Accounting Fraud Cases

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Fraud Cases

5.1You are the president of a multinational company where an executive confessed to kiting $100,000. In a kiting scheme, cash is created using the lag between the time a check is deposited and the time it clears the bank. Suppose a fraud perpetrator opens accounts in banks A, B, and C. The perpetrator “creates” cash by depositing a $1,000 check from bank B in bank C and withdrawing the funds. If it takes two days for the check to clear bank B, he has created $1,000 for two days. After two days, the perpetrator deposits a $1,000 check from bank A in bank B to cover the created $1,000 for two more days. At the appropriate time, $1,000 is deposited from bank C in bank A. The scheme continues, writing checks and making deposits as needed to keep the checks from bouncing.

  1. How can your company detect kiting and what can your company do to prevent it?
  2. How would you respond to the confession?
  3. What issues must you consider before pressing charges?

5.2 You were asked to investigate extremely high, unexplained merchandise shortages at a department store chain. Classify each of the five situations as a fraudulent act, an indicator of fraud, or an event unrelated to the investigation. Justify your answers.

a.The receiving department supervisor owns and operates a boutique carrying many of the same labels as the chain store. The general manager is unaware of the ownership interest.

b.The receiving supervisor signs receiving reports showing that the total quantity shipped by a supplier was received and then diverts 5% to 10% of each shipment to the boutique.

c.The store is unaware of the short shipments because the receiving report accompanying the merchandise to the sales areas shows that everything was received.

d.Accounts Payable paid vendors for the total quantity shown on the receiving report.

e.Based on the receiving department supervisor’s instructions, quantities on the receiving reports were not counted by sales personnel.

5.3A client heard through its hot line that John, the purchases journal clerk, periodically enters fictitious acquisitions. After John creates a fictitious purchase, he notifies Alice, the accounts payable ledger clerk, so she can enter them in her ledger. When the payables are processed, the payment is mailed to the nonexistent supplier’s address, a post office box rented by John. John deposits the check in an account he opened in the nonexistent supplier’s name.

  1. Define fraud, fraud deterrence, fraud detection, and fraud investigation.
  1. List four personal (as opposed to organizational) fraud symptoms, or red-flags, that indicate the possibility of fraud.</para></listitem> Do not confine your answer to this example.
  1. List two procedures you could follow to uncover John’s fraudulent behavior.

5-4Environmental, institutional, or individual pressures and opportune situations, which are present to some degree in all companies, motivate individuals and companies to engage in fraudulent financial reporting. Fraud prevention and detection require that pressures and opportunities be identified and evaluated in terms of the risks they pose to a company.

  1. Identify two company pressures that would increase the likelihood of fraudulent financial reporting.
  1. Identify three corporate opportunities that make fraud easier to commit and detection less likely.
  1. For each of the following, identify the external environmental factors that should be considered in assessing the risk of fraudulent financial reporting

ï‚·The company’s industry

ï‚·The company’s business environment

ï‚·The company’s legal and regulatory environment

  1. What can top management do to reduce the possibility of fraudulent financial reporting?

5.5For each of the following independent cases of employee fraud, recommend how to prevent similar problems in the future.

  1. Due to abnormal inventory shrinkage in the audiovisual department at a retail chain store, internal auditors conducted an in-depth audit of the department. They learned that a customer frequently bought large numbers of small electronic components from a certain cashier. The auditors discovered that they had colluded to steal electronic components by not recording the sale of items the customer took from the store.

b.During an unannounced audit, auditors discovered a payroll fraud when they distributed paychecks instead of department supervisors. When the auditors investigated an unclaimed paycheck, they discovered that the employee quit four months previously after arguing with the supervisor. The supervisor continued to turn in a time card for the employee and pocketed his check.

  1. Auditors discovered an accounts payable clerk who made copies of supporting documents and used them to support duplicate supplier payments. The clerk deposited the duplicate checks in a bank account she had opened using a name similar to the supplier’s.</para></listitem></orderedlist><source>

5.6An auditor found that Rent-A-Wreck management does not always comply with its stated policy that sealed bids be used to sell obsolete cars. Records indicated that several vehicles with recent major repairs were sold at negotiated prices. Management vigorously assured the auditor that performing limited repairs and negotiating with knowledgeable buyers resulted in better sales prices than the sealed-bid procedures. Further investigation revealed that the vehicles were sold to employees at prices well below market value. Three managers and five other employees pleaded guilty to criminal charges and made restitution.

a.List the fraud symptoms that should have aroused the auditor’s suspicion.

b.What audit procedures would show that fraud had in fact occurred.

5.7A bank auditor met with the senior operations manager to discuss a customer’s complaint that an auto loan payment was not credited on time. The customer said the payment was made on May 5, its due date, at a teller’s window using a check drawn on an account in the bank. On May 10, when the customer called for a loan pay-off balance so he could sell the car, he learned that the payment had not been credited to the loan. On May 12, the customer went to the bank to inquire about the payment and meet with the manager. The manager said the payment had been made on May 11. The customer was satisfied because no late charge would have been assessed until May 15. The manager asked whether the auditor was comfortable with this situation.

The auditor located the customer’s paid check and found that it had cleared on May 5. The auditor traced the item back through the computer records and found that the teller had processed the check as being cashed. The auditor traced the payment through the entry records of May 11 and found that the payment had been made with cash instead of a check.

What type of embezzlement scheme does this appear to be, and how does that scheme operate?

5-8The controller of a small business received the following e-mail with an authentic-looking e-mail address and logo:

From: Big Bank [antifraud@bigbank.com]

To: Justin Lewis, Controller, Small Business USA

Subject: Official Notice for all users of Big Bank!

Due to the increased incidence of fraud and identity theft, we are asking all bank customers to verify their account information on the following Web page: www.antifraudbigbank.com

Please confirm your account information as soon as possible. Failure to confirm your account information will require us to suspend your account until confirmation is made.

A week later, the following e-mail was delivered to the controller:

From: Big Bank [antifraud@bigbank.com]

To: Justin Lewis, Controller, Small Business USA

Subject: Official Notice for all users of Big Bank!

Dear Client of Big Bank,

Technical services at Big Bank is currently updating our software. Therefore, we kindly ask that you access the website shown below to confirm your data. Otherwise, your access to the system may be blocked.

web.da-us.bigbank.com/signin/scripts/login2/user_setup.jsp

We are grateful for your cooperation.

a.What should Justin do about these e-mails?

b.What should Big Bank do about these e-mails?

c.Identify the computer fraud and abuse technique illustrated.

5.9An accountant with the Atlanta Olympic Games was charged with embezzling over $60,000 to purchase a Mercedes-Benz and to invest in a certificate of deposit. Police alleged that he created fictitious invoices from two companies that had contracts with the Olympic Committee: International Protection Consulting and Languages Services. He then wrote checks to pay the fictitious invoices and deposited them into a bank account he had opened under the name of one of the companies. When he was apprehended, he cooperated with police to the extent of telling them of the bogus bank account and the purchase of the Mercedes-Benz and the CD. The accountant was a recent honors graduate from a respected university who, supervisors stated, was a very trusted and loyal employee.

  1. How does the accountant fit the profile of a fraudster?
  1. What fraud scheme did he use to perpetrate his fraud?
  1. What controls could have prevented his fraud?
  1. What controls could have detected his fraud?

5.10 Lexsteel, a manufacturer of steel furniture, has facilities throughout the United States. Problems with the accounts payable system have prompted Lexsteel’s external auditor to recommend a detailed study to determine the company’s exposure to fraud and to identify ways to improve internal control. Lexsteel’s controller assigned the study to Dolores Smith. She interviewed Accounts Payable employees.

Lexsteel’s purchasing, production control, accounts payable, and cash disbursements functions are centralized at corporate headquarters. The company mainframe at corporate headquarters is linked to the computers at each branch location by leased telephone lines.

The mainframe generates production orders and the bills of material needed for the production runs. From the bills of material, purchase orders for raw materials are generated and e-mailed to vendors. Each purchase order tells the vendor which manufacturing plant to ship the materials to. When the raw materials arrive, the manufacturing plants produce the items on the production orders received from corporate headquarters.

The manufacturing plant checks the goods received for quality, counts them, reconciles the count to the packing slip, and e-mails the receiving data to Accounts Payable. If raw material deliveries fall behind production, each branch manager can send emergency purchase orders directly to vendors. Emergency order data and verification of materials received are e-mailed to Accounts Payable. Since the company employs a computerized perpetual inventory system, periodic physical counts of raw materials are not performed.

Vendor invoices are e-mailed to headquarters and entered by Accounts Payable when received. This often occurs before the branch offices transmit the receiving data. Payments are due 10 days after the company receives the invoices. Using information on the invoice, Data Entry calculates the final day the invoice can be paid, and it is entered as the payment due date.

Once a week, invoices due the following week are printed in chronological entry order on a payment listing, and the corresponding checks are drawn. The checks and payment listing are sent to the treasurer’s office for signature and mailing to the payee. The check number is printed by the computer, displayed on the check and the payment listing, and validated as the checks are signed. After the checks are mailed, the payment listing is returned to Accounts Payable for filing. When there is insufficient cash to pay all the invoices, the treasurer retains certain checks and the payment listing until all checks can be paid. When the remaining checks are mailed, the listing is then returned to Accounts Payable. Often, weekly check mailings include a few checks from the previous week, but rarely are there more than two weekly listings involved.

When Accounts Payable receives the payment listing from the treasurer’s office, the expenses are distributed, coded, and posted to the appropriate cost center accounts. Accounts Payable processes weekly summary performance reports for each cost center and branch location.

  1. Discuss three ways Lexsteel is exposed to fraud and recommend improvements to correct these weaknesses.
  1. Describe three ways management information could be distorted and recommend improvements to correct these weaknesses.
  1. Identify and explain three strengths in Lexsteel’s procedures

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