Magazine article The CPA Journal

When It Comes to Fraud, It's Better to Be Safe Than Sorry

Magazine article The CPA Journal

When It Comes to Fraud, It's Better to Be Safe Than Sorry

Article excerpt

The Importance of a Keen Eye and the Courage to Speak Up

Contrary to popular mythology, not all corporate accounting frauds begin at the top. This article tells three stories of corporate accounting irregularities that I have encountered - all of which began at the bottom.

Case 1: CS Company

In my earlier career as an auditor of publicly owned corporations, I came across a situation both puzzling and instructive. My client was a multioffice computer service company (CS Company) with about 25 offices in large cities throughout the United States.

In one of these offices (it was later discovered), a bookkeeper, concerned about the monthly financial results, decided to help local management. She set about to alter the monthly report so as to improve results. CS Company did not merely consolidate subsidiary monthly reports. The reports were arrayed and compared. Accounting analysts looked for trends in operating results and statistical discrepancies between offices.

It took three months of review for the errors to become egregious enough to result in follow-up and detection. The misstatements were both detected and connected. The investigation revealed that the bookkeeper had found a way to falsify the accounts receivable aging in order to disguise a deterioration in accounts receivable collections. An analyst had noted that the number of days sales in accounts receivable had been increasing in this office, both in relation to historical data and to other offices. After these contradictory aging statistics failed to correct themselves in subsequent months, internal auditors were dispatched and quickly identified the problem.

An investigation revealed that no corporate assets had been lost. Adequate efforts resulted in collection of most of the past due receivables. Local management was not implicated, and the bookkeeper was fired. The systems had been well designed. Follow-up was reasonably effective. The outcome was reassuring.

Fast-forward to several decades later. My auditing career is a bittersweet memory; I am now a consultant on auditing and accounting matters, principally on issues involving controversy and, hence, litigation. Two recent cases in which the author was an expert witness provided more information and instruction about what can go wrong in a far-flung business operation and the manner - both good and bad - in which the error-detection process and corrective actions function.

This article will set forth the facts (some of which have been altered to preserve anonymity) involving the violations of procedures, detection of errors, and appropriate (or inappropriate) follow-up and corrective actions. Unlike the CS Company matter described above, the errors in both cases below were made deliberately by subsidiary management and, in both cases, were both quantitatively and qualitatively material.

Case 2: Alpha Company

Alpha Company had about six domestic and three foreign operations, each manufacturing the same product, sold locally to both local and multinational corporations. The company's product was becoming technologically obsolete and its financial results were declining. Alpha's net income in 2005 was marginally positive, largely as the result of profits generated by one of its foreign subsidiaries.

When auditors arrived at this subsidiary in January 2006 to begin their yearend fieldwork, they found the books and records confusing and incomplete. Several control accounts had significant reconciliation differences from the subsidiary ledgers. Schedules of other accounts, prepared by the client's controller, had other apparent errors. Auditor inquiries were not appropriately answered.

After a few days, realizing that the subsidiary was not prepared for the audit and that something might be amiss, the local audit team withdrew and notified the lead audit office partner of the problems encountered. The corporate office immediately dispatched a team of accounting executives. …

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