**Summary**




During
      the planning stage of the audit, the auditors obtained information needed to
      identify fraud risks by making certain inquiries and considering fraud risk
      factors and other information. They identified certain risks that may result
      in
      a material misstatement due to fraud and they assessed the identified risks
      after considering the Company’s internal controls. Initially, the auditors
      responded to the results of the assessment using an overall response. However,
      after they found one suspected fraudulent transaction and other internal control
      problems, they developed specific responses that addressed the risk of stolen
      assets. Those responses resulted in additional audit procedures that uncovered
      numerous instances of embezzlement by the Company’s bookkeeper. As the auditors
      found suspected fraudulent or unusual transactions through their additional
      procedures, they informed management, who investigated the transactions and
      reported back to the auditors. At first, the auditors thought the embezzlement
      was limited to the cash account (through forging, doctoring of accounting
      records, fictitious payees, etc.), but as it turned out, the majority was
      through identity theft and fraudulent electronic funds
      transfers.




Importantly,
      management had no knowledge of any actual fraud or suspicions of fraud and
      was
      unaware of any allegations of fraud or suspected fraud affecting the Company.
      The fraud was uncovered by the audit team solely through the assessment of
      fraud
      risk factors. The Company has two managers, a bookkeeper and two warehouse
      personnel. Annual revenues were approximately $336,000 and the embezzlement
      totalled approximately $134,000 in a one year period.







**Developing
      Specific Responses to Identified Fraud Risk Factors**





Per
      discussion with the bookkeeper and management, the auditors determined that
      there was a lack of segregation of duties as the bookkeeper assumed virtually
      all administrative functions, such as received and opened the mail, processed
      customer payments in QuickBooks (the accounting software used by the Company),
      deposited checks in the bank, processed vendor payments, and performed the
      monthly bank reconciliation. Monthly bank statements and reconciliation were
      not
      reviewed by management. Normal audit procedure showed (1) bank statements were
      not reconciled to the accounting balance, (2) an inaccurate inventory listing,
      and (3) no supporting documentation evidencing certain transactions selected
      for
      testing.





Based
      on
      the information above, the audit team noted that fraud risks related to stolen
      assets were present. The audit senior informed and discussed this with
      management during the course of the audit and recommended that the bank
      reconciliation and a review of bank statements be performed by management.
      Also,
      during the discussion, management expressed their trust and confidence in the
      bookkeeper’s ability. Based on this, the auditors initially established an
      overall response to the fraud risks factors, by increasing supervision of
      engagement staff, incorporating an element of unpredictability in their test
      work, and i ncreased
      recognition of the need to corroborate client explanations through examination
      of documentation, or corroboration with others within or outside the
      company.




**Embezzlement
          at LGA Holdings, Inc.**
 **Page
          2** **of 
          3**







The
      auditors requested certain documents for testing. The bookkeeper indicated
      and
      insisted that the supporting invoice for a particular vendor payment was located
      in the vendor file. After the auditors spent several minutes attempting to
      locate the invoice, they obtained the canceled check for the payment and noted
      that the check was paid to and endorsed by the bookkeeper, not the vendor.
      The
      auditors were told that the bookkeeper was unaware of how the discrepancy
      between the accounting records and the canceled check occurred.





Because
      of this finding, the audit partner met with management. After presenting the
      discrepancy to management, management felt that the discrepancy was an honest
      mistake. After the meeting, the audit partner and audit senior reassessed the
      fraud factors. The audit partner instructed the audit senior to develop specific
      responses to those fraud risks factors. The audit senior extended the audit
      procedures as follows:





1.
            Review
                all canceled checks and compare the payee and amount to the payee
                and
                amount in the cash ledger. Review cancelled checks for endorsement,
                bank
                encrypted amounts, and possible
                alterations.




2.
            Review
                all deposit slips and verify the customer’s name and deposit amounts with
                entries recorded in the cash ledger. Compare deposit dates in the
                cash
                ledger and deposit tickets to ensure that they were identical or
                within a
                reasonable time period.





3.
            Obtain
                monthly bank statements for the audit period and trace the withdrawals
                and
                deposits on the bank statements to disbursements and receipts in
                the cash
                ledger. Verify that all withdrawals and deposits on the bank statements
                were recorded in the general
                ledger.





4.
            Compare
                the client withdrawals and deposits per the bank statements to the
                cash
                ledger to identify discrepancies.





5.
            The
                auditors attempted to reconcile the bank statement to the general
                ledger,
                normally a management function, to arrive at the cash balance at
                year-end.







**How
      the Bookkeeper Stole the Company’s Assets**





After
      performing the above procedures, the auditors noted the following:





1.
            Located
                another canceled check that was paid to and endorsed by the bookkeeper,
                but was shown on the cash ledger as being paid to a vendor.





2.
            Checks
                that cleared the bank, but the Company could not provide the auditors
                with
                the canceled checks.





3.
            Deposits
                made to the bank account but not recorded in the cash
                ledger.


**Embezzlement
          at LGA Holdings, Inc.**
 **Page
          3** **of 3**









4.
            Suspicious
                electronic merchant card withdrawals in the bank statements (shown
                as
                negative deposits!) that the auditors were unable to trace directly
                to the
                cash ledger.





The
      auditors initially informed and inquired of management the findings 1 and 2
      above. In addition to the list above, the auditors also provided management
      with
      a punch-list of open items, including credit card statements and invoices for
      certain payments or transactions selected from the accounting records. The
      punch-list together with the knowledge of the findings above prompted management
      to investigate further.





During
      the course of management’s investigation, they discovered the
      following:





1.
            The
                bookkeeper disbursed unauthorized checks to herself and to a fictitious
                payee. She concealed this activity in the accounting records by changing
                the payee name in QuickBooks to a legitimate vendor name. Additionally,
                the bookkeeper forged management’s signature on the checks payable to
                herself. The approximate fraud amounted to
                $11,548.


2.
            The
                bookkeeper obtained a Company credit card in her own name by forging
                management’s signature which she used to then pay for personal expenses
                and cash advances. She attempted to conceal the credit card activities
                by
                disposing of the credit card statements. The approximate fraudulent
                charges amounted to $55,276.


3.
            The
                bookkeeper arranged for her Pay-Pal and EBay online purchases to
                be billed
                to the Company’s credit card. These activities were undetected due to the
                individually insignificant charges. Additionally, certain Company
                authorized charges from EBay, such as product listing fees, were
                combined
                with her personal charges. The approximate fraudulent charges amounted
                to
                $6,525.


4.
            She
                sent merchant credit card refunds, electronically withdrawn from
                the
                Company’s bank account, to her personal credit card using the Company’s
                credit card machine. (Management believed that she observed a member
                of
                management issue a cash refund to a customer through the credit card
                machine.) The approximate fraudulent merchant credit card refunds
                amounted
                to $60,589.


5.
            She
                used blank checks sent by the credit card agency to the Company to
                borrow
                money on behalf of the Company. She then deposited these checks in
                the
                corporate bank account. These credit card advances were used to divert
                funds from the Company’s account and to possibly conceal unauthorized
                withdrawals from the Company’s bank accounts (or provide an additional
                source of cash from which to steal.) The credit card checks were
                also
                forged.





Based
      on
      the review of the Company’s banking records and credit card statements, we
      believe that the bookkeeper diverted approximately $133,938 of the Company’s
      funds.