Transcript Employee Fraud - The Institute of Internal Auditors

Identifying and
Recognizing the
Red Flags
of Fraud
James S. Fellin CPA CFE
The Nottingham Group, LLC
Agenda
 Red Flags…Looking beyond the obvious
 Cost of Fraud
 Types of Red Flags
 Red Flags of various employee fraud schemes
 Searching for Red Flags in Data Mining
 Pitfalls
 Questions and Answers
What is a RED FLAG
of Fraud?
A red flag is a set of circumstances that
are unusual in nature or vary from
normal activity. It is a signal that
something is out of the ordinary and
may need to be investigated further.
These are warning signs.
Some Red Flags are easily discerned,
while others may be more subdued
and/or concealed.
Why are
RED FLAGS
important in fraud
deterrence and
prevention?
Detection of Fraud Schemes
Initial Detection Method by Organization Type8
8The
sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.
©2008 by the Association of Certified Fraud Examiners, Inc.
The
True Cost
of Fraud
How Costly is Fraud
 The direct amount that is misappropriated is
oftentimes only a small portion of the cost
to an organization.
 What are the other tangible and intangible
costs associated with employee fraud and
abuse???
Employee Fraud Example
Amount of Defalcation
Plus: Opportunity Cost-Internal Investigation
Plus: Cost of outside professionals
Total Amount of loss
Provable portion of claim
Less: insurance deductible
Amount recovered
Unrecovered loss
$80,000
$100,000
10,000
25,000
$135,000
80,000
25,000
55,000
Other Intangible Costs
 Distraction of organization
 Employee morale
 Embarrassment
 Loss of customer confidence
Behavioral
Red Flags
Behavioral Red Flags
 Fraudsters oftentimes demonstrate behaviors that
may serve as warning signs
 Some perpetrators may exhibit behavioral
warnings signs. They may act irritable, may spend
lavishly or become secretive.
 The presence of these signs do not, in and of itself,
indicate fraud is occurring
 Management and anti fraud professionals should
be trained to understand and identify potential
warning signs so that they may be investigated.
23-24The
sum of percentages in this
table exceeds 100 percent
because in several cases the
perpetrator exhibited more than
one behavioral red flag.
©2008 by the Association of Certified Fraud Examiners, Inc.
Behavioral Red Flags Present During Fraud Scheme24
24The
sum of percentages for each scheme type
exceeds 100 percent because in several cases
the perpetrator exhibited more than one
behavioral red flag.
©2008 by the Association of Certified Fraud Examiners, Inc.
RED FLAGS
in the
Accounting Data
Break data or information down
into manageable segments so it can
be effectively and efficiently
analyzed. Failure to segment data
yields a cumbersome and unwieldy
data that is of little use
Breakdown of Fraud Schemes
Into Functional Areas
Cash Fraud
Accounts Receivable Fraud
Inventory Fraud
Fixed Asset Fraud
Accounts Payable/Vendor Fraud
Payroll Fraud
Expense Reporting Fraud
Cash Fraud
Red Flags
 Discrepancies between cash count and account balance
 Excessive voids/ “No sales” rung
 Mutilated/destroyed cash register receipts
 Employee working from open cash drawer
 Unexplained inventory adjustments
 Unexplained increase in the use of petty cash
 Personal checks included in cash funds
 Excessive customer refund transactions
 Unusual journal entries affecting cash accounts
 Differences between daily receipts and bank deposits
 “Less Cash” line on deposit tickets indicates cash taken
Accounts Receivable Fraud
Red Flags
 Customer complaints regarding amounts owed
 Discrepancies between deposit tickets and customer records
 Different dates between deposits and customer payments
 Unusual discounts or credits
 Increase in delinquent accounts
 Increase in the amount of write-offs
 Receivables with unusual characteristics
 Customers with unusual name, address or phone number
 Unusually low collection by collection agency
Inventory Fraud
Red Flags
 Unexplained inventory shrinkage
 Excessive inventory adjustments
 Decrease in gross margins
 Unusual journal entries to inventory
 Unusual trash removal practices
 Increase in credit memos
 Temporary workers with access to
inventory
Fixed Asset Fraud
Red Flags
 Unusual or unexpected asset purchases
 Missing assets
 Unusual increases in repairs and maintenance on
assets that could be subject to personal use
 Unusual fluctuations in depreciation accounts
Accounts Payable/Vendor Fraud
Red Flags
 Higher-than-usual costs or expenses
 Vendor complaints
 Altered or modified vendor invoices
 Unexplained fluctuations in payables
 Unusual endorsements on checks
 Unusual vendor names and addresses
 Unusual payees on checks
 Discrepancy between payees on checks and check register
 Unusual increase in purchases to vendor(s)
 Copies of vendor invoices instead of originals
 Missing cancelled checks
Payroll Fraud
Red Flags
 Unusual fluctuations in payroll expense or hours
 Checks to employees with minimal or no personnel records
 Missing payroll checks
 Employee complaints
 Number of paychecks not commensurate with number of




employees
Employee complaints regarding W-2 amounts
Employees who pick up paychecks for other employees
Highly compensated employees who elect no withholdings
Dual endorsements on cancelled payroll checks
Expense Reporting Fraud
Red Flags
 Improper or inadequate receipts underlying expenses
 Information on expense report differs from receipts
 Photocopies of expense receipts submitted instead of
originals
 Repeated entertainment expenses with customer with no
associated business
 Failure to utilize company credit cards when available
 Expenses submitted not in line with other employees
DATA MINING -Searching for the
RED FLAGS
Common Data Mining
Computer Programs
ACL Desktop Edition
IDEA Data Analysis
Microsoft Access
ActiveData for Excel
2 Most Significant Data Files
for Data Mining
 Master Vendor
File
 Payables (A/P
File)
No Telephone Number
Company
Address
Telephone
Fed ID
Able Co
145 Newburn Dr, Clev. OH 13088
607-308-9122
34-2907833
Brown Ent
88 Mcknight Rd, Pgh PA 22091
412 555 -2219
22-9789872
Cross Corp
66 West Main, Pgh PA 15220
111-111-1111
31-9918288
Nestor Inc
444 Noble Lane, Pgh PA 56301
412-456-0011
25-9328993
Rivers LLC
35 Fifth Street, Pgh PA 15004
412-003-2297
41-7932211
Strata Ent.
67 Mean Street, Erie PA 17338
Turner Co
1 Park Place, Phil PA 43009
Vactor Co
53-9204832
215-994-0778
305-220-8923
22-9789872
No Federal ID Number
Company
Address
Telephone
Fed ID
Able Co
145 Newburn Dr, Clev. OH 13088
607-308-9122
34-2907833
Brown Ent
88 Mcknight Rd, Pgh PA 22091
412 555 -2219
22-9789872
Cross Corp
66 West Main, Pgh PA 15220
111-111-1111
31-9918288
Nestor Inc
444 Noble Lane, Pgh PA 56301
412-456-0011
25-9328993
Rivers LLC
35 Fifth Street, Pgh PA 15004
412-003-2297
41-7932211
Strata Ent.
67 Mean Street, Erie PA 17338
Turner Co
1 Park Place, Phil PA 43009
215-994-0778
Vactor Co
King Street, Chi IL 60609
305-220-8923
53-9204832
22-9789872
No Address
Company
Address
Telephone
Fed ID
Able Co
145 Newburn Dr, Clev. OH 13088
607-308-9122
34-2907833
Brown Ent
88 Mcknight Rd, Pgh PA 22091
412 555 -2219
22-9789872
Cross Corp
66 West Main, Pgh PA 15220
111-111-1111
31-9918288
Nestor Inc
444 Noble Lane, Pgh PA 56301
412-456-0011
25-9328993
Rivers LLC
35 Fifth Street, Pgh PA 15004
412-003-2297
41-7932211
Strata Ent.
67 Mean Street, Erie PA 17338
Turner Co
1 Park Place, Phil PA 43009
Vactor Co
53-9204832
215-994-0778
305-220-8923
22-9789872
Duplicated Data
 Same Address
 Same Federal ID Number
 Same Phone
2 Vendors with Same Federal
ID Number
Company
Address
Telephone
Fed ID
Able Co
145 Newburn Dr, Clev. OH 13088
607-308-9122
34-2907833
Brown Ent
88 Mcknight Rd, Pgh PA 22091
412 555 -2219
22-9789872
Cross Corp
66 West Main, Pgh PA 15220
111-111-1111
31-9918288
Nestor Inc
444 Noble Lane, Pgh PA 56301
412-456-0011
25-9328993
Rivers LLC
35 Fifth Street, Pgh PA 15004
412-003-2297
41-7932211
Strata Ent.
67 Mean Street, Erie PA 17338
Turner Co
1 Park Place, Phil PA 43009
Vactor Co
53-9204832
215-994-0778
305-220-8923
22-9789872
Round Dollar Amounts
Most transactions are non-round numbers
Can do a search for round dollar amount
Round Dollar Amount
Check No
Date
Payee
Amount
1265
4/18/2008
Vactor Co
1,252.63
1266
4/18/2008
Murphy Plumbing
1,153.93
1267
4/18/2008
Lowes
1269
4/18/2008
Boyle Automotive
11,211.00
1270
3/2/2008
Cross Corp
10,000.00
1271
4/18/2008
Boyda Floral
1272
4/19/2008
Turner Co
1,193.00
1273
4/19/2008
Strata
1,492.77
1274
4/19/2008
Vactor Co
3,272.44
1276
4/20/2008
Nestor Inc
1,818.18
908.66
67.72
Searches on Checks
Duplicate Check Number
Invoice Number Deleted
Missing Invoice Number
Check No
Date
Payee
1265
4/18/2008
Vactor Co
1266
4/18/2008
Murphy Plumbing
1267
4/18/2008
1269
Invoice
Amount
499345
1,252.63
108
1,153.93
Lowes
1449
908.66
4/18/2008
Boyle Automotive
9443
11,211.00
1270
3/2/2008
Cross Corp
1271
4/18/2008
Boyda Floral
1272
4/19/2008
Turner Co
1273
4/19/2008
Strata
1274
4/19/2008
1276
4/20/2008
10,000.00
394949584
67.72
24243
1,193.00
111111111
1,492.77
Vactor Co
43564
3,272.44
Nestor Inc
12342
1,818.18
Repeated Digit
Check No
Date
Payee
1265
4/18/2008
Vactor Co
1266
4/18/2008
Murphy Plumbing
1267
4/18/2008
1269
Invoice
Amount
499345
1,252.63
108
1,153.93
Lowes
1449
908.66
4/18/2008
Boyle Automotive
9443
11,211.00
1270
3/2/2008
Cross Corp
1271
4/18/2008
Boyda Floral
1272
4/19/2008
Turner Co
1273
4/19/2008
Strata
1274
4/19/2008
1276
4/20/2008
10,000.00
394949584
67.72
24243
1,193.00
111111111
1,492.77
Vactor Co
43564
3,272.44
Nestor Inc
12342
1,818.18
Cautions: Be Careful of
What’s Left Out!
Make sure that searches and queries pick up all data
including where there is no data
Watch for Unmatched Data
Good Article in September 2008 Journal of Accountancy
Other Relevant Data
Files
Employee Database
Payroll File
HR File
What are some of the searches that can be
done with these files?
Other Key Searches
Vendor Address same as Employee Address
Vender Names same as employee names
Vendor Phone same as Employee Phone
Vendor Tax ID Number same as Employee Social Security
Number
Compare Employee File with Payroll for Ghost Employees
Summary
 Knowing how to spot and investigate Red
Flags is imperative in a proactive fraud
deterrence program.
 Learn to spot the behavioral and data red
flags.
 When red flags are present, investigate and
document.
 Data mining is an effective tool for identifying
red flags in the company data files
Questions
Thank You
Please take a moment to complete
speaker evaluations.