Question

Jiffy Corporation has its seen its earning increase steadily each quarter from 2004 (its founding) through 2008. Because of the recession, Jiffy has struggled to provide investors with the same level of growth. Jiffy’s CEO, COO and CFO whose wealth is significantly leveraged by Jiffy’s equity-based compensation, are trying to focus on how to keep the company on a growth climb despite the hard time. Interestingly, each quarter, Jiffy has been able to meet or beat the investor’s forecasts. Jiffy’s typical business model is to ship its products to customers on account with payments due within 30 days after delivery. Jiffy’s products are manufactured in two plants, one in Columbus, Ohio and the other in Houston, Texas. Jiffy’s inventory is stored in 20 different warehouses located in 15 states. Many of Jiffy’s smaller customers are start-up companies. Surprisingly, Jiffy has a relatively rate of uncollectible accounts relative to others in its industry. Anderson & Cooper is Jiffy’s external auditor. You are the engagement partner assigned to Jiffy’s audit. Please respond the following question: 1. What are some of the red flags for possible management fraud based on the client’s profile?

2. Identify three types of management (financial statement) fraud that might be attempted in
this situation. What red flags will you look for to identify the frauds, and how will the
frauds be attempted?

Answer 1

Hello Student

As an accounting professional, an important aspect of your job is to identify fraud during an audit. To help accounting professionals detect fraud, While one of these may not necessarily be cause for concern, the presence of two or more should raise suspicion and may require a more in-depth examination:

1. Missing Documents -- It isn’t uncommon for documents to go missing in the workplace. After all, accidents do happen. However, if this becomes a frequent occurrence, fraudulent acts could be the culprit, especially for checks. Missing checks numbers or gaps in reconciled check numbers can also be an indicator of fraud.
2. Complaints -- It’s easy to write off complaints as nonsense venting, but complaints are one of the best ways to identify fraud. If employees are complaining about something, don’t take it lightly. Dig further into the situation to identify the cause of the complaint and what else could be behind it.
3. Excess Purchases -- Fake payees can be used to convert funds. Be aware of excessive purchases as they could be covering a possible payoff of a purchasing agent.
4. Inventory Shortages -- Internal shrinkage and product loss happens. However, excessive shrinkage could be an indicator of a plethora of fraudulent activities.
5. Excessive Voids/Returned Checks -- Voided sales slips mean that the sale has been rung up, but the payment was diverted, potentially into the wrong hands. This is similar to cancelled checks. While they are usually legitimate transactions, a cancelled check can be returned to the wrong hands and be re-written to the fraudster. Excessive voids and cancelled or returned checks are common indications of theft and should be watched carefully.
6. Duplicate Payments -- Duplicate payments in many cases are not fraud-related. However, if a duplicate payment is accidentally made by a company, it is possible for an employee to forge an endorsement of the check. Watch this closely as well.
7. Rounded-Amount Invoices -- Fraudsters will often create invoices with rounded amounts. If you don’t see any pennies, it may be a sign that you need to look into that invoice further.
8. Abnormal Invoice Volume -- Rapid invoice volume increases may be due to a legitimate increase in business, but is also may point to fraudulent behavior. Monitoring vendor invoice volume and being aware of spikes is a good way to spot abnormal behavior.
9. Invoices Just Under Approval Amounts -- Some employees may be aware of the dollar threshold for management approval and create an invoice just below that approval level. For example, if the approval level is $5,000 and you get an invoice for $4,998, you may want to do a bit more research on that invoice.
10. Mail Drop Address -- A mail drop, or ghost address, is an entity that can receive mail in your name. Companies using a mail drop as their address rather than a P.O. Box may be doing so to hide their fraudulent activity.

Ans 2

Employee fraud comes in many shapes and sizes. It goes by several different names, including internal fraud, occupational fraud, or employee dishonesty. There are three basic types of fraud:asset misappropriation, bribery and corruption, and financial statement fraud. In many fraud schemes perpetrated by employees, more than one type of fraud is present.

We hear about asset misappropriation the most often, probably because they are the frauds that occur the most often and they’re the easiest schemes to understand. An asset misappropriation might include things like check forgery, theft of money, inventory theft, payroll fraud, or theft of services.

Recent statistics show that asset misappropriation happens in over 91% of fraud schemes. This easily makes it the most common fraud, but statistics show that it is the least expensive fraud on a per-fraud basis. The average asset misappropriation costs a company $150,000.

The next most frequently occurring fraud scheme is bribery and corruption, which is part of about 30% of all fraud that is uncovered. Bribery and corruption include schemes such as kickbacks, shell company schemes, bribes to influence decision-making, manipulation of contracts, or substitution of inferior goods. The average bribery/corruption scheme is far more costly than asset misappropriation, at $538,000 per scheme.

The least common type of fraud is financial statement fraud. Although it occurs least frequently, in only 10% of all fraud cases, it is easily the most expensive. The average financial statement fraud costs a company $2 million. This type of fraud centers on the manipulation of financial statements in order to create financial opportunities for an individual or entity. Think manipulation of stock price, increased year-end bonuses, favorable loan terms, or other indirect benefits from the financial statement fraud.

It is easy to see how quickly the cost of fraud can rise. Could your company withstand a fraud the size of any of the above averages?

Red Flags to look to identify the frauds

Scandals in companies after economic globalization drew the attention of audit authorities on detection of fraud and manipulation before suffering massive losses. Upon examination of fraud and manipulation in the past, it is seen that many of them emerged after similar symptoms. These symptoms are more frequent in companies with weak management structure. Although not considered as a definite proof of fraud, these symptoms that indicate fraud in financial statements are reported as “red flag” . Red flags may be described as “potential symptoms existing within the company’s business environment that would indicate a higher risk of an intentional misstatement of the financial statements” Situations that involve fraud usually exhibit a significant deviation and red flags signify the unnatural situations or those different than the normal ones . International accounting institutions use red flags in their regulations as they have signs about fraudulent activities. SAS No: 99 and ISA Article 240 are the most important ones among these regulations . In accounting literature, there are many red flag classifications to be used in audit applications. The most commonly accepted of these classification methods was devised by Federal Trade Commission (FTC) in Fair Accurate Credit Transactions Act (FACTA) which was regulated in 2003. FACTA classified red flags as follows.

.Warning and notices from customer report agencies,

.Suspicious documents,

. Suspicious personnel identification,

. Unusual activities in accounts,

. Notices from customers, captured criminals, and law enforcement authorities.

Detecting fraud and manipulation committed by creative accounting practices is more difficult. They are usually committed by experts without violating any accounting principles so they require a more careful examination and if a situation seems suspicious even with a tiny possibility, it should be checked for any sign of fraud danger Red flags about financial statement manipulations are as follows :

. Unusually positive financial data

. Debt collection rate is lower than normal

.Suppliers are constantly making discounts

. Excessive borrowing of the company

. Consistent fulfillment of earnings targets,

. Questionable definitions of income for the company to reach its targets,

. Significant changes in income policies.

"Why it is attempted"?

To explain why financial fraud attempted we have to turn to the Fraud Triangle which was a theory developed by the famous criminologist and sociologist Donald R. Cressey. His theory is that all three legs of the triangle must be present, simultaneous, for an individual to engage in fraud.

.Pressure

.Oppurtunity

.Rationalisation

The fraud begins with Pressure…usually financial pressures. For example, there is financial pressure when the spouse of the fraudster loses his or her job. The economic pressures brought on by the recession can have a big effect. Some other reasons are the inability for the fraudster to pay their bills or a drug or gambling addiction. (It seems like more and more are happening because of gambling addictions.) The desire for status symbols such as a bigger home or a nicer car. (Keeping up with the Jones’.) It can also be brought on by the need to meet specific professional goals. Opportunity – This is the method in which the crime can be committed. The key elements are Too much Power and keeping the crime a secret. Some ways a person can commit the crime is when there are no segregation of duties. Self-managed associations beware. When the Treasurer or on-site manager is authorizing the invoice, signing the check and producing the financial reports with little or no oversight, look out. Keeping the crime a secret is a key element in the opportunity phase. If the other Board members are actively overseeing the treasurer or manager in these situations, the fraud could be avoided. Having a management company is no guarantee that all fraud will be avoided but most management companies with an accounting department will have developed a much stronger internal control system to help avoid a financial fraud. If the Association is selfmanaged, they should strongly consider outsourcing their financial accounting to a reputable company, whether it is a management company or an accounting firm. The Final leg of the fraud triangle is Rationalization. If the fraudster has financial pressure and opportunity, the rationalization will help them move to commit the fraud. Rationalization is the way the person justifies the act. Some common rationalizations are:

1. “I was only borrowing the money.”

2. “I was entitled to the money.”

3. “I had to steal to provide for my family.”

4. “I was underpaid; my employer deserved it.”

5. “My company does bad things and I got them back for it.”

How it attempted

We have discussed why it attempted and partly how it attempted.

Some of the ways of how frauds occur for community associations are classified in 4 basic categories:

1. Taking income that is meant for the Association. Examples are assessments, user fees, unauthorized waiver of fees or assessments, ancillary income such as antenna income, cable income, vending income, interest income, parking income.

2. Unauthorized or inflated purchase of materials or services from Association funds. Examples are purchasing items for personal use or gain with Association funds. Other examples are kickbacks on contracts signed on behalf of the association. Usage of company credit cards for personal purchases, are included under this category too. Increasing time reported for payroll or ghost employees.

3. Taking of Association equipment or inventory for personal use. Included in this category is when a maintenance person installs items in a unit for personal gain while paying for the parts with Association funds.

4. Use of Association assets for personal gain. Included in this category is using Association investments as collateral on a personal loan or placing Association accounts into a person’s name to gain investment income from the association’s investment.