Magazine article Security Management

Delving Deeper to Decipher Fraud

Magazine article Security Management

Delving Deeper to Decipher Fraud

Article excerpt

TRADITIONALLY the corporate fraud problem has been addressed as an accounting exercise. Many security professionals incorrectly assume that periodic audits b both the in-house accounting staff and outside auditors provide a sufficient safeguard against fraud. Audits, however, are performed to determine the degree to which a company complies with standards and practices that have been mandate by the company's management. An auditor does not necessarily look for fraud or go beyond what is presented in the company books and records. A new breed of professional, the fraud auditor, does.

The fraud auditor, sometimes referred to as a forensic accountant, usually has an education in accounting and auditing. He or she then may get a job with some public agency that is engaged in investigations. Although the variations on thi scenario are countless, the definition remains the same: the melding of knowledge of both accounting and investigations within one individual is the hallmark of the fraud auditor.

The accountant and the investigator may look at the same problem from two different perspectives. The fraud auditor, however, is trained to look at a problem with two sets of eyes simultaneously.

A forensic accountant is frequently engaged as a consultant after an auditor ha noted some irregularity. Most industrial companies are subject to three layers of financial review--internal auditors, auditors employed by a bank or other lending institution, and independent public auditors. If any one of these financial reviews uncovers suspicious activity, particularly transactions involving officers of the company, they may decide to call in a fraud auditor. The inquiry of the forensic accountant will differ from that of the previously described audits in that the forensic accountant will be specifically looking for fraud.

The fraud auditor typically builds a case by carefully examining records. When something out of the ordinary is noted, he or she delves deeper to find out why it occurred. A recent case provides a good example of how a fraud auditor investigates a fraud problem.

A large metal processing company with manufacturing facilities in three separat eastern states was recently forced into bankruptcy because of reported declinin sales and increased expenses. Company management placed the blame on poor economic conditions and specifically on decreased defense spending. This explanation satisfied many of the company's creditors, but a local bank ordered a full accounting review prior to accepting the losses that would have to be sustained in the event of a bankruptcy.

This audit found irregularities in a number of areas that directly reflected on the company president and controller. Inventory figures on the books did not accurately reflect the raw material or the finished product on hand. Additionally, after directly contacting a number of the customers who had done business with the company, the accounts receivable ledger was found to be overstated. The creditor's committee insisted that an independent forensic accountant be retained to determine whether fraud had caused the company to fail.

During the course of a typical inventory procedure, approximately 25 percent of the raw material and finished product is actually counted; the remainder is estimated or derived from preexisting records. In this case, the forensic accountant conducted a full inventory, including a stand-still count of inventory in transit.

The actual inventory was found to be overstated in the last financial statement by approximately $500,000. In addition to the incorrect count, the inventory valuation was inflated. Similarly, direct contact with the company's customers determined that the accounts receivable ledger was overstated by more than $1 million.

Based on these findings, interviews with accounting department personnel and management were conducted. The accounting background of the fraud auditor is an essential element when conducting these interviews. …

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