Fraud Prevention and Internal Controls - A Winning Combination
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The document discusses the prevalence and impact of financial statement fraud, which, while making up less than 5% of fraud cases, incurs significant losses averaging over $4 million per case. It outlines common schemes and preventive controls to mitigate fraud risks, emphasizing the importance of effective oversight, understanding business operations, and establishing layered internal controls. The presentation also includes actionable hints for organizations to enhance their detection and prevention strategies against fraud.
Fraud Prevention and Internal Controls - A Winning Combination
- 1. A Global Reach with a Local Perspective University of North Alabama 19th Annual Decosimo Accounting Forum July 22, 2011 www.decosimo.com Fraud Prevention and Internal Controls – A Winning Combination PAM MANTONE, CPA, CFF, CFE, FCPA, CITP Senior Assurance Manager
- 2. ACFE 2010 Report to the Nation Financial statement fraud cases were less than 5% of the total fraud cases reported However Financial statement fraud cases were the most costly of all fraud cases reported, causing a median loss of more than $4 Million!
- 3. Percent of Total Dollar Losses 20.8% Asset Missapropriation 11.30% Corruption 67.90% Financial Statement Fraud
- 4. Spotting Creative Accounting Why boost the Balance Sheet? Create appearance of a strong financial position – More easily obtain lines of credit at low interest rates Easier to issue debt financing or issue bonds on better terms Maintain compliance with existing loan covenants Increase earnings power in future periods Increase earnings power in current period Keep investors happy! Food for thought – Why decrease the Balance Sheet?
- 5. Financial Statement Fraud The deliberate misrepresentation of the financial condition of an entity. Intentional misstatement or omission of amounts or disclosures in the financial statements in order to deceive financial statement users Objectives Overstate profits, revenues or assets Understate losses, expenses or liabilities What about reversing these – would you think financial statement fraud in this case? Committed at the upper-management level
- 6. Common Schemes Improper revenue recognition End result – overvaluing assets Improper asset valuation Provision for doubtful accounts Inventory manipulation Fixed Assets Concealed expenses and liabilities In July 2002, the SEC charged Adelphia with fraudulently excluding over $2.3B in bank debt by deliberately shifting liabilities to off-balance sheet unconsolidated entities Improper disclosures or omissions
- 7. Common Schemes Additional concerns Subsidiaries and Joint Ventures – consolidation or equity method
- 8. Overvaluing Assets My hints for the day: Inventory increasing faster than sales Inventory rising faster than total assets and falling cost of sales as a percentage of sales Balance sheet item growing at a faster pace than the income statement item Equity method limits available information-easier to conceal or overstate
- 9. Improper Disclosures or Omissions Loan covenants or contingent liabilities Subsequent events Significant fraud committed by officers, executives, and others in key positions of trust Changes in accounting principles, estimates, and reporting entities Related party transactions Tyco – failed to disclose hundreds of millions of dollars of low-interest and interest-free loans. Also CEO forgave $50M in loans to himself and another $56M for 51 favored employees
- 10. Preventive Controls Effective oversight a must! Gain a solid understanding of the business Maintain appropriate levels of skepticism Consider incentives, pressures, opportunities and rationalizations to commit fraud Explore fraud risk scenarios Assess the financial reporting culture Organizational Structure “Tone at the Top” Zero Tolerance Ethics Policy
- 11. Preventive Controls Related Parties My hint for the day: Search for Inter-relationships (see next slide)
- 12. Co. B Board Co. A Member Board Your Board Co. C Member Operation Member Board Board Member Member Co. F Co. E Co. G Board Member Inter-relationships
- 13. Accounts Payable Detection and Prevention Potential Fraud schemes Employees Committing Purchase Fraud Fictitious Vendors Personal purchases with company funds Vendors Committing Fraud Over-charging for goods purchases Duplicate billings Billing for goods not ordered or shipped Collusion Kickbacks
- 14. Identification of Red Flags Employees committing purchasing fraud Vendor name, address = employee name, address Undisclosed conflicts of interest Vendors committing fraud Documentation does not exist or lacks appropriate detail Pricing does not agree with contracts Duplicate invoices Invoices submitted for materials not ordered or delivered
- 15. Preventive Controls Implement a fraud hotline and notify employees and vendors of its existence Separate duties of A/P processing, vendor file maintenance, check stock custody, check preparation, check signing, check mailing and bank reconciliation Separate purchasing and receiving functions Require mandatory vacations and cross train employees so that someone else can fill in for these positions
- 16. Preventive Controls Use physical and software controls to restrict access to A/P and cash disbursements systems, including access to banking software Maintain an approved vendor list independently of the purchasing department Restrict access to the vendor master file and flag any changes to the file Periodically purge the vendor master file to maintain only active approved vendors Require proper authorization of all transactions Do not pay from statements!
- 17. Preventive Controls Never sign blank checks! Severely restrict the use of manual checks Use positive pay or reverse positive pay systems Use quality check stock Investigate and void and reissue checks more than 90 days outstanding Deface voided checks Use pre-numbered, multi-part checks Do not allow access to blank checks to those with signatory authority Lock up check stock, signature stamps, plates
- 18. Preventive Controls Require dual signatures for payments over an established threshold Request bank notification if a duplicate debit is pending posting
- 19. Detection My hints for the day: Use dimensional testing Use geo-coding
- 20. Standard Detection Testing Employees as Vendors: Common Common
- 21. Dimensional Testing Technique Employee Networks as Vendors:
- 22. Searching for Addresses: Geo-Coding Must be consistent in entering data for both the Employee Master and the Vendor Master files for matching Obstacles St. vs. Street NE vs. North East 123 Main Street, Apartment B vs. 123 Main Street B or 123 Main Street Apartment B
- 23. Geo-Coding http://www.gpsvisualizer.com/geocode I enter: 1089 East Harrison Street, Martinsville, IN The Google geocoder found: 1089 E Harrison St, Martinsville, IN 46151, USA street address: 1089 E Harrison St ZIP/postal code: 46151 city: Martinsville state/province: IN country: USA latitude, longitude: 39.429443, -86.415746 39.429443 -86.415746 N39° 25.7666', W086° 24.9448' (precision: address)
- 24. By themselves, internal controls will not prevent fraud. - Yet - The perception of detection through monitoring of internal controls is a great way of discouraging fraud.
- 25. Connect with me Pamela S. Mantone, CPA, CFF, CITP, CFE, FCPA, Senior Assurance Manager 423.756.7100 pammantone@decosimo.com On LinkedIn: http://www.linkedin.com/pub/pamela -mantone/10/824/807 Disclaimer: The contents of this presentation are for informational purposes only. The information is not intended to be a substitute for professional accounting counsel. Always seek the advice of your accountant or other financial planner with any questions you may have regarding your financial goals or specific situations.