FOR 335 Exam 2
Net Profit Margin (profitability);
Net income/ Sales.
Local and State GAAP is determined by:
The Governmental Accounting Standard Board (GASB).
Crimes of Intent
Circumstantial evidence (including expert testimony) is used to establish or infer *fraudulent intent*.
Rational Choice Theory
"Rational calculators" who choose courses of action such as fraud that produce optimal rewards with limited effort. Decision to commit crime is based on a number of factors, such as: 1. Once the person has decided to commit a crime, 2. The specified crime goes through an analysis of opportunities and cost-benefit tradeoffs. - Perceived *benefits* of a crime increase the likelihood by including *low effort, little skill, available targets, high expected yield, lack of confrontation with victim, and low risk of apprehension.* - Perceived *costs* of a crime include *high effort, high skill, high risk of apprehension, etc.*
What does the valuation of inventory include:
(a) physical goods. (b) costs. (c) cost flow assumption- (cost or cost lower or market) (d) the accounting cost flow assumption- (LIFO, FIFO, or moving average).
(3) Arson- Insurance Fraud
- A common motive alleged by insurance companies in denials of claims is financial distress on the part of the claimant. - o support or refute this allegation, forensic accounting experts for both sides will analyze personal financial statements *to identify indicators of financial distress.*
Forensic Engagements for FSA
- Business valuations. - Management assessments. - Contract negotiations. - Reorganizations. -Buy-sell agreements. - Shareholder disputes. - Damage claims. -Financing agreements. - Bankruptcy. - Incentive stock options. - Govern. actions. - Fraud
Why do private companies NOT us GAAP standards?
- It is not useful. - It is costly. - Private companies warrant different accounting standards.
Other Forensic Accounting Engagements using Personal Financial Statements include:
- Mortgage fraud. - Tax fraud. - Risk management audits. - Employment/ background checks.
Major Types of White-Collar Crime(6-1; Pg. 147):
- Security/Commodity Fraud. - Corporate Fraud. - Health Care Fraud -Mortgage Fraud - Financial Institution Fraud. -Insurance Fraud. -Mass-marketing Fraud. -Money Laundering.
(1) Domestic (divorce) Relations:
- These statements measure an individual's net worth, or wealth, as of a specific date. - A comparative analysis (for example, the last three years) allows the measurement of changes in specific assets and liabilities. - The personal financial statement might also establish one's ability to pay child support or alimony.
Characteristics of a White-Collar Fraudster:
-Above-average intelligence - Relatively well-educated - 36-45 years old -Male -White - Inclined to take risk - Commits fraud against own employer -Works in collusion with another offender -Employed by the company for more than ten years -Holds a senior management position -Works in finance or accounting -Lacks feelings of anxiety and empathy -Feels a lack of control over circumstances (external locus of control)
What federal agencies have governance over white-collar crime?
-FBI -IRS - Secret Service -Security Exchange Commission (SEC). -Environmental Protection Agency (EPA) - U.S. Customs
Other Types of White- Collar Crime:
-Tax Fraud - Mail Fraud -Social Security Fraud - Food Stamp Fraud - Immigration Fraud - Bank Fraud *All of of FBI's Jurisdiction**** *Investigated by:* ------------------ 1. IRS; 2. U.S.P.S.; 3. Secret Service; 4. Social Security Admin.; 5. Dept. of Agriculture; and 6. U.S. Immigration.
Phase 1 of Fraud Investigation:
1(a): Confirms the reasonableness of the suspicions of fraud. 1(b): Create a fraud hypothesis. - Hypothesis: An educated guess about hoe something works or an explanation for an event. - Exercise critical thinking/ reasoning skills based on assumption or direct evidence.
Steps of the Fraud Diamond:
1. *Opportunity* opens the door. 2. *Incentive (pressure) and rationalization* draws offender towards the door. 3. *Capability* pushes offender through the door.
4 Basic Elements of Fraud
1. A material false statement or omission ***material refers to a statement that would induce a reasonable person to assent or that the maker knows is likely to induce a reasonable person to assent. 2. Knowledge that the statement or omission was false. 3. Intended to induce the victim to rely on the false statement or omission. 4. The victim relied on the false statement or omission and suffered injury or damage as a result.
2 Ways that Horizontal (trend) Analysis is conducted:
1. Absolute dollar amounts- can assist in identifying the effects of outside influences on a company 2. Percentages- useful when comparing companies of different size.
Engagements of a Forensic Accountants in a Fraud Investigation (4):
1. Agent of law enforcements. 2. Member of audit team. 3. Private accountant engaged by victim(s) counsel. 4. Private accountant engaged by accused or accused counsel.
3 Types of Financial Statements:
1. Audit- large companies. 2. Review- small companies. 3. Compilation.
3 Basic Financial Statements:
1. Balance Sheet (BS) 2. Income Statement (IS) 3. Statement of Cashflows (SOCF)
Characteristics of Opportunity:
1. Commit 2. Conceal 3. Convert (to personal gain).
What is Horizontal (trend) Analysis compared to?
1. Compound annual growth rate (CAGR). 2. Sustainable growth rate (SGR)
7 Financial Reporting Standard Principles:
1. Cost- used to measure, record, and report transactions. 2. Matching- costs incurred during a specific time match the revenues reported at the same time. 3. Objectivity- requires accounting transactions to be supported by objective evidence. 4. Consistency- requires consistent applications of a selected method, period after period, to allow comparability. 5. Full-Disclosure- requires FS and accompanying notes fully disclose all material and relevant data for the reporting period. 6. Conservatism- requires the financial reporting to be conservative, not over or understating a situation. 7. Materiality- holds the strict adherence that a distinction between material and immaterial item needs to be considered if it would influence one's judgement of a situtation.
5 Aspects of Financial Crime:
1. Criminal Offenses. 2. Crimes of Intent. 3. Non-Victimless. 4. Possible Violent Acts. 5. Govern. Correctness.
6 Attributes to White-collar Crime:
1. Deceit - Offenders misrepresent and conceal the truth. 2. Intent - Fraud does not happen by accident. 3. Breach of trust - Offenders are generally in a position of trust that is manipulated or breached to facilitate the fraudulent action. 4. Losses - White-collar crime is the unlawful taking of another's property. 5. Concealment - White-collar crime can continue for years or might never be discovered. 6. Outward respectability - As the name implies, white-collar crime is commonly perpetrated by individuals (for example, professionals and executives) who are seemingly beyond reproach.
Techniques of Rationalization (Neutralization):
1. Denial of responsibility: when offenders deny responsibility, they view their behavior as a result of circumstances beyond their control. 2. Denial of injury: when offenders deny injury, they feel as though their behavior did not hurt anyone, even though it is against the law. 3. Denial of the victim: when offenders deny the victim, they conclude that the victim was deserving of the injuries. 4. Condemnation: an effort to neutralize one's actions by shifting blame to those who condemn the behavior (co-workers, employees, prosecutors, and law enforcement). 5. High loyalty to a group with which the offender associates with.
Forensic Accountant vs Financial Analyst for FSA:
1. Differing mindset. 2. Analysis conducted with professional skepticism. 3. Purpose to identify expected AND unexpected results. 4. Working backwards by using incomplete information.
Why are white-collar crime often a LOW priority for law enforcement:
1. Difficult and expense to prove. 2. Data-intensive nature. 3. Circumstantial evidence to infer. *Offenders often likely to: 1. receive light or no detention 2. rarely receive full restitution.*
3 Common Forensic Accounting Engagements that require Personal Financial Statements:
1. Domestic relations. 2.Embezzlement/fraud. 3. Arson.
Types/ Characteristics of Pressures:
1. Employee - Financial - Lifestyle - Emotional 2. Financial Statement - Financial - Management - Industry Conditions
Fraud Investigation: Cautions & Reminders
1. Every case is unique and has its own characters, facts, and circumstances. 2. Initiated after the fact (in-response to allegation or suspicion). 3. FA should operate in a state of disbelief or suspended belief (professional skepticism). 4. The scientific process is most effective and efficient approach (hypothesis is a tentative explanation). 5. Gather and analyze both documentary and interactive evidence.
Governments Role in Prosecuting White-Collar Crime:
1. Generally advances a financial crimes case following the filing and investigation of a criminal complaint, accompanied by an investigator's affidavit that summarizes the evidence against a suspect. 2. Majority of criminal indictments are based on good-faith evidence and belief of wrongdoing, misconduct on the part of prosecutors is not uncommon.
Primary Methods of FSA employed by Forensic Accountants:
1. Horizontal (trend) analysis. 2. Vertical (common size) analysis. 3. Ratio analysis. 4. Cash flow analysis.
Characteristics of Rationalization:
1. Justify behavior. 2. Attitude that rules do not apply. 3. Lack personal integrity.
Top 5 *Personal* Fraud Characteristics:
1. Living beyond one's means 2. Abuse of drugs or alcohol 3. Feeling of being underpaid 4. Excessive gambling habits 5. Undue family or peer pressure
Several common characteristics of fraudulent J/E's prescribed by SAS 99 include:
1. Made to unrelated, unusual, or seldom-used accounts. 2. Made by individuals who do not normally make journal entries. Recorded at the end of the period or as post-closing entries with no explanation. 3. No account number. 4. Containing round numbers or consistent ending numbers. 5. Applied to accounts that contain complex transactions, contain significant estimates or end-of-period adjustments, have been prone to errors in the past, have not been timely reconciled, contain intercompany transactions, or are otherwise associated with an identified fraud risk.
In the DuPont Model (1919), return on equity (ROE) is broken down into 3 components:
1. Net Profit Margin. 2. Total Assets Turnover. 3. Equity Multiplier.
Proposed Sequence of Interviews:
1. Neutral 3rd Party. 2. Corroborative witnesses. 3. Suspected co-conspirators. 4. Target
Key factors of Cash Flow Analysis:
1. Only FS that provides information about company's operating, investing, and financing activities. 2. Shows both inflows and outflows. 3. Powerful data source for forensic accountants. 4. Uses indirect method.
The 2 Management Sanctions by GAAP for Earnings Management:
1. Operational freedom. 2. Reporting freedom.
Components to the General Theory of Crime:
1. Opportunity: routine activities often provide means for offenders to act out their motivations. 2. Self-control: is one's ability to control his or her emotions and desires.
3 Basic Schemes of Aggressive and Fraudulent Earnings Management:
1. Overstating revenues. 2. Understating expenses. 3. Overstating financial condition and/or liquidity.
2 Statements for Personal Financial Statements include:
1. Personal balance sheet. 2. Personal income (cash flow) statement.
Top 5 *Organizational* Fraud Characteristics:
1. Placing too much trust in key employees. 2. No segregation of duties/responsibilities 3. Lack of complete and timely reconciliations 4. Lack of independent checks on performance 5. Lack of clear lines of authority and responsibility
What is Financial Reporting used for:
1. Prepared to meet external reporting obligations. 2. Aid to make internal decision making. 3. Useful to shareholders, board of directors, competitors, government agencies, vendors/creditors, and other special interest groups (politicians). 4. Must disclose ALL material information that is LIKELY to effect decision making.
Cressy Fraud Triangle suggests which 3 Key Factors:
1. Pressure (p) 2. Opportunity (o) 3. Rationalization (r)
What 2 conditions MUST exist for Ratio Analysis to be useful for FSA?
1. Ratio must be meaningful. 2. Must be a standard of comparison.
3 Techniques for Cash Flow Analysis:
1. Reconciling cash-ensures that the net cash flow for a given year matches the change in the reported cash balance from the beginning of the year to the end. 2. Cash flow comparison- measures of cash flow, such as operating cash flow and free cash flow,‡ to each other and to net income. 3. Trend Analysis- cash flow trends can provide an indication of the company's future direction.
Factors to consider when using Ratio Analysis:
1. Results are only as reliable as the source documents (garbage-in; garbage-out). 2. Disclosure of all ratios in footnotes.
Examples of Characteristics of Interest include:
1. Significantly fewer colons. 2. Fewer words per sentence. 3. Fewer optimistic words. 4. More words related to downward direction. 5. Fewer words describing certainty. 6. Fewer instances of the words note and see. 7. Fewer self-references. 8. More past-tense words. 9. Fewer present-tense words.
Review of Financial Statements: The Accounting Cycle
1. Starts with a transaction or an event. 2. The process involves: (a) identifying, (b) classifying, (c) quantifying, and (d) recording the transaction. 3. his process is performed throughout the accounting period as transactions occur. 4. At the end, a trial balance is generated (debits=credits) corrections are made (adjusting entries), and FS are prepared.
3 Types of Cash Flow Manipulations:
1. Stretching out payables- slowing down payments to vendors. 2. Financing of payable- this involves a company borrowing from a third-party financial institution to pay its vendors in the current period, with the intent of paying off the loan in the subsequent period. (more advance than stretching out payables). 3. Securitization of Receivables- to accelerate cash inflows, a company can package its accounts receivable and transfer them to a financial institution. *Result: SAS No. 95 accounting regulation.*
**EXAM** Important Elements of Context for Financial Reporting:
1. They are prepared primarily for users outside the business. *2. They are representations (assertions) of management.* 3. They are prepared for a specific period of time. (10Q or 10K) 3. They reflect historical information. 4. They include the activity of the entire organization. 5. Preparation standards allow for substantial reporting flexibility. 6. They rarely, if ever, represent economic reality (accurate and comprehensive financial profile). 7. They never tell the complete story.
Various Analytical Review Methods:
1. Trend (horizontal) analysis 2. Common-size analysis (vertical analysis or component percentages) 3. Ratio analysis 4. Budgetary comparisons 5. Industry benchmark comparisons 6. Examination of footnotes 7. Review of the general ledger and adjusting entries
When investigating gross revenue projections, actual and projected, *how many years* must you look at for *an accurate analysis.*
3 or more years of gross revenue.
Government Correctness (not always right).
A *criminal indictment is not proof* of a crime. It is an *assertion* that crime has been committed.
Operational Freedom:
A GAAP management sanction that involves making operational choices at year-end to enhance appearance of certain amounts.
Reporting Freedom:
A GAAP management sanction that involves the use of judgement in determining the amounts reported.
Financial Statements:
A compiled statement used to convey a concise picture of a company's operating activity (and related profitability) over a period of time and its financial position on a specific date.
White-collar Crime:
A crime committed by a person of respectability and high social status in the course of his occupation. -Sutherland (1939).
Non-shareable Problem:
A force that induces pressure into the fraud triangle; *a real (or perceived) problem that provides the necessary stimulus or motive for a violation of trust.*
Audit:
A formal review of an organization's accounts and financial transactions in order to render an opinion on the fairness of an organization's financial statements in an annual report. *Assurance is obtained by the auditor but not provided to the user of the financial statements. Thus, reasonable assurance is implied, but NOT actually provided.*
Review:
A lower level of assurance consisting primarily of inquiries of company personnel and analytical procedures applied to financial data. *No assurance is actually provided to the user of the financial statements. Limited assurance is implied, but NOT actually provided.*
Pressure:
A need or non-shareable problem that precedes the criminal violation of financial trust. Non-sharable Example: -Status seeking. - Status maintenance. -Financial concern.
Theory of Rationalization (Neutralization):
A principal theory of rationalization is neutralization, which proposes denial, condemnation, and higher loyalty as means by which offenders neutralize their role in a crime.
Rationalization:
A process by which a person attempts to make his or her actual or intended behavior more logical or justified. *allows individuals to perceive violations of trust as a legitimate means for solving their non-shareable problems.*
If fraud is NOT an accounting problem, which type of problem is it?
A social problem.
Content Analysis:
A systematic technique for categorizing words into content categories using special coding rules. Simply stated, it's a qualitative method of determining characteristics of interest based on grammatical structure, word content, and other fundamental characteristics of communication.
What must be established for a white-collar criminal to be guilty?
Absent evidence of intent (guilty mind).
Personal financial statements represent ________________ made by the submitting party and, as such, provide evidence for consideration (analysis) by the forensic accountant.
Affirmative statements.
Prosecutorial Misconduct:
An act (or failure to act), especially involving an attempt to avoid required disclosure or to persuade the jury to wrongly convict a defendant or assess an unjustified punishment. Examples: - (1) hiding, destroying, or tampering with evidence; (2) failing to disclose evidence that might exonerate the defendant; and (3) Threatening witnesses.
(1) Horizontal (Trend) Analysis:
An analysis that compares key financial statement items over time (from one accounting period to the next) to identify changes that may warrant further investigation.
(2) Vertical (common size) Analysis:
An analysis that compares the relative size of key accounts by converting all income statement items to a percentage of revenue and all balance sheet items to a percentage of total assets. Advantage: allows comparison of FS regardless size of firm, unlike horizontal analysis.
Opportunity:
An attributable to the fact that individuals trained in the routine duties of a position of trust have essentially been trained in the skills necessary to violate that trust. *position to manipulate or circumvent functional (learned) controls through duties.*
The Knucklehead Defense:
An incapacity agreement to support the Fraud Diamond; that an attorney argues that, even if the client was motivated to commit the crime and had the opportunity, he or she did not have the ability to carry it out.
What documents do auditors use to apply the standards of auditing to for FSA.
Assertions from management.
Altman's Z-Score (1968):
Bankruptcy prediction model.
When do violators engage in rationalization?
Before or at the same time the act (crime) takes place.
When ending inventory is INCORRECT, what accounts on the IS are effected:
COGS and Net Income.
What GAAP Reporting Principle holds both operational AND reporting freedoms in check?
Conservatism principle: directs management to select methods and estimated that avoid overstating: (1) Assets. (2) Revenue (3) Income
Since 2002, the FASB and the International Accounting Standards Board (IASB) have been working to merge U.S. GAAP with international financial reporting standards (IFRS), a process known as _________.
Convergence
By testing for these multiple factors of interest, and statistically analyzing them, they can potentially pattern ________.
Deception.
What does context provide for financial report?
Definition: Includes information surrounding an event. - Provides an enhanced level of meaning and understanding through perspective, frame, background, or history. - Allows to make comparisons and contrasts that are necessary for effective FSA.
Interview:
Direct means of obtaining evidence that provides immediate results. -Widely used investigation tool.
Phase 4 of Fraud Investigation:
Draw conclusions and communicate results: - Determination of the amount misappropriated. - Related discussion of specific schemes employed. - Identify loss components. 1. Specific transaction. 2. Unreported items. 3. Correct calculations.
What is an example of rational choice theory regarding fraud?
Earnings management.
General Theory of Crime:
Explains crime as a natural consequence of uncontrolled human desire to seek pleasure and avoid pain. Meaning: Crime is an attractive means of pursuing self-interest because it provides "immediate, easy, and short-term pleasure." *Applicable to ALL crime, including white-collar.*
What is the *MOST* valuable evidence gathering technique?
Financial Statement Analysis
Steps to the Fraud Scale:
Fraud is more (less) likely to occur when there is: - High (low) pressure. - Greater (less) opportunity. - Low (high) personal integrity.
The Fraud Triangle (Cressey 1949;1953):
Fraud results in a convergence of 3 factors (1) pressure; (2) opportunity; and (3) rationalization.
Who prepares the Financial Reporting Standards?
GAAP
Personal financial statement disclosures are prepared in accordance with _____ to be __________ informative.
GAAP; adequately.
Non-victimless
In addition to economic loss, financial crimes can result in *emotional and physical harm* to individual.
Accrual Accounting Method:
Income is accounted for (recognized) when earned. It is not the actual receipt, but rather the right to receive that governs. Expenses are recognized as incurred, that is, when all events have occurred that fix the amount of the item and determine the liability to pay.
Fraud is the crime of _____.
Intent- must be proven. -Incremental
When ending inventory is INCORRECT, what other BS accounts are effected:
Inventory, total assets, and owner's equity.
External Comparison
Involve comparing the subject company with similar companies or with the industry as a whole (industry averages). Goal: reveal the company's relative performance and financial standing.
Internal Comparison:
Involves comparing the subject company's current performance and financial condition with its past experience (changes within the company overtime). Time includes: 1. Month-to-month basis. 2. Year-to-date basis.
(3) Ratio Analysis:
Is simply a ratio expressing the relationship between two items reported in the financial statements. Ratios can be expressed as fractions, decimals, percentages, or relationships. -Describes *quantitative* indicators of a firm's financial strengths and/or weaknesses. - A= L+E
Working Theory of Organizational Misconduct:
Misconduct occurs when an individual in an organization encounters the right combination of *pressure and opportunity*, *without *the fear of *detection*. - Influenced heavily on top management.
Organizational Misconduct:
Misconduct performed by individuals on behalf of an organization. -Research on organizational misconduct has historically focused on the *why (why fraud occurs).*
****EXAM****** Table 5-3 & 5-4.
Page 102 in Chapter 5
What is the *main reason* forensic accounting being highly visible in the accounting field:
Persuasiveness of fraud.
****EXAM**** Table 5-7 Financial Ratios
Pg. 109
Personal Income (Cash Flow) Statement:
Prepared on the cash basis serves to provide information regarding an individual's cash inflows and outflows over a period of time. Cash inflows: - salaries, dividends, interest, capital gain, rental income, etc. Cash outflows (living expenses): - rent/mortgage payments, car payments, utility bills, food, clothing, and entertainment.
Phase 5 of Fraud Investigation:
Present a discussion and address concerns with meaningful discussion to determine if role/duty requirements have been followed by the accused.
Phase 6 of Fraud Investigation:
Present recommendations for resolution and remediation by considering: - Strength of the evidence. - Alternative explanations. - Eligibility for criminal complaint. - Eligibility for civil complaint. - Consideration for alternative dispute resolution.
(1) Personal Balance Sheet:
Provides a snapshot of an individual's financial condition at a specific point in time. Summary of: (1) Assets- resources. (2) Liabilities- obligations. (3) Net worth (A-L=E)
Content analysis is the __________ method of determining characteristics of interest.
Qualitative
Federal GAAP is determined by:
The Federal Accounting Standards Advisory Board (FASAB).
Compound Annual Growth Rate (CAGR):
Rate at which an investment would have grown if it grew at a constant percentage rate. -soothes the year-to-year volatility, reducing noise. -Analyst can potentially identify signigifcant changes in relationships.
Phase 3 of Fraud Investigation:
Refine and confirm hypothesis via interviews, at this phase, we should have: - Developed working knowledge of business. -Developed working knowledge of accounting systems. - Identified questionable financial reporting issues. - Identified key players to be interviewed and the information sought.
Indirect method of Cash Flow Analysis:
Requires reconciliation between the accrual- and cash-basis accounting methods. Steps of reconciliation include: (1) remove the effects of accrual-basis transactions that have no cash effect. (2) include effects of cash-basis transactions that have no effect on net income.
The ________ ratio is the most widely recognized profitability ratio.
Return on Equity (ROE).
Total Asset Turnover (operating efficiency):
Sales/ Total assets.
Personal Financial Statements:
Serve to provide information about an individual's financial condition, income profile, and cash flow. - commonly required by banks and other creditors to support loan applications or other requests for financing.
Compilations
Status that provides the lowest level of proposed assurance by an external accountant, as the accountant uses information provided, without an examination of that information, to prepare financial statements. *Assist with NO implied assurance.*
Phase 2(a) of Fraud Investigation:
Test hypothesis via financial statement analysis: - Examination of FS for the purpose of acquiring additional information. - This analysis may reveal unexpected relationships (analysis to look for relationships) *or* the absence of relationships. - Use various analytical techniques. - Consider the implications of your findings.
Phase 2(b) of Fraud Investigation:
Test hypothesis via journal entry testing - J/E can potentially undermined the validity of FS and the financial reporting process (segregation of duties). -Objective: to identify and assess any inappropriate or unusual activity. - Ineffective system of internal controls and management has ability to override JE process. - Consideration of fraudulent JE (SAS 99).
(2) Embezzlement/Fraud:
The analysis of one's personal financial statement may provide support (or lack thereof) for alternative theories explaining the acquisition or expenditures of cash.
(3) Statement of Cash flows
The cash flow statement covers the reporting period and serves to reconcile sources and uses of cash, which are classified as operating, investing, or financing activities. Goal: To explain changes in consecutive balance sheets and serve as supplement information for income statement.
Financial Statement Analysis:
The examination of financial statements for the purpose of acquiring additional information (questions or concerns) about the activities of a business. *MUST be viewed in context.*
Regulatory Framework: FASB
The highest authority in establishing GAAP for public, private, and nonprofit organizations.
Illegitimate Earnings Management:
The intervening to hide real operating performance by creating artificial accounting entries or stretching estimates beyond a point of reasonableness.
Sustainable Growth Rate (SGR):
The maximum growth rate a company can sustain without obtaining additional financing (debt and/or equity). Equation= Retention ratio x Return on Equity. -Retention ratio= (NI-DIV)/NI - ROE= Net Income / Shareholder's equity 1. Provides a useful reference point for evaluating reasonableness of reported past growth or project future growth.
(1) Balance Sheet (BS)
The purpose of the balance sheet is to show the financial position of an organization on a specific date. Reports: Assets- resources owned/controlled by business. Liabilities- external claims on those assets. Equity- owner's or investors contributions or other sources of capital.
(2) Income Statement (IS)
The purpose of the income statement is to summarize the performance of the organization over a specific period of time (accounting period, such as a quarter or year). Goal: To explain some (not all) changes in the assets, liabilities, and equity of a company between 2 consecutive BS dates (Year-to-date).
Earnings Management (Schipper 1989):
The purposeful intervention in the external financial reporting process, with the intent of obtaining some private gain.
Legitimate Earnings Management:
The reasonable and proper practices that are part of operating a well-managed business and delivering value to shareholders.
Calculus of Fraud:
The simple proposition that individuals will commit fraud when the reward (R) is greater than the product of the probability of getting caught (P) and the perceived gravity of the loss (L). = R> P & L U.S. v Carroll Towing Co. 1947
Criminal Offenses
The standard of proof is beyond a reasonable doubt; the burden of proof is on the prosecution.
The Fraud Scale (Albrecht et al.'s 1984):
The underlying proposition is that integrity (reflected in one's decisions) influences deviant behavior.
The Fraud Diamond (Wolfe/Hermanson 2004):
The underlying proposition is that, in addition to pressure, opportunity, and rationalization (the fraud triangle), offenders also need the "capability" to commit the act.
Fraud:
The unlawful taking of another's property by deception.
Equity Multiplier (financial leverage):
Total assets/ Total shareholder's equity.
The most important revelation is the _________.
Trend. -Speed, direction, and magnitude trends can be compared within the company, competing companies, or industry averages.
T/F: All 3 elements of the fraud triangle must occur for fraud to occur.
True *ALL address the *who* and *why* of the fraud.*
Periodic Inventory Method:
Under this inventory method, a purchases account is used, and the beginning inventory is unchanged during the period. At the end of the period, the inventory account is adjusted by closing out the beginning inventory and recording the ending inventory, as determined by *physical inventory*
What do the analytical review methods reveal in FSA?
Unexpected relationships.
Possible Violent Acts
White-collar crime is generally considered a nonviolent activity, *the possibility of violence cannot be ignored.*
Altman's Z-score for privately held firms:
Z = 0.717(X1) + 0.847(X2) + 3.107(X3) + 0.420(X4) + 0.998(X5)
Z-Score for Public-traded Manufacturing Company:
Z = 1.2(X1) + 1.4(X2) + 3.3(X3) + 0.6(X4) + 0.999(X5) - X1 = Net working capital / Total assets. - X2 = Retained earnings / Total assets. - X3 = Earnings before interest & taxes / Total assets. - X4 = Market value of equity / Book value of total debt. - X5 = Sales / Total assets.
Altman's Z-score for publicly traded nonmanufacturing firms:
Z = 6.65(X1) + 3.26(X2) + 6.72(X3) + 1.05(X4)
Forensic accounting has became affixed with ________ and ____________.
fraud; white-collar crime.