DISTINGUISH BETWEEN ERRORS AND FRAUD

When you find misstatements as you perform an audit, you’re responsible for making an
assessment. You alone must determine whether the misstatement represents an error or fraud.
Errors aren’t deliberate. Fraud takes place when you find evidence of intent to mislead.

Keep in mind that the dollar amount of the misstatement doesn’t make a difference when
assigning a badge of fraud. It doesn’t make any difference if the intentional misstatement is
material or immaterial: Fraud is fraud.

Here are some common errors you’ll come across:

 Inadvertently taking an expense to the wrong account: For example, an advertising
expense shows up as an amortization expense. The two accounts are next to each other in
the chart of accounts, and the data entry clerk made a simple keying error.
 Booking an unreasonable accounting estimate for allowance for bad debt
expense: The person who made this mistake may have simply misinterpreted the facts.
The allowance for bad debt arises because generally accepted accounting principles call
for the matching of revenue and expenses for the same financial reporting period. Each
period, a certain amount of credit sales have to be recorded as bad debt. That way,
revenue isn’t overstated in the current period.
Auditing
Businesses use many different methods to estimate bad debt. A common method is to allocate a
percentage of gross sales to bad debt. The percentage can be an industry average or the actual
percentage of bad debt to gross sales experienced by the company in the past. Some companies
allocate all invoices that are past due more than 120 days to bad debt.
 Incorrectly applying accounting principles: Recording assets at their cost rather than
their market value is an example of an accounting principle. Make sure the company
hasn’t inadvertently made an adjustment to increase the value of assets (such as land or
buildings) to their appraised value rather than cost. It’s never appropriate to change the
value of a fixed asset on the balance sheet from its original cost.
Fraud occurs when someone purposefully produces deceptive data. You need to be on the
lookout for two types of fraud:
 Misstatements due to fraudulent financial reporting: In this type of fraud,
management or owners are usually involved, and the fraud is facilitated by overriding
internal controls.
 Misstatements because of the misappropriation of assets: This type of fraud is usually
perpetrated by nonmanagement employees.

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Fraud can take the form of the falsification or alteration of accounting records or the financial
statements. Deliberately making a mistake when coding expense checks is fraud. So is
intentionally booking a lower allowance for bad debt than is deemed reasonable by normal
estimation methods.
SAS 99

SAS 99 not only requires auditors to be reasonably sure that financial statements are free of
material misstatements, whether caused by error or fraud, but it gives them focused and clarified
guidance on meeting their responsibilities to uncover fraud.
The U.S. Statement on Auditing Standards (SAS) 99, “Consideration of Fraud in a Financial
Statement Audit,” is recommended reading for Certified Fraud Examiners worldwide.
CFEs who routinely inspect financial statements will be pleased by the greater emphasis on
fraud detection in this new SAS issued by the Auditing Standards Board of the American
Institute of CPAs. Additionally, CFEs who are also CPAs now have a new implement in their
toolboxes.
The new SAS draws heavily on the international auditing standard ISA 240 but also adds
additional steps that may be of particular interest to our non-U.S. readers. ISA 240 is now being
revised to incorporate many of these changes. With the recent rash of accounting scandals,
investors, creditors, and other financial statement users want auditors to look deeper for fraud.
SAS 99 not only requires auditors to be reasonably sure that financial statements are free of
material misstatements, whether caused by error or fraud, but it also gives them focused and
clearer guidance on meeting their responsibilities to uncover fraud. Though much of SAS 99
may be review for CFEs, they still will learn useful information from the statement whether they
are auditors, law enforcement, private investigators, attorneys, or other professionals. (Find an
overview of SAS 99 and purchasing information at
www.aicpa.org/members/div/auditstd/riasai/sas99.asp.) SAS 99 requires auditors to look for
fraud throughout the entire audit process. The standard defines fraud as an intentional act
resulting in a material misstatement in the financial statements. Fraud consists of two major
types: 1) misstatements resulting from fraudulent financial reporting and 2) misstatements
resulting from the misappropriation of assets (often referred to as theft or defalcation). SAS 99
describes three conditions typically present when fraud is committed: incentives/pressures,
opportunities, and attitudes/rationalizations (These are reminiscent of the three sides of the
renowned Fraud Triangle1). Specifically, the perpetrator of the fraud likely is under pressure or
has an incentive to commit the fraudulent act. Second, opportunities probably exist for the
perpetrator to commit the fraud. Finally, the perpetrator likely is able to rationalize his or her
fraudulent act or possesses an attitude that the act was acceptable. There is a direct relationship
between the existence of the three conditions and the likelihood of the occurrence of fraud.
However, SAS 99 emphasizes that all three conditions do not need to be present for fraud to
occur. The appendix to SAS 99 provides examples of each of the three conditions. (Exhibit 1 on
page 42 shows a sampling of some of the fraudulent financial reporting examples.)

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SAS 99 reiterates the importance of exercising professional skepticism throughout the audit. The
auditor must maintain a questioning mind and critically assess the responses from the reporting
entity’s management and other evidence examined to determine the risk or existence of
fraudulent misstatements. The auditor should never accept less-than-persuasive evidence based
on the assumption that management is honest.

Why people do fraud?

 Greed – good old fashioned human nature intervenes when an individual, or group of
individuals, sees a chance to make ‘a fast buck’. A good example being those cases
where people ‘adjust’ their expense claims upwards.
 External pressure
 Financial need
 Lack of ethics

Causes of fraud
Lack of transparency – complex financial transactions that are difficult to understand are an
ideal method to hide a fraud. The Barings fraud was perpetrated by use of an accounting ‘dump
account’ that no one understood
Poor management information – where a company’s management information system does not
produce results that are timely, accurate, sufficiently detailed and relevant; the warning signals of
a fraud, such as ongoing theft from the bank account, can be obscured.
Excessively generous performance bonus payments – the more generous the bonus, when
coupled to a demanding target; the more temptation there is to manipulate results, such as year
end sales figures, to reach that target.
Non independent internal audit department – where an organisation’s internal audit department
is not independent, e.g. where it does not report to a truly independent audit committee but to the
Finance Director, the more likely that when there are signals that a fraud is occurring the more
likely they will be ignored. It is indeed interesting to note that Cynthia Cooper (Head of Internal
Audit at WorldCom) had to bypass her boss (the CFO) and go directly to the audit committee to
report the discovery of the capital expenditure fraud.
Lack of clear moral direction from senior management – leadership comes from the top. Where
the senior management indulge themselves in ‘semi corrupt’ behaviour, e.g. adjusting their
expense claims upwards, others will follow adopting the well worn mantra ‘everyone’s at it’
Excessively complex organisational structure – designed to obfuscate the revenue streams; and
so hide reality from third parties, such as the Internal Revenue Service. Enron, with its complex
off balance sheet structure and transactions, is a textbook example of this. 8. Poor accounting
controls– where the accounting controls, such as a monthly reconciliation of the bank account,
are lapse the signals that a fraud has occurred will be missed.
Arrogance – some people believe that they are better than ‘the system’, and that they can get
away with anything. The late Robert Maxwell plundered his company pension scheme,
arrogantly assuming that since he was chairman of the company he could get away with it; he
almost did!
Complacency – I have met many a manager who has an almost childlike faith, based in part on
the ‘old boy’ network, in the probity of their colleagues; believing that fraud ‘is not the sort of
thing that could happen here’. Others will, and do, take advantage of that trust. My simple advice

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is, if you think that a fraud may be happening then fear the worst; because it probably is. Share
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HOW TO DETECT ERRORS AND FRAUD IN PAYROLL

If payroll fraud exists, it is likely to occur in one of three ways: During an audit you can use the
following methods to detect all three circumstances of payroll error and fraud: through paying
fictitious employees, employees who haven’t worked or employees who no longer work for the
company. To find these types of errors when performing an audit take the following precautions:

 Review payroll registers: A department manager needs to review and approve

the payroll register, a summary of who’s getting paid and how much, prior to being
forwarded to the payroll department. Check the registers looking for names of terminated
employees, duplicate names, duplicate mailing addresses, duplicate Social Security
numbers, or unusual hours worked. If the employee normally works Monday through
Friday and you see some Saturday or Sunday hours, follow up.

Human resources needs to enter a termination date into the system because employees
leaving a company usually receive their final check after their last day of work. A great
accounting computer system allows payment up to but not after the termination date.
After that date, any payment to the ex-employee should be stopped because the payroll
clerk won’t be able to access the employee record. If a department manager sees payroll
info for a terminated employee on the payroll register, the manager should correct it both
at the department level and at the human resources level.

 Examine canceled checks: Look at the front and back of any available paper checks
clearing through the audit client’s bank for unusual looking checks and signatures. For
example, if the payroll register has the employee as John E. Doe, and the check is
payable to JE Doe, find out why. The check could possibly be cashed by nonemployee
Jennifer Ellen Doe working in collusion with another employee.

 Observe payroll processing: It’s always nice to be able to observe from soup to nuts the
running of one complete pay period. You’ll be able to detect any breakdown in controls
listed in the payroll procedure manual.

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 If you have the thrill of watching paychecks being handed out to employees, make sure
that each employee has ID, such as a company badge, and that the name on the payroll
check matches the badge. Check to see that each employee gets only one check and
unclaimed checks are safeguarded.

The following separations of duties should eliminate any unauthorized payments (unless many
employees are committing the fraud together):

 Human resources should initiate updating any new or existing personnel records only
after the updates have been appropriately authorized by the proper level of operating
department management. The proper authorization level is something you’ll find out
while questioning management and by reading the personnel policy manual.

Many small companies don’t have a formal human resources department, so this first step
is handled by the accounting department. Even so, some sort of separation in duties
should exist so that one payroll clerk isn’t responsible for both authorizing payroll
changes and processing payroll.

 As payroll clerks input the payment information, they should check that all new hires and
pay raises have been authorized by human resources. Payroll clerks shouldn’t have the
authority to change employee master file information. (The master file contains all
payroll-related facts about the employee such as name, wage, and withholding.) So if a
payroll clerk receives a payroll register with info not in the system, he’ll have to contact
human resources to see what’s up with the orphan employee.

 REGISTER/SIGN IN
THE SOUTH ASIA CHANNEL: Remembering Pakistan’s Biggest and Baddest Fraud
Scandal

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Pakistani media representatives gather around the Axact company building after a raid by the
Federal Investigation Agency (FIA) in Rawalpindi on May 19, 2015. Pakistani investigators on
May 19 carried out raids on a firm accused of running a global fake degree empire, officials said,
confiscating computers and holding employees for questioning as the scandal deepened. AFP
PHOTO / Farooq NAEEM (Photo credit should read FAROOQ NAEEM/AFP/Getty Images)

In recent days, Pakistan has been rocked by revelations about the improprieties of Axact, a
Karachi-based software company.

A May 17 New York Times report alleged that Axact has secretly run an Internet-driven fake
diploma business. It describes how scores of unknowing victims–from accountants in the Middle
East to bakery workers in Michigan–have been snookered by Axact’s scheme. A retired FBI
agent investigating Axact is quoted in the Times story as saying that it probably represents,
“hands down,” the biggest diploma mill operation he has ever seen.

Indeed, according to the Times, Axact’s mammoth scam targeted vulnerable customers across the
world, featured at least 370 websites of bogus educational institutions, and netted tens of millions
of dollars in annual revenues (according to a former Axact employee, one customer alone spent
over $400,000 on fake degrees and certificates). Some Pakistanis worry that these revelations
will deliver a body blow to Pakistan’s already-beleaguered global image. On May 20, Interior
Minister Chaudhry Nisar Ali Khan admitted that the affair “raises questions” about Pakistan’s
reputation.

Still, as big and bad as the Axact affair is, it is nowhere near as serious or damaging as another
infamous fraud scandal that hit Pakistan more than 20 years ago.

A Very Bad Bank

In 1991, details emerged of astonishing levels of malfeasance at an institution called the Bank of
Credit and Commerce International (BCCI). Founded in 1972 by a Pakistani named Agha Hasan
Abedi (who served as director until 1990), the bank became synonymous with fraud on the most
massive (and global) of scales. BCCI attracted all the wrong superlatives: Biggest corporate
criminal enterprise, biggest Ponzi scheme, biggest bank fraud scandal. Many jokingly called it
the Bank of Crooks and Criminals International.

BCCI, interestingly, was originally launched to provide an alternative to the global financial
institutions of the West–a deeply corrupt precursor to today’s Asian Infrastructure Investment
Bank (investigations of BCCI would later find that Abedi’s stated goal was “to fight the evil
influence of the West”). Yet in the end, BCCI merely dragged unknowing banks in the West —
and across the developing world–into its huge web of illicit and highly profitable transactions.

The extent of BCCI’s crimes, chronicled in detailed American and British investigations, is
breathtaking. There was financial fraud gone wild: unrecorded deposits, phony payments, and
illegal share-buying. The bank also specialized in improper loans; it reportedly disguised one bad
loan to a British shipping company by using nearly 100 shell companies. So elaborate and

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expansive was BCCI’s subterfuge that it somehow managed to secretly control three major
American banks.

And that is merely the more innocuous side of the story. A Time magazine exposé in July 1991
alleged that BCCI featured a clandestine division, based in Karachi and described internally as a
“black network,” that served as a “global intelligence operation and a Mafia-like enforcement
squad.” It allegedly engaged in spying, bribery, extortion, and kidnapping (later investigations,
however, suggested this network, if it indeed existed, was not as vast as Time claimed).

At its height in the 1980s, BCCI had more than a million global depositors. They ranged
from street sweepers and small business owners to central banks of developing countries. Many
governments, including the United States, held accounts. Influential members of Washington’s
political class–including lobbyists close to President George H.W. Bush–had ties to BCCI. This
may explain why a young U.S. senator named John Kerry faced strong resistance from
Washington–including from fellow senators–during his initial efforts to launch an investigation
for the Senate Committee on Foreign Relations. He eventually succeeded, and published his
findings in a landmark report in 1992.

BCCI built a $20 billion empire. It boasted shell companies, offshore facilities, and other
affiliated entities in about 70 countries. It had about 400 bank branches worldwide. This wealth
and influence was achieved by preying on the world’s vulnerable, but also by courting a rogues
gallery of customers. BCCI worked with dictators such as Panama’s Manuel Noriega and Iraq’s
Saddam Hussein. BCCI also worked with terrorists–including Osama Bin Laden. Years after the
bank’s collapse in 1991, the CIA discovered that Bin Laden had an account with BCCI.

Pakistan’s Deep Footprint

BCCI was unabashedly global. It had offices around the world, including a headquarters in
London. It was incorporated in Luxembourg, and many of its shareholders were in the Arab
Gulf.

Still, according to the Time investigation: “BCCI was always a Pakistani bank, with its heart in
Karachi.” Abedi, its founder and long-time director, was Pakistani, as were many of its middle
managers and top officials. The bank was close to Pakistan’s political leadership, providing
financial assistance to military leader Gen. Zia al-Haq and finding a job for his brother.
According to Kerry’s report, BCCI also helped finance Pakistan’s nuclear weapons procurement.
Much of the bank’s start-up capital came from wealthy Pakistan-based depositors. Overseas
Pakistanis used the bank to send money home. Bank accounting ledgers were in the Urdu
language. BCCI contraband shipments often passed through Karachi. And when investigators
began honing in on the bank’s activities, BCCI officials from around the world fled to Pakistan.

Pakistan’s relationship with Washington (along with U.S. ties to BCCI) may help explain why
the bank was able to carry out its criminal acts for so long, even after information started to
circulate about BCCI’s illicit activities. Washington and Islamabad worked closely in the 1980s
to fund and arm anti-Soviet mujahideen fighters in Afghanistan, and the United States may have
concluded that confronting Pakistan about the bank would risk provoking Islamabad and

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jeopardize bilateral cooperation. There is actually evidence that Washington worked directly
with BCCI to support anti-Soviet forces in Afghanistan; an internal BCCI memo from
1987 claimed that USAID asked the bank to purchase 1,000 mules for mujahideen fighters there.

Limited vs. Lasting Impacts

The Axact and BCCI scandals share several things in common. Many of their activities were
Karachi-based, they arguably committed unprecedented levels of fraud, and their operations
were highly global. Yet the similarities end there.

The damage from the Axact scandal will likely be relatively modest. Those directly and
deleteriously affected will be restricted to the unfortunate souls duped into paying big money for
fake degrees, and to Axact’s several thousand employees. Pakistan’s impressive IT sector–which
features world-renowned innovators and award-winning software, and which Axact, by
describing itself as a software firm, claims to be a part of–should emerge unscathed. Most
Pakistanis regard Axact–a modest IT exporter–as more of an outlier than a formal member of the
IT sector.

By contrast, the BCCI scandal produced a dramatic and widespread impact. The bank’s collapse,
for example, robbed 40,000 Bangladeshi depositors–and many other working-class account
holders–of their life savings. Central banks from poor countries with BCCI
accounts feared major economic losses. It took 21 years, nearly $700 million, and more than 60
prosecutions to complete a legal settlement process.

Additionally, the scandal caused great embarrassment for governments around the world.
According to Kerry’s report, BCCI had relationships “that ranged from the questionable, to the
improper, to the fully corrupt” with officials in Pakistan and at least 31 other nations.

And then there is the issue of terrorist financing.

In the early 2000s, American and French intelligence officials discovered that companies
previously affiliated with BCCI continued to work with Bin Laden (a one-time account holder)
after the bank’s demise, and that Bin Laden’s financial network model was similar to the one
used by BCCI in the 1980s. An American investigator of BCCI would describe the bank as “the
mother and father of terrorist financing operations.”

This all makes a fake diploma scam, as reprehensible as it is, sound downright harmless by
comparison.

FAROOQ NAEEM/AFP/Getty Images

Audit Procedures to Detect Fraud

by John Freedman
Fraud Brainstorming Session

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Under generally accepted auditing standards, audit engagement teams must hold a fraud
brainstorming session at the beginning of the audit. This session, led by the partner in charge of
the audit, is designed to provide a time for the audit team to consider how the company could
commit fraud. Further, the brainstorming meeting is used to set a tone of professional skepticism
in the audit. Often, a fraud specialist attends the meeting to provide insight into other frauds
committed by similar companies or industries and help identify the client's risk factors.
Journal Entry Testing
Because committing material financial statement fraud often requires adjustments to the
company's financial records, auditors will test the company's journal entries for any signs of
manipulation. To perform this test, after gaining an understanding of the company's controls and
procedures, the auditor will make a selection from the company's journal entries. Auditors
typically select entries that are large, made by upper management, posted late in the accounting
period or otherwise of interest. Once the selections have been made, the auditor will ask for
supporting documentation that validates each entry.
Accounting Estimates
Another likely place for fraud is in accounting estimates. Because accounting estimates are
subjective, management may be able to influence accounting estimates to manipulate the
financial statements. Auditors look for fraud in accounting estimates in two major manners. First,
auditors complete a "lookback" procedure to determine if the methodology for completing
accounting estimates has changed from the prior year. Changes in methodology could be a sign
of manipulation. Auditors also examine the directionality of estimates as a whole. For example,
if nearly all estimates in the prior year were of decreasing income and nearly all estimates in the
current year were of increasing income, auditors may be concerned that the company is shifting
income from one period to another.

Two Types of Audit Fraud

Fraudulent Financial Reporting Misappropriation of Assets

Usually perpetrated by senior management (CEO, CFO, Usually perpetrated by lower level employees
COO)

Committed by the organization Committed against the organization

Benefits the organization/company Benefits the individual/employee

Auditor are highly concerned about this Rarely material and less of a concern for an
auditor

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The Audit Fraud Triangle
The fraud triangle refers to conditions that are generally present when material misstatements
due to fraud occur.

Incentives/Pressures

 Generally, refers to companies undergoing excessive pressure to meet analysts’ or

investors’ expectations
 Stock options and bonuses based on net income are examples of such incentives and/or
pressures

Opportunities for Fraud

 Ineffective governance – for example, the Board of Directors is not committed to ethical
policies and morals
 Significant judgment/estimates are involved in accounting

Potential Problems arising from Attitudes/Rationalization

 Management is very aggressive, has a risk-taking mentality, and makes highly unrealistic
forecasts that need to be met
 The ethical tone at the top is poor, which allows perpetrators to rationalize their actions

The Auditor’s Role

When the auditor is considering the potential for fraud in an audit, they will focus on risk
assessment procedures in the planning stage. Remember that auditors must maintain an attitude
of professional skepticism. One of the auditor’s responsibilities include asking management and
the audit committee if they know of any unusual situation or any employee who is acting
strangely, because the prevention and detection of fraud is ultimately their responsibility.

Fraud isn’t just about catching unusual transactions and relationships in the numbers in the books
but also about examining the general behavioral patterns of employees and any hardships,
financial or otherwise, that they may be suffering at the time.

In addition, the auditor will consider the fraud triangle and look for any fraud risk factors (red
flags) that indicate an incentive/pressure to commit fraud. Finally, in the planning stage, auditors
will also carry out ratio and trend analyses to look for any unusual patterns or unexpected results
in relation to previous year/industry data.

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The Auditor’s Responses to Audit Fraud Risks
An auditor’s action in response to potential fraud can be divided into an overall (i.e., financial
statement level) and then a more specific (specific line item/assertion level) response.

In dealing with significant fraud risks at the overall level, the accounting firm will assign more
experienced audit staff to the engagement and increase the level of supervision of lower level
staff. The auditor will also thoroughly consider the client’s accounting choices and policies to
determine acceptability. Finally, auditors may choose to implement unpredictable, surprise
procedures to verify the values on the financial statements – such as unexpectedly showing up at
the client’s inventory count unannounced.

On a more specific level, auditors will make an effort to gain more reliable evidence by relying
more on documentary evidence as opposed to oral or visual evidence. In addition, they may also
try to obtain more evidence from third parties instead of just from the client. They may also
change the extent of their procedures by increasing their sample size to substantiate values, as
well as by performing procedures closer to year end (varying the timing of the audit procedure).

We can see why the planning stage of an audit is very important. Depending on the client, the
client’s inherent risk level, and the audit risk level that auditors are willing to tolerate, the scope
of audit work can differ substantially. With effective planning, proper implementation, and a
skeptical attitude, auditors should be able to uncover most frauds that take place.

7. Warning Signs of Fraud

1. Is the person reconciling the bank statement also a check signer?
These are important duties to segregate. When combined, a person signing a fraudulent check
can go on without being detected.

2. Does your company have several bank accounts?

Multiple bank accounts make inappropriate movements of cash harder to detect. So, make sure
you understand the business need for each bank account the company has and use as few
accounts as possible.
3. Do you have a budget to compare with your actual financial results
on a monthly basis?
This is an important control in the detection of unauthorized transactions.

4. Have you noticed a controlling personality or secretive behavior on

the part of an employee?
This may be a sign that a person is being deceptive or needs to control people or the
environment in order to conceal their activity.

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5. Are there accounts on your financial statements that you do not
understand?
Ask! If your question is not welcomed or answered to your satisfaction, then pay attention to
this response.

6. Financials that are not timely or closed on a monthly basis.

Lax or non-existent cut offs leave room for inappropriate entries in months long gone.

7. Are employees related in your accounting department?

Part of a functioning internal controls system is the need for collusion in order to circumvent
controls.

How to Reduce Fraud

What can you do to reduce the chance for fraud in your organization? First, remember that
internal controls are necessary for all size organizations. Check out the following ideas that you
will find helpful as you assess controls in your organization:
Live Ethics in Your Corporate Culture
A culture of ethics starts at the top and you start by demonstrating it on a daily basis. We
cannot emphasize this enough as it sets the bar for acceptable behavior in your organization.
Trust is Not a Control
Design internal controls. Then put them in place for the position. Thus, they should not be for a
particular employee, regardless of how trusted that employee is.
Pre-Employment Screening
Conduct pre-employment screening including background checks as appropriate.
Utilize Entire Team
If you do not have enough employees in accounting, then utilize others as part of your control
system.
Have Different Signers
If your bank account reconciler is a signer, then find a different signer. Segregate the check
cutting, signing and reconciling duties from each other.
Unbiased Reviewer
Have the company bank statements go unopened for review by someone in a management
position who isn’t cutting or signing checks.

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Choose Signers Carefully
Understand what authority signers have with company bank accounts and choose signers
carefully. Add extra controls to your corporate bank accounts – an example is precluding any
counter withdrawals so that all bank account withdrawals go through the check writing process.
Anonymous Alert System
Set up an anonymous way for your employees to alert you of any concerns/suspicions related
to potential fraud within your company. Then take these alerts seriously.
Segregation of Duties & Controls
Segregation of duties and internal controls protect both your employees and the company.

Top 10 Accounting Scandals in the Past Decades

Waste Management Scandal (1998)

Waste Management Inc. is a publicly-traded US waste management company. In 1998, the

company’s new CEO, A Maurice Meyers, and his management team discovered that the
company had reported over $1.7 billion in fake earnings.

The Securities and Exchange Commission (SEC) found the company’s owner and former CEO,
Dean L Buntrock, guilty, along with several other top executives. In addition, the SEC fined Waste
Management’s auditors, Arthur Andersen, over $7 million. Waste Management eventually
settled a shareholder class action suit for $457 million.

Enron Scandal (2001)

Enron Corporation was a US energy, commodities, and services company based out of Houston,
Texas. In one of the most controversial accounting scandals in the past decade, it was
discovered in 2001 that the company had been using accounting loopholes to hide billions of
dollars of bad debt, while simultaneously inflating the company’s earnings. The scandal resulted
in shareholders losing over $74 billion as Enron’s share price collapsed from around $90 to
under $1 within a year.

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An SEC investigation revealed that the company’s CEO, Jeff Skillings, and former CEO, Ken Lay,
had kept billions of dollars of debt off the company’s balance sheet. In addition, they had
pressured the company’s auditing firm, Arthur Andersen, to ignore the issue.

The two were convicted, largely based on the testimony of former Enron employee, Sherron
Watkins. However, Lay died before serving time in prison. Jeff Skillings was sentenced to 24
years in prison. The scandal led to the bankruptcy of Enron and dissolution of Arthur Andersen.
After the fact, the convictions were as controversial as the company’s collapse had been
shocking, as prosecutor Andrew Weissman indicted not just individuals, but the entire
accounting firm of Arthur Andersen, effectively putting the company out of business. It was little
consolation to the 20,000 employees who had lost their jobs when the conviction was later
overturned.

WorldCom Scandal (2002)

WorldCom was an American telecommunications company based out of Ashburn, Virginia. In

2002, just a year after the Enron scandal, it was discovered that WorldCom had inflated its assets
by almost $11 billion, making it by far one of the largest accounting scandals ever.

The company had underreported line costs by capitalizing instead of expensing them and had
inflated its revenues by making false entries. The scandal first came to light when the company’s
internal audit department found almost $3.8 billion in fraudulent accounts. The company’s CEO,
Bernie Ebbers, was sentenced to 25 years in prison for fraud, conspiracy, and filing false
documents. The scandal resulted in over 30,000 job cuts and over $180 billion in losses by
investors.

Tyco Scandal (2002)

Tyco International was an American blue-chip security systems company based out of
Princeton, New Jersey. In 2002, it was discovered that CEO Dennis Kozlowski and CFO Mark
Swartz had stolen over $150 million from the company and had inflated the company’s earnings
by over $500 million in their reports. Kozlowski and Swartz had siphoned off money using
unapproved loans and stock sales. The scandal was discovered when the SEC and the office of
the District Attorney of Manhattan carried out investigations related to certain questionable
accounting practices by the company. Kozlowski and Swartz were both sentenced to 8 to 25
years in prison. A class action suit forced them to pay $2.92 billion to investors.

HealthSouth Scandal (2003)

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 HealthSouth Corporation is a top US publicly traded healthcare company based out of
Birmingham, Alabama. In 2003, it was discovered that the company had inflated earnings by
over $1.8 billion. The SEC had previously been investigating HealthSouth’s CEO, Richard Scrushy,
after he sold $75 million in stock a day before the company posted a huge loss. Although
charged, Scrushy was acquitted of all 36 counts of accounting fraud. However, he was found
guilty of bribing then Alabama Governor Don Siegelman and was sentenced to seven years in
prison.

Freddie Mac Scandal (2003)

The Federal Home Loan Mortgage Corporation, also known as Freddie Mac, is a US federally-
backed mortgage financing giant based out of Fairfax County, Virginia. In 2003, it was
discovered that Freddie Mac had misstated over $5 billion in earnings. COO David Glenn, CEO
Leland Brendsel, former CFO Vaughn Clarke, and former Senior Vice Presidents Robert Dean and
Nazir Dossani had intentionally understated earnings in the company’s books. The scandal came
to light due to an SEC investigation into Freddie Mac’s accounting practices. Glenn, Clarke, and
Brendsel were all fired and the company was fined $125 million.

American International Group (AIG) Scandal (2005)

American International Group (AIG) is a US multinational insurance firm, with over 88 million
customers across 130 countries. In 2005, CEO Hank Greenberg was found guilty of stock price
manipulation. The SEC’s investigation into Greenberg revealed a massive accounting fraud of
almost $4 billion. It was found that the company had booked loans as revenue in its books and
forced clients to use insurers with whom the company had pre-existing payoff agreements. The
company had also asked stock traders to inflate the company’s share price. AIG was forced to
pay a $1.64 billion fine to the SEC. The company also paid $115 million to a pension fund in
Louisiana and $725 million to three pension funds in Ohio.

Lehman Brothers Scandal (2008)

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Lehman Brothers was a global financial services firm based out of New York City, New York. It
was one of the largest investment banks in the United States. During the 2008 financial crisis, it
was discovered that the company had hidden over $50 billion in loans. These loans had been
disguised as sales using accounting loopholes. According to an SEC investigation, the company
had sold toxic assets to banks in the Cayman Islands on a short-term basis. It was understood
that Lehman Brothers would buy back these assets. This gave the impression that the company
had $50 billion more in cash and $50 billion less in toxic assets. In the aftermath of the scandal,
Lehman Brothers went bankrupt.

Bernie Madoff Scandal (2008)

Bernie Madoff is a former American stockbroker who orchestrated the biggest Ponzi scheme in
history, and also one of the largest accounting scandals. Madoff ran Bernard L. Madoff
Investment Securities LLC. After the 2008 financial crisis, it was discovered that Madoff had
tricked investors out of over $64.8 billion.

Madoff, his accountant, David Friehling, and second in command, Frank DiPascalli, were all
convicted of the charges filed against them. The former stockbroker received a prison sentence
of 150 years and was also ordered to pay $170 billion in restitution.

Satyam Scandal (2009)

Satyam Computer Services was an Indian IT services and back-office accounting firm based out
of Hyderabad, India. In 2009, it was discovered that the company had inflated revenue by $1.5
billion, marking one of the largest accounting scandals.

An investigation by India’s Central Bureau of Investigation revealed that Founder and Chairman,
Ramalinga Raju, had falsified revenues, margins, and cash balances. During the investigation,
Raju admitted to the fraud in a letter to the company’s board of directors. Although Raju and his
brother were charged with breach of trust, conspiracy, fraud, and falsification of records, they
were released when the Central Bureau of Investigation failed to file charges on time.

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Skimming Fraud Definition
Skimming fraud is the theft of cash from a business prior to its entry into the accounting system
for that company. Although skimming is one of the smallest frauds that can occur, they are also
the most difficult to detect.
Skimming Meaning
Skimming is also known as an “off book” fraud because the cash is stolen before it is entered
into the bookkeeping system. In business, skimming is the most difficult to detect because
there is not direct audit trail that can be followed to the source. Often, skimming fraud is
discovered by accident, or if a company suspects that it is going on. A company will often
investigate for skimming fraud if a certain part or the business as a whole is low on cash for no
reason. If the problem is ongoing companies will often investigate themselves or hire someone
to do so like a Certified Fraud Examiner (CFE).
(How are you’re dealing with a fraudulent employee? Learn more about what it feels like to
have fraud committed against you here.)
Skimming Example
Grant owns a sandwich shop named Real Good Wich. Lately, Grant has noticed that
the cash account has been dwindling, and decides to hire Mason a CFE to investigate. Mason
arrives on the scene and orders a sandwich. After observing the cashier for a while he notices
that one of the employees is pocketing the cash when the exact amount for a sandwich is paid.
Mason takes note of this and returns to Grant and explains the problem. He explains that when
the exact amount is paid the employee can simply pocket the cash. This is because there is no
need to open the register for change and no sale needs to be recorded. Mason also provides a
quick fix to the problem.
If Grant were to provide a free sandwich to his customers if no receipt were given to them on
the sale it would significantly reduce the amount of skimming fraud. Grant takes Mason’s
advice and fires the employee, and implements the free sandwich. After a while Grant sees that
his cash has increased as well as overall profits.

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