Chapter 2- Exercise 12

Question: Why may behavioral forensic techniques catch some fraud schemes that data
driven techniques miss?
Answer:
According to the Wikipedia encyclopedia, some forensic accountants specialize in
forensic analytics which requires the analysis of electronic data within a financial system mainly
for the purposes of detecting fraud or obtaining evidence to support a claim to fraud.
However with behavioral forensic techniques Albrecht indicated that these may be
symptoms of fraud, in other words examining changes in one’s behavior can serve as a signal or
red flag that fraud may be occurring. Some of these behaviors may include an extravagant
lifestyle e.g. expensive cars, properties, expensive vacations or even sudden change in one’s
behavior or attitude.
Having understood both data and behavioral techniques, to further explain why data
driven techniques may only detect some fraud schemes as opposed to behavior techniques, the
point to note, is that the use of data driven techniques requires that data be inputted and recorded
into a system. For example in investigating a vendor fraud according to Albrecht, with the use of
the technique of fuzzy matching one may cross reference the vendor addresses to possible
employee’s addresses to establish any unusual links. The point is in order to carry out this cross
referencing the data must be recorded in the system otherwise if not recorded use of data driven
techniques are useless.
However when you examine behavioral techniques, one will be paying attention to one’s
extravagant lifestyle or changes in their behavior. These behaviors are not recorded in the system
hence data techniques will be useless but by looking at ones dramatic change in behavior or
comparison of their lifestyle in comparison to their earnings may reveal the possibility of fraud
such as bribery or kickbacks according to Crumbly.
With these types of frauds i.e. bribery or kickbacks the behavioral aspect may provide a
red flag that there is possible fraud however these are usually revealed by an anonymous tip,
which will not be recorded in the system hence use of data driven techniques will miss this one.
It should be noted however that a combination of both techniques will be very useful in
uncovering various fraud schemes.

References
Albrecht, Albrecht & Albrecht- Fraud examination 4e
Wikipedia encyclopedia retrieved from http://en.wikipedia.org/wiki/Forensic_accounting
Crumbley.L. Forensic and Investigative Accounting 5th edition
Chapter 3 Exercise #7
What are three ways Managers override internal controls? How can a forensic Accountant
overcome Managers overriding internal controls?

According to the website Business Dictionary internal controls are systematic measures
such as reviews, check, balances, methods and procedures implemented by an institution to
conduct business in an efficient manner, safeguard its assets, deter and detect errors fraud and
theft, ensure the accuracy of accounting data and produce timely financial information for
management. Thus it may include one or a combination of segregation of duties, authorization &
approvals, physical safeguards, independent check and documentation and records.
It therefore stands to reason, since Management is responsible for implementation of
these controls because of the position that they hold at the top of an organization they also have
the power to override or compromise these controls which can defeat the purpose and objectives
of an internal control system as discussed in the definition above. According to SAS 99 the
Three Major ways Management may override controls are as follows:
 Recording of fictitious Journal entries
 Intentionally biasing assumptions and judgments used to estimate accounts
 Altering records and terms related to important and unusual transactions.

Having identified the major ways Management can override controls then logically it implies
that a forensic Accountant can overcome Managers overriding internal controls via the following
ways (Journal of accountancy SAS 99):
 Careful examination of Journal entries and the internal controls governing
Journal entries- The forensic accountant will want to obtain an in-depth
understanding of the internal control system an organization has in place for
processing journal entries. Usually Journal entries are one means of recording
transactions into the books, however a proper internal control system will ensure
that before a journal is posted into the accounting system that it has relevant
supporting documentation and the persons entering are separate from the person
approving and authorizing the journal. Thus by the forensic accountant reviewing
journal entries and looking for those that are great material value, approved by
management only with no supporting documentation is one means the forensic
can overcome the override. In other words by reviewing the journal entries the
forensic accountant will be able to identify any deviation or anomalies.
 Review of Accounting estimates for bias, i.e. not just present estimates but
also reviewing estimates from prior periods for bias- The forensic accountant
will want review all accounting estimates both present and prior whose values can
not only be easily influenced by management’s judgment but also to determine
whether there is bias on the part of management in arriving at these estimates. The
forensic accountant in relation to estimates will want to first determine what is a
reasonable estimate given the information at hand and compare this estimate to
the estimate recorded in the financial statements; hence any differences should be
examined to determine if it results from bias on the part of Management.
 Evaluating the business rationale for significant unusual transactions: The
forensic accountant should have a clear understanding of the business and how it
 operates, having this knowledge he would want to identify what is termed as
significant and unusual transaction i.e. transactions that are outside of the type of
business, however having identified these transactions the Forensic Accountant
will want to obtain from management the reasons for accounting for the
transaction and the reasoning behind the way it was accounted for. Based on the
reasoning it may reveal whether or not the transaction was entered into to conceal
a possible fraud.

References
Albrecht, Albrecht & Albrecht- Fraud examination 4e
Business dictionary retrieved from website retrieved from website
http://www.businessdictionary.com/definition/internal-control.html
Journal of accountancy SAS 99 retrieved from website http://users.ipfw.edu/pollockk/SAS99.pdf

Chapter 2 Exercise #47

Give some patterns or red flags of financial statement fraud.
The patterns or red flags of Financial Statement Fraud are as follows:
1. Early revenue recognition- with the objective to increase earnings one way may be to
recognize revenue before it is earned to illustrate for example recording of revenue in the
accounts when a sales transaction is not completed i.e. products delivered or invoice paid.
2. Holding books open past the accounting period- Here there does not exist a proper cut off
period i.e. the periods are kept open for the purposes of recording transactions that relates
to a future period in the current period for the purposes of manipulating the books
3. Factious sales: This refers to sales to fictitious or non-existent customers or unauthorized
sales to real customers.
4. Failure to record returns- This is the deliberate omission of sales returns which will affect
the bottom line.
5. Inadequate disclosure of related party transactions- Here management deliberately
withholds information on issues such as present law suits against the company that could
result in a possible liability.
6. Management Estimate- This becomes a red flag especially where on review the estimates
appear to be unreasonable which can be misleading to users of financial statements.
7. Related Party transactions: This may be a business arrangement between two parties
whose relationship e.g. (family relationship) will create a conflict of interest, the red flag
arises when this information is not disclosed.
8. Big bath – This refers to a onetime charge that is taken against an asset the objective is to
take a full hit and record the cost in the profit & loss in one year so that income is
reduced in that year so that in future years the net income will be shown as increasing.

References
Grant Thornton- the Forensic and investigative Service Practice- Financial statement fraud
opportunities examples.
Albrecht, Albrecht & Albrecht- Fraud examination 4e
Chapter 4 Exercise #17
How does a Forensic Accountant analyze inventories and receivables?
In undertaking the analysis of inventories and receivable the Forensic Accountant will be
examining the relationship and will want to analyze as follows:
 Calculate and critically examine the ratios: The Accounts receivable to sales and
inventory to cost of goods sold, percentage levels should be benchmarked for e.g. if
receivables or amounts owed by customers exceeds sales by threshold by 15% then this
can be an indicator of fraud as large amounts owed by customers and stock on hand can
lead to financial problems.
 Examine relationships: The Forensic Accountant will want to examine the relationship
between sales and inventory for e.g. In order to meet the demand for sales there will
need to be an adequate supply of inventory, hence there is a direct correlation i.e. as one
increases so should the other, therefore in the event inventory is increasing at an
unusually faster rate than sales or in the opposite direction then this too may be a signal.
 Comparison of Actuals against budgets- An organization may have a budget for sales and
inventory based on its expected output, therefore by the Forensic accountant comparing
actuals to budget it can result in material variances which in itself can be the signal of an
unusual transaction. Similarly comparing actuals of a current and prior period can also
reveal something unusual
 Examine relationships between financial and non-financial information- This may be a
comparison of the value of the inventory stated compared to the quantity value if a
physical count is undertaken. By estimating the value of the physical count to the value
recorded can also signal a red flag.

Chapter 4 Exercise #27

According to auditing standards the following statements are false:
a) A high degree of competition accompanied by declining margins would be an example of
opportunity for fraudulent financial reporting- ( Answer- False)
b) A heavy concentration of one’s wealth in a particular company would be an example of a
rationalization condition for fraudulent reporting ( Answer-False)
c) A large amount of cash on hand would be an example of rationalization to misappropriate
assets. ( Answer-False)
Chapter 4 Exercise # 32
What are the seven investigative techniques available to a Forensic Accountant?
The seven investigative techniques available to a forensic accountant are as follows:
1. Public document reviews and background investigations- This may include government
sources of information and private sources such as online databases.
2. Interviews of knowledgeable persons- Interviews are an important source of information
as it may substantiate ones findings or provide other avenues or leads for a new or
ongoing investigation.
3. Confidential sources
4. Laboratory analysis of physical and electronic evidence- This investigative technique
may involve the use of other experts in the field e.g. computer forensic expert in
analyzing data from a seized computer.
5. Physical and electronic surveillance for example use of surveillance cameras or
wiretapping.
6. Undercover operations or a covert operation, this technique was used in the Mc Donald’s
monopoly fraud as a means of uncovering the fraud involving the misuse of game pieces
by Simon Marketing in the Mc Donald’s monopoly competition.
7. Analysis of financial transactions- This involves the use of analytical techniques such as
ratios, horizontal and vertical analysis to unearth unusual material changes and
transactions.

References
Robert Durkin-Forensic Auditing – Auditing or Investigation?
Albrecht Albrecht and Albrecht- Fraud examination 4e

Chapter 4 Exercise # 41
How should auditors search for hidden liabilities?
According to the article by Gelman, Rosenberg & Freedman they defined hidden liabilities as
those items we are aware of but cannot see or touch that may have an impact on the potential
buyer perception of the company value. These may include the following items such as
unresolved tax issues; UN remedied environmental problems, unresolved tax issues and lawsuits
or litigations.

However given the nature of these liabilities auditors may search for them via the follow ways:

 Seek confirmation from the organization legal department on all existing & pending
lawsuits, tax assessments etc. detailing their nature and possible outcomes.
 Seek third party confirmation from company’s independent lawyers in an attempt to
corroborate information on the nature, possible outcomes and materiality.
 Examination of the Board minutes, these would hold important information on decisions
taken by the Board on various matters dealing with pending lawsuits, loans entered into,
and taxation issues.
 Review all Government correspondence such as tax assessment notices to determine if
there is any outstanding tax issues and possible outcomes.
  Interviews with Top management specifically seeking to determine management’s
knowledge of any hidden liabilities.

References
Gelman, Rosenberg & Freedman. Clean up hidden liabilities before selling your business
retrieved from http://www.grfcpa.com/resources/articles/clean-up-hidden-liabilities-before-
selling-your-business

Chapter 4 Exercise #42

To attempt to answer this question it is important that one understands firstly the definition of a
material weakness. According to Crumbley a material weakness is defined as follows:

“A deficiency, or combination of deficiencies in internal controls over financial

reporting, such that there is a reasonable possibility that a material misstatement of the
company’s annual statement will not be prevented or detected on a timely basis.”

To assess whether this scenario meets the definition of a material weakness it must be broken
down and assessed against the important elements of the definition. Firstly in the scenario the
following should be noted:
 There are presently no procedures in place to monitor and review any modifications to
the terms of their sales contract
 Despite management reviews management is not in a position to determine possible
misstatements/
 Additionally, there has also been improper revenue recognition which has proven to be
material.
In my opinion this scenario meets the definition of a material weakness because the lack of
controls for reviewing the terms of these contracts is a risk in itself as the terms of these sales
contracts will affect how revenue is recognized, as a result this can lead to improper revenue
recognition and as the scenario states there has been evidence of not only improper revenue
recognition but it is also material.
Additionally despite management’s reviews of the gross margins it is stated in the scenario that
they are not in a position to even identify potential misstatements.
Therefore in conclusion the lack of controls on the terms of these contracts which can and has
led to improper revenue recognition coupled with management lack of ability to identify possible
misstatement may lead to the reasonable possibility that misstatements cannot be detected on a
timely basis hence it should be classified as material weakness.

References
Crumbley, L- Forensic and Investigative Accounting
Chapter 4 Exercise # 48
Suppose you are fired because you would not “cook the books” Do you have any regress?
At times an employee rightly refuses to be party to or commit a fraudulent act and one
course of action is to report these activities to an independent external party. In fact Albrecht
made reference to the use of the Whistle blowing Act which allows employees to report on any
fraudulent activities that they may be aware of.
However in the event the employee stands his ground, refuses to commit a fraudulent act
such as cooking the books and later decides to blow the whistle, it has been known to create
problems for that individual, as a result an employee may be victimized, receive bad appraisals
and worst case even fired.
The question that now comes to mind is does the employee have any regress? To
summarize according to the U.S office of Special counsel federal employees are able to file
complaints with the OSC about matters such as abuse of authority and wastage or misstatement
of funds. Therefore if the employee has reasonable grounds to believe that he is being treated
unfairly, i.e. victimized, has received bad performance management appraisals or worst case
fired, in the event the organization fails to deal with the matter the employee can file a complaint
with the OS C who can then take disciplinary action against the party who has committed this
unfair practice (manager).
Once this case has been taken to the MSPB if it is found that the person or organization is
guilty of committing a personnel practice that is prohibited e.g. firing the employee then the
penalties may range from five year debarment from federal employment to a fine of $1000.
However for the injured party the forms of relief available to him or her may include, job
restoration, reversal of any suspension if that has been the case, back pay or even damages
which can include the cost such as attorney fees or expenses incurred by the employee because
of the action taken.

References
Albrecht, Albrecht & Albrecht- Fraud Examination 4e
Office of Special Counsel- Know your rights when reporting wrongs.