Investigation Technique for Internal Auditors

Jimmy Ardianto

When?

You’ll do the investigation when:

1. There is a fraud2. You found any

irregularities3. Suspicious

Accounting Fraud:The intentional misrepresentation or alteration of accounting records regarding sales, revenues, expenses and other factors for a profit motive such as inflating company stock values, obtaining more favorable financing or avoiding debt obligations. Employees who commit accounting fraud at the request of their employers are subject to personal criminal prosecution.

Creative Accounting

Using the flexibility within accounting to manage the measurement and presentation

of the accounts so that they serve the interests of preparers.

FraudStepping outside the Regulatory Framework

deliberately to give a false picture of theaccounts.

No Flexibility to Flexibility to Flexibility to Flexibility give a “true give a creative give a fraudulent and fair” view view view Regulatory framework Working within Working within Working outside eliminates accounting regulatory framework regulatory framework regulatory choice to ensure users’ to serve preparers’ framework interests interests Within regulatory framework Outside regulatory framework

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Methods of Creative Accounting 1Innumerable, but managers can, for example, manipulate income, expenses, assets and liabilities

1. Income Recognition2. Interest payable e.g., capitalisation3. Stock4. Depreciation5. Goodwill and Intangibles6. Off balance sheet financing

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Methods of Creative Accounting II Stock

Only one asset, stock, worth say 10 million Euros. If capital is 5 million Euros and this year’sprofit is 5 million Euros, then balance sheet A:

Balance Sheet A

Euros m Euros m Capital 5 Stock 10 Profit 5 10 10 The company: (1) adopts a more generous stock valuation policy (increases stock by 5 million Euros), (2) does a particularly thorough stock-check (increases stock by 1.0 million Euros). We now have balance sheet B. Balance Sheet B

Euros m Euros m Capital 5.0 Stock 11.5 Profit 6.5 11.5 11.5

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Methods of Creative Accounting III Depreciation

Business Profit 10,000 EurosFixed Assets 100,000 EurosDepreciation straight line 10 yearsIf company adopts 20 year asset life will this affect profit?Yes: Original policy New policy Euros EurosProfit before depreciation 10,000 10,000Depreciation (10,000) (5,000)Profit after depreciation - 5,000

Profit increases by 5,000 Euros

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Methods of Creative Accounting IVSimple off balance sheet financing scenario

Company wants to acquire new premises Merchant bank sets up a special purpose company to

acquire clients properties. Loans secured on properties Ownership spread over clients Company leases properties Rents pay loan interest End of initial lease, clients can i, buy leased properties; or ii, sell properties and repay

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Methods of Creative Accounting VFinancing Scenario

Banker10 year secured loanReceives rentalCapital Guaranteed

ClientImmediate accessIf property appreciates will gain Effective ownership without having to borrow No need for loan on financial statements

List Irregularities to Look for in Source Documents?

• Missing Documents• “Stale Items” on Bank

Reconciliation• Excessive Voids or

Credits• Payee Names &

Addresses = Customer Names & Addresses

• Photocopied Documents

• Payee Names & Addresses = Employee Names & Addresses

• Past Due A/R • Reconciling Items• Altered Documents• Duplicate Payments• Second Endorsements

on Checks

Accounting Anomalies

• Faulty Journal Entries

• Inaccuracies in the Ledgers

– Ledger doesn’t balance

–Master or Control Accounts do not equal the sum of individual customer or vendor accounts

Identify Symptoms of Journal Entry Fraud.

• Journal entries without support documentation• Unexplained adjustments to receivables,

payables, revenues or payables• Journal entries that do not balance• Journal entries made by individuals who would

not normal make such entries• Journal entries made near the end of an

accounting period

Discuss the Inaccuracies of Ledgers

• Define a Ledger – A book of accounts

• How do you prove the accuracy of a ledger?– A = L + OE or Dr = Cr

• What symptoms relate to control accounts?– Dr = Cr– Master account balances do not equal sum of the

subsidiary account balances

List Common Examples of Analytical Anomalies. Explain.

• Unexplained Inventory Shortages or Adjustments

• Deviations from Specifications

• Increased Scrap

• Excess Purchases

• Too Many Debit or Credit Memos

• Significant Increase or Decrease in Account Balances

• Physical Anomalies

• Cash Shortages or Overages

• Excessive Late Charges

• Unreasonable Expenses or Reimbursements

10 Biggest Accounting Fraud

10 Biggest Accounting Fraud

10 Biggest Accounting Fraud

10 Biggest Accounting Fraud

Good economy was masking problems….

With increasing stock prices, profits and wealth for everyone, no one worried about potential problems.

So?

• All fraud has a player• As an Internal Auditor, you are the first door of

investigation• Find the evidence• Make sure that all condition suit to the case• Focus to player, support with evidence• That’s the art

Planning for Investigation

Obtain facts of the case and organize case facts (with chart-case, witnesses and evidence)

Selection of witnesses starting with favorable witnesses

Develop structured process (Don’t talk about the case first, find the behavior or what he/she does

Preparation

• Prepare interview questions (Motive, Opportunity, Corroborate)

• Select appropriate place and timing of interview (Privacy is very important)

• Interview environment and other relevant requirements

Verification Process

• Psychologically condition subject to tell the truth

• Develop a list of case related direct questions to evaluate subject credibility

• Ask follow-up questions to deceptive verbal response

Use Direct Questions

• Direct questions should be specific and not general

• Direct questions should be objective and not elicit opinions or beliefs

Follow-up Questions• Probing questions

– When asked for details, memory can provide without problems but creating needs time and effort

• Assumptive questions– Use to confirm suspicion in a

way that is easy for admission against self-interest

• Corroborative questions– To elicit further details of an

admission and more details to verify alibi or explanation

General Principles

• Like words in a sentence, gestures in a cluster

• Conflict in verbal and non-verbal

• Pick up indicator and note what is said simultaneously

Emotions Felt When Lying

• Fear of being caught lying (facial expression)

• Guilt about lying (body language)

• Delight in having duped someone (micro expression)

Universal Facial Expressions

• Happiness – smiles• Sadness – frowns• Surprise – raise

eyebrows and mouth slightly open

• Anger – lowered eyebrows and lips tight

• Fear – Inner eyebrows raised and lips appart

• Disgust – mouth/nose

Paralinguistic

• Response latency• Volume and Rate changes• Fluency (stop/start ..emm..ehh)

Eye Contact

• Breaks in gaze• Assessing memory• Influencing factors (cultural and contextual)

Body Indicators

• Eye (blinking)• Illustrators shut down

(frozen stiff)• Aversion and body

movement / shift• Displacement activity• Adapters (rub,

scratch, cover, pinch/grab)

2 Reasons why lies fail

• Thinking (creating) betrays the lie• Feelings expose the lie

The Detection System

• Controlled sample• Contradictions (verbal vs non verbal, emotion

vs words, behavior vs norm)• Clusters (2 or more indicators)• Concentrate on reaction just before or after

and note down what is said• Corroboration (identify deception, record

interview)

Types of Evidence

• 3 main types of evidence:– Documentary– Physical/real– Oral (testimonial)

• Oral evidence most unreliable due to:– Failure of memory– Mistaken memory– Lie or contort facts

If there is enough evidence, so there is no need interrogation

Source• Investigative Interviewing Techniques, International Cybercrime and

Forensic Examiners, 2011• Moenske, The Perfect Storm-The Rise of Corporate Accountability, Kent

State University, Ohio Council IMA, 2003• Jones, Creative Accounting, Fraud and Accounting Scandals, Cardiff

Business School• www.businessdictionary.com

Thank You