CH-1 Introduction – Principles of Fraud Examination : Book Guide

ANSWERS TO EXERCISES Chapter 1 Introduction Review Questions 1-1 What is fraud examination? Answer: Fraud examination is a process for resolving allegations of fraud from inception to disposition. Fraud examinations involve not only financial analysis, but also interviewing witnesses, taking statements, writing reports, testifying to findings, and assisting in the prevention and detection of fraud. 1-2 What is the fraud theory ¬approach? Answer: The fraud theory approach is the methodology used for resolving allegations of fraud by developing a worst-case scenario of what could have occurred, then attempting to confirm or refute that theory. 1-3 Occupational fraud and abuse ¬includes any personal enrichment that results from misuse or ¬misapplication of the employing organization’s resources or ¬assets. There are four key elements to this activity. What are they? Answer: The four key elements to occupational fraud abuse are that it (1) is clandestine, (2) violates the employee’s fiduciary duties to the organization, (3) is committed for the purpose of direct or ¬indirect financial benefit to the employee, and (4) costs the employing organization assets, revenues, or reserves. 1-4 Under the common law, fraud generally consists of four elements, all of which must be ¬present. List them. Answer: The four legal elements of fraud are (1) a material false statement, (2) knowledge that the statement was false when it was uttered, (3) reliance on the false statement by the victim, and (4) damages as a result. 1-5 What is the difference between occupational fraud and occupational abuse? Give ¬examples. Answer: Occupational fraud tends to be more costly and less common than abuse. Occupational fraud consists of such actions as asset misappropriations, corruption, and fraudulent financial statements. Occupational abuse consists of petty offenses such as taking extended lunch periods or breaks, showing up late for work or leaving early, and doing slow or sloppy work. 1-6 Edwin H. Sutherland, a -criminologist, coined the phrase “white-collar crime.” What did he mean by this term? How has the meaning of this phrase changed over time? Answer: Sutherland coined the term “white-collar crime” to describe criminal acts of corporations and individuals acting in their corporate capacity (e.g., crime in the executive suite). Over time, the term has come to encompass almost any financial or economic crime, from the mailroom to the boardroom. 1-7 Sutherland developed what is known as the “theory of differential association.” What is the principal tenet of his theory? Answer: The theory of differential association’s principal tenet is that crime is learned. Sutherland believed that this learning typically occurred in intimate personal groups. 1-8 Cressey interviewed nearly 200 embezzlers in order to develop his theory on the causation of fraud. As a result of his research, what was Cressey’s final ¬hypothesis? Answer: “Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted property.” 1-9 Cressey believed that non-¬shareable problems provided the motivation for ¬employees to commit occupational fraud. What did he mean by “non-shareable”? Answer: Cressey meant that the problems, at least in the eyes of the potential offenders, must be kept secret from others, so as to avoid embarrassment or, more importantly, a loss of status. 1-10 Cressey divided the non-¬shareable problems of the subjects in his research into six different subtypes. What are they? Answer: The subtypes are (1) violation of ascribed obligations, (2) problems resulting from personal failure, (3) business ¬reversals, (4) physical isolation, (5) status gaining, and (6) employer–employee relations. 1-11 Albrecht concluded that there were three factors that led to occupational fraud. What are they? Answer: Albrecht’s list is very similar to the fraud ¬triangle. The three factors he identified are (1) situational pressures, (2) opportunities, and (3) personal integrity. 1-12 What factor did Hollinger and Clark identify as the primary cause of employee deviance? Answer: The research of Hollinger and Clark strongly ¬suggests that job dissatisfaction among employees—across all age groups but especially younger workers—is the most likely cause of counterproductive or illegal behavior in the ¬workplace. 1-13 The 2009 Global Fraud Survey covered a number of factors that are related to ¬occupational fraud. List these factors. Answer: The 2009 Global Fraud Survey gathered data on occupational fraud and abuse relating to (1) the cost of fraud and abuse, (2) position, gender, tenure, and criminal history of the perpetrator, (3) size of the victim organization, (4) actions taken against occupational fraudsters by their victims, (5) methods by which occupational frauds were detected, (6) commonness of schemes, and (7) costs associated with various schemes. Discussion Issues 1-1 How does “fraud examination” differ from “forensic accounting”? Answer: Fraud examination is a process used to resolve ¬allegations of fraud from inception to disposition. Forensic ¬accounting is any accounting work done in anticipation of ¬litigation. 1-2 There are several steps involved in the fraud theory approach. What are they? Answer: The fraud theory approach involves analyzing the available evidence, developing a theory of what fraud could have occurred based on a worst-case scenario, testing the ¬theory, revising it or amending it as necessary, then proving the theory through additional investigative work. 1-3 How does ¬occupational fraud and abuse differ from other kinds of fraud? Give examples of other fraud types. Answer: Typically, any crime that uses deceit as its principal modus operandi is considered fraud. Occupational fraud -involves those frauds that are committed against organizations by individuals who work for those organizations. Other fraud types include but are not limited to: insurance frauds committed by customers and ¬policyholders, Internet frauds and scams perpetrated by -individuals, frauds against governmental organizations ¬committed by companies and individuals, frauds against banks committed by outsiders, and credit card frauds perpetrated against businesses. 1-4 How does the study of criminology relate to the detection or deterrence of fraud? How does it differ from the study of accounting or auditing? Answer: Criminals commit frauds. Accounting relates to the classification of assets, liabilities, income, expenses, and equity. Auditing involves the verification of books and records. While accounting and auditing give us information on how fraud is committed, the study of criminology helps us understand why fraud is committed. The simple fact is that books don’t commit fraud, people do. Understanding both how and why fraud is committed helps us better detect and deter it. 1-5 Sutherland’s contribution to criminology, in addition to giving us the term “white-collar crime,” involved developing the theory of differential ¬association. What are the implications of this theory with ¬respect to ¬occupational fraud? Answer: Sutherland’s main point was that the tendency to commit crime is learned, not inherited. He believed that ¬criminals learned both the techniques of committing crimes and the value systems of criminals in small, intimate groups. This explains, in part, why prisoners frequently return to crime after they are let out of confinement. While ¬behind bars, they talk to other inmates and learn the specifics of how to better commit their crimes. They also are taught the unique values that “street” criminals hold, such as “getting something for nothing” and “society owes me a good living.” Occupational fraudsters, on the other hand, learn their techniques by working with books, records, inventory, and other assets. They frequently hear about other employees who were not successful in their crimes. Rather than being ¬discouraged by someone being caught, the potential criminal often learns a different lesson: that the method the other person used to commit fraud was faulty and that a different one must be devised in order to succeed. They also learn the value ¬systems that some businesses have: Profit is everything, and the end justifies the means. Such values obviously send the wrong ¬message. 1-6 Cressey’s “fraud triangle” states that three factors—non-shareable financial need, perceived ¬opportunity, and rationalization—are present in cases of -occupational fraud. Which of these three factors, if any, is the most ¬important in causing executives, managers, and ¬employees to commit occupational fraud? Answer: All three are equally important. A fire cannot exist without fuel, oxygen, and heat; a fraud cannot exist without motive, opportunity, and rationalization. If a person has ¬unlimited motive but no opportunity, he or she cannot commit fraud. If a person has opportunity but doesn’t need the money, the fraud is unlikely to occur. Should an individual have both motive and opportunity but cannot salve his or her conscience through rationalization, the crime will most likely not be ¬committed. 1-7 Cressey described a number of non-shareable financial problems that he uncovered during his research. Which of these, if any, apply to modern-day executives who are responsible for large financial ¬statement frauds? In the 50-plus years since Cressey did his study, are the factors he described still valid? Why or why not? Answer: Three non-shareable financial problems seem to be at the root of today’s financial frauds: violation of ascribed obligations, problems resulting from personal failure, and business reversals. Many modern-day businesses begin “cooking the books” when executives realize that they will not be able to meet their financial obligations. Similarly, some ¬executives are too ashamed to admit that they don’t have the talent or wherewithal to steer an enterprise through rough ¬economic conditions. And sometimes, business reversals—from loss of a major client or contract, recessions, high costs of ¬capital, and the like—are at the root of these so-called non-shareable ¬financial problems. One could argue that these factors are as valid today as they were over half a century ago. What motivates people to act changes little over time, although the methods that they use to accomplish their illegal goals (e.g., computer frauds) may. 1-8 Albrecht, in his research, developed the “fraud scale” and furnished a list of the reasons employees and executives commit occupational fraud. How are Albrecht’s conclusions similar to Cressey’s? How are they ¬different? Answer: Cressey’s three factors were a non-shareable ¬financial need, perceived opportunity, and rationalization. ¬Albrecht’s consisted of financial pressure, perceived -opportunity, and personal integrity. One of the factors, ¬perceived opportunity, was named by both researchers. Cressey’s non-shareable financial need is similar to Albrecht’s financial pressure; ¬however, Cressey’s is more specific. Nearly everyone suffers financial pressures of some kind, but most do not turn to fraud in order to alleviate them. The ability to rationalize illegal ¬conduct and personal integrity could be viewed as one and the same. However, personal integrity is difficult to measure, while specific rationalizations are easier to identify. 1-9 The ACFE’s 2009 Global Fraud Survey found, among other things, that the frauds committed by women had smaller median losses than those by men. What are some possible explanations for this finding? Answer: The sizes of losses due to occupational fraud are ¬almost always determined by the employee’s access to assets. This explains why executives account for the largest losses. Women, because of the so-called “glass ceiling” (where they are not promoted into jobs equal to their male counterparts’), typically occupy lower-level positions. Chapter 2 Skimming Review Questions 2-1 How is “skimming” defined? Answer: Skimming is the theft of cash from a victim organization prior to its entry in the organization’s accounting system. 2-2 What are the two principal ¬categories of skimming? Answer: Skimming schemes can be subdivided based on whether they target sales or receivables. The character of the incoming funds has an effect on how the frauds are concealed, and concealment is the crucial element of most occupational fraud schemes. 2-3 How do sales skimming schemes leave a victim organization’s books in balance, ¬despite the theft of funds? Answer: When an employee skims money by making off-book sales of merchandise, neither the sales transaction nor the incoming cash is ever recorded. For example, suppose a cash register clerk skims $500 in receipts from one sale of goods. At the end of the day, his cash drawer will be short by $500—the amount of money that was stolen. But because the sale was never recorded, the sales records will be understated by $500. Therefore, the books will remain in balance. 2-4 Under what circumstances are incoming checks received through the mail typically stolen? Answer: Checks are normally stolen when a single ¬employee is in charge of opening the mail and preparing the deposit. The employee simply removes the check from the incoming mail and forges the endorsement of the employer, then endorses it with his or her own name and cashes or ¬deposits it. 2-5 How do “understated sales” schemes differ from “unrecorded sales”? Answer: Unrecorded sales schemes are purely off-book transactions. Understated sales, on the other hand, are posted to the victim organization’s books, but for a lower amount than what the perpetrator collected from the customer. ¬Typically, the perpetrator will understate a sale by recording a lower sales price for a particular item, or by recording the sale of fewer items of merchandise than the customer actually purchased. 2-6 How is the cash register ¬manipulated to conceal skimming? Answer: There are two common methods. The first is to ring “no sale” on the register and omit giving the customer a receipt for the purchase. The second and less common method is for the cashier to alter the tape itself so that it does not show the sale. This is impossible to accomplish with cash ¬registers that also record the transaction electronically. 2-7 Give examples of skimming during nonbusiness hours and skimming of off-site sales. Answer: Certain categories of employees usually commit these schemes. Managers of department stores or employees opening or closing the store have been known to open early or close late and skim all or part of the sales during those periods. Apartment rental employees, parking lot attendants, and ¬independent salespeople are at a higher risk of skimming funds from off-site sales. 2-8 What are the six principal methods used to conceal receivables skimming? Answer: The six concealment techniques identified in this chapter are: lapping, force balancing, stealing customer ¬statements, recording fraudulent write-offs or discounts, debiting the wrong account, and document destruction. 2-9 What is “lapping” and how is it used to conceal receivables skimming? Answer: Lapping is the crediting of one account through the abstraction of money from another account. Lapping customer payments is one of the most common methods of concealing receivables skimming. Suppose a company has three ¬customers, A, B, and C. When A’s payment is received, the fraudster takes it for himself instead of posting it to A’s ¬account. When B’s check arrives, the fraudster posts it as a payment to A’s account. Likewise, when C’s payment is received, the perpetrator applies it to B’s account. This process continues indefinitely until one of three things happens: (1) someone discovers the scheme, (2) restitution is made to the accounts, or (3) some concealing entry is made to adjust the accounts receivable balances. 2-10 List four types of false entries a fraudster can make in the victim organization’s books to -conceal receivables skimming. Answer: The fraudster can lap the payments, as discussed in the previous question. He can also engage in force balancing by posting a payment to a customer’s account even though the payment was stolen. A third false entry that can be made is to fraudulently write off a customer’s account as uncollectible. A fourth technique is to credit the targeted account with a fraudulent “discount” in the amount of the stolen funds. Also, some fraudsters conceal receivables skimming by debiting ¬existing or fictitious accounts receivable. Discussion Issues 2-1 Sales skimming is called an “off-book” fraud. Why? Answer: Simply because the fraud occurs outside the books and records. There is no direct audit trail to uncover; the proof of the fraud must be determined by indirect methods, such as ratio analysis or other comparisons. 2-2 In the case study of Brian Lee, the plastic surgeon, what kind of skimming scheme did he ¬commit? Answer: Dr. Lee committed a sales (revenue) skimming scheme. In this fraud, Dr. Lee’s clinic was a partnership with several other doctors, and all of the revenue derived from his services was supposed to go to the partnership. Because of a lack of controls and periodic reconciliations by the clinic, Dr. Lee simply instructed his patients to pay him directly. His scheme was uncovered by accident, as are many frauds. 2-3 If you suspected skimming of sales at the cash register, what is one of the first things you would check? Answer: The cash register tape is one of the first things you should check. In a typical cash register skimming scheme, the crooked employee will ring up “no sale” on the register when a sale is made and pocket the money. The customer is not given a receipt. If you notice an excessive amount of “no sales” entered on the cash register, it could mean that the drawer is being opened and no money is being put in. 2-4 Assume a client who owns a small apartment complex in a different city than where he lives has discovered that the apartment manager has been skimming rental receipts, which are usually paid by check. The manager endorsed the checks with the apartment rental stamp, then ¬endorsed her own name and deposited the proceeds into her own checking account. Because of the size of the operation, hiring a separate employee to keep the books is not practical. How could a scheme like this be prevented in the future? Answer: Two simple, separate control measures might help prevent such future occurrences. Although it might not be practical for the owner to reconcile the rental receipts himself since he lives in a different city, he could obtain a restrictive endorsement stamps that states “for deposit only.” Second, the owner could have rental payments directed to a bank lockbox, where they would be less likely to be stolen. 2-5 What is the most ¬effective control to prevent receivables skimming? Answer: In almost all cases of receivables skimming, the ¬person handling the cash and the person keeping the books are one and the same. An employee who opens incoming mail or handles cash should not be permitted to post the ¬transactions. 2-6 In many cases ¬involving skimming, employees steal checks from the ¬incoming mail. What are some of the controls that can prevent such occurrences? Answer: Here are some of the basic controls over incoming checks: •The person opening the mail should be independent of the cashier, accounts receivable clerk, or employees who are ¬authorized to initiate or post journal entries. •Unopened mail should not be delivered to employees having access to accounting records. •The employee who opens the mail should (1) place ¬restrictive endorsements on the incoming checks; (2) prepare a list of checks received; (3) forward all remittances to the person responsible for preparing and making the bank ¬deposit; and (4) forward the list of checks to a person who can check to see if it agrees with the bank deposit. 2-7 In the case study of Stefan Winkler, who was the chief financial officer for a ¬beverage company in Florida, how did he conceal his skimming scheme? How could the scheme have been prevented or ¬discovered? Answer: Winkler’s scheme is a classic example of too much trust placed in one employee. The beverage company received money from two different sources: route deposits (cash sales) and office deposits (accounts receivable). The route salespeople prepared their own deposit slips showing the cash and ¬currency collected. The office personnel listed and ¬accounted for the checks received through the mail. Winkler removed currency from the route deposits and replaced it with a check for the same amount from office deposits. Although office personnel listed the checks, they did not prepare the ¬deposit slips—Winkler did that. As a result, he would ensure that the bank deposits agreed with the amount of money going into the bank. To cover his tracks with the credit customers, Winkler would lap payments made by one customer to cover thefts from another customer. He would also give unauthorized discounts to credit customers. When Winkler was fired for other reasons, he made a general ledger adjustment of over $300,000 in a vain ¬attempt to cover the shortages. There were many clues: The internal control deficiencies were glaring. All of the cash made a stop at Winkler’s desk on its way to the bank. Had there been adequate division of ¬responsibilities, Winkler’s scheme would have been much more difficult to accomplish. There were excessive false ¬discounts to customers. The cost of sales would have been out of line with sales. And, like so many other fraudsters, Winkler lived beyond his means. Had his fellow employees been properly educated about fraud, they would have easily seen the fact that Winkler was driving a $75,000 car as a red flag. Also, had they been to his home, they would have noticed that their chief financial officer lived in an excessively expensive residence. Chapter 3 Cash Larceny Review Questions 3-1 What is cash larceny? Answer: Cash larceny involves the intentional taking away of an employer’s cash without the consent, and against the will, of the employer. Cash larceny schemes involve the theft of money that has already appeared on the victim company’s books. 3-2 How do cash larceny schemes differ from fraudulent disbursements? Answer: Cash larceny schemes generally target receipts, not disbursements. Furthermore, larceny schemes usually involve the physical misappropriation of cash by the perpetrator. The method of extraction—for instance, a perpetrator putting cash in his pocket—is itself improper. Fraudulent ¬disbursements, on the other hand, typically rely on the ¬submission of phony documents or the forging of signatures in order to make a fraudulent distribution of funds appear to be legitimate. The manner by which funds are disbursed is the same as in any ¬legitimate disbursement, but the purpose of the distribution is fraudulent. 3-3 What is the difference between cash larceny and skimming? Answer: Both cash larceny and cash skimming schemes ¬involve theft of the victim company’s funds. However, cash larceny involves the removal of money after it has been recorded in the company’s books, whereas skimming involves the removal of cash before the funds appear on the books. In other words, cash larceny is an on-book fraud, whereas skimming is an off-book fraud. 3-4 Where do cash larceny schemes rank among cash misappropriations in terms of frequency? In terms of median loss? Answer: In the 2009 Global Fraud Survey, cash larceny schemes were less common than both skimming and fraudulent disbursements schemes. This is to be expected, as cash larceny is an on-book form of fraud that leaves an imbalance on the victim organization’s books. This makes cash larceny more difficult to conceal than other forms of cash misappropriation. The median loss for cash larceny schemes was greater than that for skimming schemes, but lower than that for fraudulent disbursements schemes. 3-5 What are the main weaknesses in an internal control system that permit fraudsters the ¬opportunity to commit cash larceny schemes? Answer: Cash larceny schemes can take place under any ¬circumstances in which an employee has access to cash; therefore, regular supervision and surveillance controls may prevent the opportunity for theft to occur. The lack of, or inadequate, separation of duties for receiving, recording, depositing, and disbursing cash permit cash larceny schemes to occur. 3-6 What are the five methods ¬discussed in this chapter that are used to conceal cash larceny that occurs at the point of sale? Explain how each works. Answer: In the cash larceny schemes reviewed, there were five methods that were identified as being used to conceal ¬larceny at the point of sale. The first was thefts from other ¬registers, in which an employee steals cash from another ¬person’s cash register. This does not conceal the crime, but it may help conceal the perpetrator’s identity. The second method was death by a thousand cuts, in which an employee -repeatedly steals very small amounts of cash over an extended period of time, hoping that the thefts are small enough to avoid triggering an investigation. The third method is the use of reversing transactions. After the perpetrator has stolen cash, he processes fraudulent refunds or voids sales in order to bring sales records back into balance with cash on hand. The fourth method is to alter cash counts or cash register tapes. Totals are misreported to create a fictitious balance between cash on hand and sales. The fifth method is to destroy sales records, which makes it difficult for the victim organization to discover an imbalance caused by larceny. 3-7 How do employees commit cash larceny of incoming receivables? How are the schemes -concealed? Answer: Fraudsters may post the customer’s payment to the accounting system but steal the cash, which causes an ¬imbalance in the cash account. This imbalance can be concealed if the perpetrator has control over the recording function for ledger accounts. The fraudster makes ¬unsubstantiated entries, which produce fictitious balances. Other ways to conceal cash larceny include using reversing transactions, creating unauthorized discounts, charging the theft to bad debts, or adjusting the inventory account. Alternately, the perpetrator simply may destroy all records of the transaction. 3-8 What is force balancing and how is it used to conceal cash larceny? Answer: Force balancing involves the making of unsupported entries in an organization’s books and records to produce a ¬fictitious balance. For example, if an employee steals an ¬incoming receivables payment after it has been posted to the appropriate customer account, this will create a shortage in the cash account because the amount of receipts posted will ¬exceed the amount of receipts on hand. If the employee is able to make one or more unsubstantiated entries to cash in the amount of the stolen payment, he or she can eliminate the ¬imbalance. 3-9 How do fraudsters commit cash larceny from the bank deposit? Answer: Fraudsters steal all or part of the deposit and ¬conceal the scheme by destroying the bank statement, or ¬by showing the ¬deposits as “in transit.” This type of scheme is usually effective when there is a poor internal control system over cash collections and deposits, in which the same ¬employee may be responsible for cash collections, preparing deposit slips, making deposits, and reconciling bank ¬statements. The fraudster may also alter the deposit slip after it has been returned in the bank statement. 3-10 What are some basic internal control procedures to deter and detect cash ¬larceny schemes? Answer: The separation of duties related to cash receipts, deposits, and recording is a basic internal control to deter and detect cash larceny schemes. This ¬includes segregation of authorization, recording, and custody functions for cash and related transactions. Assignment ¬rotation, mandatory vacations, surprise cash counts, and physical security of cash can also assist in deterring and ¬detecting cash larceny schemes. Discussion Issues 3-1 Briefly ¬describe some common types of cash larceny schemes. Answer: Cash larceny, which involves the theft of an ¬organization’s cash after it has been recorded, can take place in any ¬circumstance in which an employee has access to cash. Several different types of cash larceny schemes were described in this chapter. Most of these schemes involve larceny that ¬either occurs at the point of sale, involves incoming receivables payments, or targets the victim organization’s bank deposits. Within these three groups, there were several unique methods that were identified based on the steps taken to ¬conceal the thefts. Employees generally conceal larceny at the point of sale by stealing from another person’s cash register, stealing very small amounts over an extended period, ¬processing fraudulent reversing transactions, altering cash counts or sales records, or destroying sales records. Larceny of receivables is generally concealed through force balancing, fraudulent reversing -entries, or record destruction. Cash larceny from the deposit may be concealed by deposit lapping or by fraudulently recording stolen funds as deposits in transit. Larceny also ¬frequently ¬occurs because there is a breakdown of controls such that one person has solitary access to an organization’s books and records. In these cases, it may not be necessary for the perpetrator to use any concealment ¬technique; he simply steals money without trying to hide the crime. 3-2 Why is it generally more ¬difficult to detect skimming than cash larceny? Answer: The benefit of a skimming scheme is that the ¬transaction is unrecorded and the stolen funds are never ¬entered on company books. This makes the skimming scheme difficult to detect because sales records do not reflect the ¬presence of the funds that have been taken. In a larceny scheme, on the other hand, the funds that the perpetrator steals are already reflected on the victim organization’s books. As a result, an imbalance results between the sales records and cash on hand. This imbalance should be a signal that alerts a victim organization to the theft. 3-3 In the case study of bank teller Laura Grove, what type of fraud did she commit? Answer: Laura perpetrated a cash larceny scheme. In order to classify the scheme, we first look to the fact that she took cash, which means her scheme was a form of cash misappropriation. To further classify the scheme, we look to the method by which she took the cash. Remember, there are three categories of cash misappropriation: fraudulent disbursements, skimming, and cash larceny. Laura Grove’s scheme involved the physical misappropriation of cash without the use of fraudulent ¬documents or forged signatures. She made no attempt to record or justify the removal of cash as a legitimate disbursement of funds. Therefore, her scheme could not have been a fraudulent disbursement. The only two other categories of cash misappropriation are skimming and cash larceny. The difference between these two types of fraud lies in whether the stolen funds had been recorded on the victim organization’s books at the time they were stolen. In this case, the money Laura Grove stole had ¬already been recorded on the bank’s books and records; ¬therefore the scheme must be classified as a cash larceny. 3-4 What are the internal control weaknesses that failed to deter and detect the fraud in Laura Grove’s case? Answer: Various weaknesses that may have contributed to the scheme include shutting off the surveillance camera on the vault during nonbusiness hours, not maintaining the security of the vault combination, not rotating employees periodically, and not checking employees’ belongings when they left the bank. 3-5 Other than falsifying a company’s records of cash receipts, how might an employee conceal larceny from a cash register? Answer: An employee might discard or destroy cash register tapes. Missing or defaced backup documentation should ¬indicate a red flag for fraud. Altering the cash count for his or her register is another way to conceal a fraud. Proper internal control procedures would prohibit an employee from -performing a reconciling cash count of his or her own register. 3-6 What steps might an organization take to protect outgoing bank deposits from cash larceny schemes? Answer: One form of cash larceny is for an employee to steal from the bank deposits. Usually, it is perpetrated by the employee who is in charge of making the deposit. Some internal control procedures that might assist in the deterrence of such frauds are: (1) separating the duties of receiving and opening of the mail and preparing the deposit slip, (2) ¬segregating the functions for taking deposits to the bank and recording the transactions, (3) maintaining more than one copy of the deposit slip to be matched and reconciled with the bank’s receipts of deposits, (4) examining the bank deposit slip for alterations, and (5) reconciling the bank statement with the book balance by a person who is not also involved with the custody function for cash. 3-7 How is the larceny of receivables often detected? Answer: Many times, receivables schemes involve skimming—the perpetrator steals the payment but never records it. This type of scheme might be detected by the delay between the time the payment is received and when it is posted to the books. ¬Customer complaints of incorrect account balances are often a clue to a receivables skimming scheme. If the theft occurs after the payment has been recorded, then it is classified as cash larceny. In order for an employee to succeed at a cash larceny scheme, she must be able to hide the imbalances in the accounts caused by the fraud. Larceny of ¬receivables is generally concealed through force ¬balancing, reversing entries, or destroying records. Looking for -inappropriate journal entries and examining supporting documentation may help to uncover a larceny of receivables. 3-8 In the case study “The Ol’ Fake Surprise Audit Gets ’Em Every Time,” how did ¬Newfund’s accounting and management controls contribute to the detection of Gurado’s fraud scheme? How did the resulting actions of management help to deter future frauds? Answer: Newfund’s internal control procedure of conducting organized and effective surprise audits induced Gurado, a well-respected branch manager, to “come clean” at the prospect of his fraud being discovered during a prospective, imminent ¬surprise audit. In this case, the threat of detection served the same goal as detection through an actual audit. ¬Gurado was immediately fired for his misdeeds, which ¬reinforced the ¬importance of following proper procedures to other employees. 3-9 Among the proactive audit techniques suggested in this chapter are the following: (1) a summary, by employee, of discrepancies between cash receipt reports and the sales register system; and (2) a ¬summary, by employee, of discounts, returns, cash receipt ¬adjustments, ¬accounts receivable write-offs, and voids processed. Why would these two tests be effective in detecting cash larceny? Answer: Because cash larceny involves the theft of on-book funds, it creates an imbalance on the victim organization’s books. For example, if a cash register clerk steals $100 from his register, then the cash receipt report from that register will be $100 lower than the total recorded in the register sales ¬system (unless a fraudulent entry is made to correct the ¬imbalance). The first test suggested above would identify ¬employees who tend to have these imbalances, which could signal larceny. This test would be particularly helpful in ¬identifying employees who have multiple, small imbalances that individually are too small to be investigated, but ¬collectively can become quite large. In order to conceal imbalances caused by cash ¬larceny, employees often process fraudulent adjusting ¬entries to bring their cash receipt reports and register sales totals back into ¬balance. The second audit test suggested above would test for this kind of activity by identifying -employees who process an inordinate number of adjusting entries, which could be a result of efforts to hide cash ¬larceny schemes. Solution Manual for Principles of Fraud Examination 9780470646298, 9781118922347 Joseph T. Wells