorts that can work in any interaction imaginable. Because a
constantly reconciled ledger exists that is only updated when verified by all parties,
an essential part of the fraud triangle is severely hampered—opportunity. Forensic
accountants should use IT platforms in performing fraud and nonfraud services.
Advancements in technology require the adoption of new skill sets by forensic
accountants. Digital forensics, which includes subcategories of computer and
network forensics, is an area forensic accountants work in. Digital forensics
involves the use of software to analyze computer evidence. Accountants must decide
13
14
15
16
17
what evidence is beneficial, how to protect the evidence, and how not to violate an
individual’s right to due process, or the Fourth Amendment of the United States
Constitution. Laboratories are often used to analyze evidence and conduct
substantive procedures. The evidence is used during litigation proceedings to assist
to jury decisions. The rise of the Internet has led to the investigation of crimes such
as intellectual property usage, child pornography, and terrorism. An example of
digital forensics being used to aid in capture of a criminal is the Craigslist killer,
Philip Markoff. The killer hired a masseuse, Julissa Brisman, and killer her. He died
in his jail cell. The police department assigned to the case tracked his IP address
through Craigslist to identify him. The department also navigated his e-mail
exchange between him and the masseuse. Another example of digital forensic being
used to catch a criminal is Dr. Conrad Murray. He was the doctor for Michael
Jackson, who died from an overdose of the drug Propofol. The forensic team
investigated Dr. Murray’s computer and found evidence of lethal amounts of
prescriptions given to Michael Jackson. This resulted in 2 years and prison and
forfeiture of his medical license.
Digital forensics has seen many advances in the past 10 years. Several universities
have developed curricula to teaching students the changing accounting field. West
Virginia has a computer forensics program funded by Microsoft that teaches
knowledge pertinent to law enforcement. The program is designed to protect
against technology attacks. La Salle University offers a certificate in fraud and
forensic accounting. The courses required include fraud examination, occupational
fraud, and cyber fraud, to name a few. Lastly, Stevenson University offers a
Master’s in Forensic Accounting with classes in mock trial, investigation, business
valuation, and IT.
Cyberattacks and Cybercrime
A growing incident of cyber-hacking and cybersecurity breaches of information
systems (e.g., Sony, Targets, JPMorgan Chase, Home Depot, and Equifax) threats
sustainability of many firms and cost the U.S. economy more than $100 billion
annually. The Equifax cyber breach is considered as the largest data breaches in
history and expected to affect nearly half of the population in the United States
(about 143 million Americans). Hackers were able to hack Equifax system, one of
the three major consumer credit agencies, between May and July 2017 because of
the weak points in its website software. These initiatives and guidelines suggest
that board risk oversight function, managerial strategies, and adequate IT
investment and cybersecurity infrastructure could ensure the integrity of IT
systems and effectiveness of cyber-infrastructure in dealing with potential
cyberattacks and cybersecurity breaches. Prior research addresses several research
issues of the link between IT governance, board risk oversight and managerial risk
strategies, and risk management and informed risk-taking. On one hand, IT
governance, board risk oversight, and managerial risk strategies can improve risk
assessment and management, thus reducing cyberattacks. The International
Standards Organization (ISO) 31000 defines risk as an uncertainty that has an
effect on objectives. Thus, the effective board risk oversight and managerial risk
strategies are expected to improve cyberattacks risk management, reducing cyberhacking
incidents that benefit the firm and its stakeholders.
Managerial risk strategies and practices can effectively reduce the incidents of
cyberattacks. However, recent centralization of operations and information system
Internet-based technologies to improve cost efficiency and effectiveness across
supply chain creates security risks and high exposure to and dependency on the
Internet that provide opportunities for cyber hackers to engage in rewarding
cyberattacks. Centralization across organization functions requires the use of
sophisticated operations technology (OT) and IT with related network
infrastructure to connect geographically diverse functions. Thus, managerial risk
strategies pertaining to both OT and IT securities and controls are become
increasingly important under centralized system to prevent hackers to penetrate the
system and engage in costly cyberattacks. However, many OT and IT security
programs are old, underdeveloped, and outdated that give incentives and
opportunities to cyber attacker to perpetrate these programs and engage in costly
cyber-hacking activities. Managerial risk strategies and programs are initially
designed to identify the emerging cyber-hackings or information security threats
and implement risk assessment and internal control procedures to immediately
respond to such hackings and security breaches. Any outdated and underdeveloped
18
19
20
21
22
23
Step 1.
Step 2.
Step 3.
Step 4.
Step 5.
Step 6.
Step 7.
OT and IT can provide incentives and opportunities to cyber attackers to perpetrate
business systems and programs and cause costly cyber-hacking activities.
Given the importance of the cybersecurity and IT risks, it is likely that corporate
board either already has a director who is well-versed in IT and data security or is
looking for one to help better understand the company’s IT risk profile. The
Information Security Booklet of the Federal Financial Institutions Examination
Council (FFIEC) suggests several cybersecurity oversight and management
activities including the following: (1) existence of a risk compliance board
committee or executive position such as chief information officer (CIO); (2)
implementation and management of the information security and business
continuity programs by the designated executive or board committee; (3) annual
report to the board of directors or designated board committee by management on
the overall status of the business continuity programs and information security; and
(4) the existence of budgeting process for information security investments and
related expenses and annual review and approval by the board of directors.
Implemented OT and IT security programs are designed to identify security threats
and cyberattacking information and assess their risk and related internal controls
to effectively respond to any security breaches and hackings. Any risk associated
with cyberattacks should be effectively and timely assessed, and proper information
security strategies should be designed and implemented to combat cyberattacks.
Establishing tone at the top of effective oversight by the board of directors and
management strategies is vital in combatting cyberattacks. The board can oversee
managerial risk strategies and practices and obtain an understanding of risks
inherent in managerial strategies for risk appetite and access timely information on
risk appetite, risk response strategies, and effective risk assessment and
management. Forensic accountants can assist the board of directors and
management in their proper risk assessment and management.
Fraud risk assessment is the process of using a framework to identify risks that can
lead to fraud. Organizations such as COSO have released models that aid in
assessing and managing fraud risk. Fraud risk assessment contains three main
elements: inherent risk, assess inherent risk, and response to inherent and residual
risk. Identifying inherent risk surveys the fraud triangle (incentives, pressures,
opportunities) specific to the organization and its connection to fraud schemes and
internal control. Second, assess the chance of fraud occurring from observation of
data and business processes. Interviews of staff and management occur during this
phase. Lastly, an appropriate response to the assessed risk should be chosen after
analysis is done. The analysis weighs cost and benefit of implementing corrective
controls to the apparent risks. All the above-mentioned elements should appear
within a fraud risk assessment framework. This framework is designed by the
organization and can include categories such as identified risks, effectiveness of
controls, response, and impact. The risk assessment is often done across
departments to fill out an entire portfolio view of the business and maintain full
integration with business processes.
Fraud risk assessment processes include the following steps:
Identify your business processes
The possibility for fraud starts with business processes. In order to properly assess
fraud risk, processes must be identified.
Consider differences in those processes in foreign operations, as well as among
subsidiaries or decentralized divisions
Identify the “Process Owner” for each of the identified processes
Review fraud experience within the company and by process
Process Owners identify how fraud may occur in each process at each location using
Fraud Brainstorming Techniques
Identify the Parties who have the ability to commit the potential fraud
Process Owners evaluate the likelihood that each of the identified frauds could
occur
24
25
Step 8.
Step 9.
Step 10.
1.
2.
Determine the level of mitigation so as to prevent, detect, and deter fraud
Investigate the characteristics of potential fraud manifestations within each process
identified
Quantify Fraud Risk
Despite being clearly outlined, fraud risk assessment has its pitfalls. Approximately
25 percent of companies still use the 1992 framework or have not revealed which
framework they have followed. As a result, the SEC has issued the statement saying,
“The longer [corporate] issuers continue to use the 1992 framework, the more likely
they are to receive questions from the [SEC] staff about whether the issuer’s use of
the 1992 framework satisfies the SEC’s requirement to use a suitable, recognized
framework.” Some organizations underestimate the time and effort required to
properly plan for a fraud risk assessmen (FRA)t. Companies should be weary of not
planning ahead to allow for an adequate amount of time and should ensure that
relevant stakeholders are involved in the FRA process. Companies often invest a
significant amount of time identifying controls for relevant fraud schemes, without
noticing that those schemes are of minor impact to the organization even if they
occur repeatedly. Companies should note that FRA is not a one-shot item. The
landscape is constantly evolving and they must reassess to keep up. Insufficient
documentation may make it difficult for a company to show to regulators or
auditors that they have adequately met the requirements of the 2013 COSO
framework.
Ever-increasing incidents of cyberattacks are devastating to business organizations’
operations, governance, financial reporting, and audit processes. Cyberattacks at
companies such as Sony, Targets, Yahoo, JPMorgan Chase, Uber, Home Depot,
Equifax, Facebook threaten their business sustainability. Regulatory initiatives and
guidelines are being developed in assisting public companies and their directors
and officers to understand, identify, assess, and manage risks of corporate
cybersecurity. For example, the Securities and Exchange Commission (SEC)
established several initiatives of guidelines on cybersecurity disclosures,
enforcement actions against several public companies for cyber-related hacking,
and an investigatory report concerning internal control failures relevant to
cyberattacks. The growing cyberattacks create opportunities for forensic
accountants to assist business organizations in assessing their cybersecurity risks
and design proper internal controls to prevent, detect, and correct cyberattacks.
Forensic accountants can also engage in damage controls and appropriate
disclosure of cyberattacks.
Conclusion
Forensic accounting has made significant progress in the past decades and will
continue to add value in many aspects of business, particularly in the areas of fraud
and nonfraud investigation. This chapter presents challenges and opportunities in
providing fraud investigation. Forensic accounting is a rewarding and exciting
career with many opportunities for advancements as discussed in this chapter.
Forensic accountants should turn challenges into job opportunities in providing
fraud and nonfraud investigation services.
Action Items
Forensic accounting career is rewarding
and exiting with superb job opportunities.
Forensic accounting challenges are
significant in the areas of fraud
investigation.
26
27
28
3.
4.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
Demand for and interest in fraud and
nonfraud forensic accounting investigation
services are expected to continue.
Forensic accountants should turn the
challenges into job opportunities in fraud
investigation services.
Endnotes
Financial Accounting Standards Board (FASB). 1980. Status of Concepts Statements No.3.
https://www.fasb.org/status/statpg-con3.shtml
Financial Accounting Standards Board (FASB). 2006. Statement of Financial Accounting
Standards No. 157: Fair Value Measurements (September, 2006).
https://www.fasb.org/summary/stsum157.shtml
Statement of Financial Accounting Standards No. 157. Financial Accounting Standards
Board. 2006.
Ibid.
G.D. Moore, and S.R. Mark. April, 2016. “Fraud, Collusion and the Financial Statements-A
Refresher for Practicing Professionals,” Journal of Global Business Management 12, no. 1.
http://www.jgbm.org/page/16%20Gail%20D%20Moore.pdf (http://www.jgbm.org/page/16%20Gail
%20D%20Moore.pdf)
Federal Deposit Insurance Corporation (FDIC). 2009. Bank Secrecy Act and Anti-Money
Laundering. https://www.fdic.gov/regulations/examinations/bsa/index.html
J. McDowell, and G. Novis. 2001. The Consequences of Money Laundering and Financial
Crime. https://www.hsdl.org/?view&did=3549, (accessed July 18, 2018).
Ibid.
US Department of the Treasury. January 1, 2001. Guidance on Enhanced Scrutiny for
Transactions That May Involve the Proceeds of Foreign Official Corruption.
https://www.treasury.gov/press-center/press-releases/Pages/guidance.aspx
HSDL. March 2, 2000. The National Money Laundering Strategy for 2000.
https://www.hsdl.org/?view&did=439771
Congress. 1998. H.R. 1756—Money Laundering and Financial Crimes Strategy Act of 1998.
https://www.congress.gov/bill/105th-congress/house-bill/1756
Ibid.
Ibid.
ACFE. n.d. Ponzi Schemes. http://www.acfe.com/ponzi-schemes.aspx
(http://www.acfe.com/ponzi-schemes.aspx)
FBI. n.d. Scams and Safety. http://www.fbi.gov/scams-safety/fraud (http://www.fbi.gov/scamssafety/
fraud)
Forbes. 2018. 3 Ways Blockchain Can Help Combat Fraud.
https://www.forbes.com/sites/danielnewman/2018/04/17/3-ways-blockchain-can-helpcombat-
fraud/#4f46c76a92a4
Ibid.
M.A. Crain, W.S. Hopwood, C. Pacini, and G.R. Young. 2015. Essentials of Forensic
Accounting (New York, NY: AICPA).
Rasmussen College. 2018. Cracking Cases with Digital Forensics.
https://www.rasmussen.edu/degrees/justice-studies/blog/cracking-cases-with-digitalforensics/,
(accessed September 18, 2018).
20.
21.
22.
23.
24.
25.
26.
27.
28.
West Virginia. 2018. Computer Forensics.
https://graduateadmissions.wvu.edu/academics/graduate-programs/computer-forensics-gc
Center for Strategic and International Studies (CSIS). July 7, 2013. The Economic Impact of
Cyber Crime and Cyber Espionage. Available at https://www.csis.org/analysis/economicimpact-
cybercrime
L.J. SternbergJ. September 14, 2017. “Surviving the Equifax Data Breach,” AICPA Insights.
http://blog.aicpa.org/2017/09/surviving-the-equifax-data-breach.html?
<PRESIDIO_ANONYMIZED_EMAIL_ADDRESS>&cm_mmc=AICPA:CheetahMail-_-NewsUpdate-_-SEP17-
_-AICPANewsUpdate_A17SP136_IMTA#sthash.JuRiR7ZH.dpbs
Ibid.
Federal Financial Institutions Examination Council (FFIEC). June, 2015. IT Examination
Hand Book InfoBase.http://ithandbook.ffiec.gov/it-booklets/information-security.aspx
(http://ithandbook.ffiec.gov/it-booklets/information-security.aspx);
https://www.ffiec.gov/cyberassessmenttool.htm
AICPA. n.d. Managing the Business Risk of Fraud: A Practical Guide.
https://www.aicpa.org/forthepublic/auditcommitteeeffectiveness/auditcommitteebrief/dow
nloadabledocuments/managing_the_business_risk_of_fraud.pdf, (accessed September 18,
2018).
Deloitte. 2015. Fraud Risk Assessments and COSO’s 2013 Internal Control Framework:
Opportunities and Common Pitfalls.
https://www2.deloitte.com/content/dam/Deloitte/us/Documents/finance/us-fas-fra-cosoarticle.
pdf, (accessed July 19, 2018).
Ibid.
Securities and Exchange Commission (SEC). (2018). Commission Statement and Guidance
on Public Company Cybersecurity Disclosures. Release Nos. 33-1059; 34-82746, February
26, 2018. https://www.sec.gov/rules/interp/2018/33-10459.pdf
About the Author
Dr. Zabihollah (Zabi) Rezaee, PhD, CPA, CMA, CIA, CFE, CGFM, CSOXP,
CGOVP, CGRCP, CGMA, and CRMA is the Thompson-Hill Chair of Excellence, PhD
coordinator and professor of accountancy at the University of Memphis and has
served a two-year term on the Standing Advisory Group (SAG) of the Public
Company Accounting Oversight Board (PCAOB). He received his BS degree from
the Iranian Institute of Advanced Accounting, his MBA from Tarleton State
University in Texas, and his PhD from the University of Mississippi. He holds 10
certifications, including Certified Public Accountant (CPA), Certified Fraud
Examiner (CFE), Certified Management Accountant (CMA), Certified Internal
Auditor (CIA), Certified Government Financial Manager (CGFM), Certified
Sarbanes-Oxley Professional (CSOXP), Certified Corporate Governance
Professional (CGOVP), Certified Governance Risk Compliance Professional
(CGRCP), Chartered Global Management Accountant (CGMA), and Certified Risk
Management Assurance (CRMA). He served as the 2012–2014 secretary of the
Forensic Accounting (FIA) Section of the American Accounting Association (AAA)
and is currently serving on Auditing Standards Committee of the Auditing Section
of the AAA. He was one of the finalists for the position of the Faculty Trustee at the
University of Memphis in 2016 and the Ombudsperson position in 2017. He is the
incoming editor of the Journal of Forensic Accounting Research of the AAA (2019–
2020). He has served as expert witness and testified in federal courts.
Rezaee has published over 220 articles, made more than 230 presentations, and has
written 11 book chapters. He has also published 12 books: Financial Institutions,
Valuations, Mergers, and Acquisitions: The Fair Value Approach; Financial
Statement Fraud: Prevention and Detection; U.S. Master Auditing Guide 3rd
edition; Audit Committee Oversight Effectiveness Post-Sarbanes–Oxley Act;
Corporate Governance Post-Sarbanes–Oxley: Regulations, Requirements, and
Integrated Processes; Corporate Governance and Business Ethics and Financial
Services Firms: Governance, regulations, Valuations, Mergers and Acquisitions,
and contributed to several other books. His two recent books on Corporate
Sustainability: Integrating Performance and Reporting, published in November
2012, won the 2013 Axiom Gold Award in the category of Business Ethics and
Business Sustainability: Performance, Compliance, Accountability, and
Integrated Reporting was published in October 2015 by Greenleaf Publishing. The
book on Audit Committee Effectiveness was published in three volumes by Business
Expert Press in July 2016. His most recent books are on Corporate Governance in
the Aftermath of the Global Financial Crisis, in four volumes, published by
Business Expert Press in March 2018 and Business Sustainability in Asia,
published by John Wiley and Sons in March 2019. Several of these books are
translated into other languages including Chinese, Persian, Korean, and Spanish.
Index
Abetting, 46–47
Accounts receivables, 16
Aiding, 46–47
American Institute of Certified Public Accountants (AICPA), 4
Analytical procedures, 25–27
Antifraud role, 8
antifraud education, 105–106
of board of directors, 83–87
forensic accountants, 97–99
of external auditors, 91–97
of internal auditors, 88–91
of management, 87–88
market, 100–101
correction mechanisms, 101–103
policies and practices, 76–82
private-sector investigators, 99
public-sector investigator, 99
of regulators, 103–105
of short sellers, 97
standard setters, 100–101
Artificial neural networks (ANNs), 28
Asset misappropriation, 15–18
accounts receivables, 16
cash schemes, 16
employee fraud and theft, 17–18
fixed assets schemes, 16
inventory, 16
Association of Certified Fraud Examiners (ACFE), 10, 71, 149
Association of Chartered Certified Accountants (ACCA), 114
Audit risk (AR) model, 37
Benford’s law, 27
Big Data, 29, 122–125
Block-chain technology, 150
Board of directors, antifraud role of, 83–87
Brainstorming sessions, 21–22
computer-mediated technique, 21
mind-mapping, 21
open-ended technique, 21
strategic reasoning, 21
Bribery, 149
Cash schemes, 16
Certified Forensic Accounting Credential (CFAC), 2
Certified Fraud Examiner (CFE), 2, 98, 115
Certified in Financial Forensics (CFF), 2
Certified Public Accountants (CPA), 2
Certified Valuation Analyst (CVA), 2
Challenges in forensic accounting, 113–138
Big Data, 122–125
corporate governance challenges, 125–128
data analytics, 122–125
digital forensics, 120–122
forensic accountants, 115–137
antifraud program and plan, 134–135
enterprise risk management (ERM), 135–136
financial fraud investigation, 115–120
internal control reporting, 132–133
XBRL-generated financial reports, 136–137
investment decisions by investors, 126
power-sharing, 127
sustainability reporting and assurance, 130–131
whistleblowing, 128–130
Collusion, 146–147
Committee of Sponsoring Organizations (COSO), 56–57
Committee of Sponsoring Organizations of the Treadway Commission (COSO), 8, 41
Computer-mediated brainstorming, 21–22
Concealed liabilities, 9, 11–12
Conditions, corporate structure, and choice (3Cs), 66
Conspiracy, 146–147
Control risk (CR), 38
Corporate gatekeepers role in FSF, 83–106
antifraud education, 105–106
board of directors, 83–87
external auditors, 91–97
forensic accountants, 97–99
internal auditors, 88–91
management, 87–88
market correction mechanisms, 101–103
market, 100–101
private-sector investigators, 99
public-sector investigator, 99
regulators, 103–105
short sellers, 97
standard setters, 100–101
to narrow expectation gap, 95
Corporate governance
challenges, 125–128
fraud, forensic accountants role in, 55–108. See also financial statement fraud (FSF)
detecting and preventing, 55–108
Cressey, Donald, 3
Cut-off fraud, 10
Cyberattacks, 152–156
Cybercrime, 152–156
Data analytics, 28, 122–125
Demonstrative evidence, 20
Detection risk (DR), 38
Digital forensics, 120–122
Dundas BI, 124
IBM Cognos Analytics, 124
Microsoft SharePoint, 124
Direct evidence, 19
Documents, 3
Dodd–Frank (DOF) Act of 2010, 129
Dundas BI, 124
Earnings management, 9, 13–14
Economic, governance, social, ethics, and environmental (EGSEE), 131
Education, antifraud, 105–106
Electronic Data Gathering, Analysis, and Retrieval (EDGAR), 136
Emerging issues in fraud investigation, 143–156
bribery, 149
collusion, 146–147
conspiracy, 146–147
fair value estimation, 145–146
forensic accountants, 144–145
money laundering, 147–148
Ponzi schemes, 149–150
revenue recognition, 144–145
Employee fraud and theft, 17–18
detection, 18
prevention, 18
Enterprise risk management (ERM), 135–136
Error or fraud, 92
Evidence, 18–30
demonstrative, 20
direct, 19
gathering, 18–30
planning and preparation, 20–21
procedures, 20–21
reporting, and court proceedings, 21
identifying, 18–20
real or physical, 20
rules of, 19–20
testimonial, 19
types of, 19–20
Evidence-gathering methods, 21–30
artificial neural networks (ANNs), 28
Benford’s law, 27
brainstorming sessions, 21–22
computer-mediated technique, 21–22
forensic data analytics, 28
mind-mapping, 21–22
open-ended technique, 21
red flag identification, 22–24. See also individual entry
strategic reasoning, 21
Expert system aids, 24–25
Extensible business reporting language (XBRL), 136–137
External auditors, antifraud role of, 91–97
Federal Deposit Insurance Corporation (FDIC), 136
Federal Financial Institutions Examination Council (FFIEC), 153
Federal Rules of Evidence, 45–46
Fictitious revenues, 9–11
Financial Accounting Standards Board (FASB), 144–145
Financial fraud investigation, 115–120
Financial reporting analysis, 26
common size, 26
trend analysis, 27
Financial reporting fraud (FRF), 6–8
accountability element of, 7
Financial statement fraud (FSF), 56–71, 114. See also under corporate gatekeepers role
actions, 119
consequences, 119
elements, 118
The Act, 120
The Concealment, 120
The Conversion, 120
forensic accountants’ role, 59
failures, 60–61
functions, 119
harmfulness, 116–118
occurrences, reasons for, 58
conditions, corporate structure, and choice (3Cs), 66
prevention, detection, and correction, 78–80
reported FSF, 63–66
schemes, 70
Fixed assets schemes, 16
Foreign Corrupt Practices Act (FCPA), 149
Forensic Certified Public Accountant (FCPA), 2
Forensic data analytics, 28
Fraud models, 3–9
economic incentives, 8
fraud diamond, 5
fraud triangle, 4
fraud-on-the-market theory, 101
incentive, 3, 5, 7
opportunity, 3, 5, 7
Pentagon model, 5
rationalization, 3, 6–7
Fraudulent misstatements, 9–14
concealed liabilities, 9, 11–12
earnings management, 9, 13–14
fictitious revenues, 9–11
improper asset valuation, 9, 13
improper disclosure, 9, 12
timing difference fraud, 9–11
valuation, 9, 13
Free of material misstatement, 92
Hermanson, D.R., 4
High-Risk Money Laundering and Financial Crimes Areas (HIFCAs), 148
IBM Cognos Analytics, 124
Improper asset valuation, 9, 13
Improper disclosure, 9, 12
Incentive, 3, 5, 7
Information technology, fraud and, 150–152
Inherent risk (IR), 37
Integrated financial and internal control reporting (IFICR), 132
Internal auditors, antifraud role of, 88–91
Internal control over financial reporting (ICFR), 132–133
Internal controls, 43–44
International Standards Organization (ISO), 152
Interviews, 47–50
Inventory fraud schemes, 16
Investigative risk, 37
Investigative techniques, 44–51
abetting, 46–47
aiding, 46–47
deposition, 44–45
Federal Rules of Evidence, 45–46
interrogation, 49
interviews, 47–50
report, preparing, 50–51
testifying experts, 45
testimony, 44–45
Kedia, B., 7
Management, antifraud role of, 87–88
Market correction mechanisms, 101–103
Market, antifraud role of, 100–101
Matters Under Inquiry (MUI), 104
Microsoft SharePoint, 124
Misstatements, 9–18. See also fraudulent misstatements
fraudulent financial reporting, 9
misappropriation of assets, 9
Money laundering, 147–148
National Money Laundering Strategy, 148
Opportunities in forensic accounting, 3, 5, 7, 113–138
Certified Fraud Examiner (CFE) certification, 115
SEC initiatives, 115
Tennessee Bureau of Investigation (TBI), 115
Pentagon model of financial reporting fraud, 5
Ponzi schemes, 149–150
Private-sector investigators, 99
Processes of forensic accounting, 1–31
Public Company Accounting Oversight Board (PCAOB), 14, 37, 93
Public-sector investigator, 99
Rationalization, 3, 6–7
Real/physical evidence, 20
Reasonable assurance, 92, 94
Red flag identification, 22–24
change in behavior red flags, 23
employee red flags, 23
expert system aids, 24–25
management red flags, 23
regression models, 24
Regression models, 24
Regulators, antifraud role of, 100–101
Risk management, 36–43
audit risk (AR) model, 37
components, 41–42
control risk (CR), 38
detection risk (DR), 38
inherent risk (IR), 37
investigative risk, 37
Roles of forensic accounting, 1–31
documents, 3
forensic accountants, 2–3
witness statements, 3
Sarbanes–Oxley (SOX) Act, 12, 56
Securities and Exchange Commission (SEC), 19
Short sellers in discovering fraud, 97
Skepticism, 95
Special-purpose entities (SPEs), 145
Standard setters, antifraud role of, 100–101
Suspicious Activity Reports (SARs), 148
Sustainability reporting, 130–131
Techniques, forensic accounting, 35–53. See also investigative techniques; risk management
internal controls, 43–44
Testimonial evidence, 19
Thornton, Grant, 121
Timing difference fraud, 9–11
Vehicles of variable interest entities (VIESs), 145
Whistleblowing, 128–130
Witness statements, 3
Wolfe, D.T., 4
•
•
•
•
•
•
•
•
OTHER TITLES IN OUR FINANCIAL ACCOUNTING,
AUDITING AND TAXATION COLLECTION
Mark S. Bettner, Bucknell University; Michael P. Coyne, Fairfield University; and Roby
Sawyers, Editors
Accounting History and the Rise of
Civilization, Volume I by Gary Giroux
Accounting History and the Rise of
Civilization, Volume II by Gary Giroux
A Refresher in Financial Accounting by
Faisal Sheikh
Accounting Fraud, Second Edition:
Maneuvering and Manipulation, Past and
Present by Gary Giroux
Corporate Governance in the Aftermath
of the Global Financial Crisis, Volume I:
Relevance and Reforms by Zabihollah
Rezaee
Corporate Governance in the Aftermath
of the Global Financial Crisis, Volume II:
Functions and Sustainability by
Zabihollah Rezaee
Corporate Governance in the Aftermath
of the Global Financial Crisis, Volume III:
Gatekeeper Functions by Zabihollah
Rezaee
Corporate Governance in the Aftermath
of the Global Financial Crisis, Volume IV:
Emerging Issues in Corporate
•
•
•
•
•
•
•
•
•
Governance by Zabihollah Rezaee
Using Accounting & Financial
Information, Second Edition: Analyzing,
Forecasting, and Decision Making by
Mark S. Bettner
Pick a Number, Second Edition: The U.S.
and International Accounting by Roger
Hussey
The Story Underlying the Numbers: A
Simple Approach to Comprehensive
Financial Statements Analysis by S.
Veena Iyer
Forensic Accounting and Financial
Statement Fraud, Volume I:
Fundamentals of Forensic Accounting by
Zabihollah Rezaee
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