ACC705 FORENSIC ACCOUNTING AND FRAUD

INVESTIGATION
CASE STUDY QUESTION (40%)
DUE 20th May: Weighting 20% of Final Exam

Case Study 1

ABC Company manufactures and sells software packages to small businesses. The company

has enjoyed great success since it began business in 1998. Last year the firm doubled its

revenues, and its management is now looking closely to going public by making an Initial

Public Offering (IPO) next September. Senior management has been putting a lot of effort into

further increasing sales by offering the company's sales representatives a generous commission

as an incentive to increase their selling efforts.

The CEO and the CFO of the company have been in business together for 20 years. They are

high school buddies. They interact socially with one another and their wives are also very close.

In completing a background check on the company, you find that it has positive relationship

with private investors, who are excited about the IPO next September. One of the investors did

inform you that the company changed its auditors last year because of a dispute the CEO had

with the audit partner regarding some "revenue recognition rule’’.

The company has a board of directors and audit committee that meets twice a year to discuss

how the business is doing. The board has decided to meet four times over the next year since it

may be necessary to discuss issues regarding the upcoming IPO. The board seems to speak

highly of management and compensates them generously with stock options for their "good

work."
Required:

1. What areas of business are prone to fraud? (5 marks)

The areas of the business that are prone to fraud can be the whole management of the
company since the CFO and CEO have been working in the business for 20 years and they
share a personal relationship. Fraud could easily occur in payments using cheques as CFO
would be authorized maker and could easily make cheques payable to him or his family and
friends. The senior management of the company can also skim money from sales and not be
detected as they control the company and know where pitfalls are. Fraud in payroll and
using company assets as personal can also be happening since the company has been
successful and the board only meet twice a year, which does not give them much time to
discuss specific of the business operations. Proper accounting procedures may not be
followed since there was a dispute regarding revenue recognition therefore gives
opportunities to perpetrators to commit fraud.

2. Identify 10 red flags that indicate the financial statement fraud may be occurring. (10
marks)
Red flags that fraud may be occurring:
1. Success since beginning operations
2. Rapid growth in revenues
3. Pressure to perform well for the IPO
4. Increased commissions as a way to increase revenue
5. Personal relationships between executives
6. Change in auditors
7. Dispute with auditor over revenue recognition accounting
8. Infrequent board of director and audit committee meetings
9. Close relationships between the board and management
10. High level of stock options held by management
3. Assume that you have been appointed as a forensic accountant to investigate if fraud is
taking place in the above organization. Prepare your plan on the investigation procedures
you are going to use. (10 marks)
Firstly, I will prepare the objectives of the investigation as followed:
 Identifying the sort of fraud that has been going on, how long it has been going on and
how the fraud was covered up
 Establish a list of suspects
 Quantify the financial loss the company has suffered
 Collect evidence to be presented in court
 Provide recommendations to prohibit fraud from happening again.
After setting objectives, I will start gathering as much evidence as I can from examining
the report of the last audit to speaking to the auditor. I should be able to collect evidence
adequate to prove, in the end, the identification of the fraudster(s), the fraud mechanisms
and the amount of financial loss incurred. Further, I will interviewing the staff off the
company starting from the least suspicious to the prime suspect. I would not start from
interviewing the prime suspects first as it might alert them and they would start
concealing their tracks. Once I get to interview the prime suspects, I would state the
evidence against them and would use direct confrontational with a little bit of sympathy
to get a confession. Once I get the confession, I will report back to my client of my
findings and suggests action he could take towards the fraudster(s). Most probably the
client would want to proceed to legal rulings, I would than present my evidence and
investigation findings in court.

4. Consider the four aspects of the fraud diamond. You were hired by the board of directors to
tell them what they could do to prevent fraud. Write a report on the general activities you
would tell them to engage in to prevent fraud in their organization. List 4 activities for each
of the four dimensions of the fraud diamond. (15 marks)
Fraud Diamond
 Pressure
Pressure refers to factors that lead to unethical conduct. Every offender of fraud face
some pressure to commit to fraudulent activities. In this case, I would suggest to the
board of directors the following:
 Firstly is to make realistic budget and goals. Considering the pressure to perform
well might be pestering the employees and senior management to relay on
unethical conducts.
 Establish employee assistance programs to support employees that might be
going through financial difficulties in their person lives.
 Establishing a code of conduct and ethics to guide employees on a healthy work
environment.
 Conduct employees training and education for guidance of employees.

 Opportunity
Opportunity is created through an ineffective system of control or governance that
allows an individual to commit organizational fraud. In the accounting sector, this is
referred to as flaws in internal control. The definition of perceived opportunity suggests
that people benefit from circumstances at their disposal.
 Shareholders should monitor and control activities by separation of duties and a
good internal control management.
 Actively search for frauds would unveil the any intention of fraud or any fraud
that has been concealed.
 Establishing whistle-blowing systems to encourage employee to report on
suspicious activities.
 Further is to monitor controls such as internal audit and security.

 Rationalization
 Rationalization refers to the rationale and reasons for the behavior of moral corruption
that varies from illegal activity. If a person cannot explain misconduct, it is unlikely that
he or she will commit fraud.
 Create clear alignment of employee’s responsibilities so that if fraud has
occurred in one department than it would be clear who had the responsibility of
that particular job which would hinder on the justification in rationalization of
the fraudster.
 Strive for fair performance evaluation policies and incorporate a reminder of
code of conducts in annual performance evaluation.
 Create a culture of accountability and collegiality to tackle denial in
rationalization.
 Value strong board oversight and audit functions. Invest in an independent audit
firm to regularly audit the organization.

 Capability
This is the situation where the person has the necessary traits or skills and capabilities to
commit fraud. It is where the fraudster recognized the distinct possibility of fraud and
the ability to make it a reality. Position, intelligence, ego, coercion, deceit, and stress are
capability-supporting elements.
 Having a strong internal control management would be key to tackle capability.
The fraudster who possess capability will be able to understand the internal
controls and its weaknesses and would be able to implement it in the plan to
carry out fraud.
 Regularly screening employees would be beneficial to reveal any employee
taking advantage of their position and cohering in fraud. Suggest doing a
background check on the CFO and CEO to rule possibilities of fraud and
manipulation.
 Install CCTV cameras and restricted access to control and monitor behaviors’ of
employees.
 Creating awareness by inviting white-collar criminals as speakers at corporate
events the message of devastating long-term consequences of fraud.
The End.