accounting techniques used in a fraud investigation mary anne basilone, cpa, cfe, mmt, ma diane a....

ACCOUNTING TECHNIQUES USED IN A FRAUD INVESTIGATION

Mary Anne Basilone, CPA, CFE, MMT, MA

Diane A. Matthews, PhD, CPA/CFF, CFE

Carlow University Master of Science in Fraud & Forensics Bachelor of Science in Forensic Accounting Bachelor of Science in Accounting

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TOPICS COVERED

INVESTIGATIVE METHODOLOGY

METHODS OF PROOFDIRECT INDIRECT

DIGITAL ANALYSIS TECHNIQUES

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METHODOLOGY OVERVIEW

STEPS IN CONDUCTING A

COMPREHENSIVE FRAUD INVESTIGATION

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PROCESS MAP

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Dorrell, D., Gadawski, G. (2012). Financial forensics body of knowledge. Hoboken, New Jersey: John Wiley & Sons.

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INVESTIGATIVE METHODOLOGY THE PROCESS MAP

AssignmentDevelopment

References

Purpose of Stage Potential Issues

Deliverables

Tasks to be Performed

Identify parties to the case Correlate the matters of law Confirm technical capabilities

AICPA/BVFLS Practice Aids Litigation Services Handbook,

4th & Cumulative Supplements NACVA Resources

Clear conflict - firm-wide database Insure matching of expectations between counsel

and facts and circumstances of matter Determine whether engaged as consultant or

expert Prepare and secure engagement letter & retainer Establish concrete timelines, e.g. discovery cutoff,

report submittal, etc. Establish counsel communications protocol, e.g.

whether/how subject to discovery

Identification of all parties Specification of key timelines Privilege determination Agreement on standards

“Entity / Party Chart” Signed engagement letter &

retainer Retainer

Forensic Accounting/Investigation Methodology (FA/IM)Forensic Accounting/Investigation Methodology (FA/IM)©©

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover

ConfidentialInformants

Surveillance-Electronic,

Physical

Analysis ofTransactions

Testimony&

Exhibits

Post-Assignment

INTERPERSONAL DATA COLLECTION AND ANALYSIS TRIAL/REPORTSFOUNDATIONAL

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References


Deliverables


Continually define/refine universes of data, primary and secondary

Litigation Services Handbook, 4th, (matter-specific references)

GenoPro Gold

Initiate data collection processes Prepare Document Request(s) as necessary TASKS

Genogram Entity(s)/party(s) chart Background investigation

Insure that all possible data sources are defined

Establish protocol to manage data requested and obtained

“Entity(s)/Party(s) Chart” Genogram Document Request Timeline Analysis

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Gain confidence of parties Obtain information from parties

Kolb’s “Experiential Learning” www.Reid.com ; w-z.com Edwin T. Hall works ACFE Fraud Examiner’s

Manual

For Depositions: Prepare Deposition Matrix Attend depositions with counsel and advise

For Interviews: Background investigation on identified parties Use interpersonal communication techniques to

analyze responses for further investigation Proxemic communication Kinetic communication Expectations-based analysis

Prepare interview matrix (next slide) Establish preliminary hypothesis using Scientific

Method

Veracity of parties “Hidden agendas” of parties Blind leads Additional/unrelated matters Communication inhibitors

Deposition Matrix Updated Genogram Updated “Entity/Party Chart” Interview Matrix Video/audio recordings Preliminary Hypothesis

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Obtain validating data Obtain refuting data

Internet research, e.g. Best Websites for Financial Professionals, Business Appraisers, and Accountants, 2nd

TimelineXpress software InData (Events Analysis)

Combine first-hand knowledge (e.g., Interviews and Depositions) with second-hand knowledge (e.g., Background Research data

See “Online Databases – Sources of Information” See “Government Sources of Information” Identify disparities for additional investigation TASKS

Establish search protocol Collect data for validation/corroboration

Veracity of parties Currency of information Admissibility of data

Search Log Updated Genogram “Events Analysis” Output notebook

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Define data collection plan Obtain data / information Surface evidence

IRS’ MSSP (Market Segment Specialization Program) for selected industries

IRS Indirect Methods-Intro IRS Indirect Methods-Example

Identify remaining data needed to substantiate/refute positions

Develop plan to obtain data using investigatory steps

Surveillance (Electronic / Physical) Confidential Informants Undercover

NOTE: All preceding activities are dependent upon evidence admissibility – counsel must advise

TASKS Records-based expectations Reasonableness testing

Non-existent data Interpersonal data not

verifiable

Data collection plan

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Obtain data / information Surface evidence

Investigator’s Little Black Book, 4th

“TimelineXpress” from inData Corporation

Criminal Investigations

NOTE: All activities in this Stage are dependent upon evidence admissibility – counsel must advise

Mobile v. fixed surveillance Lead, participant and covert informants Develop the assumed identity to gather data /

information Document all data / information gathered Develop “Lifestyle Analysis” (See document) Validate / correlate prior data obtained through

alternate techniques

Missing information Privacy laws Unreliable informant Inconclusive information Entrapment Engagement/personal risks

Video/audio recordings Root tracing results Digital photographs Validation /correlation of prior

data and deliverables

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Substantiate information by using scientific methods

Perform any additional indirect or direct analytical forensic techniques as needed

Validate / correlate prior data obtained through alternate techniques

Genogram/Entity / Party Chart Deposition Matrix/Interview Matrix Search Log/Background Investigation Lifestyles Analysis Net Worth Method

Indirect analytical techniques are inconclusive

Direct analytical techniques do not support the indictment

Documented results Validation /correlation of prior

data and deliverables

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment

Background investigation Online sources Government sources

Software: Genogram/ Timeline/IDEA software



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References


Deliverables


Obtain sufficient relevant data to provide credible evidence

Bragg, Steven M., Business Ratios and Formulas (Wiley)

Benford’s – www.nigrini.com IDEA software

Summarize and analyze the findings of all deliverables and observations

Identify any missing information or “gaps” DRAFT the Forensic Accountant’s Report TASKS

Common-sizing Horizontal analysis Vertical analysis Statement analysis (written)

Forensic Accountant’s Report does not support the indictment

Additional techniques do not substantiate missing gaps

“Gap” Analysis Indictment Matrix WPN (words/pictures/numbers)

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Prepare for trial Integrate parties & information Ensure the completeness of all

testimony and exhibits

Writing and Defending Your Expert Report (SEAK)

The Visual Display of Quantitative Information (Tufte)

Obtain counsel’s and opposition’s DRAFT Trial Brief

Identify the presentation sequence of evidence Identify portions of report used as exhibits Identify items used for expert testimony Develop tactical trial plan TASKS

Reperform Reverse Proof

Meeting tight/changing timelines

Presentation too complicated

Scripted Report

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Add credibility to the case by providing expert information

Cross-Examination: T/he Comprehensive Guide for Experts (SEAK)

Kolb, Experiential Learning

PRACTICE, PRACTICE, PRACTICE Deliver expert witness testimony Explain exhibits TEACH the trier(s) of facts

“Surprises” Extraordinary personal stress

Expert Witness Testimony Transcript

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment



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References


Deliverables


Obtain the results of the case Benefit from the experience

Learn from the experience Assess firm’s performance TASKS

Evaluate performance of each party Update CV Extract “show and tell” as feasible Follow-up with counsel; grading form

Continuous professional development

Verdict Judge’s Ruling “Lessons Learned” Updated CV

TrialPreparation

DataCollection

Interviews&

Interrogation

Scoping

BackgroundResearch

LaboratoryAnalysis

Undercover



Physical


Testimony&

Exhibits

Post-Assignment

Your previous results



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METHODS OF PROOF (OF FRAUD)

FOR FINANCIAL INVESTIGATORS

DIRECT METHODSSPECIFIC ITEM METHODFINANCIAL RELATIONSHIPSFINANCIAL STATEMENT ANALYSIS

HORIZONTAL VERTICALTREND RATIO CASH FLOW

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INDIRECT METHODSNET WORTH METHOD

(AKA ASSET METHOD)

EXPENDITURES METHOD

(AKA LIFESTYLES METHOD)

(AKA SOURCES AND APPLICATION OF FUNDS METHOD)

BANK DEPOSIT METHOD

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Information for specific industries IRS’s Market Segment Specialization Program

(MSSP) Audit Techniques Guides (ATGs) Learn distinct , detailed practices in a particular industry Examination techniques Common & unique industry issues Business practices Terminology

Example of market segments: Construction or entertainment industry Professions: lawyers or real estate agents

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Direct-Specific item method Most common method Relies on specific transactions Uncovers specific financial transactions which relate

to illegal activity, and to the suspect Review books, records, bank accounts… directly traces a

transaction

Direct (vs circumstantial) proof Easiest to present @ trial Most difficult for the suspect to refute Example: Ghost employee on the payroll

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FINANCIAL STATEMENT ANALYSIS

NEED FOR FINANCIAL STATEMENT ANALYSISCOSOREPORT TO THE NATIONS

POWER OF FINANCIAL STATEMENT ANALYSIS

FINANCIAL RELATIONSHIPS

SALES VERSUS COST OF GOOD SOLD

SALES VERSUS ACCOUNTS RECEIVABLE

SALES VERSUS INVENTORY

ASSETS VERSUS LIABILITIES

FINANCIAL STATEMENT FRAUD

FICTITIOUS REVENUES

TIMING DIFFERENCES

CONCEALED LIABILITIES AND EXPENSES

IMPROPER DISCLOSURES

IMPROPER ASSET VALUATION

FINANCIAL STATEMENT ANALYSIS

PERCENTAGE ANALYSIS:HORTIZONAL

PERIOD TO PERIOD INDUSTRY STANDARDSCOMPETITORS

VERTICALCOMMON SIZE STATEMENTS

TREND ANALYSIS

FINANCIAL STATEMENT ANALYSIS CON’T

RATIO ANALYSISLIQUIDITYASSET MANAGEMENTDEBT MANAGEMENTPROFITABILITY

CASH FLOW ANALYSISOPERATING INVESTINGFINANCING

CIRCUMSTANTIAL PROOFADMISSIBLE IN COURT(1954 Supreme Court Holland v. U.S.)

WHEN TO USE? Inadequate books/records Suspected: books do not reflect all income Significant increase in net worth Gross profit % changes significantly Expenses exceed reported income without cause Suspected income from unidentified sources is large

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INDIRECT METHODS OF PROOF

SOURCES OF INFORMATION County courthouse: deeds

of ownership, titles, liens, UCC filings

The target Informants/associates Real estate records Bankruptcy records State motor vehicle records Loan applications

Surveillance Credit card

applications/statements Tax returns Insurance records Child support/divorce records Employment: salary, W-2s Cancelled checks Deposit slips

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INDIRECT METHODS OF PROOF

NET WORTH METHODUsed to prove illicit income

Person’s assets or expenditures exceed known sources of income

4 ways to dispose income:1. Save it

2. Buy assets

3. Pay off debt

4. Spend it

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Used extensively in drug &

money laundering cases

INDIRECT METHODS OF PROOF (O

NET WORTH METHOD FORMULA Assets

-Liabilities

=Net worth

-Prior year’s net worth

=Increase in net worth

+Living expenses

=Income (or expenditures)

-Funds from known sources

=Funds from unknown sources

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Assets valued @ cost

US BLS publishes

annual living expenses—

utilities, food, gas


EXPENDITURES METHOD Sources & Application of Funds; Lifestyles Method

CLUES Lavish residence Expensive cars/boats Vacation home Private schools for children Exotic vacations

WHEN TO USE?...WHEN TARGET Operates mostly on a cash basis Little or no net worth but large expenditures Little or no change in assets or liabilities

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EXPENDITURES METHOD FORMULA

Total expenditures (i.e., Application of funds)

-Known sources of funds

=Funds from unknown sources

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BANK DEPOSIT METHODWHEN TO USE?

Assets & liabilities are fairly constant No indications of extravagant lifestyle Target’s known income is being deposited into financial

institutions

HOW? Analyze bank deposits, cancelled checks, currency

transactions

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BANK DEPOSIT METHOD FORMULA

Total deposits to all accounts

-Transfer and redeposits

=Net deposits to all accounts

+Cash expenditures

=Total receipts from all sources

-Funds from known sources

=Funds from unknown or illegal sources

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SOFTWARE PROGRAMS PERFORMDATA MINING

Extracting information from databases Comb DB for obscure patterns Sort data to detect potential fraud

same address for two employees

DATA ANALYTICS Statistical process used to analyze data Identify red flags, transaction trends, patterns,

anomalies

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FUNCTIONS Sorting Record selection Joining files Multi-file processing Correlation analysis Date functions Graphing

Verifying multiples of a number

Compliance verification Duplicate searches Vertical ratio analysis Horizontal ratio analysis

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FUNCTIONS

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Data file inquiry Random unit sampling Calculate totals Calculate averages Specific criteria searches Unusual item inquiries Link analysis graphics

Identify gaps in sequence Identify duplicates Differentiate normal

patterns from suspect patterns

Benford’s Law analysis Stratification

EXAMPLES Identify invoices w/o PO Look for invoices from

vendors not “approved” Analyze claims paid by

insurance providers Look for high volume

purchases from one vendor

Match names, addresses, phone numbers, SS numbers between employee and vendor files

Identify dormant accounts with activity

Search for large, rounded transaction values

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COMMERCIAL SOFTWARE Excel ACL IDEA ActiveData for Excel AutoAudit SNAP! Reporter DataWatch’s Monarch for

Windows Oversight Systems

Case Management Software—Analyst’s Notebook i2; LexisNexis CaseMap Organize, evaluate, explore

evidence

Timeline Software—TimelineXpress (inData Corp)

Genogram--GenoPro

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ACCOUNTING TECHNIQUES USED IN A FRAUD INVESTIGATION

Mary Anne Basilone, CPA, CFE, MMT, MAChair, Accounting & Forensic Accounting [email protected]

Diane A. Matthews, PhD, CPA/CFF, CFEAssociate Dean, School of [email protected]

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accounting techniques used in a fraud investigation mary anne basilone, cpa, cfe, mmt, ma diane a....

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