FRAUD EXAMINATION

ALBRECHT, ALBRECHT, & ALBRECHT

Proactive
Approaches to
Detecting Fraud

CHAPTER 6
 Learning Objectives
1. Explain the importance of proactive
fraud detection.

2. Describe the role of commercial data-

mining software plays in detection.

3. List the advantages and disadvantages

of data mining and digital analysis.

4. Recognize Benfords Law.

 Learning Objectives
5. Understand
inductive fraud
detection.
6. Identify how
fraud is detected
by analyzing
financial
statements.
How is the Case of Mr. Hamanaka
Typical of Most Frauds?

It started small and grew

much larger!
 Match Terms and
Definitions.
Inductive Determining the types of fraud
fraud that can occur then query to see
if they exist
detection
Deductive Proactively searching for fraud
without determining the type of
fraud fraud to look for
detection
A mathematical algorithm that
Commercial predicts the percentage a digit
data-mining will occur
software
Commercial software used to
Benfords Law detect patterns in data
 Differentiate Between
Detecting & Investigating
Fraud.
Detection
Discovery of Fraud
Answers the Question: Does a fraud exist?

Investigation
Preceded by Detection
Proving a Fraud
Answers the Questions: How? Who? Why?
What? Where? When a fraud took place?
 Explain Data-Mining as a
Means of Detecting Fraud.
ACL- Audit Command Language
Looking for Anomalies in
Databases
Difficulty Because ACLs Are
Limited in What They Can Handle
The Result Is They May Identify
Thousands of Symptoms
Because of Their Limitations
Review How Benfords Law
Works.

Examines the Frequency

of Digits Appearing
in a Database of
Invoice #s or Amounts
0-9 Do Not Appear
10% Each
 List Disadvantages of
Benfords Law?
Looks at a Large Company as a
Whole, May Not Show Problems
With Some Individual Vendors

Not Precise

Broad Identification of
Symptoms

Does Not Zero in on Perpetrators

 What is the 5 step Process for
Inductive Fraud Detection?
1. Understand the Business

2. Understand the Types of Fraud

that Occur in this Business

3. Understand the Symptoms these

Types of Fraud Create

4. Use Databases & Information Systems to

Search for Symptoms

5. Follow Through with Investigation to Determine if

Fraud Exists or Not
Compare the 3 Approaches.

Commercial Data Mining

Packages are least costly, but
have limited usefulness. They
provide excessive symptoms,
but are easy to use and
modify.
Compare the 3 Approaches.

Statistical analysis provides lots

of symptoms and is very useful
for discovering vendor kickback
frauds.
 Compare the 3 Approaches

The Inductive Approach is the

most expensive to use.
 Summarize the Process Which
Results in Financial Statements.

Economic Journal Financial

Transaction Entry Statements

Produces Posted Analysis

Effects Investor
Source General or Creditor
Documents Ledger Decisions

Analysis Summar-
ized
 What Effect Does the Size of
the Fraud Have on the F/S?

Small Large
frauds are frauds effect
unlikely to affect F/S, detected
F/S, usually during analysis of
detected when unexplained
examining source changes in
documents F/S
 Explain How Revenue Affects
the Companys Accounts.

Accounts
Receivable
If Sales
Revenue
Increase Inventory
Cost of Then
Goods
Sold
How Can You Convert Balance
Sheets & Income Statements to
Change Statements?

Compare Calculate Key

Account Ratios Compare
Balances from from Period to
Period to Period Period

Perform Perform
Horizontal Vertical
Analysis Analysis
 Match Ratio to Name.

Current CA Inventory
Average A/R

Quick Test Current Assets

Current Liabilities
Sales
A/R Turnover
Average A/R

Days in 365 Days

Receivables A/R Turnover
 Match Ratio to Name.

Receivables % Bad Debt Expense

Average A/R
Bad Debt % 365 Days
Inventory Turnover
Inventory
Cost of Goods Sold
Turnover
Average A/R

Days in Accounts/Receivable
Inventory Total Assets
 Match Ratio to Name.

Cost of Goods Cost of Goods Sold

Sold Percent Total Sales
Inventory Sales Returns
Percent Total Sales
Property, Plant
& Equipment Inventory
Percent Total Assets

Sales Sales
Return Ave. Property Plant
Percent & Equipment
 Match Ratio to Name.

Debt to Total Liabilities

Equity Total Assets
Net Income
Debt # Share of Stock
Percentage Outstanding
Profit
Total Liabilities
Margin
Total Equity
Days in Net Income
Receivables Net Sales
Describe How to Perform
Vertical Analysis on:

An Income Statement

A Balance Sheet
Describe How to Perform
Horizontal Analysis on:

An Income Statement

A Balance Sheet
 What Questions Should Asked
When Using a Statement of
Cash Flows to Detect Fraud?
Are there any
unexpected
changes in cash?
Did A/R go up or
down? Why?
Why did inventory
go up or down?
 Statement of Cash Flows
From
From Earnings From Borrowings
Investments and Stock Issuances

Cash Flows

Cash Balance

Cash Flows

Dividends
To Operations

For Investments To Pay Off Loans

 Discuss the Use of Software for
Detecting & Identifying
Fraudsters.
Difficulty of the List
Information - Information
can be in multiple formats
Fuzzy Logic