Forensic Accounting Midterm Exam

Front 1

Asset Misappropriation schemes

Back 1

1.) Cash schemes
2.) Accounts receivable schemes
3.) Inventory, supplies, and fixed asset schemes

Front 2

Cash schemes

Back 2

1.) Larceny/embezzlement (10%)
2.) Skimming (24%)
3.) Fraudulent Disbursements (66%)

Front 3

Larceny/Embezzlement (cash schemes)

Back 3

take money after it has hit the books

Front 4

skimming

Back 4

-pocketing cash and not recording sale
-stealing money before it hits the books
1.) unrecorded/understated sales
2.) theft of incoming checks
3.) swapping checks for cash

Front 5

Unrecorded/understated sales

Back 5

unrecorded: not recording at all
understated: record sale for lesser amount than cash collected

Front 6

theft of incoming checks

Back 6

-forge the indorsement
-put pay to company or yourself

Front 7

swapping checks for cash

Back 7

deposit check and then swap it for cash

Front 8

Fraudulent disbursements

Back 8

1.) check tampering schemes: altering the check
2.) billing schemes: set up shell company and set them up as vendor
3.) expense reimbursement schemes: faking supporting documents; treating personal expenses as business
4.) payroll schemes: setting up fake employee or leaving former employee on books (look for similarities in SSN or bank account numbers); paying yourself more or paying yourself overtime

Front 9

Accounts Receivable schemes

Back 9

1.) lapping: take money out of customer A/R and put it in other customer A/R (buys time)
2.) fictitious receivables: set up fake A/R account, let it age, and write it off (once customer pays after it is written off, can pocket money
3.) bad debt write offs

Front 10

Inventory/supplies/fixed asset schemes

Back 10

1.) larceny: stealing inventory, supplies, and assets by falsifying reports or putting empty boxes in warehouse to look like inventory
2.) appropriating for personal use

Front 11

Occupational Fraud Red Flags

Back 11

1.) Items that should match but don't (ex. receiving and invoice reports), or items that shouldn't match, but do (ex. address on fake vendor is same address as employee)
2.) Suspicious trends and relationships (ex. have sales dramatically increase compared to competitors)
3.) Internal Control weaknesses: points out vulnerabilities (ex. separation of duties, close supervision on cash)
4.) analytical symptoms (ex. ratio and trend analysis)
5.) outliers and extremes; unusual behavior (ex. never taking a vacation, too much overtime, want to maintain lots of control over job)
6.) lifestyle changes (ex. buying expensive items)

Front 12

Financial statement fraud schemes

Back 12

1.) fictitious revenues
2.) timing differences
3.) improper asset valuation
4.) concealed liabilities and expenses
5.) improper disclosures

Front 13

Fictitious revenues

Back 13

1.) fabricating revenue (ex. fake customers or fake invoices to existing customers)
2.) improper recording of sales returns, allowances, and discounts
3.) sales with conditions (is it truly a sale? has sale been completed?)

Front 14

Timing differences

Back 14

1.) premature revenue recognition
2.) recording expenses in wrong period

Front 15

Improper asset valuation

Back 15

1.) inventory (ex. supposed to be at lower-of-cost-or-market but may not write off obsolete inventory, make up inventory
2.) accounts receivable
3.) fixed assets (ex. capitalizing when should be expensing)

Front 16

concealed liabilities and expenses

Back 16

-hardest to uncover
1.) liability/expense omissions
2.) capitalized expenses
3.) failure to disclose warranty costs and liabilities (ex. not having reserve for warranties)

Front 17

Improper disclosures

Back 17

1.) liability omissions
2.) subsequent events
3.) related-party transactions

Front 18

Analytical procedures

Back 18

1.) Vertical Analysis
2.) Horizontal (Trend) analysis
3.) ratio analysis

Front 19

Vertical Analysis

Back 19

-relationship within particular F/S
-% relationship between items on financial statements
-IS: net sales=100%
-BS: total assets=100%, total liabs and equity=100%

Front 20

horizontal (trend) analysis

Back 20

-% change in F/S item from one period to next
-first year used as base year (100%)

Front 21

Ratio Analysis

Back 21

1.) Liquidity ratios: current ratio, quick ratio
2.) Activity Ratios: receivable turnover, collection ratio, inventory turnover, average number of days inventory in stock, number of days sales in receivables)
3.) Leverage Ratios: debt to equity
4.) Profitability ratios: profit margin, return on equity, gross margin

Front 22

F/S Fraud red flags

Back 22

1.) rapid growth/unusual profitability (industry comparison)
2.) recurring negative cash flows from operations while reporting earnings and earnings growth
3.) significant, unusual, or highly complex transactions close to end of period
4.) significant sales or other transactions with related parties or unknown entities not in the ordinary course of business
5.) drastic increase in gross margin ratio (industry comparison)
6.) A/R-unreasonable amount of old, uncollected receivables
7.) Unusual growth in number-of-days-sales-in-receivables
8.) Assets, labs, revs, or exps based on significant estimates (subjective judgments, uncertainties
9.) non-financial management's excessive preoccupation with selection of accounting principles or determination of significant estimates

Front 23

Initiating F/S fraud investigation

Back 23

1.) Fraud sources
2.) Evaluating tips
3.) Assemble investigation team
4.) Assume that all cases will end in litigation

Front 24

Fraud sources

Back 24

1.) Tips (33%)
2.) Audit procedure (20%)
3.) Accident (almost 50%)

Front 25

Evaluating Tips-main reasons people give tips

Back 25

1.) Revenge
2.) genuine concern
3.) money: sometime IRS provides rewards

Front 26

Investigation team

Back 26

1.) fraud examiner
2.) legal counsel
3.) HR for employee rights
4.) internal auditors
5.) security

Front 27

Employees' duty to cooperate

Back 27

employee has a duty to cooperate with internal investigation as long its reasonable

Front 28

employees' rights during investigation

Back 28

1) contractual rights (ex. employment agreement, union contract)
2.) whistleblower protection
3.) employees' constitutional rights

Front 29

Whistleblower protection

Back 29

-protect employee from adverse employment action or retaliation from employer (substantial penalties if violated)
-occurred after passage of SOX

Front 30

Employee's constitutional rights

Back 30

1.) 4th amendment
2.) 5th amendment
3.) 6th amendment

Front 31

4th amendment

Back 31

1.) prohibits unreasonable searches and seizures (unreasonable depends on circumstances)
2.) search warrant requirement
3.) exclusionary rule: if considered unreasonable search, any evidence obtained isn't allowed

Front 32

Search warrant requirement

Back 32

1.) probable cause (have to contact judge)
2.) warrantless search allowed if:
- consent (you let them)
-plain view (officer can see
it on person's property)

Front 33

5th amendment

Back 33

1.) grand jury indictment required for capital offense or felony
2.) cannot be compelled to give information that may incriminate you in criminal case
3.) Miranda Warning: required during custodial interrogation (questioning by law enforcement officers after taken into custody)

Front 34

6th amendment

Back 34

1.) right to attorney
2.) right to confront witnesses against you in criminal case

Front 35

Workplace searches

Back 35

1.) 4th amendment protection to an extent
2.) reasonable expectation of privacy
3.) electronic communications
4.) company policy

Front 36

Civil Causes of Action

Back 36

intentional torts: have to prove intent

Front 37

Examples of civil causes of action

Back 37

1.) invasion of privacy: there needs to be a reasonable expectation of privacy
2.) defamation: false statement of material fact published (not widespread) and damages victim's reputation
3.) false imprisonment: confinement of another without their consent
4.) Intentional infliction of emotional distress: typically goes along with another tort
3.)

Front 38

Invasion of Privacy examples

Back 38

1.) intrusion upon seclusion
2.) public (widespread) disclosure of private facts: has to be facts, but private in nature; similar to defamation but these are true statements

Front 39

Intentional infliction of emotional distress requirements

Back 39

1.) severe distress suffered by P
2.) D's conduct was outrageous
3.) D had intent to cause severe emotional distress

Front 40

Stages of Fraud Investigation

Back 40

1.) discovery process
2.) Confirmation process
3.) Admission Seeking Interview of Suspect

Front 41

Discovery process (fraud investigation)

Back 41

1.)document collection and examination
-can use internal (least
knowledgeable to most
knowledgeable) or external
sources
-MUST MAINTAIN CHASE
OF CUSTODY
2.) Interviews: least to most knowledgeable; neutral third-party witnesses

Front 42

Confirmation process

Back 42

1.) interview corroborating witnesses
2.) interview potential co-conspirators

Front 43

Internal audience

Back 43

HR, internal audit, executive management, BOD, internal legal counsel

Front 44

External audience

Back 44

external auditors, SEC, government agencies, law enforcement, shareholders, insurance company

Front 45

Definition of forensic accounting

Back 45

-use of accounting for legal purposes
-combines law, accounting, investigative auditing, criminology

Front 46

"Forensic"

Back 46

-used in (or pertaining to) legal proceedings

Front 47

Forensic Accounting Services

Back 47

1.) Investigation (fraud examination): interviewing, document examination, observation
2.) litigation support (consultation/expert testimony)
3.) valuation services (buy/sell business, divorce assets, damages)

Front 48

Forensic accounting vs financial auditing

Back 48

Auditor=patrol officer: checks things out to make sure okay

Forensic Accounting Investigator=detective: called in when crime suspected or already committed

Front 49

"Fraud"

Back 49

1. intentional act
2. to deprive another of money or property
3. by deception or other unfair means

Front 50

Internal Fraud

Back 50

1. F/S fraud (management)
2. Occupational fraud (management or employees): misappropriation of assets, expense account fraud

Front 51

misappropriation of assets

Back 51

1. embezzlement: you have right to item in possession; can include borrowing
2. larceny (theft): taking of something you don't have authority over
3. cash/inventory/fixed assets

Front 52

expense account fraud

Back 52

-unauthorized activities and expense claims

Front 53

External fraud

Back 53

1. Vendor fraud: bribes/kickbacks, bid-rigging
2. Insurance Fraud

Front 54

Types of Fraud

Back 54

1. internal fraud
2. external fraud
3. identity theft: can result in federal charges
4. ponzi investment schemes
5. tax fraud: not reporting income or taking unallowed deductions
6. divorce or bankruptcy fraud: concerns valuing or hiding assets so don't have to give them up
7. mortgage fraud

Front 55

Fraud triangle

Back 55

1. pressures
2. perceived opportunities
3. rationalization

Front 56

pressures

Back 56

1. financial need
2. vice/addiction (gambling)
3. work-related pressures
4. desire to "beat the system"

Front 57

perceived opportunities

Back 57

1. lack of adequate controls that prevent/detect fraudulent acts (control environment, accounting system, control procedures/activities)
2. failure to discipline fraud perpetrators
3. vulnerable targets (elderly)

Front 58

Rationalization

Back 58

1. the organization owes me
2. only borrowing-I'll pay it back
3. depersonalizing the victim
4. I pay more than my fair share (income tax evasion)

Front 59

Characteristics of perpetrator

Back 59

1. Age: 30's
2. Gender: slightly more male (55%) on white collar crimes, only 10% of robberies are female
3. marital status: married w/ kids
4. education: high, post graduate
5. income level: higher the income, higher the amount of theft; decent
6. socially conforming
7. act alone

Front 60

Behavioral red flags in fraudster

Back 60

1. living beyond their means (43% of cases)
2. experiencing financial difficulties (36%)
3. excessive control issues with regards to their jobs (23%)
4. close association with vendors or customers (22%)

Front 61

Punishment

Back 61

1. formal sanctions: probability of getting caught, severity of punishment
2. Social sanctions: "everyone will know"; most effective compare to formal

Front 62

Perception of Detection

Back 62

**most effective fraud prevention method
-do people think they will get caught
1. employee education/awareness
2. tone at the top
3. ethics policy
4. hotlines/reporting programs (tips: 40% of fraud cases)
5. enforce mandatory vacations
6. rotate job responsibilities
7. employees support programs: can prevent people with gambling addiction from stealing

Front 63

Key differences between civil and criminal penalties

Back 63

1. Parties
2. Process
3. Burden of Proof
4. Consequences

Front 64

Criminal

Back 64

1.) felony (more severe)
-most fraud is this
2.) misdemeanor
-public wrongdoing (more about punishing person for wrongdoing)

Front 65

Civil

Back 65

Private wrong (compensating person who was wronged)

Front 66

Parties

Back 66

Criminal: wrong against people (people v. defendent)

Civil: plaintiff v. defendant

Front 67

Burden of Proof

Back 67

Criminal: beyond a reasonable doubt (90% or above)

Civil: preponderance of evidence (majority) (51%)

Tax or family issues: clear and convincing (75%)

Front 68

Consequences

Back 68

civil: can't go to jail; usually involves money or injunction (seize and desist)
ex. patent infringement

criminal: can be incarcerated or fined

Front 69

Common Civil and Criminal Actions for Fraud

Back 69

1. Theft or Conversion
2. Misrepresentation of Material facts
3. Breach of Fiduciary Duty

Front 70

Theft or Conversion

Back 70

-usually just conversion
-civil tort or crime
1.) intentional
2.) taking of another's property
3.) without victim's consent
ex. embezzlement or larsony

Front 71

Embezzlement

Back 71

had right to have item in custody

Front 72

larsony

Back 72

taking something that doesn't belong to you (unlawful possession)

Front 73

burglary

Back 73

breaking and entering

Front 74

robbery

Back 74

using force

Front 75

Misrepresentation of Material Facts

Back 75

-civil tort or crime
1.) misrepresentation (including concealment-if have duty to disclose)
2.) of material fact (can't be opinion)
3.) that defendant knew to be false (intentional=fraud)
4.) victim relied upon the misrepresentation (tort only)
5.) victim suffered damages (tort only)

-4&5 are only required for tort, not criminal charges
-intent=knew or should've known

Front 76

Breach of Fiduciary Duty

Back 76

-civil tort or crime
1.) in position of trust or fiduciary responsibility to plaintiff (agent or employee)
2.) breached duty owed to plaintiff to advance personal interest

"duty owed"=due care/loyalty

Front 77

SOX

Back 77

-Title 18 USC
1.) established PCAOB (overseas audits of public co's)
2.) increase in audit independence (ex. audit partner 5 year rotation, have to report to audit committee, can't provide audit and non audit services)
3.) increased corporate responsibility (management must sign off on F/S-personally liable)
4.) enhance financial disclosures (Section 404 of internal control assessment and ethics code for senior management-have to disclose if have ethics code for senior management)
5. Penalty enhancements (for altering and destroying documents)
6. Whistleblower protection
7. Document retention

Front 78

Civil Litigation Process

Back 78

1.) Allegation of wrongdoing
2.) preliminary investigation
3.) pleadings
4.) Discovery
5.) pretrial motions/settlement negotiations
6.) trial (discuss with litigation module)
7. Judgment

Front 79

Preliminary investigation-civil

Back 79

-must have predication (circumstances that suggest fraud has/is/will occur) to start investigation

Front 80

Pleadings-civil

Back 80

1.) complaint by Plaintiff (have to name specific wrongdoing, what law applies, and what damages you are seeking or injunction)
2. Service of process (complaint served to defendant)
3. Answer by defendant: defendant admits to or denies claim (have 30 days to answer) OR can file motion to dismiss (saying what they did isn't a wrongdoing-if judge grant this, case ends)

Front 81

Discovery-civil

Back 81

1.) subpoenas: legal order to do something (ex. produce documents

2.) motions for production of documents (have to be very specific about what you want)

3.) interrogatories (written questionnaire-can be mailed)

4.) depositions (used in cross examinations to see if what expert witness said in deposition matches up to expert testimony) (questioned under oath by attorneys in room who record answers)

5.) requests for admission (stipulation of facts) (state amount of money missing-don't have to prove the facts you stipulated in court)

Front 82

Pretrial motions/settlement negotiations (civil)

Back 82

ex. motion (request to court) for summary judgement: based on info, we clearly won, so skip trial
-if granted, enter judgment, which losing party can appeal
-if denied motion, then judge is saying they don't clearly win
-can settle anytime before verdict
-pretrial meeting held to see if want to settle and to handle administration of trial

Front 83

Trial-civil

Back 83

1.) opening arguments by both sides
2.) plaintiff's witnesses (direct, cross examination) and if criminal, then prosecutor
3.) defense witnesses (direct, cross examination)
4.) closing arguments
5.) jury instructions: judge reads instructions to jury
6.) jury deliberation and verdict (can waive jury and have judge determine conclusion)

Front 84

Judgment-civil

Back 84

1.) liable/not liable
2.) monetary damages and/or injunction

**judge is not supposed to make opinion, but guide trial process

Front 85

Criminal Litigation Process

Back 85

1.) Allegation of Wrongdoing
2.) Preliminary Investigation
3.) File report to Prosecutor
4.) Grand Jury: group of citizens formed in same way as trial jury
5.) Arrest
6.) Preliminary Hearing (if no grand jury)
7.) Arraignment
8.) Plea Bargains
9.) Discover
10.) Trial (discuss with Litigation Module)
11.) Sentencing

Front 86

Preliminary Investigation-criminal

Back 86

As with civil action, must have predication (circumstances that suggest fraud has/is/will occur)

Front 87

File Report to Prosecutor-criminal

Back 87

1.) Prosecutor has discretion whether to proceed (bring charges or not)
2.) Prosecutor may convene grand jury for further investigation

Front 88

Grand Jury-criminal

Back 88

1.) indictment by grand jury required for capital crime or felony

2.) Purpose: Determine if there is enough evidence to charge defendant/issue indictment (hear preliminary evidence to see if there is enough-not to determine whether the person is guilty or not guilty)
a.) Standard of Proof: probable cause (sufficient info to believe crime committed)
b.) Is there sufficient evidence of fraudulent intent?

Front 89

Grand jury proceedings-criminal

Back 89

1.) power to compel testimony, subpoena documents
2.) Secret, nor subject to rules of evidence as with trials
-if indict, then gives go ahead for prosecutor to continue

Front 90

Arrest-criminal

Back 90

1.) arrest warrant (probably cause) OR grand jury indictment
2.) Placed in custody
3.) after arrest, must be formally charged or released

Front 91

Preliminary Hearing-criminal

Back 91

Determine if there is enough evidence to charge defendant
-don't deal with this if already went through grand jury

Front 92

Arraignment-criminal

Back 92

1.) formal charges read to defendant
2.) guilty/not guilty plea by defendant
3.) court appointed attorney:if defendant needs court attorney, handled here (usually occurs if defendant can't afford attorney)
4.) set bail (pre-trail release): if out on bail, means if don't show up to trial, don't get money back
5.) set trial date

Front 93

Plea bargains-criminal

Back 93

1.) lesser/dropped charged if plead guilty
2.) reduced sentence

Front 94

Discover-criminal

Back 94

1.) defendant entitled to extensive information from government upon request (can ask for anything prosecutor has)
2.) Government may seek similar materials from defense IF defendant requested those type of materials from government

Front 95

Trial-criminal

Back 95

1.) jury selection
2.) opening arguments
3.) prosecution witness (direct, cross)
4.) defense witnesses (direct, cross)
5.) closing arguments
6.) jury instructions
7.) jury deliberation and verdict (guilty/not guilty)

Front 96

Sentencing-criminal

Back 96

1.) monetary fines/penalties
2.) incarceration

Front 97

Two basic types of evidence

Back 97

1.) direct evidence
2.) circumstantial evidence

Front 98

Direct evidence

Back 98

directly proves whatever fact you are trying to prove
ex. eyewitness or confession

Front 99

Circumstantial evidence

Back 99

-used a lot in fraud
-indirect evidence
-some inference of fact
-implied by evidence
ex. intent

Front 100

Three basic forms of evidence

Back 100

1. Testimonial evidence: oral statements by witness under oath

2. Real evidence: something tangible

3. Demonstrative evidence: visual aids, use evidence to illustrate a point, created specifically for trail (ex. proving impact)

Front 101

Admissibility of evidence (all types: real, testimonial, or demonstrative)

Back 101

1.) relevance
2.) materiality
3.) character (or prior bad acts) evidence
4.) exclusionary rule
5.) brady material

Front 102

Relevance

Back 102

1.) relevant if makes some fact in issue more or less likely than it would be without the evidence (is evidence value added?)

2.) may still be inadmissible if:
-prejudicial: might prejudice jury in some way unrelated to case
-confuse/mislead jury
-privileged

Front 103

Materiality

Back 103

1.) important value to case
2.) used to prove a point
3.) excluded if repetitive (have 1000 forged checks and present each one)

** even if evidence is relevant and material, will be kept out if repetitive

Front 104

Trial-criminal

Back 104

1.) jury selection
2.) opening arguments
3.) prosecution witness (direct, cross)
4.) defense witnesses (direct, cross)
5.) closing arguments
6.) jury instructions
7.) jury deliberation and verdict (guilty/not guilty)

Front 105

Sentencing-criminal

Back 105

1.) monetary fines/penalties
2.) incarceration

Front 106

exclusionary rule

Back 106

-evidence obtained illegally or through bad faith excluded in criminal case
ex. fourth amendment-unreasonable search and seizure

Front 107

brady material

Back 107

-U.S. supreme court case: brady v. Maryland (1963)
-prosecution required to disclose to defendant, upon request, any material evidence favorable to defendant (defendant has to ask with some degree of specificity)

Front 108

Admissibility of real (physical) evidence

Back 108

1.) authentication requirement
2.) best evidence rule
3.) chain of custody

Front 109

authentication requirement

Back 109

has to be authenticated:
1.) by testimony: someone knowledgeable about document who verifies document is authentic
2.) chain of custody: someone has to verify that chain of custody existed on witness stand

Front 110

Best evidence rule

Back 110

1.) can't testify about contents of a document without producing the document itself: can testify that document exists but not the content
2.) produce original document at trial (if there is something about document where originality is issues-ex. check forger)
-otherwise you can have
copies

Front 111

Chain of custody

Back 111

1.) who has possession of item and what they did with it (critical for investigation)
2.) evidence should be marked, identified, inventoried, and preserved in original condition until introduced at trial

-keep log of each piece of evidence
-can lose right to use evidence if lose chain of custody because if don't know where documents were for 1 day or month, defendant can say those documents were tampered with in that time

Front 112

Fact witness

Back 112

-testify only as to FACTS based on own experiences (based on 5 senses)

Front 113

Expert witness

Back 113

1. opinions based on expertise (specialized knowledge and/or experience)
2. testify when specialized knowledge needed to help trier of fact understand evidence
-help explain to jury the testimony if complex
-happens a lot with financial cases

Front 114

Attorney-client privilege requirements

Back 114

for privilege to exist:
1. confidential communication
2. between attorney and client
3. relating to legal advice

-if communication not for legal advice, not protected if related to case

Front 115

Protection provided by attorney-client privilege

Back 115

-if company is client, employees of company protected

Front 116

Accountant-client privilege

Back 116

communication not protected like attorney-client

Front 117

Attorney work product rule

Back 117

applies to materials attorney prepares for litigation
1. qualified privilege
2. materials provided by attorney in anticipation of litigation (can't just be factual, has to have analysis)
3. comments/notes showing attorney's thought processes
4. extends to investigative team hired by attorney (doesn't extend to team for attorney-client privilege)

Front 118

Does protection extend to work by forensic accountant for attorney?

Back 118

1. Consulting (non-testifying) Expert: attorney hires you; ARE protected unless get on stand

2. Expert witness: not protected so all of their work is discoverable

**if don't think you are going to be witness, but then are, lose protection for all work done previously