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Fraud Prevention and Internal Controls - A Winning Combination


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This presentation was given by Pam Mantone at the 19th Annual Decosimo Accounting Forum at the University of North Alabama.

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Fraud Prevention and Internal Controls - A Winning Combination

  1. 1. A Global Reach with a Local Perspective University of North Alabama 19th Annual Decosimo Accounting Forum July 22, 2011 www.decosimo.comFraud Prevention and Internal Controls– A Winning CombinationPAM MANTONE, CPA, CFF, CFE, FCPA, CITPSenior Assurance Manager
  2. 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. 3. Percent of Total Dollar Losses 20.8% Asset Missapropriation 11.30% Corruption67.90% Financial Statement Fraud
  4. 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. 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. 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. 7. Common Schemes Additional concerns  Subsidiaries and Joint Ventures – consolidation or equity method
  8. 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. 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. 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. 11. Preventive Controls Related Parties My hint for the day:  Search for Inter-relationships (see next slide)
  12. 12. Co. B Board Co. A MemberBoard Your Board Co. CMember Operation Member Board Board Member Member Co. F Co. E Co. G Board Member Inter-relationships
  13. 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. 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. 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. 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. 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. 18. Preventive Controls Require dual signatures for payments over an established threshold Request bank notification if a duplicate debit is pending posting
  19. 19. Detection My hints for the day:  Use dimensional testing  Use geo-coding
  20. 20. Standard Detection Testing Employees as Vendors:    Common   Common    
  21. 21. Dimensional Testing Technique Employee Networks as Vendors:           
  22. 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. 23. Geo-Coding 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. 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. 25. Connect with me Pamela S. Mantone, CPA, CFF, CITP, CFE, FCPA, Senior Assurance Manager 423.756.7100 On LinkedIn: -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.