F RAUD Ir is Ike da, Commissione r Division of F inanc ial - - PowerPoint PPT Presentation

F RAUD

Ir is Ike da, Commissione r Division of F inanc ial Institutions De par tme nt of Comme r c e and Consume r Affair s Se pte mbe r 2016

Age nda

What is F

r aud?

T

ype s of F r aud

Sour

c e s of Infor mation

Re d F

lags

F

inanc ial Analysis

Wha t is F ra ud – De te c ting a F ra ud

 Conduc ting a “should of” afte r

a fr aud happe ns may show that r e d flags we r e pr e se nt. If the vic tim had only r e c ognize d the war ning signs, the n that loss may not have oc c ur r e d or be e n substantially r e duc e d.

 Base d on a r

e c e nt sur ve y by the Assoc iation of Ce r tifie d F r aud E xamine r s (ACF E ), oc c upational fr aud substantially inc r e ase s

• r

ganizational c osts.

 Myth: fr

aud is a big sc he me that should have be e n unc ove r e d soone r and is e asy to de te c t.

 F

r aud star ts small and just ge ts bigge r and bigge r , until some thing be c ome s notic e ably diffe r e nt or unusual.

What is F r aud – F r aud de fine d

 “T

he use o f o ne ’s o c c upatio n fo r pe r so nal e nr ic hme nt thr

• ugh the de libe r

ate misuse o r misapplic atio n o f the e mplo ying o r ganizatio n’s r e so ur c e s o r asse ts.” (ACF E )

 F

ive e le me nts of fr aud ar e :

A r

e pr e se ntation about a mate r ial fac t, whic h is false ,

And made inte ntionally, knowingly, or

r e c kle ssly,

Whic h is be lie ve d, And ac te d upon by the vic tim, T

• the vic tim’s damage .

What is F r aud – F r aud de fine d

F r aud, like othe r c r ime , has thr e e fac tor s:

A supply of motivate d

• ffe nde r

s/ pe r pe tr ator s;

T

he availability of suitable tar ge ts/ vic tims;

T

he abse nc e of c apable guar dians or a c ontr

• l syste m to “mind the stor

e .”

What is F r aud – F r aud de fine d

F

• ur

e le me nts for a pe r son or e mploye e to c ommit fr aud:

Oppor

tunity

L

• w c hanc e of ge tting c aught

Rationalization in the fr

audste r s mind, and

Justific ation that r

e sults fr

• m the

r ationalization.

What is F r aud – F r aud T r iangle

Classic mode l for

fr audste r s is to use othe r pe ople s mone y or “I want some thing I don’t have mone y for .”

Wha t is F ra ud – F ra ud T ria ng le – Opportunity

Oppo r tunity is an ope n door for solving a non- shar e able pr

• ble m in se c r

e t by violating a tr ust.

 Oppor

tunity is ge ne r ally pr

• vide d thr
• ugh we akne sse s in the

inte r nal c ontr

• ls whic h inc lude inade quate or

no:

Supe r

vision and r e vie w

Se par

ation of dutie s

Manage me nt appr

• val

Syste m c ontr

• ls

Wha t is F ra ud – F ra ud T ria ng le – Pre ssure

Pr e ssur e may be anything fr

• m unr

e alistic de adline s and pe r for manc e goals to pe r sonal vic e s suc h as gambling or dr ugs.

Wha t is F ra ud – F ra ud T ria ng le – Ra tiona liza tion

Ratio nalizatio n is a c r uc ial c ompone nt be c ause most pe ople / pe r pe tr ator s ne e d to be lie ve the ir be havior me e ts the c ommonly ac c e pte d notions of de c e nc y and tr ust. Some e xample s inc lude :

 “I r

e ally ne e d this mo ne y and I’ll put it bac k whe n I ge t my payc he c k”

 “I’d r

athe r have the c o mpany o n my bac k than the IRS”

 “I just c an’t affo r

d to lo se e ve r ything – my ho me , c ar , e ve r ything”

Wha t is F ra ud – Ing re die nts of F ra ud

Poor

inte r nal c ontr

• ls

Manage me nt ove r

r ide of inte r nal c ontr

• ls

Collusion be twe e n e mploye e s Collusion be twe e n e mploye e s and thir

d par tie s

What is F r aud – Disc ove r y

De te c te d thr

• ugh tips

De te c te d by ne w manage me nt De te c te d by ac c ide nt De te c te d by inte r

nal audit

T ype s of F ra ud – T e le ma rke ting / Phone

Ca lle rs c la iming to be a nyone from polic e

• ffic e rs to disa ble d worke rs ta king a dva nta g e of

the public ’s sympa thy a nd g e ne rosity

Offe r mira c le c ure s from ba ldne ss to c a nc e r to

va c a tion time sha re s to swe e psta ke s a nd inve stme nt opportunitie s.

Ca lle rs a sk for mone y or pe rsona l informa tion. Ca lle rs use sc a re ta c tic s (IRS or F

BI a g e nts).

T ype s of F r aud – Common E xample s

 Se c ur

ity and F r aud De par tme nt of your c r e dit- or de bit- c ar d c ompany asks you for the 3- digit se c ur ity numbe r

• n the bac k of your

c r e dit c ar d to ve r ify your posse ssion of the c ar d to aid it in a fr aud inve stigation.

 Me dic ar

e now r e quir e s a National ID Car d and offe r s to pr

• vide one for

a fe e . Or the c alle r says a c ar d is be ing maile d, but he ne e ds your bank infor mation.

 U.S. F

• od and Dr

ug Administr ation (F DA) age nt or

• ffic ial and that you

must pay a fine be c ause you have bought or atte mpte d to buy disc ounte d pr e sc r iption dr ugs fr

• m a for

e ign phar mac y.

 Mic r

• soft to war

n you that your c ompute r has a se c ur ity pr

• ble m and
• ffe r

a fr e e se c ur ity c he c k. You ar e tr ic ke d into allowing ac c e ss to your c ompute r , downloading malwar e , giving out c r e dit c ar d info, or buying some softwar e or se r vic e s that you don’t ne e d.

T ype s of F r aud – Inte r ne t

 Do you visit we bsite s by c lic king on links within an e - mail?  Do you r

e ply to e -mails fr

• m pe r

sons or busine sse s you ar e not familiar with?

 Have you r

e c e ive d pac kage s to hold or ship to some one you me t

• n the Inte r

ne t?

 Have you be e n aske d to c ash c he c ks and wir

e funds to some one you me t on the Inte r ne t?

 Would you c ash c he c ks or

mone y or de r s r e c e ive d thr

• ugh an

Inte r ne t tr ansac tion without fir st c onfir ming the ir le gitimac y?

 Would you pr

• vide your

pe r sonal banking infor mation in r e sponse to an e - mail notific ation?

T ype s of F r aud – E mail Sc ams

Cybe r c r iminals use e - mail in c le ve r ways to tr y to take your mone y and ide ntity, and disr upt your c ompute r

• pe r

ation, gathe r se nsitive infor mation, or gain unauthor ize d ac c e ss to your c ompute r

 Busine ss oppor

tunitie s to make c ash fast

 Chain le tte r

s involving mone y

 Wor

k at home sc he me s

 He alth & die t br

e akthr

• ughs

 F

r e e goods offe r e d to fe e - paying me mbe r s

 Cr

e dit r e pair sc he me s

T ype s of F ra ud – Online Shopping

 Cr

e dit c ar d limite d liability to $50 for any unauthor ize d or fr audule nt c har ge s made be for e you r e por t the billing e r r

• r

(E F T A)

 Using a de bit c ar

d for shopping – c an e mpty an ac c ount quic kly

 E

xample s:

Re ntal housing Air

line tic ke ts

Conc e r

t tic ke ts

T

ime shar e pr

• pe r

tie s

Vac ation pr

• pe r

tie s

T ype s of F ra ud – Appe a ls for he lp

 Claims to be a family me mbe r

who ne e ds he lp

 Gr

andpar e nts ar e tar ge te d

 E

xample s:

 Gr

andc hild ar r e ste d or hospitalize d

 Militar

y family me mbe r s de ploye d ove r se as ar e injur e d

T ype s of F ra ud – Auto L

• a n Mods

 Companie s whic h c laim it c an r

e duc e your monthly loan / le ase payme nt

 Companie s might c har

ge fe e s of se ve r al hundr e d dollar s up fr

• nt, tout the ir

r e lationships with le nde r s, and bolste r the ir c laims to be able to signific antly lowe r your monthly payme nts with glowing te stimonials fr

• m

"satisfie d" c ustome r s.

 Some give a “guar

ante e ” that if the y c an't make a de al with your le nde r , the y'll r e fund your mone y.

T ype s of F ra ud – Ba nkruptc y F

• re c losure Re sc ue

 T

ar ge t pe ople whose home mor tgage s ar e in tr

• uble and pr
• mise to take

c ar e of your pr

• ble m with your

le nde r

• r

ge t r e financ ing

 E

xample s:

 Unsolic ite d c ontac t & use s high- pr

e ssur e sale s te c hnique s

 Calls itse lf a mor

tgage or for e c losur e c onsultant, for e c losur e pr e ve ntion spe c ialist

 Says it knows a lot of pe ople who have gone thr

• ugh for

e c losur e and just wants to he lp you or c ontac ts you be c ause the y saw a notic e of de fault or a notic e of tr uste e ’s sale in public r e c or ds

 Pr

• mise s to find “loophole s” in your

loan doc ume nts or violations of State / F e de r al le nding laws that c an ge t you off the hook

 Asks for

a fe e be for e pe r for ming a se r vic e

 Asks you to make your

home mor tgage payme nts dir e c tly to the m

 Asks you to tr

ansfe r your pr

• pe r

ty de e d or title to the m.

Sour c e s of Infor mation

Consume r Busine ss r

e c or ds

Bank state me nts Audit r

e por ts

Sourc e s of Informa tion – Me a ns of Obta ining

Voluntar

ily (fr

• m c onsume r
• r

busine ss)

Inte r

vie w both c onsume r and pe r pe tr ator

Wr

itte n r e que sts

Subpoe na

Re d F lags – Impor tanc e of Re d F lags

Re d flag is a se t of c ir c umstanc e s that ar e unusual in natur e or var y fr

• m the

nor mal ac tivity. It is a signal that some thing is out of the or dinar y and may ne e d to be inve stigate d fur the r . Re me mbe r that r e d flags do not indic ate guilt or innoc e nc e but me r e ly pr

• vide

possible war ning signs of fr aud.

 Ac c or

ding to ACF E , fr aud c ase s c onsiste ntly show that r e d flags we r e pr e se nt, but we r e e ithe r not r e c ognize d or we r e r e c ognize d but not ac te d upon by anyone . Onc e a r e d flag has be e n note d, some one should take ac tion to inve stigate the situation and de te r mine if a fr aud has be e n c ommitte d.

 Re d flags should le ad to some kind of appr

• pr

iate ac tion. Some time s an e r r

• r

is just an e r r

• r

and no fr aud has oc c ur r e d.

 You ne e d to be able to r

e c ognize the diffe r e nc e and r e me mbe r that r e spo nsibility fo r fo llo w-up inve stigatio n o f a r e d flag sho uld be c ar e fully r e vie we d.

Re d F la g s – T ype s of Re d F la g s

 T

he major ity of loss c ommitte d by manage r s was $218,000, whic h is almost thr e e time s gr e ate r than the loss r e sulting fr

• m an e mploye e

sc he me .

 Appr

• ximate ly 61 pe r

c e nt of the fr aud c ase s we r e c ommitte d by me n.

 T

he me dia n lo ss fro m fra ud b y ma le s wa s $250,000, whic h is mo re tha n twic e the me dia n lo ss b y wo me n.

 Ne ar

ly 40 pe r c e nt of all fr aud c ase s ar e c ommitte d by two or mor e individuals.

 T

he me dia n lo ss in the se c a se s is $485,000, whic h is a lmo st five time s g re a te r tha n the me dia n lo ss in fra ud c a se s invo lving o ne pe rso n.

Re d F la g s – T ype s of Re d F la g s

 Mo st fra ud pe rpe tra to rs (87.9%) ha ve ne ve r b e e n c ha rg e d o r

c o nvic te d o f a c rime . Re se a rc h sho we d tha t tho se who c o mmit

• c c upa tio na l fra ud a re no t c a re e r c rimina ls.

 T

he me dia n lo ss a ttrib uta b le to fra ud b y o lde r e mplo ye e s is g re a te r tha n tha t o f the ir yo ung e r c o unte rpa rts. T he me dia n lo ss b y e mplo ye e s

• ve r the a g e o f 60 wa s $713,000. E

mplo ye e s 25 o r yo ung e r, the me dia n lo ss wa s $25,000

 Mo st c o stly a b use s o c c ur in c o mpa nie s with le ss tha n 100 e mplo ye e s.  Gove r

nme nt and Not-for

• Pr
• fit or

ganizations have e xpe r ie nc e d the lowe st me dian losse s.

 Ma na g e me nt ig no re s irre g ula ritie s.  Hig h turno ve r with lo w mo ra le .  Sta ff la c ks tra ining .

Re d F lags – E mploye e Re d F lags

 E

mploye e life style c hange s: e xpe nsive c ar s, je we lr y, home s, c lothe s

 Signific ant pe r

sonal de bt and c r e dit pr

• ble ms

 Be havior

al c hange s: the se may be an indic ation of dr ugs, alc ohol, gambling, or just fe ar

• f losing the job

 High e mploye e tur

nove r , e spe c ially in those ar e as whic h ar e mor e vulne r able to fr aud

 Re fusal to take vac ation or

sic k le ave

 L

ac k of se gr e gation of dutie s in the vulne r able ar e a

Re d F la g s – Co ntro l Pe rso n Re d F la g s



Re luc ta nc e to pr

• vide infor

ma tion to a uditor s



Ma na g e rs e ng a g e in fre q ue nt d ispute s with a ud ito rs



Ma na g e me nt de c isions a r e domina te d by a n individua l or sma ll g r

• up



Ma na g e rs d ispla y sig nific a nt d isre spe c t fo r re g ula to ry b o d ie s



T he r e is a we a k inte r na l c ontr

• l

e nvir

• nme nt



Ac c o unting pe rso nne l a re la x o r ine xpe rie nc e d



De c e ntra liza tio n witho ut a d e q ua te mo nito ring



E xc e ssive numbe r

• f c he c king a c c ounts



F re q ue nt c ha ng e s in b a nking a c c o unts



F re q ue nt c ha ng e s in e xte rna l a ud ito rs



Co mpa ny a sse ts so ld und e r ma rke t va lue



Sig nific a nt d o wnsizing in a he a lthy ma rke t



Co ntinuo us ro llo ve r o f lo a ns



E xc e ssive numbe r

• f ye a r

e nd tr a nsa c tions



Hig h e mplo ye e turno ve r ra te



Une xpe c te d o ve rd ra fts o r d e c line s in c a sh b a la nc e s



Re fusa l b y c o mpa ny to use se ria l o r d uplic a te re c e ipts



Co mpe nsa tio n pro g ra m tha t is o ut o f pro po rtio n



Any fina nc ia l tra nsa c tio n tha t d o e sn’ t ma ke se nse - e ithe r c o mmo n o r b usine ss



Se r vic e Contr a c ts r e sult in no pr

• duc t



Photoc opie d or missing doc ume nts

Re d F lags – Be havior Change s

 Bor

r

• wing mone y fr
• m c o- wor

ke r s

 Cr

e ditor s or c olle c tor s appe ar ing at the wor kplac e

 Gambling be yond the ability to stand the loss  E

xc e ssive dr inking or

• the r

pe r sonal habits

 E

asily annoye d at r e asonable que stioning

 Pr

• viding unr

e asonable r e sponse s to que stions

 Re fusing vac ations or

pr

• motions for

fe ar

• f de te c tion

 Br

agging about signific ant ne w pur c hase s

 Car

r ying unusually lar ge sums of mone y

 Re wr

iting r e c or ds unde r the guise of ne atne ss

Re d F lags – Company Be havior Change s

 E

xc e ssive numbe r

• f voids, disc ounts and r

e tur ns

 Unauthor

ize d bank ac c ounts

 Sudde n ac tivity in dor

mant banking ac c ounts

 T

axpaye r c omplaints that the y ar e r e c e iving non- payme nt notic e s

 Disc r

e panc ie s be twe e n bank de posits and posting

 Abnor

mal numbe r

• f e xpe nse ite ms, supplie s, or

r e imbur se me nt to the e mploye e

 Pr

e se nc e of e mploye e c he c ks in the pe tty c ash for the e mploye e in c har ge of pe tty c ash

 E

xc e ssive or unjustifie d c ash tr ansac tions

 L

ar ge numbe r

• f wr

ite - offs of ac c ounts

 Bank ac c ounts that ar

e not r e c onc ile d on a time ly basis

Re d F lags – Company Be havior Change s

 Inc r

e asing numbe r

• f c omplaints about pr
• duc ts or

se r vic e

 Inc r

e ase in pur c hasing inve ntor y, but no inc r e ase in sale s or abnor mal inve ntor y shr inkage

 L

ac k of physic al se c ur ity ove r asse ts/ inve ntor y

 Char

ge s without shipping doc ume nts

 Payme nts to ve ndor

s who ar e n’t on an appr

• ve d ve ndor

list

 High volume of pur

c hase s fr

• m ne w ve ndor

s

 Pur

c hase s that bypass the nor mal pr

• c e dur

e s

 Ve ndor

s without physic al addr e sse s

 Ve ndor

addr e sse s matc hing e mploye e addr e sse s

 E

xc e ss inve ntor y and inve ntor y that is slow to tur nove r

 Pur

c hasing age nts that pic k up ve ndor payme nts, not maile d

Re d F lags – L ife style F r aud

Ofte n c ommitte d by tr uste d e mploye e s.

 Some e mbe zzle r

s ar e se c r e tive . T he y don’t want to be c aught and will “stash” stole n funds and be e xtr e me ly c ar e ful with the ir spe nding.

 Othe r

“aspir ing” e mbe zzle r s want to use , e njoy, shar e , and show off the ir fr audule ntly gaine d mone y. E xplanations of “ne w found” we alth may inc lude :

 “My husband/ wife just got a gr

e at pr

• motion.”

 “I have a fe w little inve stme nts that have be e n doing r

e ally, RE AL L Y we ll.”

 “Gr

e at Aunt E the l passe d away and I was totally sur pr ise d – she le ft us quite a nic e little ne st e gg.”

 “I finally de c ide d to ge t r

id of some pr

• pe r

ty that’s be e n in the family for ye ar s.”

Re d F lags – De pe nde nc y F r aud

Addic tions. Some one who is de pe nde nt on dr ugs, alc ohol, gambling or

• the r

addic tions typic ally e xpe r ie nc e a slow tighte ning noose of financ ial pr e ssur e s.

 De spe r

ation fue ls mone tar y ne e ds and, the r e for e , the ne e d ar ise s to “bor r

• w”

funds to e ase the financ ial dile mma. E mploye e s with addic tion pr

• ble ms may

be tough to spot. Many pe ople with addic tions c an func tion at fair ly high or nor mal le ve ls of be havior dur ing wor k hour s.

 Some patte r

ns to look for :  Abse nte e ism  Re g ula r ill he a lth or “sha ky” a ppe a ra nc e  E

a sily ma king a nd bre a king promise s a nd c ommitme nts

 Se rie s of c re a tive “e xpla na tions”  Hig h le ve l of se lf a bsorption  Inc onsiste nt or illog ic a l be ha vior  F

• rg e tfulne ss or me mory loss

 F

a mily proble ms

 E

vide nc e of de c e it (sma ll or la rg e )

Re d F lags – F inanc ial Pr e ssur e F r aud

F ac e d by e ve r yone at some pe r iod of time . Pe r haps be yond the ir c ontr

• l, e mploye e s may find the mse lve s in financ ially str

e ssful situations due to a var ie ty of fac tor

• s. Not e ve r

yone who fac e s undue pr e ssur e c ommits fr aud, but the highe r the str e ss le ve l, the mor e distr ac te d and de spe r ate an e mploye e may be c ome .

 Me dic al bills  F

amily r e sponsibilitie s

 A spouse losing a job  Divor

c e

 De bt r

e quir e me nts

 Maintaining a c ur

r e nt life style

 Car

r e pair s

F ina nc ia l Ana lysis – Ba nk Re c ords

 Using bank state me nts or

• the r

financ ial doc ume nts

 Ge t the doc ume nts – disc usse d e ar

lie r

 What c an you use the se doc ume nts to pr

• ve ?

 Se e financ ial tr

• uble

 F

r aud

 Skimming  Misappr

• pr

iation

 Une thic al ac tivity (bank pe r

sonne l)

 L

ife style of a pe r son

F ina nc ia l Ana lysis – F ina nc ia l Profiling

Atte mpt to de te r

mine if a subje c t’s (c onsume r ’s) e xpe nditur e s or ac c umulate d we alth e xc e e d his/ he r inc ome

L

• ok for

: Pote ntia l ille g a l inc ome (i.e . g a mbling ) Do you ne e d a dditiona l info

F ina nc ia l Ana lysis – Ne t Worth Ana lysis

Shows possible ille gal inc ome thr

• ugh

inc r e ase s in ac c umulate d we alth T

• tal asse ts

2012 $100,000

• T
• tal liabilitie s 2013

$200,000 = Ne t Wor th 2014 $300,000

Cha ng e in ne t worth $200,000

F ina nc ia l Ana lysis – Ne t Worth Ana lysis

 Shows possible ille gal inc ome thr

• ugh inc r

e ase s in ac c umulate d we alth

Change in ne t wor th $200,000 + e xpe nse s $150,000 = total dollar

• utlay

$250,000

T HE N, c ompar e the total dollar

• utlay with the r

e por te d inc ome $150,000 Shows tar ge t is spe nding mor e than the ir r e por te d inc ome

How to De te c t F ra ud – F ina nc ia l Sta te me nts

 F

inanc ial state me nt analysis is a pr

• c e ss that e nable s

r e ade r s of a c ompany’s financ ial r e por ts to de ve lop and answe r que stions r e gar ding the data pr e se nte d.

 F

inanc ial state me nts e xpr e ss a c ompany’s e c onomic c ondition in thr e e ways:

1. T he balanc e she e t r e por ts asse ts, liabilitie s, and owne r s’ e quity; 2. T he inc ome state me nt ac c ounts for the pr

• fit or

loss of the c ompany; 3. And the c ash flow state me nt displays the sour c e s and use s of c ash.

How to De te c t F ra ud – F ina nc ia l Sta te me nts

 At the e nd of the se state me nts, the r

e is a se c tion for footnote s— a mor e de taile d de sc r iption of se ve r al ite ms

• n the financ ial state me nts inc luding a disc ussion of

c hange s in ac c ounting me thods, r e late d par ty tr ansac tions, c ontinge nc ie s, and so on.

 Annual and quar

te r ly r e por ts also typic ally inc lude a se c tion title d Manage me nt’s Disc ussio n and Analysis (MD&A), whic h give s manage me nt’s pe r spe c tive on the financ ial r e sults of the pe r iod in the r e por t.

How to De te c t F ra ud – Une xpe c te d De via tions

 F

inanc ial analysis te c hnique s c an he lp inve stigators disc ove r and e xamine une xpe c te d re lationships in financ ial information.

 T

he se analytic al proc e dure s are base d on the pre mise that re lative ly stable re lationships e xist among e c onomic e ve nts in the abse nc e of c onditions to the c ontrary

 Une xpe c te d de viations in re lationships most like ly

indic ate e rrors, but also might indic ate ille gal ac ts or fraud.

 T

he re fore , de viations in e xpe c te d re lationships warrant furthe r inve stigation to de te rmine the e xac t c ause .

How to De te c t F ra ud – Ana lytic a l Proc e dure s

Use d to de te c t a nd e xa mine re la tionships of

fina nc ia l informa tion tha t do not a ppe a r re a sona ble .

T

he y a re use ful in ide ntifying : Diffe r

e nc e s that ar e not e xpe c te d

T

he abse nc e of diffe r e nc e s that ar e e xpe c te d

Pote ntial e r

r

• r

s

Pote ntial fr

aud and ille gal ac ts

Othe r

unusual or non- r e c ur r ing tr ansac tions or e ve nts

Analytic al te c hnique s assist with the fir st ste ps in the fr aud auditing pr

• c e ss by

e nabling the fr aud e xamine r to ide ntify ar e as

• f high r

isk, highlight the most like ly sc he me s, and ide ntify the r e d flags that war r ant fur the r inve stigation

How to De te c t F ra ud – Compa ra tive T e c hnique s

 Re la tionships a mong fina nc ia l da ta tha t do not a ppe a r

re a sona ble should be inve stig a te d.

 F

ra ud e xa mine rs c a n e mploy the following te c hnique s to he lp the m ide ntify suc h re la tionships:

 Compar

e c ur r e nt- pe r iod financ ial infor mation to pr ior

• pe r

iod financ ial infor mation, budge ts, and for e c asts.

 E

xamine r e lationships among financ ial infor

• mation. F
• r

instanc e , c ost of goods sold is e xpe c te d to var y dir e c tly in r e lation to sale s.

 Study r

e lationships of financ ial infor mation with r e late d non- financ ial infor

• mation. F
• r

e xample , de par tme nt stor e sale s ar e e xpe c te d to var y with the squar e footage of the sale s floor .

 Compar

e infor mation to that of othe r

• r

ganizational units or the industr y.

How to De te c t F ra ud – Compa ny’s F ina nc ia l Re la tionships

 An unde rstanding of ge ne ral re lationships be twe e n

c e rtain financ ial state me nt balanc e s is ne c e ssary to ide ntify re lationships that appe ar unusual.  If sa le s inc re a se , how should the c ost of sa le s re spond?  If c ommission e xpe nse de c re a se s, wha t would be

e xpe c te d of sa le s?

 Answe rs to que stions suc h as the se are the foundation

• f financ ial analysis.

 T

he following re lationships are ge ne ral, and traditionally oc c ur be twe e n financ ial ac c ounts; howe ve r, unique c irc umstanc e s may re nde r diffe re nt re sults.

How to De te c t F ra ud – Compa ny’s F ina nc ia l Re la tionships

 A financ ially he althy c ompany tr

ie s to maintain a c onsiste nt balanc e be twe e n asse ts and liabilitie s.

 By ke e ping a c e r

tain balanc e , the c ompany displays its solidity to le nde r s or e quity inve stor s and ke e ps financ ing c osts down.

 A sudde n c hange fr

• m histor

ic al nor ms me ans some thing has c hange d with manage me nt’s vie w of its busine ss.

 It also c ould indic ate that manage me nt is tr

ying to hide some thing.

 A sudde n inc r

e ase in the r atio c ould me an that liabilitie s suc h as long- te r m de bt have be e n hidde n in off balanc e she e t e ntitie s.

 If the value of liabilitie s r

ise s and the r atio spike s downwar d, it c ould r e ve al that the c ompany is bor r

• wing he avily to financ e ope r

ations and that the r isk of fr aud is ac ute .

How to De te c t F ra ud – Compa ny’s fina nc ia l re la tionships

 T

he c ompa ny g e ne ra te s sa le s be c a use it se lls its me rc ha ndise .

 T

his me rc ha ndise ha d to be purc ha se d, ma nufa c ture d, or both, a ll of whic h e nta il a c a sh outla y for ma te ria ls, la bor, a nd so on.

 T

he re fore , for e a c h sa le , the re must be a c ost a ssoc ia te d with it.

 If sa le s inc re a se , the n the c ost of g oods sold g e ne ra lly

inc re a se s proportiona lly.

 Of c ourse , the re a re c a se s whe re a c ompa ny ha s a dopte d a

more e ffic ie nt me thod of produc ing g oods, thus re duc ing its c osts, but the re still a re c osts a ssoc ia te d with the sa le s tha t a re re c og nize d upon the sa le of the g oods.

How to De te c t F ra ud – Compa ny’s F ina nc ia l Re la tionships

Whe n a c ompany make s a sale to a

c ustome r , the c ompany ge ne r ally ships the me r c handise to the c ustome r be for e the c ustome r pays, r e sulting in an ac c ount r e c e ivable for the c ompany.

T

he r e for e , the r e lationship be twe e n the sale s and the ac c ounts r e c e ivable is dir e c t.

How to De te c t F ra ud – Compa ny’s F ina nc ia l Re la tionships

 A c ompany’s inve ntory is me rc handise that is re ady to

be sold.

 A c ompany ge ne rally trie s to antic ipate future sale s,

and in doing so, trie s to me e t the se de mands by having an ade quate supply of inve ntory.

 T

he re fore , inve ntory usually re fle c ts the growth in sale s.

 If sale s inc re ase , the n inve ntory should inc re ase to

me e t the de mands of sale s.

 Inve ntory that grows at a faste r pac e than sale s might

indic ate obsole te , slow-moving me rc handise or

• ve rstate d inve ntory.

How to De te c t F ra ud – Compa ny’s F ina nc ia l Re la tionships

 Companie s ge ne r

ate sale s r e ve nue by se lling pr

• duc ts or

pr

• viding

se r vic e s.

 L

ike wise , c ompanie s inc ur dir e c t and indir e c t c osts r e late d to pr

• duc ing or

ac quir ing the pr

• duc ts the y se ll, or

pr

• viding the

se r vic e s for the ir c ustome r s.

 Gr

• ss, ope r

ating, and ne t pr

• fit mar

gins ar e shown on the inc ome state me nt.

 Ove r

time , pr

• fit mar

gins should stay c onsiste nt as the c ompany tar ge ts a c e r tain pr

• fit in or

de r to stay in busine ss.

 If the c ompany e nc ounte r

s inc r e ase d c ompe tition and must r e duc e the pr ic e for its pr

• duc ts, it will have to find ways to c ut e xpe nse s.

 Ongoing pr

e ssur e on pr

• fit mar

gins indic ate s pr e ssur e on manage me nt, whic h c ould ultimate ly le ad to fr aud in the financ ial r e por ting.

How to De te c t F ra ud – Compa ny’s F ina nc ia l Re la tionships

 Whe n analytic al pr

• c e dur

e s unc ove r an une xpe c te d r e lationship among financ ial data, the fr aud e xamine r must inve stigate the r e sults.

 T

he e valuation of the r e sults should inc lude inquir ie s and additional pr

• c e dur

e s.

 Be for

e asking the c ompany’s e mploye e s and manage me nt about the var iations, the fr aud e xamine r should fir st e stablish e xpe c tations for the c ause s of the var ianc e s.

 F

r

• m e xpe c te d c ause s, the fr

aud e xamine r will be be tte r suite d to ask me aningful que stions whe n inte r vie wing c ompany pe r sonne l.

 E

xplanations de r ive d fr

• m e mploye e s should the n be te ste d thr
• ugh

e xamination of suppor ting e vide nc e .

 F

• r

e xample , if the sale s manage r indic ate s that the inc r e ase in sale s is due to a ne w adve r tising c ampaign, e xamine the adve r tising e xpe nse ac c ount to ve r ify that a c ampaign did oc c ur .

 If the adve r

tising e xpe nse is similar to the pr ior ye ar , the r e lationship is not r e asonable and fr aud may e xist.

Pr

• c e dur

e s for Analysis

 Inve stig a ting re la tionships be twe e n numbe rs offe rs de e p

insig ht into the fina nc ia l we ll- be ing of a n org a niza tion.

 By c ompa ring the se re la tionships with othe r industrie s or

busine sse s within the sa me industry, a n e xa mine r c a n e xtra pola te via ble e vide ntia l ma tte r a nd g a in a g re a te r c ompre he nsion of the c ompa ny’s fina nc ia l c ondition.

 F

ina nc ia l sta te me nt a na lysis inc lude s the following :

 Pe r

c e ntage analysis, inc luding ve r tic al and hor izontal analysis

 Ratio analysis  Cash flow analysis

Proc e dure s for Ana lysis – Ve rtic a l a nd Horizonta l

 Ve r

tic al analysis is a te c hnique for a na lyzing the re la tionships be twe e n the ite ms on a ny one of the fina nc ia l sta te me nts in

• ne re porting pe riod.

 T

he a na lysis re sults in the re la tionships be twe e n c ompone nts e xpre sse d a s pe rc e nta g e s tha t c a n the n be c ompa re d a c ross pe riods.

 T

his me thod is ofte n re fe rre d to a s “c ommon sizing ” fina nc ia l sta te me nts.

 In the ve rtic a l a na lysis of a n inc ome sta te me nt, ne t sa le s is

a ssig ne d 100 pe rc e nt; for a ba la nc e she e t, tota l a sse ts is a ssig ne d 100 pe rc e nt on the a sse t side , a nd tota l lia bilitie s a nd e quity is e xpre sse d a s 100 pe rc e nt on the othe r side .

 All othe r ite ms in e a c h of the se c tions a re e xpre sse d a s a

pe rc e nta g e of the se numbe rs.

Proc e dure s for Ana lysis – Ve rtic a l a nd Horizonta l

 Ho r

izo ntal analysis is a te c hnique for analyzing the pe r c e ntage c hange in individual financ ial state me nt ite ms fr

• m one ye ar

to the ne xt.

 T

he fir st pe r iod in the analysis is c onside r e d the base , and the c hange s in the subse que nt pe r iod ar e c ompute d as a pe r c e ntage of the base pe r iod.

 If mor

e than two pe r iods ar e pr e se nte d, e ac h pe r iod’s c hange s ar e c ompute d as a pe r c e ntage of the pr e c e ding pe r iod.

 T

he r e sulting pe r c e ntage s ar e the n studie d in de tail.

 It is impor

tant to c onside r the amount of c hange as we ll as the pe r c e ntage in hor izontal c ompar isons.

 A 5 pe r

c e nt c hange in an ac c ount with a ve r y lar ge dollar amount may ac tually be muc h mor e of a c hange than a 50 pe r c e nt c hange in an ac c ount with muc h le ss ac tivity.

 L

ike ve r tic al analysis, this te c hnique will not de te c t small, immate r ial fr auds. Howe ve r , both me thods tr anslate c hange s into pe r c e ntage s, whic h c an the n be c ompar e d to highlight ar e as of top c onc e r n.

Pr

• c e dur

e s – Ve r tic al Analysis



Ve r tic al analysis of the inc ome sta te me nt use s tota l sa le s a s the ba se a mount, a nd a ll othe r ite ms a r e the n a na lyze d a s a pe r c e nta g e of tha t tota l.



Ve r tic a l a na lysis e mpha size s the r e la tionship of sta te me nt ite ms within e a c h a c c ounting pe r iod. T he se r e la tionships c a n be use d with histor ic a l a ve r a g e s to de te r mine sta te me nt a noma lie s.



In the a bove e xa mple , we obse r ve tha t a c c ounts pa ya ble is 29 pe r c e nt of tota l lia bilitie s a nd stoc kholde r s’ e quity.



Histor ic a lly, we ma y find tha t this a c c ount a ve r a g e s slig htly ove r 25 pe r c e nt.



In ye a r two, a c c ounts pa ya ble r

• se to 51 pe r

c e nt.



Althoug h the c ha ng e in the a c c ount tota l ma y be e xpla ina ble thr

• ug h a c or

r e la tion with a r ise in sa le s, this sig nific a nt r ise mig ht be a sta r ting point in a fr a ud e xa mina tion.



Sour c e doc ume nts should be e xa mine d to de te r mine the r ise in this pe r c e nta g e .



With this type of e xa mina tion, fr a udule nt a c tivity ma y be de te c te d.



T he sa me type of c ha ng e c a n be se e n a s se lling e xpe nse s de c line a s a pa r t of sa le s in ye a r two fr

• m 20 to 17 pe r

c e nt.



Ag a in, this c ha ng e ma y be e xpla ina ble with hig he r volume sa le s or a nothe r bona fide e xpla na tion. But c lose e xa mina tion ma y possibly c a use a fr a ud e xa mine r to unc ove r fic titious sa le s, sinc e the r e wa s not a c or r e sponding inc r e a se in se lling e xpe nse s.

Pr

• c e dur

e s – Hor izontal Analysis

 Ho r

izo ntal state me nt analysis use s pe r c e ntage c ompar ison ac r

• ss

ac c ounting pe r iods, or in a hor izontal manne r .

 T

he pe r c e ntage c hange is c alc ulate d by dividing the amount of inc r e ase or de c r e ase for e ac h ite m by the pr ior

• pe r

iod amount.

 In the pr

e vious e xample , c ash de c line d by $30,000 fr

• m ye ar
• ne to ye ar

two, a 67 pe r c e nt dr

• p.

 F

ur the r analysis r e ve als that the 80 pe r c e nt inc r e ase in sale s has a muc h gr e ate r c or r e sponding inc r e ase in c ost of goods sold, whic h r

• se 140

pe r c e nt.

 T

his is an unusual inc r e ase and displays a de te r ior ating financ ial c ondition.

 If manage me nt e mploye d fr

audule nt ac c ounting in the pe r iod, it might me an that r e ve nue s we r e unde r state d for some r e ason.

 Manage me nt might have wante d to avoid a high tax bill or

to shift r e ve nue s to the ne xt pe r iod for some r e ason.

 It might also me an that the c ost of goods is r

ising, whic h might pr e ssur e manage me nt to impr

• ve the appe ar

anc e of the c ompany’s financ ials by e ngaging in fr audule nt ac c ounting in futur e pe r iods.

Pr

• c e dur

e s – Ratio Analysis

 Ratio analysis is a me ans of me asur

ing the r e lationship be twe e n two diffe r e nt financ ial state me nt amounts.

 Ratios ar

e c alc ulate d fr

• m c ur

r e nt ye ar numbe r s and ar e the n c ompar e d to pr e vious ye ar s, othe r c ompanie s, the industr y, or e ve n the e c onomy to judge the pe r for manc e of the c ompany.

 T

his for m of financ ial state me nt analysis c an be ve r y use ful in de te c ting r e d flags for a fr aud e xamination.

 Many pr

• fe ssionals, inc luding banke r

s, inve stor s, busine ss owne r s, and inve stme nt analysts, use this me thod to be tte r unde r stand a c ompany’s financ ial he alth.

 Ratio analysis allows for

inte r nal e valuations using financ ial state me nt data.

 T

he r e lationship and c ompar ison ar e the ke ys to the analysis.

 F

• r

fur the r insight, financ ial state me nt r atios ar e use d in c ompar isons to an e ntity’s industr y ave r age s.

Pr

• c e dur

e s – Ratio Analysis

 As the fina nc ia l ra tios pre se nt a sig nific a nt c ha ng e from one

ye a r to the ne xt, or ove r a pe riod of ye a rs, it be c ome s

• bvious tha t the re mig ht be a proble m.

 As in a ll othe r a na lyse s, spe c ific c ha ng e s a re ofte n e xpla ine d

by c ha ng e s in the busine ss ope ra tions.

 Whe n a c ha ng e in a spe c ific ra tio or se ve ra l re la te d ra tios is

de te c te d, the a ppropria te sourc e a c c ounts should be re se a rc he d a nd e xa mine d in de ta il to de te rmine if fra ud ha s

• c c urre d.

 F

• r insta nc e , a sig nific a nt de c re a se in a c ompa ny’s c urre nt

ra tio mig ht point to a n inc re a se in c urre nt lia bilitie s or a re duc tion in a sse ts, both of whic h c ould be use d to c ove r fra ud.

 In the a na lysis of fina nc ia l sta te me nts, e a c h re a de r of the

sta te me nts will de te rmine whic h portions a re most importa nt.

Pr

• c e dur

e s – Ratio Analysis

 T

he se r atios may also r e ve al fr auds othe r than ac c ounting fr auds.

 If an e mploye e is e mbe zzling fr

• m the c ompany’s ac c ounts, for

instanc e , the amount of c ash will de c r e ase dispr

• por

tionate ly and the c ur r e nt r atio will de c line .

 L

iability c onc e alme nt will c ause a mor e favor able r atio.

 Similar

ly, a c he c k-tampe r ing sc he me will usually r e sult in a de c r e ase in c ur r e nt asse ts, name ly c ash, whic h will, in tur n, de c r e ase the c ur r e nt r atio.

 In fac t, the se fr

auds might be mor e e asily de te c te d with r atio analysis be c ause e mploye e s othe r than manage me nt would not have ac c e ss to ac c ounting c ove r

• ups of non-ac c ounting fr

auds.

 Anomalie s in r

atios c ould point dir e c tly to the e xiste nc e of fr audule nt ac tions.

 Ac c ounting fr

auds c an muc h mor e subtle and de mand e xte nsive inve stigation be yond the signal that some thing is out of the nor m.

Pr

• c e dur

e s – T ype s of Ratio Analysis

Curre nt Ra tio Curre nt Asse ts Curre nt L ia bilitie s

 T

he c ur r e nt r atio, c ur r e nt asse ts divide d by c ur r e nt liabilitie s, is pr

• bably the

most fr e que ntly use d r atio in financ ial state me nt analysis.

 T

his c ompar ison me asur e s a c ompany’s ability to me e t shor t- te r m

• bligations fr
• m its liquid asse ts.

 T

he numbe r

• f time s that c ur

r e nt asse ts e xc e e d c ur r e nt liabilitie s has long be e n a me asur e of financ ial str e ngth.

 In de te c ting fr

aud, this r atio c an be a pr ime indic ator

• f manipulation of

ac c ounts involve d.

 E

mbe zzle me nt will c ause the r atio to de c r e ase .

 L

iability c onc e alme nt will c ause a mor e favor able r atio.

 In the pr

e c e ding e xample , the dr astic c hange in the c ur r e nt r atio fr

• m ye ar
• ne (2.84) to ye ar

two (1.70) should c ause an e xamine r to look at the se ac c ounts in mor e de tail.

 F

• r

instanc e , a c he c k- tampe r ing sc he me will usually r e sult in a de c r e ase in c ur r e nt asse ts, or c ash, whic h will in tur n de c r e ase the r atio.

Proc e dure s – T ype s of Ra tio Ana lysis

Ac id T e st Ra tio Ca sh+Se c uritie s+Re c e iva ble s Curre nt L ia bilitie s



Compar e s asse ts that c an be imme diate ly liquidate d to liabilitie s that will be due in the ne xt ye ar .



T his c alc ulation divide s the total c ash, se c ur itie s, and r e c e ivable s by c ur r e nt liabilitie s.



T his r atio is a me asur e of c ompany’s ability to me e t sudde n c ash r e quir e me nts.



In tur bule nt e c onomic time s, it is use d quite pr e vale ntly, giving the analyst a wor st- c ase look at the c ompany’s wor king c apital situation.



An e xamine r will analyze this r atio for fr aud indic ator s.



In ye ar

• ne of the e xample , the c ompany balanc e she e t r

e fle c ts a quic k r atio of 2.05. T his r atio dr

• ps in

ye ar two to 1.00.



In this situation, a c lose r r e vie w of ac c ounts r e c e ivable shows that the y ar e inc r e asing at an unusual r ate , whic h c ould indic ate that fic titious ac c ounts r e c e ivable have be e n adde d to inflate sale s.



Of mor e c onc e r n, pe r haps, is the inc r e ase in ac c ounts payable that might r e quir e , at a minimum, a c lose r r e vie w to de te r mine why.



If the dr

• p in the r

atio indic ate s a pr

• ble m c ustome r
• r

signific ant slowing in the time to c olle c tion, it might r e fle c t a ge ne r al de c line in c ompany pr

• spe c ts.



T hat, in tur n, would be a r e d flag that manage me nt c ould fe e l pr e ssur e d to r e por t fr audule nt financ ials.

Proc e dure s – T ype s of Ra tio Ana lysis

De bt to E quity Ra tio T

• ta l L

ia bilitie s T

• ta l E

quity



T he de bt- to- e quity ra tio is c ompute d by dividing tota l lia bilitie s by tota l e quity.



It indic a te s the proportion of e quity a nd de bt a c ompa ny use s to fina nc e its a sse ts. Be c a use the ra tio provide s a pic ture of the re la tive risk a ssume d by the c re ditors a nd owne rs, it is he a vily c onside re d by le nding institutions.



T he hig he r the ra tio, the more diffic ult it will be for the owne rs to ra ise c a pita l by inc re a sing long - te rm de bt, a nd the g re a te r the risk a ssume d by c re ditors.



De bt- to- e quity re quire me nts a re ofte n inc lude d a s borrowing c ove na nts in c orpora te le nding a g re e me nts.



T he e xa mple displa ys a ye a r one ra tio of 0.89. T his is ve ry fa vora ble , a s it shows tha t the c ompa ny is fina nc e d more by e quity tha n by de bt.



Howe ve r, ye a r two shows a ra tio of 1.84, me a ning tha t de bt is g re a tly inc re a sing re la tive to e quity.



In this c a se , the inc re a se in the ra tio c orre sponds with the rise in a c c ounts pa ya ble .



Sudde n c ha ng e s in this ra tio ma y sig na l a n e xa mine r to look for fra ud.

Proc e dure s – T ype s of Ra tio Ana lysis

Profit Ma rg in Ra tio Ne t Inc ome Ne t Sa le s



T he pr

• fit mar

gin r atio is ne t inc ome divide d by sale s.



T his r atio is ofte n r e fe r r e d to as the e ffic ie nc y r atio, in that it r e ve als pr

• fits e ar

ne d pe r dollar

• f sale s.



T his pe r c e ntage of ne t inc ome to sale s e xamine s not only the e ffe c ts of gr

• ss mar

gin c hange s, but also c hange s in se lling and administr ative e xpe nse s.



If fr aud is c ommitte d, ne t inc ome may be ar tific ially ove r state d, r e sulting in a pr

• fit mar

gin r atio that is abnor mally high c ompar e d to othe r pe r iods.



F alse e xpe nse s will c ause an inc r e ase in e xpe nse s and a de c r e ase in the pr

• fit mar

gin r atio.



T his r atio should be fair ly c onsiste nt ove r time .



In this e xample , the pr

• fit mar

gin analysis is alr e ady c alc ulate d in the ve r tic al and hor izontal analyse s.



While r e ve nue s inc r e ase d by 80 pe r c e nt, the c ost of goods sold inc r e ase d by 140 pe r c e nt; this, in tur n, dr

• ppe d pr
• fit mar

gins fr

• m 6 pe r

c e nt to - 6 pe r c e nt.



F ur the r inve stigation c ould unc ove r fr audule nt ac c ounting that shifte d c osts fr

• m one pe r

iod to anothe r ,

• r

might r e ve al anothe r type of fr aud in whic h inve ntor y is be ing stole n so c osts appe ar to jump.

Proc e dure s – T ype s of Ra tio Ana lysis

Re c e ivable s T ur nove r Ratio Ne t Sale s on Ac c ount Ave r age Ne t Re c e ivable s



Re c e iva ble turnove r is de fine d a s ne t sa le s on a c c ount divide d by a ve ra g e ne t re c e iva ble s.



It me a sure s the numbe r of time s the re c e iva ble s ba la nc e is turne d ove r during the a c c ounting pe riod.



In othe r words, it me a sure s the time be twe e n sa le s on a c c ount a nd the c olle c tion of funds.



T his ra tio is one tha t use s both inc ome sta te me nt a nd ba la nc e she e t a c c ounts in its a na lysis.



If fic titious sa le s ha ve be e n re c orde d, this bog us inc ome will ne ve r be c olle c te d.



As a re sult, the turnove r of re c e iva ble s will de c re a se .



If the fra ud is c a use d from fic titious sa le s, this bog us inc ome will ne ve r be c olle c te d.



In the e xa mple , the a c c ounts re c e iva ble turnove r jumps from 1.61 to 2.14.



T he e xa mine r c a n use this ra tio a s a n indic a tor tha t re ve nue s mig ht be fa ke , thus re quiring furthe r e xa mina tion of sourc e doc ume nts.

Proc e dure s – T ype s of Ra tio Ana lysis

Colle c tion Ra tio 365 Re c e iva ble turnove r



Ac c ounts re c e iva ble a g ing is me a sure d by the c olle c tion ra tio, whic h divide s 365 da ys by the re c e iva ble turnove r ra tio to a rrive a t the a ve ra g e numbe r of da ys to c olle c t re c e iva ble s.



In g e ne ra l, the lowe r the c olle c tion ra tio, the fa ste r re c e iva ble s a re c olle c te d.



A fra ud e xa mine r ma y use this ra tio a s a first ste p in de te c ting fic titious re c e iva ble s or la rc e ny a nd skimming sc he me s.



Norma lly, this ra tio will sta y fa irly c onsiste nt from ye a r to ye a r, but c ha ng e s in billing polic ie s or c olle c tion e fforts ma y c a use a fluc tua tion.



T he e xa mple shows a fa vora ble re duc tion in the c olle c tion ra tio from 226.3 in ye a r one to 170.33 in ye a r two.



T his me a ns tha t the c ompa ny is c olle c ting its re c e iva ble s more quic kly in ye a r two tha n in ye a r one .

Proc e dure s – T ype s of Ra tio Ana lysis

Inve ntory T urnove r Ra tio Cost of Goods Sold Ave ra g e Inve ntory

 T

he r e lationship be twe e n a c ompany’s c ost of goods sold and its ave r age inve ntor y is shown thr

• ugh the inve ntor

y tur nove r r atio.

 T

his r atio me asur e s the numbe r

• f time s the inve ntor

y is sold dur ing the pe r iod.

 T

his r atio is a good de te r minant of pur c hasing, pr

• duc tion, and sale s e ffic ie nc y.

 In ge ne r

al, a highe r inve ntor y tur nove r r atio is c onside r e d mor e favor able .

 F

• r

e xample , if c ost of goods sold has inc r e ase d due to the ft of inve ntor y (e nding inve ntor y has de c line d, but not thr

• ugh sale s), the n this r

atio will be abnor mally high.

 In the c ase e xample , inve ntor

y tur nove r inc r e ase s in ye ar two, signaling the possibility that an e mbe zzle me nt is bur ie d in the inve ntor y ac c ount.

 An e xamine r

should look at the c hange s in the c ompone nts of the r atio to de te r mine a dir e c tion in whic h to disc ove r possible fr aud.

Proc e dure s – T ype s of Ra tio Ana lysis

Ave ra g e Numbe r of Da ys Inve ntory Ra tio 365 Inve ntory T urnove r



T he a ve ra g e - numbe r- of- da ys- inve ntory- is- in- stoc k ra tio is a re sta te me nt of the inve ntory turnove r ra tio e xpre sse d in da ys.



T his ra te is importa nt for se ve ra l re a sons.



An inc re a se in the numbe r of da ys tha t inve ntory sta ys in stoc k c a use s a dditiona l e xpe nse s, inc luding stora g e c osts, risk of inve ntory obsole sc e nc e , a nd ma rke t pric e re duc tions, a s we ll a s inte re st a nd othe r e xpe nse s inc urre d due to tying up funds in inve ntory stoc k.



Inc onsiste nc y or sig nific a nt va ria nc e in this ra tio is a re d fla g for fra ud inve stig a tors.



E xa mine rs ma y use this ra tio to e xa mine inve ntory a c c ounts for possible la rc e ny sc he me s.



Purc ha sing a nd re c e iving inve ntory sc he me s c a n a ffe c t the ra tio.



Unde rsta ting the c ost of g oods sold will re sult in a n inc re a se in the ra tio a s we ll.



Sig nific a nt c ha ng e s in the inve ntory turnove r ra tio a re g ood indic a tors of possible fra udule nt inve ntory a c tivity.

Conc lusion

Re d fla g s a r

e wa r ning s tha t some thing c ould be or is wr

• ng .

Auditor

s, e mploye e s, a nd ma na g e me nt ne e d to be a wa r e of r e d fla g s in or de r to monitor the situa tion a nd the n ta ke c or r e c tive a c tion a s ne e de d.

E

mploye e s who notic e tha t r e d fla g s a r e ig nor e d ma y mista ke nly be lie ve tha t it is oka y to g a me the syste m or tha t the y won’t g e t c a ug ht.

A little fr

a ud soon be c ome s a la r g e one if le ft to g r

• w.

Contac t Me

Ir

is Ike da

iike da @dc c a .Ha wa ii.g ov or

dfi@dc c a .Ha wa ii.g ov

808.586.2815 Division of F

ina nc ia l Institutions De pa r tme nt of Comme r c e a nd Consume r Affa ir s (DCCA) 335 Me r c ha nt Str e e t, Rm 221 Honolulu, Ha wa ii 96813