forensic and investigative accounting chapter 18 forensic accounting in action © 2013 cch...

Forensic and Investigative AccountingForensic and Investigative Accounting

Chapter 18

Forensic Accounting in Action

© 2013 CCH Incorporated. All Rights © 2013 CCH Incorporated. All Rights Reserved.Reserved.

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Chapter 18 Forensic and Investigative Accounting 2

Questions Answered by Fraud InvestigationQuestions Answered by Fraud Investigation

Who had the opportunity to commit fraudulent Who had the opportunity to commit fraudulent activity?activity?

How and when was the fraud committed?How and when was the fraud committed? What was taken (how much money was lost)?What was taken (how much money was lost)? Where were the assets moved (how were the Where were the assets moved (how were the

assets converted to the benefit of the perpetrator)?assets converted to the benefit of the perpetrator)? Why was the activity intentional, rather than Why was the activity intentional, rather than

accidental, or the result of mistake or accidental, or the result of mistake or misunderstanding?misunderstanding?


Accounting AnomaliesAccounting Anomalies

Accounting anomalies often signal the presence of fraud.Accounting anomalies often signal the presence of fraud.

Examples of accounting anomalies include:Examples of accounting anomalies include: Irregularities in source documents (e.g., missing Irregularities in source documents (e.g., missing

documents, excessive voids or credits, common names documents, excessive voids or credits, common names or addresses of customers, increases in past due or addresses of customers, increases in past due receivables, increased reconciling of items, etc.).receivables, increased reconciling of items, etc.).

Faulty journal entries.Faulty journal entries. Inaccuracies in ledgers.Inaccuracies in ledgers.


Internal Control WeaknessesInternal Control Weaknesses

Lack of segregation of dutiesLack of segregation of duties Lack of physical safeguardsLack of physical safeguards Lack of independent checksLack of independent checks Lack of proper authorizationLack of proper authorization Lack of proper documents and recordsLack of proper documents and records Overriding of existing controlsOverriding of existing controls Inadequate accounting systemInadequate accounting system


TruGloss Shanghai JVTruGloss Shanghai JV: Unusual or : Unusual or Unrealistic Procedures and RelationshipsUnrealistic Procedures and Relationships

What Was Taken?What Was Taken? $6 million USD of inventory missing from the $6 million USD of inventory missing from the

Shanghai warehouse.Shanghai warehouse. $6 million USD cash associated with sales to $6 million USD cash associated with sales to

customers.customers. $5 million USD of accounts receivable (70% of $5 million USD of accounts receivable (70% of

which was for sales that were claimed never to which was for sales that were claimed never to have occurred) associated with customers have occurred) associated with customers claiming never to have ordered any inventory.claiming never to have ordered any inventory.



Who Had the Opportunity?Who Had the Opportunity? Hong Wu, the sales manager in Shanghai who was Hong Wu, the sales manager in Shanghai who was

responsible for sales.responsible for sales. Daqing Yang, the logistics manager for the Daqing Yang, the logistics manager for the

Shanghai warehouse.Shanghai warehouse. Xiang Chu, accounting manager who made Xiang Chu, accounting manager who made

accounting entries and deposits.accounting entries and deposits. Alex Richards, Wu’s and Yang’s supervisor.Alex Richards, Wu’s and Yang’s supervisor. Grant Williams, Chu’s supervisor.Grant Williams, Chu’s supervisor.



How Were the Assets Moved?How Were the Assets Moved? Individuals—likely not actual customers—picked Individuals—likely not actual customers—picked

up inventory from the warehouse, sometimes up inventory from the warehouse, sometimes without the need for required documentation.without the need for required documentation.

Logistics manager released inventory to Logistics manager released inventory to individuals (supposedly customers) for cash.individuals (supposedly customers) for cash.

Cash was transferred from Yang to Wu.Cash was transferred from Yang to Wu.



How Was the Theft Concealed?How Was the Theft Concealed? Wu attributed all/some of cash received by Wu attributed all/some of cash received by

legitimate customers to other customers—some of legitimate customers to other customers—some of which would have been used as down payments which would have been used as down payments for other fictitious/improper sales.for other fictitious/improper sales.

Part of cash received from individuals for Part of cash received from individuals for inventory used to account for actual sales and part inventory used to account for actual sales and part of cash withheld by Yang and Wu.of cash withheld by Yang and Wu.

(continued on next slide)(continued on next slide)



How Was the Theft Concealed? (continued)How Was the Theft Concealed? (continued) Sales made to future customers could have been Sales made to future customers could have been

made for amounts below those approved by made for amounts below those approved by TruGloss Shanghai JV.TruGloss Shanghai JV.

Yang and Wu could have involved Chu, Richards, Yang and Wu could have involved Chu, Richards, and/or Williams to help ensure that fraud was not and/or Williams to help ensure that fraud was not detected.detected.



How Were the Assets Converted?How Were the Assets Converted? Inventory sold to individuals (who are not actual Inventory sold to individuals (who are not actual

customers) at below market prices for cash—not customers) at below market prices for cash—not possible to trace payments originating from possible to trace payments originating from certain customers to accounting transactions certain customers to accounting transactions (because of the nature of a cash transaction).(because of the nature of a cash transaction).

Yang and Wu may have laundered cash.Yang and Wu may have laundered cash. Lapping of accounts receivable enabled turnover Lapping of accounts receivable enabled turnover

to occur until fraud detected.to occur until fraud detected.



What Were the Red Flag Symptoms?What Were the Red Flag Symptoms? Better than expected growth relative to local competition.Better than expected growth relative to local competition. Lack of proper separation of duties for operations, custody, Lack of proper separation of duties for operations, custody,

accounting, and monitoring of assets.accounting, and monitoring of assets. Insufficient oversight of operational employees.Insufficient oversight of operational employees. Above average performance for one segment of the joint Above average performance for one segment of the joint

venture, involving only a few individuals.venture, involving only a few individuals. Sales of inventory for cash at the warehouse, often without Sales of inventory for cash at the warehouse, often without

necessary documentation.necessary documentation. High concentrations of repeat customers for one segment High concentrations of repeat customers for one segment

of the joint venture.of the joint venture. Increase in accounts receivable aging.Increase in accounts receivable aging.



What Pressures and Rationalization Might Have Motivated the What Pressures and Rationalization Might Have Motivated the Frauds?Frauds?

None—perpetrators could be sociopathic fraud perpetratorsNone—perpetrators could be sociopathic fraud perpetrators—TruGloss Shanghai happens to be the latest victim.—TruGloss Shanghai happens to be the latest victim.

Financial pressures on any individual: Wu, Yang, Chu, Financial pressures on any individual: Wu, Yang, Chu, Richards, and/or Williams.Richards, and/or Williams.

Pressure to achieve growth targets in a new market.Pressure to achieve growth targets in a new market. Competitive pressure among sales or logistics managers.Competitive pressure among sales or logistics managers. Belief that other competitors are conducting business in the Belief that other competitors are conducting business in the

same fashion.same fashion. Culturally acceptable to conduct sales based on cash Culturally acceptable to conduct sales based on cash

transactions at warehouse locations, regardless of internal transactions at warehouse locations, regardless of internal controls imposed by partner from the United States.controls imposed by partner from the United States.


TruGloss Shanghai JVTruGloss Shanghai JV: Unusual or : Unusual or Unrealistic Procedures and RelationshipsUnrealistic Procedures and RelationshipsWhat Key Internal Controls Could Have Prevented or Detected What Key Internal Controls Could Have Prevented or Detected

the Fraud?the Fraud? Background checks of managers at TruGloss Shanghai JV.Background checks of managers at TruGloss Shanghai JV. Proper oversight by General Manager (Richards) and Proper oversight by General Manager (Richards) and

Finance Manager (Williams).Finance Manager (Williams). Completion of required monitoring mechanism (i.e., internal Completion of required monitoring mechanism (i.e., internal

audits) as required by policy.audits) as required by policy. Insistence by accounting managers that no transaction be Insistence by accounting managers that no transaction be

recorded without proper documentation and approval.recorded without proper documentation and approval. Periodic and diligent comparisons of the joint venture to Periodic and diligent comparisons of the joint venture to

local competition and other international joint ventures—are local competition and other international joint ventures—are the results at TruGloss Shanghai “too good to be true”?the results at TruGloss Shanghai “too good to be true”?

(continued on next slide)(continued on next slide)



What Key Internal Controls Could Have Prevented or What Key Internal Controls Could Have Prevented or Detected the Fraud? (continued)Detected the Fraud? (continued)

Periodic monitoring and follow-up for aged accounts Periodic monitoring and follow-up for aged accounts receivable.receivable.

Required physical counts of inventories and mandatory Required physical counts of inventories and mandatory reconciliations.reconciliations.

Periodic analysis of gross margins and any other key ratios Periodic analysis of gross margins and any other key ratios based on recorded amounts.based on recorded amounts.

Mandatory vacations for all management positions.Mandatory vacations for all management positions.


Tallahassee BeanCounters: Problem-Tallahassee BeanCounters: Problem-Based Learning to Ask the Right Based Learning to Ask the Right

QuestionsQuestionsQuestions to answer with respect to the potential or Questions to answer with respect to the potential or

likely fraud circumstances in this case:likely fraud circumstances in this case: Who could have committed a fraud?Who could have committed a fraud? How could the fraud have been committed?How could the fraud have been committed? Evidence of intent (which can be shown by repeated Evidence of intent (which can be shown by repeated

instances of taking).instances of taking). Economic impact (difference in reported and actual Economic impact (difference in reported and actual

revenue, plus (if negative) underpaid sales tax (to the state) revenue, plus (if negative) underpaid sales tax (to the state) and arena rent (to the stadium owner) must be included as and arena rent (to the stadium owner) must be included as total loss due to theft.total loss due to theft.

Evidence of conversion tracing funds to “dummy” (usually Evidence of conversion tracing funds to “dummy” (usually bank) account of employee suspect under a different, or bank) account of employee suspect under a different, or possibly assumed, name.possibly assumed, name.


Tallahassee BeanCountersTallahassee BeanCounters: : The Fraud SchemesThe Fraud Schemes

Ghost employee fraudGhost employee fraud Ticket fraudTicket fraud Equipment purchase fraudEquipment purchase fraud

forensic and investigative accounting chapter 18 forensic accounting in action © 2013 cch...

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