ACCT 410610Fraud Examination

1
ACCT 410/610--Fraud Examination

• An NDSU course developed taught by
• Thomas A. Buckhoff, Ph.D., CFE, CPA
• Class Session 10 October 30, 2002

2
Agenda for Today

• Exercise 11
• Indirect methods of proof
• Jane and Joe Blow Exercise
• Common vendor schemes
• Criminal of the day
• Exercise 10

3
Exercise 11

• Complete the Mary and John Cooke - Part 3
  exercise on p. 7.8 of the Student Workbook

4
Instructions

• Respond to the questions at the end of each of
  the four parts of the exercise.

5
Part I Surveillance

• Restaurant traffic does not appear heavy even
  though the business is doing extremely well
  financially.
• People are entering restaurant but do not appear
  to be using services.

6
Part II Interview

• There are four employees.
• Do the employee records verify this?
• Customer traffic seems light.
• Compare this to reported sales for
  reasonableness.
• Mary Cooke maintains the books.
• Do all business records match?
• John Cooke has frequent visitors.
• Why are they there?

7
Part III Business Records

• A review of the CRJ indicates
• Total cash receipts seems to be constant even
  when restaurant traffic is slow.
• Reconcile entries in the CRJ with cash register
  tapes and bank deposits.
• Entries are in even dollar amounts.

8
Part III Business Records

• A review of the CDJ indicates
• CK 278 to J. Reynolds
• Is this a legitimate expense?
• What was the service rendered?
• Trace to customer invoice and examine endorsement
  on canceled check.
• Six payroll checks were disbursed
• Interview revealed four employees.
• Review all payroll records and supporting
  documentation.

9
Part IV Bank Records

• The bank statement indicates
• Deposits made on 3-07 and 3-24 do not correlate
  with journal entries.
• Examine corresponding deposit slips
• The J. Reynolds check was cashed
• Examine the endorsement
• Time cash withdrawals totaled 1,500
• Where did the cash go? Are there corresponding
  deposits in the Crooks personal accounts on these
  dates?

10
Indirect Evidence

• Evidence that the suspect lives beyond his or her
  means and must have had unexplained income is
  admissible in court.

11
Indirect Methods of Proof

• Direct items of proof are not always available.
  Consequently, we must rely on indirect methods of
  proof
• Net worth
• Expenditures
• Bank deposits

12
Basic Principle

• Money eventually shows up, either directly or
  indirectly, in the accounts, assets or
  expenditures of the recipient.

13
The Financial Profile

• Objective is to discover what suspect
• Owns (assets)
• Owes (liabilities)
• Earns (income)
• Spends (expenditures)

14
Disposition of Income

• Save it
• Increases assets
• Buy assets
• Increases assets
• Pay off debts
• Decreases liabilities
• Spend it
• Improves lifestyle

15
Net Worth Method

• Unknown sources of funds identified by analyzing
  net worth increases
• Applied when significant changes in A L have
  occurred

16
Keys to Net Worth Analysis

• Cash-on-hand
• Cash in banks
• Asset valuation
• Known expenses

17
Net Worth Analysis Formula

• Increase in NW
• Known expenses
• Total NW increase
• - Known income
• Unknown income

• Assets
• - Liabilities
• Net Worth (NW)
• - Previous Yr NW
• Increase in NW

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Net Worth Method

• When using this method, be sure to
• Establish a reliable opening net worth.
• Investigate leads showing suspects innocence.

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Indirect Methods of Proof Example

• Jane and Joe Blow Matter
• Read background information on website link
  containing Excel spreadsheet.
• Do we have predication?

20
Jane and Joe Blow Matter

• Estimate the Blows funds from unknown sources
  using the net worth method.

21
Net Worth Method Solution
22
Expenditures Method

• Applied when significant changes in expenditures
  have occurred. Formula
• Total expenditures
• Minus Known sources of funds
• Equals Funds from unknown sources

23
Jane and Joe Blow Matter

• Estimate the Blows funds from unknown sources
  using the expenditures method.

24
Expenditures Method Solution
25
Expenditures Method Solution
26
Indirect Methods of Proof

• After confronting the target with the funds from
  unknown sources, s/he will likely offer
  explanations.
• You must be ready to validate those explanations
  (i.e. rebut defenses).

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Rebutting Defenses

• Defense
• Claim of a prior cash hoard
• Rebuttal Show that the suspect
• Borrowed money
• Made installment purchases
• Incurred large debts
• Was delinquent on his accounts
• Had a poor credit rating
• Filed for bankruptcy

28
Rebutting Defenses

• Defense
• Cash came from family or private loans
• Rebuttal Show that
• The alleged lender was incapable of generating
  the amounts lent.
• No documentation exists to support the alleged
  loan (e.g. no bank withdrawals)
• The alleged lender has no knowledge of the
  supposed loan.

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Common Vendor Schemes

• Fictitious vendor
• Pass-through schemes
• Ghost employee
• Overbilling
• Kickbacks

30
Fictitious Vendor Schemes

• Red Flags
• Unprofessional-looking invoices
• Vendors with only P.O. box addresses and/or no
  phone number
• Vendors and employees with matching addresses
• Multiple vendors with same address
• Invoices not being folded
• Vendors with no or invalid taxpayer ID number

31
Pass-through Schemes

• Usually perpetrated by someone in the purchasing
  department.
• Fraudster inserts himself (via a shell
  company) as an unnecessary intermediary between a
  legitimate vendor and the employer.
• Fraudster makes an unauthorized profit on the
  transaction.

32
Pass-through Scheme Example

• Ron, the fraudster, manages 5 large apartment
  complexes.
• Instructed a vendor to send all invoices for
  services rendered to him rather than the
  apartment complexes he managed.
• Using the vendors original invoice and his
  computer, Ron creates a new invoice with the
  amounts being greatly marked up.
• Ron submits the inflated invoice to the complex
  which he approves and pays.

33
Ghost Employee Schemes

• Suspicious items
• Employees who do not have taxes
  withheld.
• Employees who do not enroll in health
  insurance programs.
• Employees with matching SSN.
• Employees with no job applications on file

34
Overbilling Schemes

• Suspicious items
• Invoice notation of extra or
  special charges.
• Discrepancies between the purchase
  order/invoice amount and the amount of the
  payment.
• Unusually large amounts on bill or bills which
  break a pattern.

35
Fraudulent Telemarketing Schemes

• Edward Tunick was convicted of 9 counts of mail
  fraud
• Estimated losses suffered by victims 170-200
  million

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Kickback Schemes

• May involve
• Fraudulent invoice
• Inflated invoice
• Inferior quality materials/services
• Fraudster receives
• Payment
• Gratuities
• Other benefits

37
Kickback Schemes Red Flags

• Increased use of certain vendor(s).
• Bidding policy not being followed.
• Cost of materials or services not competitive.
• Extravagant lifestyle of fraudster

38
Data Analysis Software

• The computer can be used as a tool to identify
  red flags such as those associated with vendor
  fraud schemes
• ACL and Benfords Law

39
Reviewing Suspect Payments

• Review canceled checks
• Trace canceled checks to supporting documentation
  and investigate
• Discrepancies
• Unnumbered or sequentially unusual invoices
• Altered or photocopied documents

40
Exercise 10 Example of a Fictitious Vendor
Scheme

• Complete the Double Trouble Case Study on p. 7.3
  of the Student Workbook

41
Instructions Part 1

• Read the newspaper article on p.
  7.3.
• How do you think this fraud was discovered?

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Part 1 Answer

• Investigative procedure
• Matched payments for invoices to receiving
  documents.
• Finding
• No receiving documents existed for numerous
  invoices approved for payment by Lisa Chaffey.

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Instructions Part 2

• Review pages 7.4, 7.5, and 7.6.
• Identify items that support the fraud theory that
  Fairmont Co. is a fictitious vendor.
• The case began with the money order.
• The other documents were among hundreds of items
  seized from the Chaffeys residence.

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Part 2 Answer

• A legitimate vendor would issue a company check
  rather than use a money order.
• Fictitious vendors generally list only a P.O. Box
  address.
• Paid for an answering service with another money
  order. Legitimate vendors rarely, if ever, use
  an answering service.

45
Fraudwise, LLC

• Specializing in fraud detection, investigation,
  and prevention consulting services
• Senior Investigators
• Thomas Buckhoff, Ph.D., CFE, CPA
• Thomas OHalloran, MBA, CFE, EA
• 2974 Southgate Drive
• Fargo, ND 58103-3524
• 701-231-8512
• www.fraud-wise.com