Fraud Examination, 3E Chapter 5: Recognizing Symptoms of Fraud
Jan 18, 2018
Fraud Examination, 3E
Chapter 5: Recognizing Symptoms of Fraud
COPYRIGHT © 2009 South-Western, a part of Cengage Learning
Learning Objectives• Understand how symptoms help in the
detection of fraud.• Identify and understand accounting
symptoms of fraud.• Describe internal controls that help detect
fraud.• Identify and understand analytical
symptoms of fraud.
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Learning Objectives• Explain how lifestyle changes help detect
fraud.• Discuss how behavioral symptoms help
detect fraud.• Recognize the importance of tips and
complaints as fraud symptoms.
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Symptoms of FraudCan be separated into six groups: 1.Accounting anomalies2.Internal control weaknesses3.Analytical anomalies4.Extravagant lifestyle5.Unusual behavior6.Tips and complaints
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Elgin Aircraft CaseAccounting Anomalies– result from unusual processes or procedures
in the accounting system
Example:– the 22 phony doctors – checks were sent to the same two common
addresses
Why?– managers trusted the perpetrator completely – auditors merely matched claim forms with
canceled checks5
Elgin Aircraft CaseInternal Control WeaknessesExample:– Manager had not taken a vacation in 10 years– Employees never received payment
confirmations– Payments to new doctors were never
investigated or cleared
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Elgin Aircraft CaseAnalytical Anomalies– relationships in financial or nonfinancial data
that do not make sense
• 12 million be paid to only 22 doctors over a period of four years
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Elgin Aircraft CaseLifestyle SymptomsThe manager…– took the employees to lunch in a limousine,– lived in a very expensive house,– drove luxury cars,– wore expensive clothes and jewelry,– was “independently wealthy,”– inherited a large sum of money,– yet never took a vacation!
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Elgin Aircraft CaseBehavioral Symptoms– The manager had a “Dr. Jekyll and Mrs. Hyde”
personality– Her highs and lows had become more intense
and more frequent in recent months
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Accounting AnomaliesCommon anomaly frauds involve:• Irregularities in source documents • Faulty journal entries • Inaccuracies in ledgers
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Accounting AnomaliesIrregularities in Source DocumentsInclude the following:– Missing documents– Stale items on bank reconciliations– Excessive voids or credits– Common names or addresses of payees or
customers– Increased past-due accounts– Increased reconciling items– Alterations on documents
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Accounting AnomaliesIrregularities in Source DocumentsInclude the following (cont.):– Duplicate payments– Second endorsements on checks– Document sequences that do not make sense– Questionable handwriting on documents– Photocopied documents
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Faulty Journal EntriesFraud is hidden by using accounting language
Legal Expense .....................5,000Cash ...................……………5,000
English:“An attorney was paid $5,000 in cash”
Accounting:“Debit Legal Expense; Credit Cash”
Was the attorney really paid $5,000? 13
Faulty Journal EntriesFraud is hidden by increasing the expense account
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Assets = Liabilities + Owner’s Equity
Stock
Dividends
Revenues
Retained Earnings
Net Income
Expenses
Faulty Journal EntriesCommon journal entry fraud symptoms:• Journal entries without documentary
support• Unexplained adjustments to receivables,
payables, revenues, or expenses• Journal entries that do not balance• Journal entries made by individuals who
would not normally make such entries• Journal entries made near the end of an
accounting period 15
Inaccuracies in LedgersFraud symptoms relating to ledgers:• Ledger that does not balance– the total of all debit balances does not equal
the total of all credit balances• Master (control) account balances do not
equal the sum of the individual customer or vendor balances
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Internal Control WeaknessesInternal control fraud symptoms include :• Lack of segregation of duties• Lack of physical safeguards• Lack of independent checks• Lack of proper authorization• Lack of proper documents and records• Overriding of existing controls• Inadequate accounting system
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Analytical Fraud SymptomsAnalytical Fraud symptoms include:• Unexplained inventory shortages or
adjustments• Deviations from specifications• Increased scrap• Excess purchases• Too many debit or credit memos• Significant increases or decreases in
account balances, ratios, or relationships
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Analytical Fraud Symptoms• Physical abnormalities• Cash shortages or overages• Excessive late charges• Unreasonable expenses or reimbursements• Excessive turnover of executives• Strange financial statement relationships,
such as:– Increased revenues with decreased inventory– Increased revenues with decreased receivables
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Analytical Fraud Symptoms• Strange financial statement relationships,
such as (cont.):– Increased revenues with decreased cash flows– Increased inventory with decreased payables– Increased volume with increased cost per unit– Increased volume with decreased scrap– Increased inventory with decreased
warehousing costs
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Extravagant LifestylesExampleKay…• Embezzled $3 million from her employer• Bought a $500,000 or more home• Bought five luxury cars• Filled home with artwork and glass• Bought a boat• Paid cash to have yard landscaped• Served lobster flown in from the east coast
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Unusual Behaviors
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Guilt
Fear
Stress
Behavior Changes
• Insomnia• Increased drinking• Taking drugs• Unusual irritability and suspiciousness• Inability to relax• Lack of pleasure in things usually enjoyed• Fear of getting caught• Inability to look people in the eyes• Showing embarrassment around friends,
co-workers, and family• Defensiveness or argumentativeness• Unusual belligerence in stating opinions• Confessing (either to a religious leader,
psychologist, or other professional)
• Obsessively contemplating possible consequences
• Working standing up• Sweating• Increased smoking
Tips and Complaints
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Theft Act
Concealment Conversion
The Fraud Element Triangle
Who is in the best position to recognize fraud in each of these elements—Auditors or Company Employees? Company Employees
Tips and ComplaintsWhy are tips and complaints just symptoms?– Many tips and complaints turn out to be
unjustified– Difficult to know what motivates a person to
complain or provide a tip• Customers may feel taken advantage of• Employee may have malice, personal problems, or
jealousy• Spouses and friends may be motivated by anger,
divorce, or blackmail
– Individuals should always be considered innocent until proved guilt
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Tips and ComplaintsWhy people are hesitant to come forward:– Impossible to know for sure that a fraud is
taking place– Fear of being the whistle-blower– Intimidation by the perpetrator– Feel that squealing on someone is wrong– Not easy to come forward
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