FRAUD EXAMINATIONALBRECHT, ALBRECHT, & ALBRECHT

Proactive

Approaches to

Detecting Fraud

CHAPTER 6

Learning Objectives

1. Explain the importance of proactive

fraud detection.

2. Describe the role of commercial data-

mining software plays in detection.

3. List the advantages and disadvantages

of data mining and digital analysis.

4. Recognize Benford’s Law.

Learning Objectives

5. Understand

inductive fraud

detection.

6. Identify how

fraud is detected

by analyzing

financial

statements.

How is the Case of Mr. Hamanaka Typical of Most Frauds?

It started small and grew

much larger!

Match Terms and Definitions.

Inductive

fraud

detection

Deductive

fraud

detection

Commercial

data-mining

software

Benford’s Law

Determining the types of fraud

that can occur then query to see

if they exist

Proactively searching for fraud

without determining the type of

fraud to look for

A mathematical algorithm that

predicts the percentage a digit

will occur

Commercial software used to

detect patterns in data

Differentiate Between Detecting & Investigating Fraud.

Detection

Discovery of Fraud

Answers the Question: Does a fraud exist?

Investigation

Preceded by Detection

Proving a Fraud

Answers the Questions: How? Who? Why?

What? Where? When a fraud took place?

Explain Data-Mining as a Means of Detecting Fraud.

ACL- Audit Command Language

Looking for Anomalies in

Databases

Difficulty Because ACLs Are

Limited in What They Can Handle

The Result Is They May Identify

Thousands of Symptoms

Because of Their Limitations

Review How Benford’s Law Works.

Examines the Frequency

of Digits Appearing

in a Database of

Invoice #s or Amounts

0-9 Do Not Appear

10% Each

List Disadvantages of Benford’s Law?

Looks at a Large Company as a

Whole, May Not Show Problems

With Some Individual Vendors

Not Precise

Broad Identification of

Symptoms

Does Not Zero in on Perpetrators

5. Follow Through with Investigation to Determine if Fraud Exists or Not

What is the 5 step Process for Inductive Fraud Detection?

4. Use Databases & Information Systems to Search for Symptoms

3. Understand the Symptoms these Types of Fraud Create

2. Understand the Types of Fraud that Occur in this Business

1. Understand the Business

Compare the 3 Approaches.

Commercial Data Mining Packages are least costly, but have limited usefulness. They provide excessive symptoms,

but are easy to use and modify.

Compare the 3 Approaches.

Statistical analysis provides lots of symptoms and is very useful for discovering vendor kickback

frauds.

Compare the 3 Approaches

The Inductive Approach is the most expensive to use.

Summarize the Process Which Results in Financial Statements.

Effects Investor or Creditor Decisions

Economic Transaction

Produces

Journal Entry

Posted

Financial Statements

Analysis

General Ledger

Summar-ized

Source Documents

Analysis

What Effect Does the Size of the Fraud Have on the F/S?

Small frauds are

unlikely to affectF/S, usually

detected when examining source

documents

Large frauds effectF/S, detected

during analysis ofunexplainedchanges in

F/S

Explain How Revenue Affects the Company’s Accounts.

If Sales

Increase Then

Accounts Receivable

Revenue

Cost of Goods Sold

Inventory

Perform Vertical Analysis

Perform Horizontal Analysis

Calculate Key Ratios Compare from Period to

Period

How Can You Convert Balance Sheets & Income Statements to Change Statements?

Compare Account

Balances from Period to Period

Match Ratio to Name.

Current CA – Inventory

Average A/R

Current Assets

Current Liabilities

Sales

Average A/R

365 Days

A/R Turnover

A/R Turnover

Days in Receivables

Quick Test

Match Ratio to Name.

Receivables %

Inventory Turnover

Days in Inventory

Bad Debt %

Bad Debt Expense

Average A/R

365 Days

Inventory Turnover

Cost of Goods Sold

Average A/R

Accounts/Receivable

Total Assets

Match Ratio to Name.

Cost of Goods Sold Percent

Property, Plant & Equipment Percent

Sales Return Percent

Inventory Percent

Cost of Goods Sold

Total Sales

Sales Returns

Total Sales

Inventory

Total Assets

Sales

Ave. Property Plant & Equipment

Match Ratio to Name.

Debt to Equity

Total Liabilities

Total Assets

Net Income

# Share of Stock Outstanding

Total Liabilities

Total Equity

Net Income

Net Sales

Profit Margin

Days in Receivables

Debt Percentage

Describe How to Perform Vertical Analysis on:

•An Income Statement

•A Balance Sheet

Describe How to Perform Horizontal Analysis on:

•An Income Statement

•A Balance Sheet

What Questions Should Asked When Using a Statement of Cash Flows to Detect Fraud?

Are there any

unexpected

changes in cash?

Did A/R go up or

down? Why?

Why did inventory

go up or down?

Statement of Cash Flows

Cash Flows

Cash Flows

From Investments From Borrowings and Stock Issuances

From Earnings

To Operations

For Investments To Pay Off Loans

Dividends

Cash Balance

Discuss the Use of Software for Detecting & Identifying Fraudsters.

Difficulty of the List

Information - Information

can be in multiple formats

Fuzzy Logic