Question

A local school district cannot explain where all of the money that it receives from the state for operations is going. Although annual appropriations to the school district have been steadily increasing, funds available for school operations and equipment purchases have been decreasing. Consequently, you have been asked by the school board to investigate the situation.

During your interview with the local school superintendent, you discover the following about Jane Brown, the part-time bookkeeper who manages the school district’s finances:

• Jane has total control over the entire process of receiving, recording, depositing, and disbursing the district’s funds.
• Jane has declined offers by the superintendent to hire another part-time person to alleviate some of her workload.
• Jane is very protective of the financial records and, for “confidentiality reasons,” will not allow others to inspect them.
• Jane and her husband, John Brown, seem to be living a very nice lifestyle given their modest employment situations. Jane earns about $30,000 per year as the district’s part-time bookkeeper. John is “self-employed” and reports about $20,000 per year in net income.
• When first hired Jane often complained about how underpaid she was, although she has not complained recently.

In light of the above, you develop the fraud theory that Jane is embezzling funds from the school district. Accordingly, you request access to the financial records of the school district but are denied access due to “confidentiality issues.” Consequently, you must use an indirect method to test your fraud theory. The following information was collected to help test your fraud theory:

1. Exhibit 1 contains an estimate of the Brown’s net worth as of December 31, 2018.

2. Exhibit 2 contains an estimate of the Brown’s net worth as of December 31, 2019.

3. The Brown’s known sources of income during 2019 include:

Jane Brown                   $30,000

John Brown                  20,000

Investment Income            5,000

Total Income                $55,000

4. The Brown’s known expenditures during 2019 include:

Mortgage payments       $25,000

Airline tickets               10,000

Living expenses             30,000

Total Expenses             $65,000

Exhibit 1

Estimated Net Worth for Jane and John Brown

As of December 31, 2018

Cash in bank	$5,000		Mortgage	$90,000
Investments	25,000		Auto loan	10,000
Automobile	20,000		TOTAL LIAB.	$100,000
Residence	100,000
TOTAL ASSETS	$150,000		NET WORTH	$50,000

Exhibit 2

Estimated Net Worth for Jane and John Brown

As of December 31, 2019

Cash in bank	$10,000		Mortgage	50,000
Investments	50,000		Auto loan	0
Automobile	40,000		TOTAL LIAB.	$50,000
Residence	100,000
TOTAL ASSETS	$200,000		NET WORTH	$150,000

Required: Estimate the Brown’s funds from unknown sources using: (1) the net worth method, and (2) the expenditures method. Note that for the expenditures method, increases in assets and pay offs of debt not reflected elsewhere are considered expenditures (e.g., the mortgage balance decreased by $40,000, and Brown's known mortgage expenditure in 2019 was $25,000; thus, $15,000 must also be an expenditure).

Answer 1

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Ans : (1) Brown’s funds from unknown sources using the net worth method

	$$
Ending Net worth	150000
Less : Begining Net worth	- 50000
Increase in Net worth	100000
Add: Living expenses and other expenditure	65000
Total Expenditures	165000
Less : Income from known sources ( 30000 + 20000 + 5000 )	-55000
Expenditures in excess of known sources	1100000

Analysing the above information , we can see that Increase in Net worth as per books is $ 100000 and unexplained income from unknown sources is $ 110000.

2) Brown’s funds from unknown sources using the expenditures method

	$$
Increase in cash in bank [ Closing – Opening ] ( 10000 – 5000)	5000
Increase in Investments ( 50000 - 25000 )	25000
Increase in Automobile ( 40000 – 20000 )	20000
Mortgage Loan repaid ( 90000 -50000 )	40000
Auto Loan repaid ( 10000 – 0 )	10000
Total expenditure	100000
Add : Total exp on living and others	65000
	165000
Less : Income from Known sources	-55000
Expenditures in excess of known sources	110000

Hence we can see the same conclusion is achieved from both the above methods.