Fraud Examination, 4th Edition Wells Test Bank

Principles of Fraud Examination, 4th Edition By

Wells

Chapter 1 – Introduction

1. Which of the following best describes the objective of a fraud examination? a. To make recommendations to management about how to prevent fraud b. To determine whether financial statements are free of misstatements due to fraud c. To express an opinion on the guilt or innocence of a suspect d. To determine whether a crime has been committed, and if so, who is responsible 2. Which of the following is not a part of the fraud theory approach? a. Analyze available data. b. Develop “what-if” scenarios. c. Identify who committed the fraud. d. Refine the hypothesis.

3. Once sufficient predication has been established, what is the first step a fraud examiner following the fraud theory approach should take? a. Create a hypothesis. b. Analyze data. c. Interview witnesses. d. Interview the suspect.

4. The discipline of fraud examination includes all of the following except: a. Writing investigative reports b. Determining the guilt of the suspect c. Testifying to findings d. Interviewing witnesses 5. Fraud examination differs from auditing in that fraud examination is: a. Recurring b. Adversarial c. General in scope d. All of the above 6. Predication, although important, is not required in a fraud examination. a. True b. False 7. In a fraud examination, evidence is usually gathered in a manner that moves from general to specific. a. True b. False

8. Which of the following is the correct order for a fraud examiner to interview witnesses? a. Corroborative witnesses, neutral third-parties, co-conspirators, suspect b. Suspect, co-conspirators, corroborative witnesses, neutral third-parties c. Neutral third-parties, corroborative witnesses, co-conspirators, suspect d. Suspect, corroborative witnesses, co-conspirators, neutral third-parties 9. In order to prove that fraud occurred, four elements must be present. Which of the following is not one of those elements? a. A material false statement b. Knowledge that the statement was false c. Reliance on the false statement by the victim d. Intent to cause the victim damages 10. The basic tenet of Edwin Sutherland’s theory of differential association is that crime is passed on genetically; that is, the offspring of criminals commit crimes because their parents did. a. True b. False 11. Who developed the Fraud Scale? a. Joseph T. Wells b. W. Steve Albrecht c. Richard C. Hollinger d. Donald R. Cressey 12. Which of the following is not one of the legs of the Fraud Triangle? a. Situational environment b. Perceived non-sharable financial need c. Perceived opportunity d. Rationalization 13. According to Cressey, the perceived opportunity to commit fraud consists of two elements: general information and technical skill. a. True b. False 14. In a study by Steve Albrecht, Marshall Romney, and Keith Howe, participants were asked to rank personal characteristics as motivating factors that contributed to fraud.

The highest ranked factor was: a. Undue family or peer pressure b. Lack of recognition of job performance c. Living beyond one’s means d. Lack of appreciation by management

15. In a study by Steve Albrecht, Marshall Romney, and Keith Howe, participants were asked to rank characteristics of the organizational environment that contributed to fraud. The highest ranked factor was: a. Lack of clear lines of authority b. Inadequate attention to detail c. Lack of an internal audit function d. Placing too much trust in key employees 16. Research in the Hollinger-Clark study suggests that the best way to deter employee theft is by: a. Increasing sanctions imposed on occupational fraudsters b. Increasing the perception of detection c. Strengthening internal controls d. Communicating the organization’s fraud policies to employees 17. According to the results of the Hollinger-Clark study, employees steal primarily because of: a. Job dissatisfaction b. Greed c. Informal organizational structures d. Economic pressures 18. In the 2012 Report to the Nations on Occupational Fraud and Abuse, the category that committed the smallest percentage of occupational fraud was: a. Managers b. Employees c. Owners/Executives d. External parties 19. In the 2012 Report to the Nations on Occupational Fraud and Abuse, the median loss in schemes committed by males was higher than the median loss in schemes committed by females. a. True b. False 20. In the 2012 Report to the Nations on Occupational Fraud and Abuse, most frauds were initially detected during an external audit. a. True b. False 21. In the 2012 Report to the Nations on Occupational Fraud and Abuse, financial statement fraud had a higher median loss than asset misappropriation and corruption schemes. a. True b. False

22. In the 2012 Report to the Nations on Occupational Fraud and Abuse, most perpetrators of fraud had been previously charged with or convicted of a fraud-related offense. a. True b. False 23. Joel Baker, a customer of ABC Electronics, stole a box containing computer games while the sales associate waited on another customer. Which of the following could Joel be charged with? a. Larceny b. Embezzlement c. Fraud d. All of the above 24. While conducting a routine internal audit, Sally Franks overheard one of the company’s purchasing agents bragging about receiving a substantial discount on a new SUV from the company’s supplier of fleet cars. Is there sufficient predication to initiate a fraud examination? a. Yes b. No 25. When Jill Michaels, an assistant to the director of procurement, moved into her new home, she used the company’s flat bed truck to move her furnishings on an afternoon when her boss was out of town. Which of the following best describes Michael’s act? a. Fraud b. Abuse c. Embezzlement d. Larceny 26. Eddie Dolan is the manager of shipping and receiving and has been working at the UFA Company for twenty years. He rarely calls in sick and gets good performance reviews every year. For the past year, his wife’s company, ABC Co., has been in serious financial trouble. ABC Co. likely will not be able to make the payroll for next month and may have to close down. Which leg of the Fraud Triangle best applies to Dolan’s situation? a. Motive b. Perceived opportunity c. Rationalization d. Non-sharable financial need

27. Alice Durant works in the accounts payable department for the BC Group. She recently found out that Della Granger, another A/P clerk, received a bigger raise than she did, even though Durant has been with the company longer and frequently has to correct Granger’s errors. Which leg of the Fraud Triangle best applies to Durant’s situation? a. Motive b. Perceived opportunity c. Rationalization d. Non-sharable financial need 28. Arthur Baxter, a manager in records retention for SWC Company, has ordered seven laptop computers for his department, even though he only has five employees. In addition to each laptop, he ordered extra copies of several software programs. When the equipment arrives, Baxter sends one of the extra laptops to his son who is a freshman at Eastern University and sells three of the original software packages to friends. Which of the following offenses could Baxter be charged with? a. Larceny b. Embezzlement c. Conversion d. All of the above 29. Richard Moore is the controller for Ajax Company. Recently, he suffered several large losses at the race track, causing him to incur enormous personal debts. Which type of non-sharable financial problem best describes Richard’s situation? a. Business reversal b. Physical isolation c. Violation of ascribed obligations d. Status gaining 30. Samantha Lewis, CFE, is conducting an investigation into possible skimming of the accounts receivable at Southwest Paint and Supply Co. If Lewis plans to interview all of the following parties, whom should she interview first? a. Marie Riley, the primary suspect b. Jose Rodriguez, an accounts receivable clerk who filled in for Riley while she was on vacation c. Sean Miles, a regular customer of the company, whose complaint about his account balance prompted the investigation d. Thomas Banks, Riley’s supervisor, who is suspected of helping Riley cover up the fraud in exchange for a portion of the proceeds

Chapter 2 – Skimming

1. ____________________ is the theft of cash from a victim entity prior to its entry in an accounting system. a. A fictitious disbursement b. Skimming c. Larceny d. Conversion 2. To a fraudster, the principle advantage of skimming is the difficulty with which the scheme is detected. a. True b. False 3. Peggy Booth is the bookkeeper for an equipment rental company. After recording the cash sales and preparing the bank deposit, she takes $200 dollars from the total. This is an example of a skimming scheme. a. True b. False 4. In the Fraud Tree, asset misappropriations are broken down into cash and non-cash schemes. Which of the following is not considered a misappropriation of cash? a. Larceny b. Skimming c. Concealed expenses d. Fraudulent disbursements 5. Methods of skimming sales include which of the following? a. Conducting unauthorized sales after hours b. Rigging the cash register so that the sale is not recorded c. Posting a sale for less than the amount collected d. All of the above 6. Skimming can be either an on-book scheme or an off-book scheme, depending on whether cash or a check is stolen. a. True b. False 7. Which of the following procedures would not be useful in preventing and detecting sales skimming schemes? a. Comparing register tapes to the cash drawer and investigating discrepancies b. Summarizing the net sales by employee and extracting the top employees with low sales c. Installing video cameras at cash entry points d. Offering discounts to customers who do not get receipts for their purchases

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8. To cover up a skimming scheme in which the employee takes cash from the register, the employee must make a voided sale in order for the register to balance. a. True b. False 9. Which of the following techniques is not used to conceal sales skimming schemes? a. Lapping b. Inventory padding c. Destroying records of transaction d. Recording false voids 10. The customer service department at JNC, Inc. has been receiving phone calls from customers for whom there is no record. This is a red flag of what type of scheme? a. Receivables skimming b. Shell company c. Unrecorded sales d. None of the above 11. Skimming receivables is generally more difficult to conceal than skimming sales. a. True b. False 12. The concealment of receivables skimming can be difficult because: a. The audit trail must be destroyed. b. The incoming payments are expected. c. Inventory must be padded to conceal shrinkage. d. All of the above 13. Receivables skimming can be concealed through: a. Lapping b. Force balancing c. Document destruction d. All of the above 14. A method of concealing receivables skimming by crediting one account while abstracting money from a different account is known as: a. Account substitution b. Kiting c. Lapping d. Plugging 15. Procedures that can be used to prevent and/or detect receivables skimming include which of the following? a. Reconciling the bank statement regularly b. Mandating that employees take annual vacations c. Performing a trend analysis on the aging of customer accounts d. All of the above -2-

16. Mandating supervisory approval for write-offs or discounts can help prevent receivables skimming schemes. a. True b. False 17. Which of the following computer audit tests can be used to detect skimming schemes? a. Summarizing by employee the difference between the cash receipt report and the sales register system b. Identifying unique journal entries to the cash account c. Joining the customer statement report file to the accounts receivable and reviewing for balance differences d. Extracting invoices paid by cash 18. Computing the percentage of assigned time to unassigned time for employees is one method to detect an employee skimming scheme. a. True b. False 19. Asset misappropriations are broken down into two categories: cash schemes and noncash schemes. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, cash schemes are much more common than non-cash schemes. a. True b. False 20. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, skimming schemes are both the most common and the most costly type of cash misappropriation scheme. a. True b. False 21. George Albert was a property manager for a large apartment complex while he was going to college. One of his duties was to collect rent from the tenants. If rent was paid after the third of the month, a late fee was tacked on to the amount due. When a tenant paid his rent late, George would backdate the payment, record and remit only the rent portion to his employers, and pocket the late fee. This is an example of what type of fraud? a. Larceny b. Sales skimming c. Fraudulent write-offs d. Plugging 22. Anne Mullens is the bookkeeper for DWG Refrigeration Repair. One afternoon while she was preparing the bank deposit, a customer came in to the office and paid his account in full with a $57 check. Rather than adding the check to the deposit, Anne pocketed $57 cash from the previously recorded amount and included the customer’s check in the money to be taken to the bank. What type of scheme did Anne commit? a. Larceny -3-

b. Kiting c. Skimming d. Currency balancing 23. Sue Meyers was an accounts receivable clerk for an insurance broker. When premium payments were received, she would steal the check of every tenth customer and cash it at a liquor store. To conceal her scheme, she would credit the account of the customer that she stole from with a payment that was received from another customer’s account. This is an example of: a. Force balancing b. Lapping c. Understating sales d. A forged endorsement scheme 24. Jason Herman works part-time as a retail clerk at a local bookstore. One night while his manager was out of town, Jason decided to keep the store open for a few extra hours. He reset the cash registers at the normal closing time, but continued making sales. Two hours later, when he closed for the night, he reset the registers again, removing all evidence that any extra transactions had been made, and pocketed the money from the after-hours sales. What kind of scheme did Jason commit? a. Register disbursement b. Force balancing c. Receivables skimming d. Unrecorded sales 25. Myra Manning, CFE, was hired to investigate some suspicious activity at Arizona Medical Supply after one of the company’s largest customers complained several times that its account statements do not reflect all the payments it has made. While examining the accounts receivable activity, Myra noticed a significant rise in the volume of overdue accounts during the last 6 months. What type of scheme might this situation indicate? a. Cash larceny b. Shell company c. Receivables skimming d. False refunds 26. In one of the case studies in the textbook, Brian Lee, a top-notch plastic surgeon, collected payments from his patients without giving a cut to the clinic where he practiced. How was his fraud discovered? a. Through a routine audit of the clinic’s records b. Through an anonymous tip to the clinic c. By accident d. None of the above 27. In one of the case studies in the textbook, Brian Lee, a top-notch plastic surgeon, collected payments from his patients without giving a cut to the clinic where he practiced. What was his motivation for committing the fraud? a. He needed to repay his student loan.

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b. He was greedy. c. He felt that the clinic was taking too much of a cut from his income. d. He wanted to use the proceeds to fund his “doctors without borders” practice.

28. In one of the case studies in the textbook, Brian Lee, a top-notch plastic surgeon, collected payments from his patients without giving a cut to the clinic where he practiced. How was he punished? a. He was convicted of grand larceny and sentenced to probation. b. He was sued in civil court for the amount of the loss. c. He was terminated from the practice and was required to make full restitution in lieu of prosecution. d. He was allowed to continue to practice at the clinic but was required to make full restitution.

29. In one of the case studies in the textbook, Stefan Winkler was the controller for a beverage company in south Florida. Money was collected by either the delivery drivers who brought in the cash and checks from their route customers (route deposits), or by credit customers who mailed in their payments (office deposits).

Winkler stole cash from the route deposits and made up for it by using checks from the office deposits. How did Winkler conceal his crime? a. He altered electronic files b. He stole cash receipt journals, copies of customer checks, and deposit slips c. He removed his personnel file d. All of the above 30. In one of the case studies in the textbook, Stefan Winkler was the controller for a beverage company in south Florida. Money was collected by either the delivery drivers who brought in the cash and checks from their route customers (route deposits), or by credit customers who mailed in their payments (office deposits).

Winkler stole cash from the route deposits and made up for it by using checks from the office deposits. Which of the following red flags were present that could have alerted the company to the fraud? a. Missing deposit slips b. Customer complaints c. Winkler never took vacations d. All of the above

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Chapter 3 – Cash Larceny Schemes 1. Cash misappropriations are divided into two broad groups: fraudulent disbursements schemes and cash receipts schemes. a. True b. False 2. The two categories of cash receipts schemes are: a. Lapping and skimming b. Lapping and cash larceny c. Cash larceny and skimming d. Skimming and billing schemes 3. What is the primary difference between cash larceny and skimming? a. Cash larceny is an on-book scheme; skimming is an off-book scheme. b. Cash larceny is an off-book scheme; skimming is an on-book scheme. c. Cash larceny is a disbursement scheme; skimming is a cash receipts scheme. d. Cash larceny involves cash only; skimming can involve either cash or checks.

4. Skimming involves the theft of money that has already appeared on a victim’s books, while cash larceny involves stealing money before it has been recorded. a. True b. False 5. Where do most larceny schemes involving cash occur? a. In the accounting department b. In the mailroom c. At the point of sale d. At off-site locations 6. Larceny schemes are generally more difficult to detect than skimming schemes. a. True b. False 7. Which of the following methods can be used to conceal a larceny scheme that occurred at the point of sale? a. Falsifying the cash count b. Destroying the register tape c. Stealing from another employee’s register d. All of the above 8. If discrepancies are found between the sales records and the cash on hand, which of the following schemes might be occurring? a. Cash larceny at the point of sale b. Cash larceny from the deposit c. Fraudulent disbursements d. Sales skimming -1-

9. The central weakness of a cash larceny scheme is the resulting imbalance in the organization’s accounting records. a. True b. False 10. To prevent cash larceny through falsification of cash counts, an independent employee should verify the cash count in each register or cash box at the end of each shift. a. True b. False 11. Methods for concealing larceny of receivables include which of the following? a. Lapping b. Stolen statements c. Reversing entries d. All of the above 12. Deposit lapping is considered an off-book scheme. a. True b. False 13. All of the following are ways a fraudster might conceal cash larceny from the deposit except: a. Posting missing money as “deposits in transit” b. Deposit lapping c. Falsifying the bank copy of the deposit slip d. Destroying customer statements 14. The most important factor in preventing cash larceny from the deposit is: a. Separating the duties of the deposit function b. Having two employees deliver the deposit to the bank c. Having a visible management presence in the mailroom d. None of the above 15. Which of the following antifraud controls can help prevent and detect cash larceny from the deposit? a. Having two copies of the bank statement delivered to different persons in an organization b. Comparing the bank authenticated deposit slip with the general ledger posting of the day’s receipts c. Preparing the deposit slip to show each individual check and money order along with currency receipts d. All of the above

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16. Which of the following computer audit tests would be the least useful in detecting a cash larceny scheme? a. Summarizing the difference between the cash receipt report and the sales register system by employee b. Summarizing the top sales producers by employee c. Summarizing discounts, returns, and cash receipt adjustments by employee d. Reviewing all unique journal entries in the cash accounts 17. Running a report that summarizes user access for the sales, accounts receivable, cash receipt, and general ledger systems during non-business hours might identify a cash larceny scheme. a. True b. False 18. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, cash larceny schemes had the largest median loss of all cash misappropriations. a. True b. False 19. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, cash larceny schemes were the least common form of cash misappropriations. a. True b. False 20. Jan Ashley worked for the R&S Department Store as a sales associate in the fine linens department. As she would give change back to a customer for cash sales, she would also pull out a $10 bill and slip it in her pocket. She concealed her scheme by issuing one false refund at the end of her shift for the total amount she stole that day.

This is an example of what type of scheme? a. Sales skimming b. Larceny at the point of sale c. Lapping d. Larceny at the deposit 21. Dorothy McNally stole $232 from the company deposit while on the way to the bank.

She can conceal the theft by recording the missing amount on the bank reconciliation as a(n): a. Deposit in transit b. Outstanding check c. Credit memo d. None of the above 22. Jeff Lewis is an accounts receivable clerk for FTB Industries. As customers pay off their balances, Lewis posts the payments but pockets the money. He can conceal his theft by: a. Making unsupported entries for the amount stolen b. Adjusting the account with a discount -3-

c. Destroying the records d. All of the above 23. Mel Turner, the runner for a small bookstore, had a bad habit of helping himself to cash from the deposit on the way to the bank. He covered his tracks by substituting a check from the next day’s deposit for the amount he stole from the previous day’s deposit. This is an example of what type of concealment? a. Deposits in transit b. Deposit lapping c. Force balancing d. None of the above 24. Victor Jackson, CFE, was hired by BRS Carpet and Tile to investigate possible cash larceny at the point of sale. Which of the following red flags should he look for? a. Large differences between sales records and cash on hand b. Unusual journal entries to the cash accounts c. A large number of small differences between sales records and cash on hand d. All of the above 25. Danielle Boyle, CFE, was hired to investigate some suspicious activity in the accounts receivable department at Red Technologies. While examining the company’s accounting records, she noticed several payments posted to customers’ accounts that were later reversed with journal entries to “courtesy discounts.” What type of scheme might this situation indicate? a. Receivables skimming b. Deposit lapping c. Cash larceny of receivables d. Shell company 26. In one of the case studies in the textbook, Laura Grove was the head teller at a bank in Tennessee. As the head teller, she had the authority to open the night depository along with another teller. For security reasons, each teller only had half of the combination to the vault. In the end, Grove opened the vault and stole two deposit bags worth approximately $16,000. Which of the following red flags made the investigators suspect Laura? a. The security system showed that she was the last one to leave the bank on the day before the bags were stolen. b. She broke out in a rash when she was interviewed. c. During the interview she made a point of mentioning that the other teller had been having financial problems. d. All of the above 27. In one of the case studies in the textbook, Laura Grove was the head teller at a bank in Tennessee. As the head teller, she had the authority to open the night depository along with another teller. For security reasons, each teller only had half of the combination to the vault. In the end, Grove opened the vault and stole two deposit bags worth approximately $16,000. How was she ultimately caught?

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a. She broke down and confessed to the investigators during a routine interview of all tellers. b. Her husband found the bank’s money and turned her in. c. The bank found some of the checks in the dumpster near her house with her fingerprints on them. d. None of the above 28. In one of the case studies in the textbook, Laura Grove was the head teller at a bank in Tennessee. As the head teller, she had the authority to open the night depository along with another teller. For security reasons, each teller only had half of the combination to the vault. In the end, Grove opened the vault and stole two deposit bags worth approximately $16,000. How was the case settled? a. She paid the bank back in lieu of prosecution. b. She was prosecuted and sentenced to eighteen months in jail. c. She was dismissed and signed a promissory note to repay the money. d. She was prosecuted but received probation in lieu of prison time.

29. In one of the case studies in the textbook, Bill Gurado was a branch manager for a consumer-loan finance company in New Orleans who decided to help himself to the daily deposits. Instead of depositing the money into the company’s bank account, he deposited the money into his own personal account. How was Gurado’s fraud discovered? a. He suspected he was on the verge of being caught, called the company’s president, and confessed that he had taken the money. b. The auditors found it during a surprise audit of the branch Gurado managed. c. His assistant suspected him and reported him to the company’s audit committee. d. A customer called to complain about receiving an overdue notice.

30. In one of the case studies in the textbook, Bill Gurado was a branch manager for a consumer-loan finance company in New Orleans who decided to help himself to the daily deposits. Instead of depositing the money into the company’s bank account, he deposited the money to his own personal account. How was the case settled? a. The company pursued civil action for the repayment of the stolen funds. b. Gurado was terminated and he immediately paid back the money. c. Gurado was convicted of grand theft and scheming to defraud, and he was placed on probation. d. Gurado was placed on deferred adjudication and required to make restitution.

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Chapter 4 – Billing Schemes 1. Categories of billing schemes include which of the following? a. Shell company schemes b. Larceny billing schemes c. Fictitious disbursements schemes d. All of the above 2. When a billing scheme is occurring, the company’s expenses appear lower than they should, causing the financial statements to show falsely inflated profits. a. True b. False 3. In a ______________ scheme, the perpetrator uses false documentation to cause a payment to be issued for a fraudulent purpose. a. Purchasing b. Skimming c. Larceny d. Billing 4. In the Fraud Tree, all of the following are categories of fraudulent disbursements except: a. Payroll schemes b. Cash larceny c. Check tampering d. Billing schemes 5. Fictitious entities created for the sole purpose of committing fraud are called: a. Ghost companies b. Non-accomplice vendors c. Shell companies d. “Rubber stamp” companies 6. Most shell company schemes involve the purchase of goods rather than services. a. True b. False 7. Invoices that are submitted by shell companies can be for fictitious goods or services or for items that were actually sold to the victim company. a. True b. False 8. In order to start up a shell company, the fraudster will most likely need which of the following? a. Certificate of incorporation b. Mailing address

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c. Bank account d. All of the above 9. Producing an invoice that looks professional is the most difficult part of a shell company scheme. a. True b. False 10. Warning signs of a shell company scheme include which of the following? a. Invoices lacking details of the items purchased b. A vendor that is not listed in the phone book c. An unexpected and significant increase in “consulting expenses” d. All of the above 11. A pass-through scheme is usually undertaken by someone who works in which department? a. Accounts payable b. Receiving c. Purchasing d. Accounts receivable 12. Which of the following actions is least likely to help prevent and detect schemes involving fraudulent invoices from non-accomplice vendors? a. Marking “paid” on every voucher that has been paid b. Verifying vendor address changes before disbursements are issued c. Matching all bank statement items to canceled checks d. Separating the duties of purchasing, authorizing, and distributing payments 13. ____________________ are schemes in which the employee intentionally mishandles payments that are owed to legitimate vendors. a. Pass-through schemes b. Pay-and-return schemes c. Shell company schemes d. Switch-and-swap schemes 14. In a shell company scheme, which of the following methods might a fraudster use to get a phony invoice approved for payment? a. Collusion b. A “rubber stamp” supervisor c. Falsification of purchase orders and receiving reports d. Any of the above 15. Purchasing personal items using an organization’s money is what type of scheme? a. Larceny scheme b. Billing scheme c. Pay-and-return scheme

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d. Skimming scheme 16. Which of the following controls can be used to prevent or detect personal purchases on company credit cards? a. Having credit card statements sent directly to someone with signature authority on the account for review and payment b. Requiring employees to receive store credits rather than cash when returning items they purchased with the company’s credit card c. Monitoring credit card expenses for unexplained increases in purchasing levels d. All of the above 17. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, the most common fraudulent disbursement schemes were: a. Billing schemes b. Check tampering schemes c. Payroll schemes d. Register disbursement schemes 18. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, billing schemes were the second most costly type of fraudulent disbursements schemes. a. True b. False 19. Which of the following computer audit tests can be used to detect billing schemes? a. Extracting manual checks and summarizing by vendor and issuer b. Extracting a sample of vendor open invoices for confirmation with the vendor c. Extracting delivery addresses that do not correspond to company locations d. All of the above 20. Sally Fuller is a buyer for GWA publishing company. Her job is to purchase supplies and services for the printing of technical manuals. Her brother sets up a printing company, and Sally hires him to print most of these manuals for GWA. However, rather than actually printing the manuals, her brother hires another printer to do the work, then sells the printed manuals to GWA at a 50 percent markup. As a result, his prices are much higher than the other printers who serve GWA. This type of scheme is most likely a: a. Pay-and-return scheme b. Pass-through scheme c. Inventory-markup scheme d. Non-accomplice vendor scheme 21. Eli Adams is an accounts payable clerk for MJF Productions. By forging signatures, he was able to procure a company credit card. He recently bought home stereo equipment and put it on his company credit card. When the credit card statement

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arrived at MJF, Eli prepared a check to the credit card company and buried the purchase in the monthly expenses of the company’s largest cost center, knowing that his manager is generally inattentive when approving payments. What type of fraud is this? a. Larceny b. Pass-through scheme c. Personal purchases scheme d. Forged maker scheme 22. Charles Dieter and Joey Davis worked together to steal nearly $50,000 from Valdosta Medical Supply. Charles, an accounts payable clerk, deliberately overpaid a few of the company’s vendors. He then called the vendors, explained the “mistake,” and asked for the excess to be refunded. Joey, a mailroom employee, intercepted the incoming refund checks and cashed them. The two men split the proceeds. What type of scheme did Charles and Joey commit? a. Shell company b. Larceny c. Pass-through d. Pay-and-return 23. Abby Watkins works in the accounts payable department for SVX Company.

Recently, she set up a payment to Pacific Industries for invoice number 7001a, which is unlike any invoice number she has seen from Pacific in the past. The voucher contains a purchase order that backs up the invoice, but it looks like a photocopy.

Additionally, the accounting system shows that invoice number 7001 from Pacific was for a slightly different amount and has already been paid. Pacific Industries is an established vendor with SVX, but the payment address has recently been changed to a P.O. Box in the vendor file. What type of fraud does this situation most likely indicate? a. Personal purchases scheme b. Shell company scheme c. Non-accomplice vendor scheme d. False purchase requisition scheme 24. The internal auditor for the Bremer Group recently ran a computer audit test that showed that Ouetzen Company, one of the company’s listed vendors, doesn’t have a telephone number or a tax ID number. Of the choices given, what type of fraud does this situation most likely indicate? a. Larceny scheme b. Shell company scheme c. Non-accomplice vendor scheme d. Personal purchases scheme 25. Nicolas Hill, CFE, has been hired to look into suspicious activity at Mason & Jefferson, LLC. The company’s controller has reason to believe that the company has

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fallen victim to a shell company scheme. As part of his investigation, Nicolas should do which of the following? a. Match the vendor master file to the accounts receivable file b. Review payments with little or no sequence between invoice numbers c. Extract all employees without a social security number d. All of the above 26. In one of the case studies in the textbook, a Southeastern medical college was plagued with fraudulent activity. What started as an investigation into some suspicious expense reimbursement activity eventually led to the discovery of a fictitious company that was set up to fraudulently bill the college for supplies that never existed. What was the first sign that there were more problems than the initial expense reimbursement fraud? a. The auditors found an usually high number of new unapproved vendors. b. The administrative assistant suddenly left town when requested to be interviewed. c. The supervisor resigned his position immediately. d. A tip was received by internal auditors.

27. In one of the case studies in the textbook, a Southeastern medical college was plagued with fraudulent activity. What started as an investigation into some suspicious expense reimbursement activity eventually led to the discovery of a fictitious company that was set up to fraudulently bill the college for supplies that never existed. Which of the following red flags were found during the investigation? a. Some vendors didn’t have street addresses or telephone numbers. b. Invoices were received for just under the amount that required two authorized signatures. c. Some of the checks were cashed at check cashing companies. d. All of the above 28. In one of the case studies in the textbook, a Southeastern medical college was plagued with fraudulent activity. What started as an investigation into some suspicious expense reimbursement activity eventually led to the discovery of a fictitious company that was set up to fraudulently bill the college for supplies that never existed. How was the case resolved? a. The perpetrator was terminated, and the funds were recovered. b. The perpetrator was convicted and placed on probation, and partial restitution was ordered. c. The perpetrator left the state and was caught pulling the same scam at another company. d. A civil suit was filed and restitution was ordered.

29. In one of the case studies in the textbook, Albert Miano, the facilities supervisor for a popular magazine, submitted phony invoices. When Miano received the checks for the phony invoices, he forged the contractor’s signature. He then endorsed the check in his own name. How was the fraud caught?

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a. The auditors found a discrepancy in the invoices that were submitted. b. The new chief of internal audit found it by accident. c. A vendor received a check by mistake and called the accounts payable department. d. The external audit found it in an audit sample of canceled checks.

30. In one of the case studies in the textbook, Albert Miano, the facilities supervisor for a popular magazine, submitted phony invoices. When Miano received the checks for the phony invoices, he forged the contractor’s signature. He then endorsed the check in his own name. What controls weaknesses did the company have that facilitated Miano’s scheme? a. Employees in the accounts payable department did not follow departmental procedures. b. Accounts payable never checked signatures on the invoices against the authorized signatures on file. c. Miano was allowed to pick up the approved invoices from the administrative vicepresident’s office and deliver them to the accounts payable department. d. All of the above

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Chapter 5–Check Tampering 1. Check tampering is unique from other fraudulent disbursement schemes because in a check tampering scheme: a. The perpetrator physically prepares the fraudulent check. b. The perpetrator must have access to a signature stamp in order to conceal the crime. c. The perpetrator submits a phony document in order to generate the fraudulent payment. d. The perpetrator must endorse the check in order to cash or deposit it.

2. Check tampering includes both fraudulently preparing a company check for one’s own benefit and intercepting a company check that is intended for a third party and converting it for one’s own benefit. a. True b. False 3. To successfully carry out and conceal a check tampering scheme, the fraudster must have: a. Access to the check stock b. Access to the bank statements c. The ability to forge signatures or alter other information on the check d. All of the above 4. Check tampering schemes involving checks made payable to “cash” are extremely difficult to resolve, as there is no way to tell who converted the check. a. True b. False 5. Which of the following choices is not a category of check tampering? a. Forged maker schemes b. Altered payee schemes c. Unauthorized endorsement schemes d. Concealed check schemes 6. The person who prepares and signs the check is known as the ______________ of the check. a. Author b. Endorser c. Payer d. Maker 7. In which of the following schemes does the fraudster intercept and convert a company check made payable to a third party? a. Forged maker scheme b. Authorized maker scheme c. Altered payee scheme -1-

d. Concealed check scheme 8. In a forged maker scheme, the perpetrator fraudulently affixes the signature of an authorized maker to a check. a. True b. False 9. Producing a counterfeit check using the company’s logo and bank account number is one type of concealed check scheme. a. True b. False 10. Which of the following is not an effective control mechanism to safeguard an organization’s check stock? a. Boxes of blank checks should be sealed with security tape. b. Organizations should use check stock that is high-quality and distinctly marked. c. The employee in charge of the check preparation function should periodically verify the security of unused checks. d. Voided checks should be promptly destroyed.

11. To prevent and detect forged maker schemes, an organization should: a. Separate the duties of check preparation and check signing. b. Rotate authorized check signers. c. Maintain a usage log for the signature stamp. d. All of the above 12. Which of the following procedures can help prevent and detect the theft and conversion of outgoing company checks? a. Train employees to look for dual endorsements on canceled checks. b. Chart the date of mailing for every outgoing check. c. Track changes made to vendor records. d. All of the above 13. Which of the following is not a type of altered payee scheme? a. “Tacking” on b. Forged maker c. Using erasable ink d. Leaving the payee designation blank 14. To prevent altered payee schemes, the person who prepares the check should also review the check after it has been signed. a. True b. False 15. Which of the following computer audit tests can be used to detect forged maker schemes? a. Extract checks that are out of sequence -2-

b. Extract manual checks and summarize by vendor and issuer c. Extract all checks payable to “cash” and summarize by issuer for reasonableness d. All of the above 16. Which type of check tampering scheme is usually the most difficult to defend against? a. Authorized maker b. Forged endorsement c. Concealed check d. Altered payee 17. Concealing a check tampering scheme generally means hiding both the identity of the perpetrator and the fact that the fraud ever occurred. a. True b. False 18. Methods used to conceal check tampering schemes include all of the following except: a. Falsifying the disbursements journal b. Forced reconciliation c. Check kiting d. Re-altering the canceled checks 19. Methods used to manipulate electronic payments include which of the following? a. Abusing legitimate access to the employer’s payment system b. Gaining access to the employer’s payment system through social engineering c. Exploiting weaknesses in the employer’s internal control over its electronic payment system d. All of the above 20. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, check tampering is the most common fraudulent disbursement fraud. a. True b. False 21. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, check tampering has the lowest median loss of all fraudulent disbursement frauds. a. True b. False 22. Mavis Bosman works as an accounts receivable clerk at Brooks Publishing. She steals an incoming check from a customer and cashes it at a grocery store by forging the endorsement on the back of the check. This is an example of a check tampering scheme. a. True b. False

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23. Kristen Diamond worked in the mailroom at B&R Industries. When attaching postage to the outgoing mail, she would search for payments being sent to a specific vendor, K. D. Sand. She intercepted these checks and carefully changed them to appear payable to K. Diamond. She then endorsed the checks with her own name and deposited them into her personal bank account. What type of scheme did Kristen commit? a. Concealed check b. Payables skimming c. “Tacking on” d. Forged endorsement 24. Vicky Rogers works in the accounts payable department at HDU, Inc. When checks are returned to the company for incorrect vendor addresses, she is supposed to research them, correct them, and then forward them to the proper address. Instead, Rogers decided to convert some of the returned checks for her own use. Based on the information provided, what type of check tampering scheme is this likely to be? a. Forged maker b. Forged endorsement c. Concealed check b. Authorized maker 25. Melanie Diggers is an internal auditor for Atlantic Equipment Rental and Sales.

While performing a routine review of one of the company’s bank accounts, she noticed an unusual “adjusting entry” to the account on the general ledger. She also found that several checks that had cleared the bank in the last few months were absent from the stack of canceled checks. She requested copies of these checks from the bank and discovered that they were all made payable to the company’s controller who has check signing authority on the account. The controller is also responsible for performing the bank reconciliation and recording month-end journal entries. Which of the following schemes do these signs most likely indicate? a. Concealed check scheme b. False voids scheme c. Authorized maker scheme d. Forged maker scheme 26. Billy Hodges was in charge of preparing checks for the Lightner Company. He entered the payment information into the accounting system, and the completed checks were sent back to him to review. He then forwarded the checks to his supervisor for signing. In each batch of legitimate checks, Hodges would insert checks made payable to himself. When his supervisor was busy, he would take the stack of checks to him and ask him to sign them immediately in order to meet their cycle time deadline. The supervisor would inattentively sign the checks, and then Hodges would extract the checks he made payable to himself. This is an example of what type of check tampering scheme? a. Concealed check scheme b. Forged endorsement scheme c. Forged maker scheme -4-

d. Altered payee scheme 27. Mary Duncan is an internal auditor for the Western Realty Group. Recently, she ran a program that extracted checks that were out of the normal sequence. She found that four or five checks were written every month that fit this category. Based on the information given, which of the following schemes is likely occurring? a. Multiple reimbursement scheme b. Shell company scheme c. Personal purchases scheme d. Forged maker scheme 28. In one of the case studies in the textbook, Melissa Robinson, who worked as an executive secretary for a worldwide charitable organization and was active in her children’s school, was also a thief. As one of two people allowed to sign checks on the organization’s bank accounts, she learned early on that she could forge the second person’s signature without anyone becoming suspicious. How was she finally caught? a. A co-worker contacted the organization’s executive director when she found that a company check had been written to the children’s school for Robinson’s personal items. b. New officers were elected, and they took the accounting books from her. c. The auditors discovered her fraud during an annual audit of the books. d. Robinson’s husband tipped off the audit committee after he became suspicious of some of Robinson’s purchases.

29. In one of the case studies in the textbook, Melissa Robinson, who worked as an executive secretary for a worldwide charitable organization and was active in her children’s school, was also a thief. As one of two people allowed to sign checks on the organization’s bank accounts, she learned early on that she could forge the second person’s signature without anyone becoming suspicious. What red flags were present that indicated that something wasn’t appropriate? a. Robinson would not take vacation leave. b. There were a lot of missing files that the auditors couldn’t locate during their annual audit. c. Robinson would not release any financial information when requested and gave excuses for why it wasn’t available. d. All of the above 30. In one of the case studies in the textbook, Melissa Robinson, who worked as an executive secretary for a worldwide charitable organization and was active in her children’s school, was also a thief. As one of two people allowed to sign checks on the organization’s bank accounts, she learned early on that she could forge the second person’s signature without anyone becoming suspicious. How was Robinson punished? a. She was allowed to resign and agreed to pay the money back. b. She resigned, and a civil suit was filed to recover the loss. c. She was found guilty and ordered to make restitution to the organization and its insurance company.

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d. Charges were dismissed with prejudice when the evidence was thrown out on a technicality.

31. In one of the case studies in the textbook, Ernie Phillips was a CPA who had fallen on hard times both financially and personally. He eventually got a job as a controller for a friend who had just been named as the receiver for a financial services company.

Within a short period of time Phillips began writing checks to himself that had nothing to do with payroll. How was the fraud discovered? a. The president received a bank statement containing canceled checks that had been written to Phillips. b. The receiver received a call from the bank asking him to verify a check. c. A vendor received a check in error and reported it to the operations manager. d. The operations manager found a check made payable to Phillips while searching Phillips’ desk for some accounting records.

32. In one of the case studies in the textbook, Ernie Phillips was a CPA who had fallen on hard times both financially and personally. He eventually got a job as a controller for a friend who had just been named as the receiver for a financial services company.

Within a short period of time Phillips began writing checks to himself that had nothing to do with payroll. Control weaknesses that facilitated the commission of this fraud include which of the following? a. The bank statements were sent directly to Phillips. b. Phillips had check signing authority. c. There was no separation of duties between accounts payable and the treasury department. d. All of the above 33. In one of the case studies in the textbook, Ernie Phillips was a CPA who had fallen on hard times both financially and personally. He eventually got a job as a controller for a friend who had just been named as the receiver for a financial services company.

Within a short period of time Phillips began writing checks to himself that had nothing to do with payroll. What happened to Phillips? a. He quit his job and moved to another state. b. He pleaded guilty to fraud and grand theft and spent 24 months in prison. c. He paid the money back by mortgaging his home. d. He was charged criminally, and while out on bail, he fled with his family.

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Chapter 6 – Payroll Schemes 1. A _______________ is an individual on the payroll who does not actually work for the organization. a. Falsified employee b. Phantom employee c. Ghost employee d. Shell employee 2. Which of the following is not a type of payroll scheme? a. Ghost employee scheme b. False deduction scheme c. Falsified hours and salary scheme d. Commission scheme 3. Marsha Wood added her one-year-old niece, Jackie, to the payroll at JNC Company and began issuing paychecks in Jackie’s name, even though Jackie did not work for the organization. Marsha’s niece is not considered a ghost employee because she is a real individual rather than a fictitious person. a. True b. False 4. Which of the following is not necessary for a ghost employee scheme to succeed? a. Timekeeping and wage rate information must be collected. b. The ghost must be added to the payroll. c. The perpetrator must have access to a bank account in the ghost employee’s name. d. A paycheck must be issued to the ghost.

5. To safeguard against ghost employee schemes, the person in charge of entering new employees in the payroll system should also distribute the paychecks so that he or she can look for payments to unauthorized employees. a. True b. False 6. If a fraudster fails to remove a terminated employee from the payroll and collects the former employee’s fraudulent paychecks, he or she is committing a: a. Payroll larceny scheme b. Falsified hours and salary scheme c. Forged endorsement scheme d. Ghost employee scheme 7. Salaried ghost employees are generally easier to create and more difficult to conceal than hourly ghost employees a. True b. False

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8. Which of the following analyses can be used to identify ghost employee schemes? a. Identifying employees who have no withholding taxes taken out b. Comparing actual payroll expenses to budgeted expenses c. Comparing employees who have the same Social Security number, bank account, or physical address d. All of the above 9. Which of the following procedures will not help prevent ghost employee schemes? a. The personnel records are maintained separately from the payroll and timekeeping functions. b. The personnel department conducts background and reference checks on all prospective employees before hiring them. c. The person responsible for hiring new employees also supervises the payroll function. d. The personnel department verifies all changes to the payroll.

10. The most common method of misappropriating funds from the payroll is: a. Overpayment of wages b. Using a ghost employee c. Overstating commissions d. Theft of payroll deductions 11. Which of the following is not a method typically used by an employee to fraudulently inflate his or her hours in a manual timekeeping system? a. Collusion b. “Lazy manager” method c. Forging the supervisor’s signature d. Manipulating the pay grade 12. If an employee generates a much higher percentage of uncollected sales than his coworkers, what type of scheme might he be committing? a. Sales skimming b. Commission scheme c. Multiple reimbursement scheme d. Shell company scheme 13. Which of the following controls will help prevent and detect falsified hours and salary schemes? a. The duties of payroll preparation, authorization, and distribution are segregated. b. Sick leave and vacation time are monitored for excesses by the payroll department. c. Supervisors return authorized timecards to the employees for review before they are sent to the payroll department. d. All of the above 14. Which of the following computer audit tests can be used to detect ghost employee schemes?

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a. Extract users who can write checks and also add new employees in the payroll and timecard system. b. Extract all employees without a social security number. c. Compare employees reported per timecard system to the payroll system. d. All of the above 15. Which of the following can be used to test for commission schemes? a. Extract manual checks and summarize by salesperson and amount. b. Compare hours reported per timecard system to payroll system. c. Extract customer sale balances that exceed the customer credit limit. d. None of the above 16. Comparing actual payroll expenses to budget projections can help identify falsified hours and salary schemes. a. True b. False 17. Comparing salaried employees’ gross pay from one pay period to the next is one way of testing for payroll fraud. a. True b. False 18. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, payroll frauds are the most common type of fraudulent disbursement schemes. a. True b. False 19. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, payroll frauds are the least costly type of fraudulent disbursement schemes. a. True b. False 20. Jim Stevens is a payroll manager for a mid-sized insurance company in the southeast.

Last year, his performance review was conducted late, so he received a retroactive pay increase. Because he was not authorized to access his own employee records, Stevens stole another employee’s password and logged into the payroll system. He manipulated his records to keep the retroactive pay increase in effect in future periods, effectively doubling his intended pay raise. What type of fraud is this? a. Larceny of wages b. Falsified hours and salary scheme c. Commission scheme d. Ghost employee scheme 21. Ellie Weaver works for the JAG Group as the customer service supervisor. When Joel Carter was hired into her department, she listed his start date as one month before he actually began work. Accordingly, the payroll department generated an extra paycheck for Carter, which Weaver intercepted and cashed at a liquor store. What type of fraud is this?

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a. Forged endorsement scheme b. Ghost employee scheme c. Altered payee scheme d. Falsified wages scheme 22. Jed Butler is an internal auditor for Billings Industries. Recently he ran a program that identified customer accounts which had previously been dormant for six months or more but had sales in the last two months of the year. What type of fraud would this test most likely reveal? a. Shell company scheme b. Pay-and-return scheme c. Commission scheme d. Personal purchases scheme 23. During a review of A+ Service’s payroll records, Judy Penney, an internal auditor, noticed that Bradley Banks has no deductions taken from his paychecks for withholding taxes or insurance. She then searched for Banks in the personnel records, but could not locate him. Based on this information, what type of scheme did Penney most likely uncover? a. Ghost employee scheme b. Falsified salary scheme c. Fictitious vendor scheme d. None of the above 24. Orange Publishing hired Moe McDonnell, CFE, to investigate some large variances in the company’s labor costs. While looking through the payroll records for the shipping department, McDonnell noticed several employees who claimed extensive overtime during pay periods in which the company’s incoming and outgoing shipments were minimal. McDonnell pulled the timesheets for these pay periods and noticed that those belonging to the suspect employees had signatures that didn’t match the signatures on the other timesheets. What type of fraud might these findings indicate? a. Ghost employee scheme b. Commission scheme c. Falsified hours and salary scheme d. Overstated expenses scheme 25. Allison Duval, CFE, has been retained by National Mortgage Company to investigate some suspicious activity. As part of her examination, Duval compares the company’s payroll expenses to budgeted projections and to prior years’ totals. She also runs an exception report looking for any employees whose compensation has increased disproportionately over the prior year. She then compares the payroll files to the human resource files to test for differing salary rates. What type of scheme is Duval most likely looking for? a. Ghost employee scheme b. Payroll tampering scheme c. Commission scheme d. Falsified hours and salary scheme -4-

26. In one of the case studies in the textbook, Jerry Harkanell worked as an administrative assistant for a large San Antonio hospital, where his clerical duties included the submission of the payroll information for his unit. He found that he could add hours to the timesheets and receive extra pay. He continued to alter his timesheets until he was finally caught. How was his scheme detected? a. An exception report showed that Harkanell had claimed overtime hours for a period when there was no need to work overtime. b. The payroll department sent the timesheets for one pay period back to the supervisor for review when a suspicious number of hours had been indicated. c. An overtime audit was conducted revealing that Harkanell had worked an unusual number of hours compared to others in the department. d. The internal auditors received an anonymous tip.

27. In one of the case studies in the textbook, Jerry Harkanell worked as an administrative assistant for a large San Antonio hospital, where his clerical duties included the submission of the payroll information for his unit. He found that he could add hours to the timesheets and receive extra pay. He continued to alter his timesheets until he was finally caught. What red flag was present that should have made someone suspicious? a. He used erasable ink to record the hours on the timesheets. b. He showed up for work on a day he had off so he could personally turn in the timesheets. c. No one else in the department had overtime hours but Harkanell. d. All of the above 28. In one of the case studies in the textbook, Jerry Harkanell worked as an administrative assistant for a large San Antonio hospital, where his clerical duties included the submission of the payroll information for his unit. He found that he could add hours to the timesheets and receive extra pay. He continued to alter his timesheets until he was finally caught. How was the case resolved? a. He confessed to falsifying the overtime and was terminated. b. A civil suit was filed to recover the loss. c. He was convicted and sentenced to prison. d. None of the above 29. In one of the case studies in the textbook, Katie Jordon was the “All-American Girl Next Door” working her first job out of college. As an on-site manager for an apartment complex in Dallas, she did such a good job that when her employer purchased a huge apartment complex in Houston, she was asked to run it. All was well until a member of the maintenance crew resigned. She continued to keep him on the payroll and pocketed his wages. She later added a non-existent assistant once she saw how easy it was to add an employee without being questioned. However, her scheme eventually came to light, and her days of bonus pay were over. What was her motivation for stealing? a. Her boyfriend, a professional motocross racer, was injured in a race. b. She was getting married and needed money for the wedding. c. She blew the engine in her car and didn’t have the money to replace it.

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d. She wanted to pay off her college loan early so she could save for a house.

30. In one of the case studies in the textbook, Katie Jordon was the “All-American Girl Next Door” working her first job out of college. As an on-site manager for an apartment complex in Dallas, she did such a good job that when her employer purchased a huge apartment complex in Houston, she was asked to run it. All was well until a member of the maintenance crew resigned. She continued to keep him on the payroll and pocketed his wages. She later added a non-existent assistant once she saw how easy it was to add an employee without being questioned. However, her scheme eventually came to light, and her days of bonus pay were over. How was her scheme discovered? a. An employee tipped off the main office when she saw the timesheets listing an employee that she had never heard of. b. When Jordon’s boss made a routine visit to the office, he noticed that there was no sign of an assistant in the office. c. She was splitting the proceeds with her boyfriend, and he contacted the home office when she broke up with him. d. The auditors found it when they conducted a routine audit of all new acquisitions after being in business for one year.

31. In one of the case studies in the textbook, Katie Jordon was the “All-American Girl Next Door” working her first job out of college. As an on-site manager for an apartment complex in Dallas, she did such a good job that when her employer purchased a huge apartment complex in Houston, she was asked to run it. All was well until a member of the maintenance crew resigned. She continued to keep him on the payroll and pocketed his wages. She later added a non-existent assistant once she saw how easy it was to add an employee without being questioned. However, her scheme eventually came to light, and her days of bonus pay were over. What happened to Jordon? a. The company terminated her employment but failed to press charges against her in order to keep things quiet. b. She was convicted but served no jail time. c. She skipped town and a warrant was issued for her arrest. d. She took out a loan for the amount stolen and paid the company back in lieu of the company pressing charges against her.

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Chapter 7 – Expense Reimbursement Schemes 1. Because they leave a solid audit trail, expense reimbursement schemes are generally easier to detect than other types of fraud schemes. a. True b. False 2. Expense reimbursement schemes include which of the following? a. Multiple reimbursements b. Mischaracterized expenses c. Overstated expenses d. All of the above 3. Claiming personal travel as a business expense is an example of what type of expense reimbursement scheme? a. Multiple reimbursements b. Overstated expense reimbursements c. Mischaracterized expense reimbursements d. Altered expense reimbursements 4. Which of the following procedures can be used to prevent mischaracterized expense reimbursement schemes? a. A policy should be established and communicated to employees regarding what types of expenses will and will not be reimbursed. b. Employees should be required to sign their expense reports before being reimbursed. c. The internal audit department should review all expense reports under a certain dollar amount. d. None of the above 5. Which of the following procedures can be used to detect mischaracterized expense reimbursement schemes? a. Compare the dates of claimed reimbursable business expenses to the employees’ work schedules. b. Compare current expense reimbursement levels to amounts for prior years. c. Compare current expense reimbursement levels to budgeted amounts. d. All of the above 6. If an employee submits a photocopy of a receipt as support for a business expense, the expense should be independently verified before it is reimbursed. a. True b. False 7. An altered or forged receipt can indicate what type of expense reimbursement scheme? a. Mischaracterized expense reimbursements

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b. Fictitious expense reimbursements c. Overstated expense reimbursements d. All of the above 8. Permitting employees to book their own travel using their own credit card is an effective internal control over expense reimbursement schemes. a. True b. False 9. Which of the following methods can be used to perpetrate a fictitious expense reimbursement scheme? a. Creating counterfeit receipts b. Stealing blank receipts c. Submitting expenses that were paid by a third party d. All of the above 10. What type of expense reimbursement scheme occurs when an employee submits a receipt for an entertainment expense that a client paid for? a. Mischaracterized expense reimbursement b. Overstated expense reimbursement c. Fictitious expense reimbursement d. Duplicate reimbursement scheme 11. Which of the following is not considered a red flag of a fictitious expense reimbursement scheme? a. An employee repeatedly uses the company credit card for business travel expenses. b. An employee’s reimbursement requests are always for round-dollar amounts. c. An employee submits reimbursement requests that consistently fall just below the reimbursement limit. d. An employee frequently requests reimbursement for high-dollar items that he claims were paid for in cash.

12. To safeguard against expense reimbursement schemes, organizations should require that employee expense reports be reviewed and approved by a supervisor outside the requestor’s department. a. True b. False 13. According to the 2010 2012 Report to the Nations on Occupational Fraud and Abuse, expense reimbursement schemes are the least common type of fraudulent disbursement schemes. a. True b. False

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14. According to the 2010 2012 Report to the Nations on Occupational Fraud and Abuse, expense reimbursement schemes have a lower median loss than check tampering schemes. a. True b. False 15. Donna Holbrook, an administrative assistant at Mason Enterprises, charged some office supplies to the company credit card. Several weeks later, she attached the store receipt from the purchase to an expense report and requested reimbursement from the company. This is an example of which type of expense reimbursement scheme? a. Overstated expense b. Multiple reimbursement c. Mischaracterized expense d. Over-purchased reimbursement 16. Daniel Isley works as an internal auditor for Atlantic Insurance Co. While reviewing the company’s travel and entertainment expenses, Isley noticed that one employee had submitted several receipts from Chase’s Restaurant for round-dollar amounts just under the company’s reimbursement limit. Further, the receipts were consecutively numbered, but were submitted over a six-month period. What type of scheme did Isley most likely uncover? a. Fictitious expense reimbursement b. Multiple reimbursement c. Mischaracterized reimbursement d. None of the above 17. Charlene DiAngelo is a sales manager for Northwest Paper & Plastics. On April 11, she took some clients out for a business lunch to discuss a potential contract. When she returned to the office, she made a photocopy of her restaurant receipt. Using correction fluid, she changed the date on the photocopy to read June 11. She submitted the original restaurant receipt with a reimbursement request on April 11 and held on to the photocopy for 2 months. On June 12, she submitted the altered photocopy along with a second reimbursement request. What type of fraud scheme did DiAngelo commit? a. Altered receipt b. Fictitious expense reimbursement c. Billing d. Multiple reimbursement 18. Kevin Chitry, a sales executive for CIT Manufacturing, frequently took clients out for dinner and shows when they came to town to tour the plant. He usually paid for these expenses himself and submitted the receipts to his supervisor for approval and reimbursement. Occasionally, however, he also took his family out to restaurants and rock concerts and included these expenses in his reimbursement requests by indicating that he was entertaining a client. This type of fraud is known as a(n): a. Overstated expense reimbursement

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b. Mischaracterized expense reimbursement c. Fictitious expense reimbursement d. Altered receipt reimbursement 19. Linda Dudley, an employee of Bingham Company, was sent to an out-of-state conference to learn about the latest innovations in computer security. While she was at the seminar, her meals were picked up by a vendor hoping to get business from Bingham. Dudley also turned in receipts and requested reimbursement from her company for the same meals that the vendor paid for. What type of expense reimbursement fraud is this? a. Mischaracterized expense b. Overstated expense c. Fictitious expense d. None of the above 20. Daisy McMillan works as the office manager for Timball and Lewis, a medium-sized law firm. One afternoon, she went to the hardware store to purchase a few maintenance items for the office. While there, she also bought her husband a hammer as a birthday present. At the register, the items, including the hammer, totaled $63.

She paid for all the items together and received both a carbon copy receipt and a separate credit card receipt. Back at the office, she carefully scratched additional numbers on to the carbon copy receipt to increase the total price to $168 and turned in the altered receipt for reimbursement. Several weeks later, she turned in the credit card receipt along with another reimbursement request for the $63. What type of expense reimbursement fraud did she commit? a. Overstated expense reimbursement b. Multiple reimbursements c. Mischaracterized expense reimbursement d. All of the above 21. As the manager of a local auto-parts store, Manny Ortega was responsible for reimbursing employees when they purchased supplies for the store with their own money. When employees brought Ortega their receipts for reimbursement, he would often alter the receipts to show a larger amount. Then he would ring a “no sale” on the cash register, remove the full amount per the altered receipt, and pocket the excess. Because the employee received the expected amount and the register totals remained in balance, Ortega was able to continue this scheme for nearly 2 years before being caught. What type of fraud did Ortega commit? a. Overstated expense reimbursement scheme b. Mischaracterized expense reimbursement scheme c. Register disbursement scheme d. None of the above 22. Phil O’Hara is an internal auditor for the Shield Corporation. Recently he ran a report that listed payments to employees for business expenses that occurred while the employee was on vacation. What type of fraud scheme is Phil most likely to find?

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a. Cash larceny b. Forged expenses c. Overstated expense reimbursement d. Mischaracterized expense reimbursement 23. Remy Lewis has just started working as a marketing research analyst for Commercial Casting Company in New York City. He is relocating his family to New York from North Carolina, but they haven’t moved yet. Twice a month, the company pays for Lewis to travel to North Carolina to visit his family and help with the move. During the month of September, Lewis only visited his family once; however, he submitted expense reports for mileage for two separate trips to North Carolina and back. What type of scheme is this? a. Mischaracterized expense reimbursement b. Billing c. Fictitious expense reimbursement d. None of the above 24. In one of the case studies in the textbook, Marcus Lane, a geologist for an environmental management and engineering services firm, traveled all over North and South America as part of his job, resulting in numerous expense reimbursements.

Unfortunately, Lane went too far and began to double book his air travel using his personal credit card. He booked two separate flights to the same location, but with a huge cost difference. He used the cheaper ticket for the actual flight and returned the more expensive ticket for credit. And, of course, he submitted the more expensive ticket for reimbursement. How was his scheme detected? a. The internal auditor discovered it during a routine audit of expense reimbursements. b. The department’s administrative assistant took a message from the travel agency about a trip that she knew Lane didn’t take. c. Lane’s manager received an anonymous tip. d. The external auditors discovered it while sampling expenses during their annual audit.

25. In one of the case studies in the textbook, Marcus Lane, a geologist for an environmental management and engineering services firm, traveled all over North and South America as part of his job, resulting in numerous expense reimbursements.

Unfortunately, Lane went too far and began to double book his air travel using his personal credit card. He booked two separate flights to the same location, but with a huge cost difference. He used the cheaper ticket for the actual flight and returned the more expensive ticket for credit. And, of course, he submitted the more expensive ticket for reimbursement. What changes to internal controls were made as a result of Lane’s fraud? a. Enforcement of a new policy that business expenditures other than travel be charged to personal credit cards only b. Clarification and better enforcement of the policy that all travel be booked through the company travel agent using a designated company credit card

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c. Enforcement of a new policy that employees submit their travel expense reports for reimbursement within five days of returning from a trip d. All of the above 26. In one of the case studies in the textbook, Marcus Lane, a geologist for an environmental management and engineering services firm, traveled all over North and South America as part of his job, resulting in numerous expense reimbursements.

Unfortunately, Lane went too far and began to double book his air travel using his personal credit card. He booked two separate flights to the same location, but with a huge cost difference. He used the cheaper ticket for the actual flight and returned the more expensive ticket for credit. And, of course, he submitted the more expensive ticket for reimbursement. How was he punished? a. He was convicted of grand theft and received probation. b. He resigned from the company and a civil suit was filed against him. c. He was terminated and agreed to pay the money back. d. He was allowed to resign and the company agreed not to seek a refund if it was kept quiet.

27. In one of the case studies in the textbook, Cy Chesterly was the vice president in charge of sales for one of the largest machine parts manufacturers in the Midwest. He was an excellent salesman and helped build the company into one of the most successful in the industry. While Chesterly was known to go overboard on the entertainment expenses, he really went wild when it came to buying personal items— vacations, furniture, and jewelry to name a few. How was he caught? a. He purchased one too many high-ticket items for his son and this was brought to the attention of the CEO. b. A new president was hired and he found Chesterly out while reviewing the accounting records. c. Chesterly became ill and the receipts for personal items were found while he was out sick. d. The internal auditors found Chesterly out during an audit of his cost center’s expenses.

28. In one of the case studies in the textbook, Cy Chesterly was the vice president in charge of sales for one of the largest machine parts manufacturers in the Midwest. He was an excellent salesman and helped build the company into one of the most successful in the industry. While Chesterly was known to go overboard on the entertainment expenses, he really went wild when it came to buying personal items— vacations, furniture, and jewelry to name a few. What other frauds turned up in the investigation? a. Chesterly put his girlfriend on the payroll as a ghost employee. b. Chesterly skimmed some of the cash sales. c. Chesterly falsified sales figures to collect unearned bonuses. d. Chesterly cut special deals to his customers and received kickbacks in return.

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29. In one of the case studies in the textbook, Cy Chesterly was the vice president in charge of sales for one of the largest machine parts manufacturers in the Midwest. He was an excellent salesman and helped build the company into one of the most successful in the industry. While Chesterly was known to go overboard on the entertainment expenses, he really went wild when it came to buying personal items— vacations, furniture, and jewelry to name a few. He was caught, however, and his lifestyle came to a halt. What was the most likely reason that the company didn’t have Chesterly prosecuted? a. Chesterly was well liked by everyone and, with new management coming in, the company thought that prosecuting him would have a negative impact on morale. b. Chesterly’s wife became seriously ill and the company felt that it would have been too much of a blow to her recovery if he were in prison. c. Some of the company’s customers were believed to have been involved in Chesterly’s schemes. d. He agreed to mortgage his home to repay the money.

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Chapter 8 – Register Disbursement Schemes 1. Register disbursement schemes are different from skimming and larceny at the register in that they: a. Are on-book schemes, where as skimming and larceny are off-book schemes b. Require the use of an accomplice c. Leave a record of the removal of money on the register tape d. All of the above 2. Which of the following is a type of register disbursement scheme? a. Fictitious refunds b. Overstated refunds c. False voids d. All of the above 3. When an employee perpetrates a credit card refund scheme, the perpetual inventory will show a greater amount than the physical inventory. a. True b. False 4. An excessive number of reversing sales transactions at the register is an indicator of which of the following schemes? a. Skimming b. Register disbursement c. Pass-through scheme d. Multiple reimbursements 5. Register disbursement schemes are difficult to conceal because they cause the cash drawer to be out of balance with the cash register tape. a. True b. False 6. Which of the following can be used to conceal a false refund scheme? a. Destroying register tapes b. Issuing refunds below the review limit c. Forcing inventory totals d. All of the above 7. For the perpetrator, the most dangerous part of a typical register disbursement scheme is often: a. Physically removing the cash from the register and carrying it out of the store b. Adjusting the cash register tape to match the cash count c. Replacing the returned merchandise in the physical inventory d. Forging the customer receipt as documentation for the reversing transaction

8. To safeguard against false voids schemes, companies should require a copy of the customer’s receipt from the initial purchase as documentation for voided sales. a. True b. False 9. Which of the following tests can be used to detect register disbursement schemes? a. Extract the top 10 employees with the lowest sales activity. b. Identify and examine unique journal entries in the cash accounts. c. Identify customer sales posted to one credit card and refunds posted to another credit card. d. None of the above 10. Running a computer program that compares adjustments to inventory to the void/refund transactions summarized by employee can detect which of the following schemes? a. Register disbursement schemes b. Cash larceny schemes c. Skimming schemes d. All of the above 11. According to the textbook, the best way for an organization to prevent fraudulent register disbursements is to: a. Have each employee compare the cash in his or her register drawer to the register tape at the end of each shift. b. Maintain appropriate separation of duties. c. Have a policy requiring photocopied receipts for sales refunds. d. All of the above 12. Which of the following procedures can be used to prevent and detect a register disbursement scheme? a. Randomly call customers who have returned merchandise or voided sales. b. Restrict access to the control key or management code that authorizes reversing transactions. c. Place signs around the store encouraging customers to ask for and examine their receipts. d. All of the above 13. Sara Michaels works as a sales associate in the shoe department at a large chain department store. To supplement her income, Sara processed multiple fictitious refunds on sales made to customers. This is an example of what type of asset misappropriation? a. Register disbursement fraud b. Pay and return scheme c. Skimming scheme d. Cash larceny scheme

14. Billy Mitchell is the head cashier for a clothing store that specializes in men’s silk suits. After losing big at the local dog track, Billy was in the hole financially. To cover his gambling debts, he started issuing numerous refund credits to his own credit card for amounts just below the store’s review limit. This is an example of a __________________ scheme. a. Cash larceny b. Credit card skimming c. Fictitious refunds d. Understated reimbursement 15. Leslie White, CFE, was called in to investigate suspicious activity at Anderson’s Department Store. During her investigation, she ran a test to search for customer sales and refunds that occurred on the same day. She also summarized refunds by employee and extracted the names of all employees who can post both refunds and inventory adjustments. What type of scheme is Leslie most likely looking for? a. Skimming b. Unconcealed larceny c. Fraudulent reimbursements d. Fictitious refunds 16. Meredith Chapman works as a retail clerk at a children’s clothing store. When a customer returns an item for a cash refund, Meredith enters an amount greater than the actual refund into the register, pays the customer the amount owed for the returned merchandise, and keeps the excess cash for herself. What type of scheme is Meredith committing? a. Overstated expenses b. Cash larceny c. Overstated refunds d. Skimming 17. Greg Manor is the sales manager at County Arts & Crafts Supply. Recently he has received several complaints from customers who claim they were not given a receipt for their purchases. What type of scheme might this situation indicate? a. Skimming b. False refunds c. False voids d. All of the above 18. Nicolas Barrens conspired with his manager to steal nearly $6,000 over 2 months from the grocery store where they worked. Each time Nicolas rang up a customer at the register, he asked the customer if he’d like a receipt. When a customer said no, Nicolas pretended to discard the receipt in the trash, but actually slipped the receipt into his pocket. At the end of his shift, he filled out a void slip for each of these sales and submitted them to his supervisor for approval. With the original receipt and the approved void slip, Nicolas removed cash from the register in the amount of the

voided sales and split the proceeds with his supervisor. Nicolas committed what type of fraud scheme? a. Fictitious expenses b. False voids c. Skimming d. None of the above 19. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, register disbursement schemes were the most frequently reported type of fraudulent disbursement scheme. a. True b. False 20. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, median losses due to register disbursement schemes were the highest of all the fraudulent disbursement schemes. a. True b. False 21. In one of the case studies in the textbook, Bob Walker was the head cashier for a discount drug store who perpetrated his fraud scheme by issuing fictitious refunds.

What was Walker’s motive for committing the crime? a. His wife became ill and needed money to pay for prescription drugs. b. He had been demoted from a management position and wanted to get back at the store. c. He lost a lot of money gambling and was too embarrassed to tell his wife. d. He had accumulated nearly $60,000 in credit card debt and was about to lose his house.

22. In one of the case studies in the textbook, Bob Walker was the head cashier for a discount drug store who perpetrated his fraud scheme by issuing fictitious refunds.

How was the fraud discovered? a. The bookkeeper noticed an unusually large number of policy overrides by Walker. b. The internal auditor developed a computer program that identified cashiers with an unusually high number of returns. c. The store manager caught Walker pocketing cash. d. An anonymous tip from the company’s hotline came into the asset protection department.

23. In one of the case studies in the textbook, Bob Walker was the head cashier for a discount drug store who perpetrated his fraud scheme by issuing fictitious refunds.

What happened to Walker? a. He was placed on probation and ordered to make full restitution. b. The store terminated his employment and accepted a promissory note for the amount stolen in return for not turning him over to the police.

c. His parole for a previous conviction was revoked and he was returned to prison. d. He was arrested, but disappeared after making bail.

24. In one of the cases in the textbook, Joe Anderson, a part-time shoe salesperson at a department store, perpetrated a fictitious returns scheme using third-party credit cards. Why was a fraud examination initiated? a. Another employee witnessed Anderson pocketing cash and reported the incident. b. The shoe department was losing money and had a high rate of returns on its shoes. c. The store’s surveillance camera caught Anderson pocketing the money. d. Anderson credited the wrong account and the customer called up to inquire as to why her credit card had been credited.

25. In one of the cases in the textbook, Joe Anderson, a part-time shoe salesperson at a department store, perpetrated a fictitious returns scheme using third-party credit cards. What happened as the result of the investigation? a. Anderson was terminated and promised to pay back all the fraudulent proceeds. b. The department store recovered most of its losses through its bonding company. c. Local and federal charges for embezzlement and financial transaction card fraud were brought against Anderson and 27 co-conspirators. d. All of the above

Chapter 9 – Non-Cash Assets

1. Borrowing a company asset for personal use without permission, even if it is returned unharmed, is a form of non-cash asset misappropriation. a. True b. False 2. Which of the following is not a red flag in a fraudulent shipment scheme? a. An increase in bad debt expense b. An unexplained decrease in the scrap account c. Unusually high levels of reorders for inventory items d. Shipments with missing sales documents 3. Manually altering entries in an organization’s books in order to conceal fraud is called: a. Padding the books b. Forced reconciliation c. Shrinkage d. Fictitious reconstruction 4. To prevent fraudulent shipments of merchandise, organizations should: a. Match every receiving slip to an approved purchase order. b. Match every outgoing shipment to a sales order. c. Make sure that all increases to perpetual inventory records are supported by proper source documents. d. All of the above 5. Which of the following methods can be used to conceal inventory shrinkage on a company’s books? a. Creating fictitious sales and receivables b. Writing off inventory as obsolete c. Physical padding d. All of the above 6. An employee causes his organization to purchase merchandise that it does not need.

This is an example of what type of scheme? a. Purchasing and receiving scheme b. False billing scheme c. Unconcealed larceny scheme d. Asset requisition scheme 7. An unexplained increase in uncollectible accounts receivable may be a warning sign of a non-cash asset misappropriation scheme involving false shipments of inventory.

a. True b. False 8. Of the following, which is the best method for detecting the theft of inventory? a. Have the warehouse manager personally oversee bi-monthly inventory counts. b. Have someone from purchasing conduct inventory counts every quarter. c. Have a designated person in customer service follow-up with customers who have complained about short shipments. d. Match vendor addresses against employee addresses.

9. To deter inventory theft schemes, organizations should install security cameras in the warehouses without the employees’ knowledge. a. True b. False 10. Which of the following procedures would be least helpful in preventing larceny of non-cash assets? a. Segregating the duties of sales and accounts payable b. Installing surveillance cameras in the warehouse and on sales floors c. Creating access logs to track employees that enter restricted areas d. Employing security guards at the entrance of the warehouse 11. The unaccounted-for reduction in the company’s inventory that results from theft is called: a. Physical defalcation b. Spoilage c. Shrinkage d. Misappropriation of intangible assets 12. Unexplained increases in inventory shrinkage can be a red flag that signals which type of fraud scheme? a. Fictitious refunds b. Inventory larceny c. Sales skimming d. All of the above 13. Which of the following computer audit tests can be used to detect purchasing and receiving schemes? a. Identifying dormant customer accounts for the past six months that show a sale in the last two months of the year b. Calculating the ratio of the largest sale to the next largest sale by customer c. Extracting all inventory coded as obsolete and possessing reorder points within the inventory system d. All of the above

14. Which of the following computer audit tests can be used to detect an inventory misappropriation scheme? a. Identifying inventory receipts in the receiving system that do not agree to the receipts per the accounts payable system b. Identifying inventory shipments delivered to an address that is not designated as a business address c. Identifying inventory with a negative quantity balance d. All of the above 15. Running a computer program that identifies shipping documents with no associated sales order can detect which of the following non-asset cash misappropriation schemes? a. False shipments b. Purchasing and receiving schemes c. Unconcealed inventory larceny d. Asset requisition schemes 16. Which of the following is not a method used to conceal false shipments of inventory? a. Creating false sales orders b. Falsely increasing the perpetual inventory c. Writing off the inventory as scrap d. Physical padding 17. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, noncash schemes occur more frequently than cash schemes. a. True b. False 18. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, cash schemes have a higher median loss than non-cash schemes. a. True b. False 19. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, the theft of which type of non-cash asset was the least common but caused the highest median loss? a. Equipment b. Proprietary information c. Securities d. Inventory 20. Andy Kaplan is a foreman for JCP Enterprises, a regional construction company. He recently ordered some plumbing supplies from the company warehouse for an office building project he is overseeing. When the supplies arrived at the job site, however, he loaded them in his truck and took them home to use in remodeling his master bathroom. What kind of inventory theft scheme did Andy commit?

a. b. c. d.

False shipments Unconcealed larceny Asset requisition Misappropriation of intangible assets

21. Nicolette Garrison works part-time at an independent record store. Whenever her friend, Jacob Barker, comes into the store during one of her shifts, he picks up a CD and brings it to the register where Nicolette is stationed. After ringing a “no sale” transaction on the cash register, Nicolette pretends to swipe Jacob’s credit card for payment. She puts the CD in a bag and gives it to Jacob, who walks out without actually paying for the merchandise. What kind of scheme is being committed? a. Fake sale b. False refund c. Sales skimming d. Cash larceny 22. Ben Rogers works as a cashier for Tillis Sporting Goods. One afternoon, he asked his sister Dawn to come into the store. When she arrived, Ben put three watches, two fishing reels, and four pairs of sunglasses in a sack and gave it to her. Dawn walked out of the store, sold two of the watches, and returned to the store later to return the other items for a refund. What type of asset misappropriation has been committed? a. Sales skimming b. Pay-and-return scheme c. False refund scheme d. Inventory larceny scheme 23. Ace Electronics is a company that sells computers, televisions, home entertainment centers, DVD players, and other electronic equipment. A downturn in the market has caused severe financial problems in the company. In order to fool the auditors as they begin their inventory count, several of Ace’s managers have begun stacking empty boxes in the warehouse to create the illusion of extra inventory. This scheme is known as: a. Forced reconciliation b. Physical padding c. Inventory shuffling d. Misappropriation of intangible assets 24. To supplement her income, Jeanne Lester decided to start her own bookkeeping business while still working as an office assistant at Howe & Lyon, a small CPA firm.

Not having much start-up capital for her new business, she used her phone at work to contact clients and her work computer to print invoices and client letters. However, she ordered and paid for her own office supplies and used her own postage stamps to mail the invoices and letters. From the information given, has Jeanne misappropriated any of the firm’s assets?

a. Yes b. No 25. In one of the cases in the textbook, Larry Gunter was a shipping clerk for a computer company that manufactured microprocessor chips. After learning that the chips were valuable, he stole three boxes and sold them to his girlfriend’s father. Since the scheme worked so well the first time, he continued stealing and selling the chips, even letting a co-worker in on the scheme. How was the theft discovered? a. A security guard found the chips in a routine check of his work cart. b. An inventory manager filling an order noticed that many of the chips were missing. c. The auditors found the shortage when they conducted the annual inventory count. d. His co-worker notified the loss prevention department in exchange for a cash award.

26. In one of the cases in the textbook, Larry Gunter was a shipping clerk for a computer company that manufactured microprocessor chips. After learning that the chips were valuable, he stole three boxes and sold them to his girlfriend’s father. Since the scheme worked so well the first time, he continued stealing and selling the chips, even letting a co-worker in on the scheme. How was Gunter punished? a. He was arrested, charged with grand theft and embezzlement, and sentenced to prison. b. He was indicted for receiving stolen property, placed on probation, and ordered to repay the company for the value of the stolen chips. c. The company fired him but agreed not to prosecute him if he repaid the money and did not go to the media. d. He wasn’t, because he found out about the investigation and skipped town on the day he was to be arrested.

27. In one of the cases in the textbook, Swainler’s Technology discovered that someone had stolen 1,400 hard drives from its computer warehouse. In order to collect on its theft insurance policy, the company had to show that the theft was an outside job.

Before the insurance company paid Swainler’s claim, it hired an independent investigator, who ultimately found that the hard drives were stolen and sold by Swainler’s marketing manager, Frederic Boucher. How did the investigator identify Boucher’s involvement? a. Boucher’s ex-wife found out and contacted Swainler’s board of directors. b. A former employee of Swainler’s went to work for a competitor and told his manager about Boucher’s involvement. c. The investigator found telephone calls made by Boucher to a warehouse where some of the stolen drives had been traced. d. Investigators found a large cash deposit in Boucher’s bank account around the time that the drives went missing.

28. In one of the cases in the textbook, Swainler’s Technology discovered that someone had stolen 1,400 hard drives from its computer warehouse. In order to collect on its

theft insurance policy, the company had to show that the theft was an outside job.

Before the insurance company paid Swainler’s claim, it hired an independent investigator, who ultimately found that the hard drives were stolen and sold by Swainler’s marketing manager, Frederic Boucher. Which of the following control weaknesses were present in the company? a. Because the company was run primarily on trust, many transactions were conducted without any documentation or controls. b. The surveillance cameras on the loading dock didn’t work. c. Background checks were required only on senior executives and accounting personnel. d. All of the above

Chapter 10 – Corruption 1. Which of the following is not a type of corruption scheme? a. Bribery b. Conflict of interest c. Illegal gratuities d. Concealed payments 2. ___________________ is the offering, giving, receiving, or soliciting of something of value as a reward for a favorable decision. a. Business diversion b. Economic extortion c. Illegal gratuity d. Commercial bribery 3. The offering, giving, receiving, or soliciting of something of value for the purpose of influencing a business decision without the knowledge or consent of the principal is known as: a. Official bribery b. Commercial bribery c. Conflict of interest d. Illegal gratuity 4. Which of the following is a type of kickback scheme? a. Improper disclosure b. Overbilling c. Turnaround sale d. Extortion 5. A corruption scheme in which several bidders conspire to split contracts, thereby ensuring that each gets a certain amount of work, is known as: a. Bid pooling b. Bid rigging c. Bid division d. Bid diversion 6. To deter kickback schemes, an organization should implement which of following procedures? a. Separate the purchasing, authorization, and cash disbursements functions. b. Track purchase levels by vendor. c. Compare the prices paid for goods and services to market rates. d. All of the above

7. The key component to most kickback schemes is: a. Forged endorsements b. Counterfeit invoices c. Price inflation d. Stealing customer statements 8. Which of the following is a red flag indicating that an employee may be receiving kickbacks? a. The purchase of inferior-quality inventory or merchandise b. An unusually high volume of purchases from a particular vendor c. The payment of purchase amounts that are frequently above market rates d. All of the above 9. To facilitate a bribery scheme, a fraudster might divert company funds to a noncompany account from which the illegal payments can be made. This account is called a: a. Slush fund b. Petty cash fund c. Bid pool d. None of the above 10. To safeguard against kickback schemes, which of the following procedures should an organization implement? a. Have an employee in the purchasing department review the organization’s payment patterns on a quarterly basis. b. Establish a written policy specifying that employees cannot accept more than $500 annually in gifts from customers or suppliers. c. Prohibit employees from engaging in any transaction on behalf of the organization when they have an undisclosed personal interest in the transaction. d. All of the above 11. Which of the following would likely not be a potential target for accepting bribes in a big-rigging scheme? a. A product assurance representative b. An accounts payable clerk c. A contracting official d. The engineer in charge of the project’s technical specifications 12. The typical bid-rigging scheme committed during the need recognition phase of the contract negotiation process involves defining a “need” that can be met only by a certain supplier or contractor. a. True b. False 13. Which of the following is a red flag that might indicate that a bid-rigging scheme is occurring?

a. b. c. d.

The contract price is unusually low.

A high bid is followed by amendments that reduce the payments to the contractor.

The losing bidders become sub-contractors on the project.

Many more bidders responded to the request for proposals than expected.

14. If a government employee agrees to award a contract to a vendor in exchange for a promise of future employment, this is considered to be an illegal gratuity. a. True b. False 15. The primary approach for preventing conflicts of interest schemes is to develop and implement which of the following? a. A voucher system b. A company ethics policy c. A document retention program d. An anonymous reporting mechanism to receive tips and complaints 16. If an employee approves payment on an invoice that originates from a real company in which he or she has a hidden economic interest, this is considered to be a conflict of interest scheme. a. True b. False 17. Which of the following schemes can be detected by identifying vendor addresses that are not designated as a business address? a. Shell company schemes b. Kickback schemes c. Conflicts of interest d. All of the above 18. Extracting round-dollar payments and summarizing them by vendor can help detect both corruption and billing schemes. a. True b. False 19. Identifying trends in over-purchased and/or obsolete inventory over several periods is a proactive computer audit test that can be used to detect which of the following schemes? a. False purchases b. Corruption c. Overstated expenses d. None of the above 20. Matching the vendor master file to the employee master file is a proactive computer audit test that can be used to detect which type of fraud scheme(s)? a. Bribery b. Shell company

c. Both bribery and shell company d. None of the above 21. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, schemes involving corruption were the least common of the three types of occupational fraud schemes. a. True b. False 22. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, the median loss due to corruption schemes was the highest of the three types of occupational fraud schemes. a. True b. False 23. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, bribery schemes occurred more often than other types of corruption schemes. a. True b. False 24. Stanley Block works in the IT department at Towery, Inc. After finding out that the company is planning to purchase four more computers for the accounting department, Stanley bought four computers from a friend for $1,200. Then, using his brother’s name and address as vendor information, he resold the computers to Towery for $2,300. This type of scheme is known as a(n): a. Over-purchase sale b. Resource diversion sale c. Double-sided sale d. Turnaround sale 25. Johanna Pye is a hair stylist at Mamon Salon. The salon’s policy states that stylists receive 40 percent of the revenue they generate as their compensation. Johanna grew tired of sharing her income with the salon and decided she wanted to make more money. She continued seeing her existing clients at the salon, but when new clients called for an appointment, Johanna lied and told them the salon was completely booked for the next few months. She then offered to come to their homes and cut their hair for 10 percent less than what the clients would be charged at the salon. She did not report the house call appointments to the salon, and was therefore able to keep all the income she generated from these side clients. This is an example of what type of scheme? a. Shell company b. Resource diversion c. Business diversion d. Double dealing

26. Fred Weaver is the contracts manager for a city government. In order for anyone to do business with the municipality, he or she must pay Fred 10 percent of the total amount of the contract. This type of corruption is known as: a. Bribery b. Economic extortion c. A conflict of interest d. Bid-rigging 27. Abe Wilson works as a city councilman in large city on the east coast. As part of his duties, he negotiated the purchase of some land in order to build a new water treatment plant for the city. The land was sold to the city by Jake Bryan for terms that were favorable to the city. After the sale was finalized, Bryan treated Abe and his wife to an all-expenses-paid Alaskan cruise. This type of fraud is known as: a. A conflict of interest b. Bribery c. An illegal gratuity d. Economic extortion 28. John Clark works as a land buyer for a city government. After negotiating the purchase of a parcel of land to be used for a new library, he asked the seller out for a coffee date, and she accepted. This situation is an example of an illegal gratuity. a. True b. False 29. Julius Smith is a purchasing agent for a Louisiana state agency. He has a project budgeted for $24,000 that he would like to hire RGS Consultants to handle.

Unfortunately for Julius and RGS Consultants, the state has a requirement that all projects over $10,000 must be sent out for competitive bids. In order to avoid the bidding process, Julius breaks the project into three component projects worth $8,000 each. RGS Consultants is subsequently awarded the contracts for all three projects.

What type of bid-rigging scheme is this? a. Bid pooling b. Underbidding c. Bid splitting d. Bid diversion 30. Donna Boyd is an internal auditor for GDP, Inc., an electronics manufacturer. While conducting a routine review of the company’s inventory costing, she discovers that the cost of one of the parts they use in manufacturing DVD players has been steadily increasing over the last six months and is now much higher than the general market price. Additionally, she notices that the company has been heavily favoring one specific supplier for that part. Based on these circumstances, what type of fraud scheme may be occurring at GDP? a. Kickbacks b. Conflict of interest c. Shell company d. Any of the above

31. In one of the case studies in the textbook, the General Services Administration (GSA), the federal government’s bookkeeping agency, purchased more than $200 million worth of defective and useless furniture from a New Jersey furniture manufacturer. After reviewing the books of the furniture manufacturer, it was clear that the company was paying off GSA inspectors. How did the investigation get started? a. A whistleblower called the GSA’s hotline to report that inspectors in New Jersey were receiving bribes for certifying the furniture. b. A series of articles in a Washington, D.C., newspaper led to a congressional investigation. c. An audit conducted by the GSA found a high rate of return of modular furniture during a six-month period. d. A senator had his desk collapse when he threw his sub-committee’s budget on his desk after a hearing.

32. In one of the case studies in the textbook, the General Services Administration (GSA), the federal government’s bookkeeping agency, purchased more than $200 million worth of defective and useless furniture from a New Jersey furniture manufacturer. After reviewing the books of the furniture manufacturer, it was clear that the company was paying off GSA inspectors. The investigators eventually focused on one particular regional inspector because: a. He vacationed in Europe with the vendor and charged the trip back to the government as a business related trip. b. He paid cash for a new home on the Jersey shore. c. He purchased eleven race horses. d. He had credit card charges of more than twice his annual salary during a sixmonth period.

33. In one of the case studies in the textbook, the General Services Administration (GSA), the federal government’s bookkeeping agency, purchased more than $200 million worth of defective and useless furniture from a New Jersey furniture manufacturer. After reviewing the books of the furniture manufacturer, it was clear that the company was paying off GSA inspectors. What happened to the furniture manufacturing company? a. It was charged with making false certifications and fined $2 million. b. It lost its contract with the GSA and went bankrupt. c. It was bought by another company. d. All of the above 34. In one of the case studies in the textbook, Rita Mae King was a purchasing agent at an electronics and appliance chain. She frequently worked with travel vendors and managed to put Spicewood Travel on the top of the preferred vendor list. Upon investigation, the fraud examiners discovered that she ran her own travel agency out of her office at the store and received kickbacks from Spicewood Travel in return for having her company use them to book trips. What triggered the investigation of Rita Mae King’s activities?

a. Her supervisor found an invoice for a trip that she booked showing she received an employee discount from Spicewood Travel. b. An employee from Spicewood Travel called King’s office and left an urgent message for King to call them concerning a travel problem with a group she booked to the Cayman Islands. c. Another employee of her company found a business card that she had left in a fishbowl for a drawing showing that she was an employee of Spicewood Travel. d. Her former boyfriend called the loss prevention department’s hotline and informed them that she was receiving kickbacks from Spicewood Travel.

35. In one of the case studies in the textbook, Rita Mae King was a purchasing agent at an electronics and appliance chain. She frequently worked with travel vendors and managed to put Spicewood Travel on the top of the preferred vendor list. Upon investigation, the fraud examiners discovered that she ran her own travel agency out of her office at the store and received kickbacks from Spicewood Travel in return for having her company use them to book trips. Why didn’t the company pursue legal action against King? a. The company didn’t want the publicity so they quietly let her resign. b. The vice president of loss prevention recommended against criminal action because of King’s age and her husband’s ill health. c. There was not enough evidence to pursue a conviction. d. Spicewood Travel agreed to reimburse the company for overcharges if they wouldn’t pursue criminal action against King.

Chapter 11 – Accounting Principles and Fraud 1. According to COSO’s study, Fraudulent Financial Reporting: 1998-2007, which of the following is the most likely to commit financial statement fraud? a. Organized criminals b. Mid-level employees c. The chief exective officer and/or chief financial officer d. Lower-level employees 2. Which of the following is a reason that a chief executive officer might commit financial statement fraud? a. To receive or increase a performance bonus b. To avoid termination due to poor performance c. To conceal the company’s true performance d. All of the above 3. Senior management is most likely to understate business performance in the financial statements for which of the following reasons? a. To reduce the value of an owner-managed business for purposes of a divorce settlement b. To comply with loan covenants c. To increase the value of a corporate unit whose management is planning a buyout d. To trigger performance-related compensation or earn-out payments 4. Which of the following is not a reason that senior management would overstate business performance to meet certain objectives? a. To meet a lender’s criteria for granting/extending loan facilities b. To meet or exceed the earnings or revenue growth expectations of stock market analysts c. To reduce current expectations so that future growth will be better perceived and rewarded d. To increase the amount of financing available from asset-based loans 5. If a fraudster manipulates the assumptions used to calculate depreciation charges in order to increase earnings to a desired figure, which general method of financial statement fraud is the fraudster using? a. Going outside the accounting system b. Beating the accounting system c. Going around the accounting system d. Playing the accounting system 6. When a fraudster feeds fictitious information into the accounting system in order to manipulate reported results, this is called: a. Going outside the accounting system b. Beating the accounting system c. Going around the accounting system d. Playing the accounting system

7. If a fraudster uses his computer to produce fictitious financial statements while completely ignoring the data in the accounting system, this is an example of what general financial statement fraud method? a. Beating the accounting system b. Playing the accounting system c. Going outside the accounting system d. None of the above 8. The conceptual framework for financial reporting includes several assumptions that underlie generally accepted accounting principles. Which of the following is one of these assumptions? a. Economic entity b. Relevance c. Matching d. Comparability 9. Fraudulent manipulation of the going concern assumption usually results from an organization trying to conceal its terminal business situation. a. True b. False 10. Intentionally reporting product sales in the financial statements for the period prior to when they actually occurred is a violation of which generally accepted accounting principle? a. Periodicity b. Matching c. Historical cost d. Revenue recognition 11. The financial statements for DRG Industries contain a misstatement that is so significant that reasonable investors would likely make a different investment decision if they were given the correct information. What concept of GAAP applies to this situation? a. Full disclosure b. Revenue recognition c. Materiality d. Cost-benefit 12. Walden Industries is being sued by a former employee for wrongful termination. It is probable that the company will lose the case and be ordered to pay the plaintiff a significant sum of money. If Walden fails to report this information somewhere in its financial statements, it is violating the GAAP concept of: a. Materiality b. Full disclosure c. Matching d. Cost-benefit

13. The conservatism constraint for financial reporting states that, if there is any doubt, companies should aim to avoid overstating assets and income. a. True b. False 14. A company’s financial statements are the responsibility of: a. The independent auditors b. The shareholders c. The accounting department d. Management 15. The term “financial statement” does not include a statement of cash receipts and disbursements, because this type of presentation violates the required use of accrual accounting under GAAP. a. True b. False 16. Which of the following is not one of the provisions established under the SarbanesOxley Act? a. Code of ethics for senior financial officers b. Management assessments of internal controls c. The creation of the Public Accounting Standards Board d. Criminal penalties for altering documents 17. As the result of the Sarbanes-Oxley Act, the Securities Exchange Commission has implemented which of the following rules? a. New standards of professional conduct for attorneys b. Insider trades during pension fund blackout periods c. Conditions for use of non-GAAP financial measures d. All of the above 18. Which of the following is a duty of the Public Company Accounting Oversight Board? a. Registering accounting firms that audit publicly traded companies b. Establishing or adopting standards relating to audits of publicly traded companies c. Enforcing compliance with professional standards and securities laws relating to public company audits d. All of the above 19. Investigating registered public accounting firms and their employees, conducting disciplinary hearings, and imposing sanctions where justified are duties of which of the following bodies? a. General Accounting Office’s Oversight Board b. Public Company Accounting Oversight Board c. AICPA’s Accounting Standards Board d. SEC’s Subcommittee on Corporate Governance

20. Under Sarbanes-Oxley, chief executive officers and chief financial officers are required to personally certify annual and quarterly SEC filings. Which of the following is an item that they must certify in their reports? a. They have disclosed to the audit committee any material control weakness. b. The financial statements were prepared in conformity with GAAP. c. The company’s internal controls have prevented or detected all material instances of fraud during the last year. d. All of the above 21. The Sarbanes-Oxley Act provides that members of the audit committee may receive compensation for consulting or advisory work only if approved by a majority of the board members. a. True b. False 22. The Sarbanes-Oxley Act placed restrictions on the types of services that public accounting firms are allowed to perform for audit clients. Which of the following services are public audit firms now expressly prohibited from performing for their audit clients? a. Quarterly review services b. Tax services c. Bookkeeping services d. All of the above 23. Under Sarbanes-Oxley, pubic accounting firms must rotate the lead partner or the partner reviewing the audit every year. a. True b. False 24. The civil and criminal protections for whistleblowers under Sarbanes-Oxley apply only to employees of publicly traded companies. a. True b. False 25. Vanessa Armstrong was the chief financial officer for D&G Technologies, a publicly traded corporation. During the 20X1 fiscal year, she caused the company’s financial statements to violate reporting requirements by including a significant overstatement of revenue so that she would receive a large performance bonus. When her transgression came to light, the company was required to issue restated financial statements for 20X1. Under the provisions of Sarbanes-Oxley, Vanessa must reimburse the company for any bonus she received during the 12 months after the 20X1 financials were initially filed. a. True b. False 26. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, the most common type of occupational fraud is financial statement fraud. a. True

b. False 27. According to the 2012 Report to the Nations on Occupational Fraud and Abuse, losses due to financial statement frauds are higher than other occupational fraud schemes. a. True b. False

Chapter 12 –Financial Statement Fraud Schemes 1. Which of the following is not an example of financial statement fraud? a. Falsification of material financial records, supporting documents, or business transactions b. Unintentional misapplication of accounting principles c. Deliberate omission of material disclosures d. All of the above are examples of financial statement fraud 2. Staff Accounting Bulletin Topic 13, “Revenue Recognition,” indicates that revenue is considered realized or realizable and earned when four criteria are met. Which of the following is one of these criteria? a. Collectibility is reasonably assured. b. Goods have been scheduled to be delivered or services have been scheduled to be rendered within the current fiscal period. c. The seller has located alternate buyers. d. All of the above are criteria for revenue recognition.

3. Recording revenue from a sale even though the rights and risks of ownership have not yet passed to the purchaser is an example of what type of fictitious revenue scheme? a. Partial sale b. Circumstantial sale c. Tentative sale d. Sale with conditions 4. Which of the following is a red flag associated with fictitious revenues? a. An unusual decrease in gross margin b. An unusual decline in the number of days’ purchases in accounts payable c. Several unusual and highly complex sales transactions recorded close to the period end d. Recurring losses while reporting increasing cash flows from operations 5. While conducting the annual audit of Bluebird Company’s financial statements, Elsie Finnegan, CFE, CPA, came across some fishy findings. The company recorded several large and unusual sales at the end of the fiscal year to customers Elsie had never heard of. Further, all of these sales occurred within the company’s specialty division, which had previously been in danger of closing due to recurring losses.

Based on these findings, what type of financial statement fraud is likely occurring? a. Expense omission b. Unrecorded warranties c. Fictitious revenues d. All of the above 6. An unusual growth in the number of days’ sales in receivables can be a red flag for which of the following financial statement fraud schemes?

a. Timing differences b. Fictitious revenues c. Improper asset valuation d. All of the above 7. Sharpe Medical Supply, Inc. has suffered a recent slow-down in sales and is in danger of showing a loss for the 20X1 fiscal year. To boost income, the sales manager encourages two of the company’s largest customers to overbuy several slow-moving products at deep discounts. He also offers them extended payment terms, some of which delay payment until the end of 20X2. This is an example of what type of scheme? a. Channel stuffing b. Discount extension c. Sales re-routing d. Long-term contracts 8. The preferred and easiest method of concealing liabilities and expenses is to simply fail to record them. a. True b. False 9. An organization that seeks to fraudulently minimize its net income due to tax considerations may do so by: a. Recording fictitious revenues b. Omitting existing liabilities c. Expensing capitalized expenditures d. Underestimating warranty repairs expense 10. It is more difficult to manipulate construction contracts that use the percentage of completion method than contracts that use the completed contract method. a. True b. False 11. Capitalizing revenue-based expenses as depreciable assets will cause income to be ____________ in the current period and _______________ in future periods. a. Understated; overstated b. Understated; understated c. Overstated; understated d. Overstated; overstated 12. Which of the following is a red flag associated with concealed liabilities and expenses? a. Gross margin significantly lower than industry average b. An unusual increase in the number of days’ purchases in accounts payable c. An unusual change in the relationship between fixed assets and depreciation

d. Significant reductions in accounts payable while competitors are stretching out payments to vendors 13. An inability to generate cash flows from operations while reporting earnings and earnings growth is a red flag for which of the following financial statement fraud schemes? a. Improper asset valuation b. Fictitious revenues c. Concealed liabilities and expenses d. All of the above 14. GAAP strictly prohibits companies from engaging in all related-party transactions because, without an arm’s-length business negotiation process, the company may suffer economic harm and ultimately injure unsuspecting shareholders. a. True b. False 15. Management has an obligation to disclose to the shareholders any fraud that is committed by the company’s employees or vendors. a. True b. False 16. At the suggestion of the external auditors, the audit committee of Alpha Technologies called in Bryce Miller, CFE, to investigate some suspected improprieties. During his investigation, Bryce learns that the company has been involved in several highlycomplex transactions with related parties that do not appear to have any logical business purpose. Further, Alpha’s organizational structure is overly complex and involves some unusual legal entities with overlapping lines of authority. Bryce also discovers four large bank accounts in the Cayman Islands that have no clear business justification. When questioned about these situations, the company’s CEO treats them as unimportant and refuses to provide any further explanation. What type of financial statement fraud scheme do Bryce’s findings most likely indicate? a. Fictitious revenues b. Improper asset valuation c. Improper disclosures d. Concealed expenses 17. Recurring attempts by management to justify marginal or inappropriate accounting treatments on the basis of materiality is a red flag associated with which type of financial statement fraud? a. Improper disclosures b. Fictitious revenues c. Concealed liabilities d. None of the above 18. Which of the following is a common target for improper asset valuation schemes?

a. Accounts receivable b. Business combinations c. Inventory valuation d. All of the above 19. An unusual change in the relationship between fixed assets and depreciation is a red flag associated with which type of financial statement fraud scheme? a. Timing differences b. Improper asset valuation c. Improper disclosure d. All of the above 20. Which of the following is an example of improper asset valuation? a. Fictitious accounts receivable b. Understating assets c. Misclassifying assets d. All of the above 21. According to SAS 99 (AU 240), “Consideration of Fraud in a Financial Statement Audit,” the auditor should ask management about the risks of fraud and how they are addressed. Which of the following is not described as an issue that the auditor should ask management about? a. Whether management has knowledge of fraud or suspected fraud b. Management’s understanding of the risk of fraud c. Whether and how management communicates the company’s financial results to its employees d. Programs that the entity has established to prevent, deter, or detect fraud 22. According to AU 240, fraud involving senior management should be reported directly to the shareholders as soon as the fraud is documented. a. True b. False 23. AU 240 requires auditors to document: a. Any specific risks of material misstatement due to fraud that were identified b. The discussion among engagement personnel regarding the susceptibility of the entity’s financial statements to material misstatement due to fraud c. The reasons supporting the auditor’s conclusion if the auditor has not identified improper revenue recognition as a risk d. All of the above 24. Vertical analysis is also known as “common sizing” of financial statements. a. True b. False

25. In the vertical analysis of an income statement, _____________ is assigned 100 percent, with all other items expressed as a percentage thereof. a. Gross sales b. Net sales c. Net income d. Gross margin 26. The technique for analyzing the percentage change in individual financial statement items from one accounting period to the next is known as: a. Ratio analysis b. Vertical analysis c. Horizontal analysis d. Correlation analysis 27. The textbook lists several ways to reduce the pressures to commit financial statement fraud, including: a. Avoiding setting unachievable financial goals b. Maintaining accurate and complete internal accounting records c. Having confidential reporting mechanisms to communicate inappropriate behavior d. Maintaining accurate personnel records including background checks on new employees 28. Establishing clear and uniform accounting procedures with no exception clauses can help reduce financial statement fraud by addressing which side of the fraud triangle? a. Pressures to commit fraud b. Opportunity to commit fraud c. Rationalizations of financial statement fraud d. Non-sharable problems 29. Promoting strong values, based on integrity, throughout the organization can help reduce financial statement fraud by addressing which side of the fraud triangle? a. Non-sharable financial needs b. Opportunity to commit fraud c. Pressure to commit fraud d. Rationalization of fraud 30. Bill Raymond is the CEO of the Drummond Group, a consulting group in the Carolinas. Sales have increased at least five percent every year for the past seven years. Unfortunately, the company has hit a slump this year, and revenue is far less than anticipated. However, in order to receive his performance bonus, Bill must show a sales increase of at least seven percent. When the financials are released, sales have increased by exactly seven percent. Which of the following ratio analyses would be most helpful in revealing that Bill included bogus sales in the company’s financials? a. Inventory turnover b. Receivable turnover

c. Debt-to-equity ratio d. Quick ratio 31. Sally Lauren is the external auditor for Modus Industries, a public company that manufactures disk drives. As she analyzes the numbers, she finds that the quick ratio, which has typically remained consistent, increased from 1.7 to 2.3 over the previous year. What type of financial statement fraud scheme could be occurring? a. Inflated inventory b. Omitted expenses c. Fictitious accounts receivable d. None of the above 32. Scott Ruskin is the CEO of Decatur Materials. The company has been struggling for the last few years and is in danger of defaulting on several of its bank loan covenants.

Scott is facing significant pressure from the board of directors to turn the company around. Unless he meets all of the financial goals for the year, he will be out the door without a golden parachute. To improve the financial appearance of the company, Scott undertakes a scheme to boost the balance sheet by faking inventory. The analysis of what financial ratio would most likely bring this scheme to light? a. Quick ratio b. Collection ratio c. Inventory turnover d. Profit margin 33. In one of the cases in the textbook, Eddie Antar, the CEO of the Crazy Eddie electronic stores in the New Jersey area, took fraud to a higher level. The company started out as a small, family-owned business, but Eddie soon found that he could really clean up by taking his company public and making a fortune off the sale of stock. However, in order to sustain his financial success, he turned to cooking the books. Unfortunately for Eddie, his scheme eventually came to an end. What financial statement fraud scheme did Eddie commit? a. Overstatement of inventory b. Improper disclosures c. Fictitious revenues d. All of the above 34. In one of the cases in the textbook, Eddie Antar, the CEO of the Crazy Eddie electronic stores in the New Jersey area, took fraud to a higher level. The company started out as a small, family-owned business, but Eddie soon found that he could really clean up by taking his company public and making a fortune off the sale of stock. However, in order to sustain his financial success, he turned to cooking the books. Unfortunately for Eddie, his scheme eventually came to an end. How was the fraud caught? a. His ex-wife contacted the SEC. b. Eddie lost a proxy battle for ownership, and the company’s new owners quickly discovered the fraud as they reviewed the books.

c. The audit committee received an anonymous tip which led them to the fraud. d. The auditors found that the inventory count had been changed.

35. In one of the cases in the textbook, Eddie Antar, the CEO of the Crazy Eddie electronic stores in the New Jersey area, took fraud to a higher level. The company started out as a small, family-owned business, but Eddie soon found that he could really clean up by taking his company public and making a fortune off the sale of stock. However, in order to sustain his financial success, he turned to cooking the books. Unfortunately for Eddie, his scheme eventually came to an end. What happened to Eddie Antar? a. He fled the country and is still at large. b. He repaid the money and was placed on probation. c. He was convicted of racketeering and sentenced to prison. d. He became a witness for the SEC against his cousin, the CFO, in exchange for a reduced sentence.

36. In one of the cases in the textbook, Michael Weinstein was the head of Coated Sales, Inc., a company that coated fabrics for use in producing things like parachutes, helmet liners, and camouflage suits. By engaging in financial shenanigans, Coated Sales moved to the top of its industry, but ultimately the good times turned into bad times, and the company declared bankruptcy. What type of financial statement fraud was committed? a. Fictitious assets b. Fictitious sales c. Improper disclosures d. Concealed expenses 37. In one of the cases in the textbook, Michael Weinstein was the head of Coated Sales, Inc., a company that coated fabrics for use in producing things like parachutes, helmet liners, and camouflage suits. By engaging in financial shenanigans, Coated Sales moved to the top of its industry, but ultimately the good times turned into bad times, and the company declared bankruptcy. Which of the following was a red flag that a fraud was being perpetrated? a. A single check was used to pay off several different customer accounts. b. The company experienced extremely rapid growth even while its competitors’ growth was flat. c. The company kept changing auditors every other year. d. The bank account had been overdrawn on at least four occasions in one year.

38. In one of the cases in the textbook, Michael Weinstein was the head of Coated Sales, Inc., a company that coated fabrics for use in producing things like parachutes, helmet liners, and camouflage suits. By engaging in financial shenanigans, Coated Sales moved to the top of its industry, but ultimately the good times turned into bad times, and the company declared bankruptcy. What happened to Weinstein? a. After the bankruptcy, he raised new capital and started another fabric coating company.

b. He was convicted, sentenced to prison, and ordered to make restitution. c. He cooperated with the government and became an informant against his partners who had been siphoning cash off of government contracts. d. He was placed on probation after reimbursing the shareholders with the profits he had made on investments in the stock market.

Chapter 13 – External Fraud Schemes 1. Which of the following is NOT one of the three sources of external fraud discussed? a. Vendors b. Customers c. Auditors d. Unrelated third parties 2. Which of the following statements is true with regard to external fraud threats? a. Unrelated third parties pose the greatest threat to an organization b. Only companies that contract with vendors are at a risk of external fraud c. A member of an organization’s board of directors committing fraud against that organization is an example of external fraud d. Companies that house large amounts of customer payment data are especially vulnerable to external fraud threats 3. What is a paperhanger? a. A person who is an expert in check fraud b. A person who counterfeits money c. A person who specializes in e-commerce check scams d. A person who is an expert in credit card fraud 4. Which of the following statements is true with regard to credit cards? a. Less than half of the U.S. population has a credit card b. The chances of being caught using an unauthorized card are small c. Counterfeit credit cards are known as “black plastic” cards d. The hologram is the easiest part of a credit card to duplicate 5. Taylor is a procurement specialist for Hillside Corporation. He is reviewing contracts, and notices a pattern between three particular contractors. Contractor A bid the lowest on the first job, Contractor B bid the lowest on the second job, and Contractor C bid the lowest on the third job. All three contractors bid on all three jobs. Which of the following is a potential scheme perpetrated by these contractors? a. Bid tailoring b. Bid rotation c. Complementary bids d. Phantom bids 6. Which of the following is NOT one of the four phases of the procurement process? a. The presolicitation phase b. The solicitation phase c. The performance phase d. The project review phase 7. A caterer has been contracted by Austin Corp. to provide the food for a large banquet.

The catering contract explicitly states that the caterer will serve a fish entrée and a

chicken entrée, and the fish entrée will consist of red snapper. The caterer decides to use tilapia instead, which costs about a third as much as red snapper, but is also a white fish and looks quite similar. He figures that no one at the banquet will be able to tell the difference. Austin Corp. is charged the price of the red snapper. What type of scheme has the caterer perpetrated? a. Product substitution b. Cost mischarging c. Material deception d. Contract falsification 8. Which of the following is the best way to prevent vendor fraud? a. Conduct vendor audits b. Perform services in-house rather than using vendors c. Disallow any contract modifications d. Require a minimum of three vendors to be considered for any project 9. Which of the following is a key finding from the 2010/2011 Computer Crime and Security Survey? a. Data manipulation is one of the most commonly seen attacks. b. Almost 80% of the survey respondents experienced at least one security incident. c. Respondents believed that the activities of outsiders accounted for much of their losses from cybercrime. d. All companies surveyed had a technical expert on staff.

10. Why are computer fraud cases difficult for a fraud examiner to investigate? a. They lack a traditional paper audit trail. b. They require an understanding of the technology used to commit the crime. c. They require the use of one or more specialists to assist the fraud examiner. d. All of the above are reasons why computer fraud cases are difficult to investigate.

11. ________________ is the use of technology to gain unauthorized access to sensitive information on a computer system. a. Data manipulation b. Computer hacking c. Social engineering d. Computer crime

12. Password cracking, social engineering, and phishing are all: a. Methods used to gain unauthorized access b. Data manipulation tactics c. Corporate espionage tactics d. None of the above

13. Max Reynolds is trying to obtain customer payment data from Stella Corporation. He wanders around Stella’s offices pretending to be a confused intern, looking for someone who can help him get on his computer. An unsuspecting employee gives him her login information, not realizing the amount of data she has just given him access to. He downloads several spreadsheets of customer payment data and takes off.

What type of scheme has Max committed against Stella Corporation? a. Phishing b. Password cracking c. Social engineering d. Employee hijacking 14. Which of the following is commonly used to perpetrate data manipulation and destruction schemes? a. Wire tapping b. Data dumps c. Network infiltration d. Malware 15. If an organization offers wireless or remote access, its server software should terminate any connection: a. From a foreign country b. Cash larceny c. After a certain number of unsuccessful attempts to enter an invalid password d. Skimming 16. All of the following are examples of malware EXCEPT: a. Blackware b. Virus c. Trojan horse d. Botnet 17. What is encryption? a. Impersonating one of the organization’s computers to get access to the network b. A type of intrusion detection system c. A company’s criteria for password selection d. Procedures used to convert information using an algorithm that makes it unreadable 18. Which of the following does corporate espionage include? a. Legitimate intelligence collection b. Acquisition of information through clandestine means c. Intelligence analysis using legal means d. All of the above 19. According to the textbook, which of the following is NOT one of a corporate spy’s favorite departments to target?

a. b. c. d.

Research and development Legal Marketing Human resources

20. What is a recommended preventative measure a company should take to protect its physical property? a. Send and receive all mail from company premises b. Ensure outdoor waste receptacles are locked and guarded c. Keep sensitive documents out of sight and in employees’ drawers d. Ensure the cleaning staff only works after business hours

Chapter 14 – Fraud Risk Assessment 1. Factors that influence the level of fraud risk faced by an organization include which of the following? a. The nature of the business b. The effectiveness of the organization’s internal control c. The ethics and values of the organization and the people in it d. All of the above 2. _________ controls are designed to stop an undesirable event from occurring, whereas _________ controls are designed to identify an undesirable event that has already occurred. a. Preventive; detective b. Internal; external c. Risk; discovery d. Operating; review 3. The objective of a fraud risk assessment is to help management recognize factors that make an organization most vulnerable to fraud so that management can address those factors to reduce the exposure. a. True b. False 4. In general, management should avoid sharing the fraud risk assessment process and results with employees. a. True b. False 5. Fraudulent financial reporting risks include which of the following? a. Payment of bribes or gratuities b. Aiding and abetting of fraud by outside parties c. Inappropriately reflected balance sheet amounts d. Misappropriation of intangible assets 6. Effective internal controls can eliminate the need for a fraud risk assessment. a. True b. False 7. Which of the following factors should be considered when selecting a sponsor for the fraud risk assessment? a. Seniority b. Independence c. Ability to elicit cooperation d. All of the above

8. Which of the following factors should be considered in assessing the likelihood of occurrence of each fraud risk? a. Financial statement and monetary significance b. Internal control environment of the organization c. Criminal, civil, and regulatory liabilities d. Financial condition of the organization 9. Management is not likely to have sufficient knowledge of controls to override them. a. True b. False 10. Risks resulting from ineffective or nonexistent controls are known as which of the following? a. Residual risks b. Inherent risks c. Control risks d. Audit risks 11. Assessing an area as having a high fraud risk means that fraud is occurring there. a. True b. False 12. Which of the following is not one of the three interrelated elements that enable someone to commit fraud? a. Opportunity b. Non-sharable financial need c. Ability to rationalize d. Fraud risk 13. The results of a fraud risk assessment can help auditors design programs and procedures in a way that enables the auditors to look for fraud in known areas of high risk. a. True b. False 14. It is not important to consider reputation risk in performing a fraud risk assessment since this risk cannot easily be mitigated. a. True b. False 15. The vulnerability of an organization to those capable of overcoming the three elements of the fraud triangle is known as which of the following? a. Inherent risk b. Fraud risk assessment c. Fraud risk d. Control risk

16. Which of the following is a type of detective control? a. Segregating duties b. Performing background checks c. Performing surprise audits d. Ensuring proper alignment between an individual’s authority and level of responsibility 17. In assessing the significance to the organization of identified fraud risks, the fraud risk assessment team should first consider them on an inherent basis. a. True b. False 18. Which of the following information-gathering techniques enables the fraud risk assessor to observe the interactions of employees as they discuss a question or issue? a. Interviews b. Surveys c. Focus groups d. Anonymous feedback mechanisms 19. When assessing the potential incentives, pressures, and opportunities to commit fraud, the fraud risk assessment team should evaluate which of the following? a. Incentive programs and how they may affect employees’ behavior when conducting business or applying professional judgment b. Highly complex business transactions and how they might be used to conceal fraudulent acts c. Opportunities for collusion d. All of the above 20. Which of the following is not a true statement regarding the fraud risk assessment process? a. It is more of a science than an art b. To be most effective, it should be an ongoing, continuous process c. It should be influenced by the culture of an organization d. It is aimed at proactively identifying an organization’s vulnerabilities to fraud 21. Which of the following is not true regarding fraud risk? a. It can be analyzed quantitatively b. It results exclusively from sources internal to the organization c. It can be analyzed qualitatively d. It encompasses reputation risk 22. Which of the following is not a potential corruption risk? a. Payment of bribes to public officials, companies, or private individuals b. Inadequate disclosures pertaining to related-party transactions c. Receipt of kickbacks, bribes, or gratuities

d. Aiding and abetting of fraud by customers or vendors 23. Which of the following techniques can be used to evaluate the effectiveness and efficiency of internal controls? a. Review of the accounting policies and procedures in place b. Interviews with management and employees c. Consideration of the risk of management’s override of controls d. All of the above 24. Both management and auditors have a responsibility for fraud risk management. a. True b. False 25. Management should consider which of the following in establishing an acceptable level of fraud risk for the organization? a. The organization’s business objectives b. The organization’s risk tolerance level c. Both A and B d. Neither A nor B 26. Which of the following factors enhances a fraud risk assessment? a. Collaboration between management and auditors b. Independence and objectivity of those leading and conducting the work c. Inclusion of people’s perceptions at all levels of the organization d. All of the above 27. One of the first steps in a fraud risk assessment involves identifying potential fraud risks inherent to the organization. a. True b. False 28. To maximize the effectiveness of the fraud risk assessment process, the fraud risk assessment team should include both facts and opinions in its report. a. True b. False 29. Which of the following actions might management take in order to transfer a residual fraud risk? a. Eliminate the related asset b. Exit the related activity c. Purchase fidelity insurance d. Implement countermeasures 30. Internal control is a process aimed at proactively identifying and addressing an organization’s vulnerabilities to internal and external fraud. a. True

b. False

Chapter 15 – Conducting Investigations and Report Writing 1. A company may need to undertake an internal investigation into alleged employee fraud for which of the following reasons? a. To mitigate the company’s vicarious liability for the wrongful conduct b. To determine the source and amount of loss c. To guard against wrongful termination accusations d. All of the above 2. Officers and directors of companies are bound by the duties of _________ and _________ in overseeing the operations of their companies. a. loyalty; reasonable care b. due process; loyalty c. reasonable care; imputed practice d. loyalty; implicit care 3. The failure to adequately investigate an allegation of employee fraud may be a violation of legal and regulatory requirements. a. True b. False 4. When choosing a fraud examination team, it is important to include as many parties as possible to ensure that all investigatory perspectives are covered. a. True b. False 5. In most cases, which of the following parties should be primarily responsible for directing a fraud examination? a. The external auditors b. The head of the security department c. The company’s legal counsel d. The human resources manager 6. Fraud examination teams should be broken down into two segregated groups: one that focuses on the financial side of the investigation and one that performs the investigatory field work. a. True b. False 7. Which of the following factors should be considered when determining whether to employ outside consultants during a fraud examination engagement? a. Company politics b. The degree of expertise required for specific tasks c. Potential threats of retaliation against internal investigators d. All of the above

8. Which of the following statements is true regarding the use of undercover operations as part of a fraud examination? a. Undercover operations are never legal and should not be used in fraud examinations. b. Undercover operations should be used only if there is sufficient probable cause that a crime has been committed. c. There are no restrictions governing the use of undercover operations as part of fraud investigations. d. None of the above 9. Able is a fraud examiner who works for XYZ, a private company. While investigating an allegation of employee embezzlement, Able calls Baker, a suspected co-conspirator, and pretends to be a member of the local police force. Able tells Baker that if he turns over his financial records to Able, that he will be provided immunity from prosecution. Is Able’s use of impersonation in this situation legally acceptable? a. Yes b. No 10. _____________ involves obtaining information through the use of falsehoods or deception. a. Pretexting b. Subject manipulation c. Forensic investigation d. Surveillance 11. While investigating an alleged conflict of interest scheme, Green, an internal investigator, is contacted by the ex-wife of Brown, the primary suspect. After calling her ex-husband some unsavory names and telling Green that Brown hasn’t paid a dime of his court-ordered alimony, the jilted former spouse informs Green that she has some dirt on Brown. She tells Green that she’d be more than happy to spill the beans about Brown’s misdeeds if Green can ensure that she receives half of any money recovered as a result of the investigation. Because Brown’s ex-wife is clearly seeking a financial reward for supplying information, Green should discontinue speaking with her and should not rely on any information she provides. a. True b. False 12. Baker, CFE, is on a stakeout at the home of Potter, the prime suspect in a large false billing scheme. When Baker arrives at Potter’s street, she notices Potter’s garbage has been placed on the curb for pickup. Baker believes she could obtain much of the information she needs by going through Potter’s garbage. In order to legally sift through Potter’s trash and seize discarded documents to be used as evidence, Baker must: a. Obtain a search warrant b. Obtain a subpoena duces tecum

c. Obtain Potter’s consent d. None of the above 13. To be valid, a search warrant must be issued by a judge and must be served by a law enforcement official. a. True b. False 14. Lloyd, CFE, has asked Betsy for access to her bank records as part of an investigation into an alleged embezzlement scheme. If Betsy agrees, her consent must be written, signed, and dated in order for it to be binding. a. True b. False 15. Which of the following statements about handling and storing documentary evidence is not true? a. Documents received should be initialed and dated by the fraud examiner. b. The original document should be preserved for forensic examinations. c. Photocopied documents should be stored in transparent plastic envelopes. d. Documents should never be stapled or paper-clipped.

16. _________________ refers to establishing how and when a piece of evidence was received; how it was maintained or stored while in each person’s possession; what changes, if any, it underwent in that person’s custody; and how it left that person’s custody. a. Authentication b. Forensic examination c. Chain of custody d. None of the above 17. If, during the handling of a piece of documentary evidence, an investigator inadvertently holds the document with bare hands and leaves fingerprints on it, the document should be destroyed and a new copy should be obtained. a. True b. False 18. Of the following, which is the preferred method of organizing documentary evidence? a. Chronological order b. Alphabetical order c. By witness d. Order received 19. When organizing documentary evidence, it is recommended that investigators keep which of the following? a. Chronologies b. To-do lists

c. A separate file for key documents d. All of the above 20. Jackson, CFE, is investigating a suspected embezzlement by one of XYZ Corp.’s employees. As part of this investigation, she is assembling a financial profile of the suspect. Among other things, she wants to know if the suspect has made any significant real estate purchases since the embezzlement scheme began. Information on real estate transactions such as deeds, grants, transfers, and mortgages is located: a. With the county recorder b. With the state tax assessor c. With the secretary of state d. With the U.S. Department of Land Management 21. Which of the following information is typically not included in a corporate registration? a. The location of the corporation’s principal office b. The tax returns and quarterly reports for the corporation c. The names of the corporation’s directors and officers d. The date of incorporation 22. Information concerning a corporation’s name, ownership, stock value, initial shareholders, directors, and officers is registered and maintained at which of the following levels? a. Federal b. State c. Municipal d. County 23. McCloud, an internal investigator for a private company, has reason to believe that LaRue, the company’s controller, has been embezzling cash and living the high life on the company’s dime. McCloud has just discovered that LaRue bought a mansion on the edge of town last year and McCloud wants to find out more about the purchase. Information about whether LaRue took out a mortgage on the property may be found by searching: a. LaRue’s income tax return b. County real property records c. LaRue’s bank account transactions d. All of the above 24. To obtain information about an auto loan, such as where and when the loan originated and the current address of the debtor, an investigator should search the Uniform Commercial Code documents filed with the Secretary of State. a. True b. False

25. To find the names of the parties who have an interest in the estate of a deceased individual, an investigator should search the records of which court? a. County civil court b. U.S. District court c. Probate court d. None of the above 26. Fraud examinations conclude with: a. A conviction of the guilty party b. A report of the investigation findings c. A confession from the suspect d. An opinion on the guilt or innocence of the implicated party 27. A well-written, accurate, and understandable investigation report will: a. Convey all pertinent evidence b. Add credibility to the investigation c. Accomplish the objectives of the case d. All of the above 28. When preparing an investigative report, the fraud examiner should assume that it will be read by outside parties. a. True b. False 29. Bob Taylor, CFE, is writing a report on his findings from an investigation into an alleged inventory larceny scheme. During his investigation, he was unable to accurately quantify the amount of the loss to the victim company, but he assumes that the loss falls between $100,000 and $200,000. In the report, Bob should report the amount of the loss as $200,000 so that the company can recoup as much money as possible from the perpetrator. a. True b. False 30. In which section of the standard fraud examination report should the investigator discuss the identity and background information obtained about the individuals implicated in the matter under investigation? a. Summary b. Introduction c. Body d. Results 31. In a written fraud examination report, the fraud examiner’s conclusions about how the fraud occurred should be explicitly stated. a. True b. False

Chapter 16 – Interviewing Witnesses 1. Which of the following question types will generally not be asked during an information-gathering interview of a neutral witness? a. Introductory b. Informational c. Assessment d. Closing 2. While conducting an interview, you have reason to believe that the respondent is not being truthful. What type of questions will help you establish the respondent’s credibility? a. Open b. Non-leading c. Admission-seeking d. Assessment 3. ______________ questions are asked if you have a reasonable cause to believe that the respondent is responsible for the fraud under investigation. a. Admission-seeking b. Assessment c. Leading d. Closing 4. Which of the following is not one of the primary purposes of asking introductory questions during an interview? a. Establishing rapport between the interviewer and the subject b. Asking sensitive questions before the subject has the ability to go on the defensive c. Observing reactions to questions d. Establishing the theme of the interview 5. During the introductory phase of an interview, the respondent states that he won’t provide any information unless he is promised confidentiality. In this situation, you should give in to his request to ensure that you get the information you are seeking. a. True b. False 6. Which of the following is a rule that the interviewer should follow when asking questions during the introductory phase of the interview? a. Promise confidentiality to the respondent. b. Give the interviewee the opportunity to respond to the source of the allegations. c. Question only one person at a time. d. All of the above

7. The purpose of informational questions is to gather unbiased, factual information.

Which of the following is a type of informational question? a. Assessment b. Norming c. Closing d. Leading 8. When asking informational questions, you should start with general questions and then proceed to specific questions. a. True b. False 9. An open question is a question that is worded in a way that makes it difficult to answer with a simple “yes” or a “no.” a. True b. False 10. During an interview, you ask the respondent a question that contains the answer as part of the question. This is called a(n): a. Open question b. Closed question c. Assessment question d. None of the above 11. A(n) _____________ interview is one that has the potential to bring about strong emotional reactions in the respondent. a. Explosive b. Aggressive c. Volatile d. Emotive 12. During a potentially volatile interview, there should be only one person in the room with the respondent in order to prevent intimidation. a. True b. False 13. At the conclusion of an interview, closing questions should be asked for which of the following purposes? a. Reviewing key facts to ensure that they have not been misunderstood b. Gathering previously unknown facts c. Asking the respondent if he or she has been treated fairly d. All of the above 14. Assessment questions are worded so that dishonest people will likely agree with many of the statements, while honest people likely won’t. a. True

b. False 15. The question “Do you think someone around here might be justified in making a secret arrangement with one of the company’s vendors?” is an example of what type of interview question? a. Allusive b. Admission-seeking c. Assessment d. Alternative 16. In an interview situation, the process of observing behavior before critical questions are asked is called: a. Calibrating b. Leading c. Attribution d. None of the above 17. Respondents in an interview give both verbal and nonverbal clues that can be used to determine whether they are being deceptive. Which of the following is generally not considered a verbal clue to deception? a. Changes in speech patterns b. Tolerant attitude c. Feigned unconcern d. Overuse of emotive words 18. During an interview, when an interviewee repeatedly fiddles with a pen or picks lint from her clothing, she is giving non-verbal clues called: a. Illustrators b. Manipulators c. Exemplifiers d. None of the above 19. During an interview, the respondent frequently uses the phrases “honestly” and “I swear to God.” The respondent is giving a type of verbal clue known as: a. Character testimony b. Illustrators c. Oaths d. Manipulators 20. Melinda Speed, CFE, was conducting an interview of Charles Fuhrman, the shipping manager at B&D Supply Co. During the interview, Charles sat with his arms crossed over his chest and his legs aimed awkwardly at the door. Charles’ nonverbal clues indicate that he is probably being deceptive. a. True b. False

21. During an admission-seeking interview, Andrew Douglas, the primary suspect, repeatedly began his responses with the phrase “to tell the truth.” Additionally, he had trouble remembering several key facts regarding the events in question, even though his memory of the small details was excellent. Andrew’s verbal clues likely indicate that he is being truthful. a. True b. False 22. Private employers conducting an internal investigation are generally required to give Miranda warnings before commencing an admission-seeking interview with a nonunion employee. a. True b. False 23. Oral confessions are as legally binding as written confessions. a. True b. False 24. Generally, there is nothing illegal about accusing an innocent person of misdeeds as long as: a. The accuser has predication to believe the accused has committed an offense. b. The accusation is made under reasonable conditions and in private. c. The accuser does not take any action that is likely to make an innocent person confess. d. All of the above 25. During an admission-seeking interview in which an accusation has been made, the respondent will normally object to the accusation and attempt to deny it. When you are convinced of the respondent’s guilt, it is important to: a. Interrupt the denial. b. Ask the respondent to put the denial in writing. c. Repeat the denial for confirmation of understanding. d. None of the above 26. When the subject of an investigation has been accused of misconduct, establishing a morally acceptable rationalization might allow the accused to reconcile his actions with his conscience. Which of the following is not an example of an acceptable rationalization? a. The accused has been unfairly treated by his management. b. The accused felt that he needed to get back at someone in the organization. c. The accused is a bad person by nature. d. The accused engaged in the misconduct for the benefit of others.

27. During an admission-seeking interview, the accused individual will likely present reasons why he or she could not have committed the offense. When this occurs, the fraud examiner should step in and diffuse these alibis by:

a. Discussing the accused’s deceptions b. Displaying the physical evidence c. Discussing the testimony of other witnesses d. Any of the above 28. In an admission-seeking interview, once the accused has provided a verbal confession, the interviewer should focus on obtaining: a. An estimate of the total amount of money involved b. A motive for the offense c. The names of other people who are involved d. All of the above 29. When obtaining a written confession during an admission-seeking interview, which of the following is not an item that should be included in the written statement? a. Willingness to cooperate b. Promise of leniency c. Excuse clause d. Intent to perpetrate the crime 30. When obtaining a written statement during an admission-seeking interview, the investigator should prepare the statement for the confessor to sign. a. True b. False 31. All notes taken by the interviewer should be preserved, as they may be needed if the case goes to trial. a. True b. False 32. James Turner, CFE, was called in to investigate a sales skimming case at Durant Hardware. During an admission-seeking interview of Nadia Brown, the primary suspect, James asked, “Did you just want some extra money, or did you do this because you had financial problems?” Nadia began crying and nodded yes. This small admission as a response to James’ question is called a: a. Provisional admission b. Point-of-reference confession c. Benchmark admission d. Tentative confession

Chapter 17 – Occupational Fraud and Abuse: The Big Picture 1. The terms deterrence and prevention mean the same thing and can be used interchangeably. a. True b. False 2. Fraud prevention involves removing the root cause of fraudulent behavior, such as economic deprivation or social injustice. a. True b. False 3. Modification of behavior through the perception of negative sanctions is called: a. Deterrence b. Prevention c. Preclusion d. Dissuasion 4. The axiom that states “employees who believe that they will be caught engaging in occupational fraud and abuse are less likely to commit it” is called: a. Cognitive choice b. Preventive selection c. Perception of detection d. None of the above 5. For the past several months the Adams Shop, a mom and pop retail store, has suffered costly losses due to the theft of merchandise. Putting in a comprehensive surveillance system that covers all of the entrances and exits at all four of their locations is not feasible at this time. Nevertheless, they have decided to install several surveillance cameras in their flagship store. They notified their employees that the cameras were being installed and placed posters at the store entrances notifying their customers of the new security. Not surprisingly, thefts decreased dramatically within a month and continued to decline over the next six months. Without the cash to install cameras in all the stores, Adams installed fake cameras at the other three stores and let employees and customers at those locations know about the cameras. Thefts dropped at the other stores as well. The concept that most likely explains why the thefts decreased is known as: a. Pre-emptive anti-fraud strikes b. Surreptitious detection c. Proactive deterrence d. Perception of detection 6. Which of the following choices is not an action that will increase the perception of detection within an organization? a. Conducting clandestine audits b. Increasing the use of analytical reviews c. Developing employee anti-fraud education programs d. Establishing a reporting program

7. Vigorously prosecuting fraud perpetrators is considered to be the best proactive way to deter fraud. a. True b. False 8. The implementation of hidden controls is a crucial component of an effective proactive fraud deterrence plan. a. True b. False 9. Having an adequate program to report fraud is vital to the success of an organization’s efforts to detect and deter fraud. Which of the following is a key point that should be emphasized in such a program? a. If everyone works together, fraud, waste, and abuse can be completely eliminated within the organization. b. There is an exact method for reporting suspected wrongdoing. c. Penalties may be assessed on employees who report inaccurate information, regardless of intent. d. All of the above 10. Although hotlines are an essential part of an effective fraud reporting system, only about 5 percent of hotline calls are actually developed into solid cases. a. True b. False 11. The concept of ______________ provides that corporations can legally be held criminally responsible for the acts of their employees if those acts were done in the course and scope of their employment and for the apparent benefit of the corporation. a. Civil responsibility b. Displaced criminal sanctions c. Imputed liability d. Connected accountability 12. Dean Crawley is a foreman for the Albuquerque Construction Co. As part of his duties, Dean often must run to the hardware store to purchase supplies when they are needed immediately for a building project. One afternoon, Dean’s building crew ran out of a particular sized nail and needed 35 more right away to meet their tight project deadline. Dean went to the nearest hardware store to restock, but quickly realized he had forgotten his wallet. Rather than waste precious time retrieving his wallet, he slipped 40 nails into his pockets and walked out without paying for them. Even though Dean’s actions specifically violated company policies, the company may still be held criminally responsible for his theft. a. True b. False

13. The Corporate Sentencing Guidelines allow organizations that have an effective fraud prevention and detection program in place to receive more lenient criminal sentences than those without such a program. a. True b. False 14. As it relates to Corporate Sentencing Guidelines, corporations are required to perform certain minimum steps for due diligence. Which of the following is not one of the required steps? a. Consistently enforce standards through appropriate discipline. b. Have policies defining standards and procedures to be followed by the organization’s agents and employees. c. Assign internal audit personnel to ensure compliance. d. Use due care not to delegate significant authority to people who are known to have a propensity to engage in illegal activities.

15. The school of ethical thought that advocates concrete ethical principles that cannot be violated is the: a. Fundamental ethical principle b. Utilitarian ethical principle c. Modern ethical principle d. Imperative ethical principle 16. The school of ethical thought that advocates situational ethics, i.e., each behavior should be evaluated on its own merits, is the: a. Imputed ethical principle b. Circumstantial ethical principle c. Utilitarian ethical principle d. Imperative ethical principle 17. Brian Ferguson is a cashier at a 24-hour convenience store. He has worked the night shift for the last year and a half, and often fills in for other employees at the last minute, but has never received a raise. Furthermore, Brian just got passed over for a promotion to store manager, which would have nearly doubled his pay.

Understandably, he is outraged. Because his employer is so “cheap” and “unfair,” Brian begins taking cases of beer and snacks home to supplement his income. The term that best describes Brian’s theft as retribution for his inadequate pay is: a. Involuntary breach b. Wages in kind c. Actionable rationalization d. Imperative ethics 18. Which of the following should be included in an organization’s formal ethics policy? a. Specific conduct that violates the policy b. A statement that dishonest acts will be punished c. Information on how unethical conduct can be reported d. All of the above

19. The “tone at the top” that is set by management is more important in providing a strong ethical message to employees than having a formal organizational ethics policy in place. a. True b. False 20. All organizations, regardless of size, should institute a formal ethics policy. a. True b. False

ANSWERS TO EXERCISES Chapter 1 Review Questions 1-1 (Learning objective 1-1) What is fraud examination?

Answer: Fraud examination is a process for resolving allegations of fraud from inception to disposition. Fraud examinations involve not only financial analysis, but also interviewing witnesses, taking statements, writing reports, testifying to findings, and assisting in the prevention and detection of fraud.

1-2 (Learning objective 1-2) What is the fraud theory approach?

Answer: The fraud theory approach is the methodology used for resolving allegations of fraud by developing a worst-case scenario of what could have occurred, then attempting to confirm or refute that theory.

1-3 (Learning objective 1-3) Occupational fraud and abuse includes any personal enrichment that results from misuse or misapplication of the employing organization’s resources or assets. There are four key elements to this activity. What are they?

Answer: The four key elements to occupational fraud abuse are that it (1) is clandestine, (2) violates the employee’s fiduciary duties to the organization, (3) is committed for the purpose of direct or indirect financial benefit to the employee, and (4) costs the employing organization assets, revenues, or reserves.

1-4 (Learning objective 1-4) Under the common law, fraud generally consists of four elements, all of which must be present. List them.

Answer: The four legal elements of fraud are (1) a material false statement, (2) knowledge that the statement was false when it was uttered, (3) reliance on the false statement by the victim, and (4) damages as a result.

1-5 (Learning objectives 1-4 and 1-5) What is the difference between occupational fraud and occupational abuse? Give examples.

Answer: Occupational fraud tends to be more costly and less common than abuse.

Occupational fraud consists of such actions as asset misappropriations, corruption, and fraudulent financial statements. Occupational abuse consists of petty offenses such as taking extended lunch periods or breaks, showing up late for work or leaving early, and doing slow or sloppy work.

1-6 (Learning objective 1-7) Edwin H. Sutherland, a criminologist, coined the phrase “white-collar crime.” What did he mean by this term? How has the meaning of this phrase changed over time?

Answer: Sutherland coined the term “white-collar crime” to describe criminal acts of corporations and individuals acting in their corporate capacity (e.g., crime in the executive suite). Over time, the term has come to encompass almost any financial or economic crime, from the mailroom to the boardroom.

1-7 (Learning objective 1-7) Sutherland developed what is known as the “theory of differential association.” What is the principal tenet of his theory?

Answer: The theory of differential association’s principal tenet is that crime is learned.

Sutherland believed that this learning typically occurred in intimate personal groups.

1-8 (Learning objective 1-8) Cressey interviewed nearly 200 embezzlers in order to develop his theory on the causation of fraud. As a result of his research, what was Cressey’s final hypothesis?

Answer: “Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted property.”

1-9 (Learning objective 1-9) Cressey believed that non-shareable problems provided the motivation for employees to commit occupational fraud. What did he mean by “nonshareable”?

Answer: Cressey meant that the problems, at least in the eyes of the potential offenders, must be kept secret from others, so as to avoid embarrassment or, more importantly, a loss of status.

1-10 (Learning objective 1-9) Cressey divided the non-shareable problems of the subjects in his research into six different subtypes. What are they?

Answer: The subtypes are (1) violation of ascribed obligations, (2) problems resulting from personal failure, (3) business reversals, (4) physical isolation, (5) status gaining, and (6) employer–employee relations.

1-11 (Learning objective 1-11) Albrecht concluded that there were three factors that led to occupational fraud. What are they?

Answer: Albrecht’s list is very similar to the fraud triangle. The three factors he identified are (1) situational pressures, (2) opportunities, and (3) personal integrity.

1-12 (Learning objective 1-12) What factor did Hollinger and Clark identify as the primary cause of employee deviance?

Answer: The research of Hollinger and Clark strongly suggests that job dissatisfaction among employees—across all age groups but especially younger workers—is the most likely cause of counterproductive or illegal behavior in the workplace.

1-13 (Learning objective 1-13) The 2011 Global Fraud Survey covered a number of factors that are related to occupational fraud. List these factors.

Answer: The 2011 Global Fraud Survey gathered data on occupational fraud and abuse relating to (1) the cost of fraud and abuse, (2) position, gender, tenure, and criminal history of the perpetrator, (3) size of the victim organization, (4) actions taken against occupational fraudsters by their victims, (5) methods by which occupational frauds were detected, (6) commonness of schemes, and (7) costs associated with various schemes.

Discussion Issues 1-1 (Learning objective 1-1) How does “fraud examination” differ from “forensic accounting”?

Answer: Fraud examination is a process used to resolve allegations of fraud from inception to disposition. Forensic accounting is any accounting work done in anticipation of litigation.

1-2 (Learning objective 1-2) There are several steps involved in the fraud theory approach. What are they?

Answer: The fraud theory approach involves analyzing the available evidence, developing a theory of what fraud could have occurred based on a worst-case scenario, testing the theory, revising it or amending it as necessary, then proving the theory through additional investigative work.

1-3 (Learning objectives 1-3 through 1-6) How does occupational fraud and abuse differ from other kinds of fraud? Give examples of other fraud types.

Answer: Typically, any crime that uses deceit as its principal modus operandi is considered fraud. Occupational fraud involves those frauds that are committed against organizations by individuals who work for those organizations. Other fraud types include but are not limited to: insurance frauds committed by customers and policyholders, Internet frauds and scams perpetrated by individuals, frauds against governmental organizations committed by companies and individuals, frauds against banks committed by outsiders, and credit card frauds perpetrated against businesses.

1-4 (Learning objectives 1-7 and 1-8) How does the study of criminology relate to the detection or deterrence of fraud? How does it differ from the study of accounting or auditing?

Answer: Criminals commit frauds. Accounting relates to the classification of assets, liabilities, income, expenses, and equity. Auditing involves the verification of books and records. While accounting and auditing give us information on how fraud is committed, the study of criminology helps us understand why fraud is committed. The simple fact is that books don’t commit fraud, people do. Understanding both how and why fraud is committed helps us better detect and deter it.

1-5 (Learning objective 1-7) Sutherland’s contribution to criminology, in addition to giving us the term “white-collar crime,” involved developing the theory of differential association. What are the implications of this theory with respect to occupational fraud?

Answer: Sutherland’s main point was that the tendency to commit crime is learned, not inherited. He believed that criminals learned both the techniques of committing crimes and the value systems of criminals in small, intimate groups. This explains, in part, why prisoners frequently return to crime after they are let out of confinement. While behind bars, they talk to other inmates and learn the specifics of how to better commit their crimes. They also are taught the unique values that “street” criminals hold, such as “getting something for nothing” and “society owes me a good living.”

Occupational fraudsters, on the other hand, learn their techniques by working with books, records, inventory, and other assets. They frequently hear about other employees who were not successful in their crimes. Rather than being discouraged by someone being caught, the potential criminal often learns a different lesson: that the method the other person used to commit fraud was faulty and that a different one must be devised in order to succeed. They also learn the value systems that some businesses have: Profit is everything, and the end justifies the means. Such values obviously send the wrong message.

1-6 (Learning objective 1-8) Cressey’s “fraud triangle” states that three factors—nonshareable financial need, perceived opportunity, and rationalization—are present in cases of occupational fraud. Which of these three factors, if any, is the most important in causing executives, managers, and employees to commit occupational fraud?

Answer: All three are equally important. A fire cannot exist without fuel, oxygen, and heat; a fraud cannot exist without motive, opportunity, and rationalization. If a person has unlimited motive but no opportunity, he or she cannot commit fraud. If a person has opportunity but doesn’t need the money, the fraud is unlikely to occur. Should an individual have both motive and opportunity but cannot salve his or her conscience through rationalization, the crime will most likely not be committed.

1-7 (Learning objectives 1-8 and 1-9) Cressey described a number of non-shareable financial problems that he uncovered during his research. Which of these, if any, apply to modern-day executives who are responsible for large financial statement frauds? In the 50-plus years since Cressey did his study, are the factors he described still valid? Why or why not?

Answer: Three non-shareable financial problems seem to be at the root of today’s financial frauds: violation of ascribed obligations, problems resulting from personal failure, and business reversals. Many modern-day businesses begin “cooking the books” when executives realize that they will not be able to meet their financial obligations.

Similarly, some executives are too ashamed to admit that they don’t have the talent or wherewithal to steer an enterprise through rough economic conditions. And sometimes, business reversals—from loss of a major client or contract, recessions, high costs of capital, and the like—are at the root of these so-called non-shareable financial problems.

One could argue that these factors are as valid today as they were over half a century ago. What motivates people to act changes little over time, although the methods that they use to accomplish their illegal goals (e.g., computer frauds) may.

1-8 (Learning objectives 1-8 through 1-11) Albrecht, in his research, developed the “fraud scale” and furnished a list of the reasons employees and executives commit occupational fraud. How are Albrecht’s conclusions similar to Cressey’s? How are they different?

Answer: Cressey’s three factors were a non-shareable financial need, perceived opportunity, and rationalization. Albrecht’s consisted of financial pressure, perceived opportunity, and personal integrity. One of the factors, perceived opportunity, was

named by both researchers. Cressey’s non-shareable financial need is similar to Albrecht’s financial pressure; however, Cressey’s is more specific. Nearly everyone suffers financial pressures of some kind, but most do not turn to fraud in order to alleviate them. The ability to rationalize illegal conduct and personal integrity could be viewed as one and the same. However, personal integrity is difficult to measure, while specific rationalizations are easier to identify.

1-9 (Learning objective 1-13) The ACFE’s 2011 Global Fraud Survey found, among other things, that the frauds committed by women had smaller median losses than those by men. What are some possible explanations for this finding?

Answer: The sizes of losses due to occupational fraud are almost always determined by the employee’s access to assets. This explains why executives account for the largest losses. Women, because of the so-called “glass ceiling” (where they are not promoted into jobs equal to their male counterparts’), typically occupy lower-level positions.

Chapter 2 Review Questions 2-1 (Learning objective 2-1) How is “skimming” defined?

Answer: Skimming is the theft of cash from a victim organization prior to its entry in the organization’s accounting system.

2-2 (Learning objective 2-2) What are the two principal categories of skimming?

Answer: Skimming schemes can be subdivided based on whether they target sales or receivables. The character of the incoming funds has an effect on how the frauds are concealed, and concealment is the crucial element of most occupational fraud schemes.

2-3 (Learning objective 2-3) How do sales skimming schemes leave a victim organization’s books in balance, despite the theft of funds?

Answer: When an employee skims money by making off-book sales of merchandise, neither the sales transaction nor the incoming cash is ever recorded. For example, suppose a cash register clerk skims $500 in receipts from one sale of goods. At the end of the day, his cash drawer will be short by $500—the amount of money that was stolen. But because the sale was never recorded, the sales records will be understated by $500.

Therefore, the books will remain in balance.

2-4 (Learning objective 2-3) Under what circumstances are incoming checks received through the mail typically stolen?

Answer: Checks are normally stolen when a single employee is in charge of opening the mail and preparing the deposit. The employee simply removes the check from the incoming mail and forges the endorsement of the employer, then endorses it with his or her own name and cashes or deposits it.

2-5 (Learning objective 2-4) How do “understated sales” schemes differ from “unrecorded sales”?

Answer: Unrecorded sales schemes are purely off-book transactions. Understated sales, on the other hand, are posted to the victim organization’s books, but for a lower amount than what the perpetrator collected from the customer. Typically, the perpetrator will understate a sale by recording a lower sales price for a particular item, or by recording the sale of fewer items of merchandise than the customer actually purchased.

2-6 (Learning objective 2-5) How is the cash register manipulated to conceal skimming?

Answer: There are two common methods. The first is to ring “no sale” on the register and omit giving the customer a receipt for the purchase. The second and less common method is for the cashier to alter the tape itself so that it does not show the sale. This is impossible to accomplish with cash registers that also record the transaction electronically.

2-7 (Learning objective 2-6) Give examples of skimming during nonbusiness hours and skimming of off-site sales.

Answer: Certain categories of employees usually commit these schemes. Managers of department stores or employees opening or closing the store have been known to open early or close late and skim all or part of the sales during those periods. Apartment rental employees, parking lot attendants, and independent salespeople are at a higher risk of skimming funds from off-site sales.

2-8 (Learning objective 2-8) What are the six principal methods used to conceal receivables skimming?

Answer: The six concealment techniques identified in this chapter are: lapping, force balancing, stealing customer statements, recording fraudulent write-offs or discounts, debiting the wrong account, and document destruction.

2-9 (Learning objective 2-9) What is “lapping” and how is it used to conceal receivables skimming?

Answer: Lapping is the crediting of one account through the abstraction of money from another account. Lapping customer payments is one of the most common methods of concealing receivables skimming. Suppose a company has three customers, A, B, and C. When A’s payment is received, the fraudster takes it for himself instead of posting it to A’s account. When B’s check arrives, the fraudster posts it as a payment to A’s account.

Likewise, when C’s payment is received, the perpetrator applies it to B’s account. This process continues indefinitely until one of three things happens: (1) someone discovers the scheme, (2) restitution is made to the accounts, or (3) some concealing entry is made to adjust the accounts receivable balances.

2-10 (Learning objective 2-10) List four types of false entries a fraudster can make in the victim organization’s books to conceal receivables skimming.

Answer: The fraudster can lap the payments, as discussed in the previous question. He can also engage in force balancing by posting a payment to a customer’s account even though the payment was stolen. A third false entry that can be made is to fraudulently write off a customer’s account as uncollectible. A fourth technique is to credit the targeted account with a fraudulent “discount” in the amount of the stolen funds. Also, some fraudsters conceal receivables skimming by debiting existing or fictitious accounts receivable.

Discussion Issues 2-1 (Learning objective 2-3) Sales skimming is called an “off-book” fraud. Why? Answer: Simply because the fraud occurs outside the books and records. There is no direct audit trail to uncover; the proof of the fraud must be determined by indirect methods, such as ratio analysis or other comparisons.

2-2 (Learning objective 2-3) In the case study of Brian Lee, the plastic surgeon, what kind of skimming scheme did he commit?

Answer: Dr. Lee committed a sales (revenue) skimming scheme. In this fraud, Dr. Lee’s clinic was a partnership with several other doctors, and all of the revenue derived from his services was supposed to go to the partnership. Because of a lack of controls and periodic reconciliations by the clinic, Dr. Lee simply instructed his patients to pay him directly. His scheme was uncovered by accident, as are many frauds.

2-3 (Learning objectives 2-5 and 2-12) If you suspected skimming of sales at the cash register, what is one of the first things you would check?

Answer: The cash register tape is one of the first things you should check. In a typical cash register skimming scheme, the crooked employee will ring up “no sale” on the register when a sale is made and pocket the money. The customer is not given a receipt.

If you notice an excessive amount of “no sales” entered on the cash register, it could mean that the drawer is being opened and no money is being put in.

2-4 (Learning objective 2-3) Assume a client who owns a small apartment complex in a different city than where he lives has discovered that the apartment manager has been skimming rental receipts, which are usually paid by check. The manager endorsed the checks with the apartment rental stamp, then endorsed her own name and deposited the proceeds into her own checking account. Because of the size of the operation, hiring a separate employee to keep the books is not practical. How could a scheme like this be prevented in the future?

Answer: Two simple, separate control measures might help prevent such future occurrences. Although it might not be practical for the owner to reconcile the rental receipts himself since he lives in a different city, he could obtain a restrictive endorsement stamps that states “for deposit only.” Second, the owner could have rental payments directed to a bank lockbox, where they would be less likely to be stolen.

2-5 (Learning objectives 2-8 and 2-11) What is the most effective control to prevent receivables skimming?

Answer: In almost all cases of receivables skimming, the person handling the cash and the person keeping the books are one and the same. An employee who opens incoming mail or handles cash should not be permitted to post the transactions.

2-6 (Learning objectives 2-3 and 2-7) In many cases involving skimming, employees steal checks from the incoming mail. What are some of the controls that can prevent such occurrences?

Answer: Here are some of the basic controls over incoming checks: • The person opening the mail should be independent of the cashier, accounts receivable clerk, or employees who are authorized to initiate or post journal entries.

• Unopened mail should not be delivered to employees having access to accounting records.

•

The employee who opens the mail should (1) place restrictive endorsements on the incoming checks; (2) prepare a list of checks received; (3) forward all remittances to the person responsible for preparing and making the bank deposit; and (4) forward the list of checks to a person who can check to see if it agrees with the bank deposit.

2-7 (Learning objectives 2-7 and 2-11) In the case study of Stefan Winkler, who was the chief financial officer for a beverage company in Florida, how did he conceal his skimming scheme? How could the scheme have been prevented or discovered?

Answer: Winkler’s scheme is a classic example of too much trust placed in one employee.

The beverage company received money from two different sources: route deposits (cash sales) and office deposits (accounts receivable). The route salespeople prepared their own deposit slips showing the cash and currency collected. The office personnel listed and accounted for the checks received through the mail. Winkler removed currency from the route deposits and replaced it with a check for the same amount from office deposits.

Although office personnel listed the checks, they did not prepare the deposit slips— Winkler did that. As a result, he would ensure that the bank deposits agreed with the amount of money going into the bank.

To cover his tracks with the credit customers, Winkler would lap payments made by one customer to cover thefts from another customer. He would also give unauthorized discounts to credit customers. When Winkler was fired for other reasons, he made a general ledger adjustment of over $300,000 in a vain attempt to cover the shortages.

There were many clues: The internal control deficiencies were glaring. All of the cash made a stop at Winkler’s desk on its way to the bank. Had there been adequate division of responsibilities, Winkler’s scheme would have been much more difficult to accomplish. There were excessive false discounts to customers. The cost of sales would have been out of line with sales. And, like so many other fraudsters, Winkler lived beyond his means. Had his fellow employees been properly educated about fraud, they would have easily seen the fact that Winkler was driving a $75,000 car as a red flag. Also, had they been to his home, they would have noticed that their chief financial officer lived in an excessively expensive residence.

Chapter 3 Review Questions 3-1 (Learning objective 3-1) What is cash larceny?

Answer: Cash larceny involves the intentional taking away of an employer’s cash without the consent, and against the will, of the employer. Cash larceny schemes involve the theft of money that has already appeared on the victim company’s books.

3-2 (Learning objective 3-2) How do cash larceny schemes differ from fraudulent disbursements?

Answer: Cash larceny schemes generally target receipts, not disbursements.

Furthermore, larceny schemes usually involve the physical misappropriation of cash by the perpetrator. The method of extraction—for instance, a perpetrator putting cash in his pocket—is itself improper. Fraudulent disbursements, on the other hand, typically rely on the submission of phony documents or the forging of signatures in order to make a fraudulent distribution of funds appear to be legitimate. The manner by which funds are disbursed is the same as in any legitimate disbursement, but the purpose of the distribution is fraudulent.

3-3 (Learning objective 3-3) What is the difference between cash larceny and skimming?

Answer: Both cash larceny and cash skimming schemes involve theft of the victim company’s funds. However, cash larceny involves the removal of money after it has been recorded in the company’s books, whereas skimming involves the removal of cash before the funds appear on the books. In other words, cash larceny is an on-book fraud, whereas skimming is an off-book fraud.

3-4 (Learning objective 3-4) Where do cash larceny schemes rank among cash misappropriations in terms of frequency? In terms of median loss?

Answer: In the 2011 Global Fraud Survey, cash larceny schemes were less common than both skimming and fraudulent disbursements schemes. This is to be expected, as cash larceny is an on-book form of fraud that leaves an imbalance on the victim organization’s books. This makes cash larceny more difficult to conceal than other forms of cash misappropriation. The median loss for cash larceny schemes was greater than that for skimming schemes, but lower than that for fraudulent disbursements schemes.

3-5 (Learning objective 3-5) What are the main weaknesses in an internal control system that permit fraudsters the opportunity to commit cash larceny schemes?

Answer: Cash larceny schemes can take place under any circumstances in which an employee has access to cash; therefore, regular supervision and surveillance controls may prevent the opportunity for theft to occur. The lack of, or inadequate, separation of

duties for receiving, recording, depositing, and disbursing cash permit cash larceny schemes to occur.

3-6 (Learning objective 3-6) What are the five methods discussed in this chapter that are used to conceal cash larceny that occurs at the point of sale? Explain how each works.

Answer: In the cash larceny schemes reviewed, there were five methods that were identified as being used to conceal larceny at the point of sale. The first was thefts from other registers, in which an employee steals cash from another person’s cash register.

This does not conceal the crime, but it may help conceal the perpetrator’s identity. The second method was death by a thousand cuts, in which an employee repeatedly steals very small amounts of cash over an extended period of time, hoping that the thefts are small enough to avoid triggering an investigation. The third method is the use of reversing transactions. After the perpetrator has stolen cash, he processes fraudulent refunds or voids sales in order to bring sales records back into balance with cash on hand. The fourth method is to alter cash counts or cash register tapes. Totals are misreported to create a fictitious balance between cash on hand and sales. The fifth method is to destroy sales records, which makes it difficult for the victim organization to discover an imbalance caused by larceny.

3-7 (Learning objective 3-8) How do employees commit cash larceny of incoming receivables? How are the schemes concealed?

Answer: Fraudsters may post the customer’s payment to the accounting system but steal the cash, which causes an imbalance in the cash account. This imbalance can be concealed if the perpetrator has control over the recording function for ledger accounts.

The fraudster makes unsubstantiated entries, which produce fictitious balances. Other ways to conceal cash larceny include using reversing transactions, creating unauthorized discounts, charging the theft to bad debts, or adjusting the inventory account. Alternately, the perpetrator simply may destroy all records of the transaction.

3-8 (Learning objective 3-8) What is force balancing and how is it used to conceal cash larceny?

Answer: Force balancing involves the making of unsupported entries in an organization’s books and records to produce a fictitious balance. For example, if an employee steals an incoming receivables payment after it has been posted to the appropriate customer account, this will create a shortage in the cash account because the amount of receipts posted will exceed the amount of receipts on hand. If the employee is

able to make one or more unsubstantiated entries to cash in the amount of the stolen payment, he or she can eliminate the imbalance.

3-9 (Learning objective 3-9) How do fraudsters commit cash larceny from the bank deposit?

Answer: Fraudsters steal all or part of the deposit and conceal the scheme by destroying the bank statement, or by showing the deposits as “in transit.” This type of scheme is usually effective when there is a poor internal control system over cash collections and deposits, in which the same employee may be responsible for cash collections, preparing deposit slips, making deposits, and reconciling bank statements. The fraudster may also alter the deposit slip after it has been returned in the bank statement.

3-10 (Learning objectives 3-5, 3-7, and 3-10) What are some basic internal control procedures to deter and detect cash larceny schemes?

Answer: The separation of duties related to cash receipts, deposits, and recording is a basic internal control to deter and detect cash larceny schemes. This includes segregation of authorization, recording, and custody functions for cash and related transactions. Assignment rotation, mandatory vacations, surprise cash counts, and physical security of cash can also assist in deterring and detecting cash larceny schemes.

Discussion Issues 3-1 (Learning objectives 3-1, 3-6, 3-8, and 3-9) Briefly describe some common types of cash larceny schemes.

Answer: Cash larceny, which involves the theft of an organization’s cash after it has been recorded, can take place in any circumstance in which an employee has access to cash.

Several different types of cash larceny schemes were described in this chapter. Most of these schemes involve larceny that either occurs at the point of sale, involves incoming receivables payments, or targets the victim organization’s bank deposits. Within these three groups, there were several unique methods that were identified based on the steps taken to conceal the thefts. Employees generally conceal larceny at the point of sale by stealing from another person’s cash register, stealing very small amounts over an extended period, processing fraudulent reversing transactions, altering cash counts or sales records, or destroying sales records. Larceny of receivables is generally concealed through force balancing, fraudulent reversing entries, or record destruction. Cash larceny from the deposit may be concealed by deposit lapping or by fraudulently recording stolen funds as deposits in transit. Larceny also frequently occurs because

there is a breakdown of controls such that one person has solitary access to an organization’s books and records. In these cases, it may not be necessary for the perpetrator to use any concealment technique; he simply steals money without trying to hide the crime.

3-2 (Learning objective 3-3) Why is it generally more difficult to detect skimming than cash larceny?

Answer: The benefit of a skimming scheme is that the transaction is unrecorded and the stolen funds are never entered on company books. This makes the skimming scheme difficult to detect because sales records do not reflect the presence of the funds that have been taken. In a larceny scheme, on the other hand, the funds that the perpetrator steals are already reflected on the victim organization’s books. As a result, an imbalance results between the sales records and cash on hand. This imbalance should be a signal that alerts a victim organization to the theft.

3-3 (Learning objectives 3-2 and 3-3) In the case study of bank teller Laura Grove, what type of fraud did she commit?

Answer: Laura perpetrated a cash larceny scheme. In order to classify the scheme, we first look to the fact that she took cash, which means her scheme was a form of cash misappropriation. To further classify the scheme, we look to the method by which she took the cash. Remember, there are three categories of cash misappropriation: fraudulent disbursements, skimming, and cash larceny. Laura Grove’s scheme involved the physical misappropriation of cash without the use of fraudulent documents or forged signatures. She made no attempt to record or justify the removal of cash as a legitimate disbursement of funds. Therefore, her scheme could not have been a fraudulent disbursement.

The only two other categories of cash misappropriation are skimming and cash larceny. The difference between these two types of fraud lies in whether the stolen funds had been recorded on the victim organization’s books at the time they were stolen. In this case, the money Laura Grove stole had already been recorded on the bank’s books and records; therefore the scheme must be classified as a cash larceny.

3-4 (Learning objective 3-5) What are the internal control weaknesses that failed to deter and detect the fraud in Laura Grove’s case?

Answer: Various weaknesses that may have contributed to the scheme include shutting off the surveillance camera on the vault during nonbusiness hours, not maintaining the security of the vault combination, not rotating employees periodically, and not checking employees’ belongings when they left the bank.

3-5 (Learning objectives 3-6 and 3-7) Other than falsifying a company’s records of cash receipts, how might an employee conceal larceny from a cash register?

Answer: An employee might discard or destroy cash register tapes. Missing or defaced backup documentation should indicate a red flag for fraud. Altering the cash count for his or her register is another way to conceal a fraud. Proper internal control procedures would prohibit an employee from performing a reconciling cash count of his or her own register.

3-6 (Learning objectives 3-10 and 3-11) What steps might an organization take to protect outgoing bank deposits from cash larceny schemes?

Answer: One form of cash larceny is for an employee to steal from the bank deposits.

Usually, it is perpetrated by the employee who is in charge of making the deposit. Some internal control procedures that might assist in the deterrence of such frauds are: (1) separating the duties of receiving and opening of the mail and preparing the deposit slip, (2) segregating the functions for taking deposits to the bank and recording the transactions, (3) maintaining more than one copy of the deposit slip to be matched and reconciled with the bank’s receipts of deposits, (4) examining the bank deposit slip for alterations, and (5) reconciling the bank statement with the book balance by a person who is not also involved with the custody function for cash.

3-7 (Learning objective 3-8) How is the larceny of receivables often detected?

Answer: Many times, receivables schemes involve skimming—the perpetrator steals the payment but never records it. This type of scheme might be detected by the delay between the time the payment is received and when it is posted to the books. Customer complaints of incorrect account balances are often a clue to a receivables skimming scheme.

If the theft occurs after the payment has been recorded, then it is classified as cash larceny. In order for an employee to succeed at a cash larceny scheme, she must be able to hide the imbalances in the accounts caused by the fraud. Larceny of receivables is generally concealed through force balancing, reversing entries, or destroying records.

Looking for inappropriate journal entries and examining supporting documentation may help to uncover a larceny of receivables.

3-8 (Learning objective 3-11) In the case study “The Ol’ Fake Surprise Audit Gets ’Em Every Time,” how did Newfund’s accounting and management controls contribute to the detection of Gurado’s fraud scheme? How did the resulting actions of management help to deter future frauds?

Answer: Newfund’s internal control procedure of conducting organized and effective surprise audits induced Gurado, a well-respected branch manager, to “come clean” at the prospect of his fraud being discovered during a prospective, imminent surprise audit.

In this case, the threat of detection served the same goal as detection through an actual audit. Gurado was immediately fired for his misdeeds, which reinforced the importance of following proper procedures to other employees.

3-9 (Learning objective 3-11) Among the proactive audit techniques suggested in this chapter are the following: (1) a summary, by employee, of discrepancies between cash receipt reports and the sales register system; and (2) a summary, by employee, of discounts, returns, cash receipt adjustments, accounts receivable write-offs, and voids processed. Why would these two tests be effective in detecting cash larceny?

Answer: Because cash larceny involves the theft of on-book funds, it creates an imbalance on the victim organization’s books. For example, if a cash register clerk steals $100 from his register, then the cash receipt report from that register will be $100 lower than the total recorded in the register sales system (unless a fraudulent entry is made to correct the imbalance). The first test suggested above would identify employees who tend to have these imbalances, which could signal larceny. This test would be particularly helpful in identifying employees who have multiple, small imbalances that individually are too small to be investigated, but collectively can become quite large.

In order to conceal imbalances caused by cash larceny, employees often process fraudulent adjusting entries to bring their cash receipt reports and register sales totals back into balance. The second audit test suggested above would test for this kind of activity by identifying employees who process an inordinate number of adjusting entries, which could be a result of efforts to hide cash larceny schemes.

Chapter 4 Review Questions 4-1 (Learning objective 4-1) What are the five categories of fraudulent disbursements, and where did billing schemes rank in terms of frequency and cost in the 2011 Global Fraud Survey?

Answer: The five categories of fraudulent disbursements are: billing schemes, check tampering schemes, payroll schemes, expense reimbursement schemes, and register disbursement schemes. Among these categories, billing schemes were most commonly reported. Fifty-two percent of fraudulent disbursements in the survey involved billing fraud. Billing schemes were the second most costly form of fraudulent disbursement, with a reported median loss of $100,000.

4-2 (Learning objectives 4-2 and 4-3) How is the term “billing schemes” defined, and what are the three categories of billing schemes covered in this chapter?

Answer: Billing schemes are frauds in which a perpetrator causes the victim organization to issue a fraudulent payment by submitting invoices for fictitious goods or services, inflated invoices, or invoices for personal purchases. The three categories of billing schemes are: shell company schemes, non-accomplice vendor schemes, and personal purchases schemes.

4-3 (Learning objective 4-4) What is the purpose of a shell company and how is it normally formed?

Answer: A shell company is a fictitious entity established for the purpose of committing fraud. It may be nothing more than a fictitious name and a post office box that the employee uses to collect disbursements from false billings. Since checks received will be payable to the shell company, the fraudster will normally set up a bank account in the name of the fictitious company, listing himself as the authorized signer on the account.

4-4 (Learning objective 4-5) There are four ways in which fraudulent invoices are approved for payment. What are they?

Answer: Fraudulent invoices are approved for payment by self-approval, by a rubber stamp supervisor, or through the normal internal control system by reliance on the authenticity of the false voucher the fraudster creates. In addition, collusion among several employees can overcome even well-designed internal controls and can enable fraudsters to obtain approval on bogus invoices.

4-5 (Learning objective 4-5) Why does collusion among employees in the purchasing process make it very difficult to detect billing schemes?

Answer: One of the main purposes of a well-defined internal control system is to separate the duties of individuals who are involved in the purchasing process in order to prevent any one person from having too much control over a particular business function. It provides a built-in monitoring mechanism in which each person’s actions are verified by another person. But, if everyone in this process works together to create fraudulent voucher documents, then billing schemes will be very difficult to detect.

4-6 (Learning objective 4-6) Why do most shell company schemes involve the purchase of services rather than goods?

Answer: Services are intangible, which makes it more difficult for the victimized company to verify whether they were ever actually delivered by a vendor. If a billing scheme involves fictitious goods, the defrauded company may be able to detect the fraud by comparing its purchases to inventory levels, but this comparison will not identify the purchase of nonexistent services.

4-7 (Learning objective 4-7) What is a pass-through scheme and how does it differ from a typical shell company billing scheme?

Answer: In a typical shell company scheme, the perpetrator bills the victim organization for fictitious goods and services. In a pass-through scheme, on the other hand, the perpetrator actually provides real goods and services.

Pass-through schemes are usually undertaken by employees in charge of purchasing on behalf of the victim company. Instead of buying merchandise directly from a vendor, the employee sets up a shell company and purchases the merchandise through that fictitious entity. He then resells the merchandise to his employer from the shell company at an inflated price, thereby making an unauthorized profit on the transaction.

4-8 (Learning objective 4-9) What is a pay-and-return scheme? List three examples of how this type of fraud can be committed.

Answer: In a pay-and-return scheme, an employee intentionally mishandles payments to a vendor and then steals the excess payment when it is returned by the vendor. Generally, the perpetrator either double-pays an invoice, intentionally makes a vendor payment for an excess amount, or sends a payment to the wrong vendor. In all cases, the perpetrator then contacts the non-accomplice vendor, explains that a “mistake” was made, and asks the vendor to return the excess payment to her attention. When the overpayment is returned, the fraudster steals it.

4-9 (Learning objective 4-10) How does an employee use a non-accomplice vendor’s invoice to generate a fraudulent payment?

Answer: Typically, the fraudster either prepares a fake vendor invoice and submits it to his company for payment or reruns an invoice that already has been paid. After his company prepares a check for payment, the perpetrator intercepts the check before it is sent out or has an accomplice do the same after the check arrives at the vendor’s place of business. Alternatively, he could alter the vendor’s address or electronic payment information in the payables and online banking system so that the check is delivered to the fraudster or an accomplice.

In addition to the preceding examples, an employee can generate fraudulent payments using a non-accomplice vendor invoice by committing a pay-and-return scheme, as was discussed in the preceding question.

4-10 (Learning objective 4-12) How does an employee make personal purchases on company credit cards, purchasing cards, or running charge accounts?

Answer: Instead of running false invoices through accounts payable, some employees make personal purchases on company credit cards, purchasing cards, or running charge accounts with vendors. An employee with a company credit card or purchasing card can buy an item merely by signing his name (or forging someone else’s) at the time of purchase. Some companies keep open charge accounts with vendors with whom they do regular business. Office supply companies are a good example of this kind of vendor.

Purchases on charge accounts may require a signature or other form of authorization from a designated company representative. Obviously, that representative is in a position to buy personal items on the company account. Other employees might do the same by forging the signature of an authorized person at the time of a fraudulent purchase. In some informal settings, purchases can be verified by as little as a phone call.

Discussion Issues 4-1 (Learning objectives 4-3 and 4-4) In the case study of Cheryl Brown, the administrative assistant at a Southeastern medical school, what type of billing scheme did she commit?

Answer: Cheryl committed a shell company scheme. She and an outside accomplice created a shell company and bilked her employer out of thousands of dollars through the use of fake invoices.

4-2 (Learning objectives 4-8, 4-11, and 4-13) Explain how separation of duties contributes to the prevention and detection of billing schemes.

Answer: By enforcing a rigid separation of duties in the purchasing process, an organization can significantly limit its exposure to billing schemes. Segregating the purchasing process into four basic functions—purchasing, approval of purchase, receipt of goods, and cash disbursement—can prevent most forms of billing fraud. This is because most billing schemes succeed only when an individual has control over two or more of these functions. If these duties are strictly segregated, it will be very difficult for an employee to commit most forms of billing fraud.

4-3 (Learning objectives 4-8 and 4-14) List and explain at least four proactive audit tests that could be performed to help detect a shell company scheme.

Answer: Examples of tests that can be used to detect a shell company scheme include the following. Vendors lacking certain identifying information such as a telephone number or tax ID can be extracted from the vendor master file for investigation. Similarly, the vendor master file can be matched to the employee master file for duplicate telephone numbers, addresses, and so on. The invoice payment file can be searched for vendors who had multiple invoices just below established review limits—a possible sign of an attempt to circumvent management review of bogus invoices. The vendor master file can also be matched to the invoice payment file to identify payments to any unapproved vendors. There are several other tests identified in this chapter that could also be used.

4-4 (Learning objectives 4-4, 4-5, and 4-8) What are some of the ways shell company invoices can be identified?

Answer: Auditors, accounting personnel, and other employees should be trained to identify red flags relating to fraudulent invoices. One common red flag is a lack of details such as a telephone, fax, tax identification, or invoice number. Another common red flag is an invoice that lacks detailed descriptions of items ordered. Lastly, using a mail drop or residential address may also indicate a billing fraud scheme. All of these red flags should be investigated.

4-5 (Learning objectives 4-4 and 4-7) Sharon Forsyth worked in the purchasing department of a retail store. She was in charge of ordering merchandise inventory and various supplies for the organization. She purchased merchandise through a fictitious shell company and then resold it to her employer at an inflated price. What is the name of this type of fraud?

Answer: This type of fraud is called a pass-through billing scheme and is a subcategory of shell company schemes in which actual goods or services are sold to the victim company.

4-6 (Learning objective 4-9) Karen Martinis was responsible for opening mail, processing vendor claims, and authorizing payments. She was involved in a scheme in which she either double-paid vendor invoices, paid the wrong vendors, or overpaid the right vendors. What type of billing scheme is being described in this case?

Answer: This is a pay-and-return billing scheme involving non-accomplices. In a payand-return billing scheme the perpetrator does not prepare fake invoices and submit them to the victim company. Instead, she intentionally mishandles vendor payments that are owed to a legitimate vendor. The perpetrator then requests that the vendor send a check for the amount owed back to the victim company.

4-7 (Learning objective 4-9) What type of internal controls can be used to help prevent pay-and-return billing schemes?

Answer: As with most billing frauds, pay-and-return schemes can be mostly prevented if the duties of the purchasing, authorizing, and payment functions are separated and if invoices are matched to purchase orders before payments are made. Also, incoming mail should never be delivered directly to an employee, but rather opened at a centralized point with all incoming checks being properly recorded. Organizations should also instruct their banks not to cash checks made payable to the company. In some cases, employees attempt to conceal the theft of returned checks by running targeted invoices through the payables system a second time so that the intended recipient of a stolen check still gets paid. An effective duplicate checking system can help prevent this type of scheme and make it easier to detect a pay-and-return fraud.

4-8 (Learning objective 4-12) In terms of classifying frauds under the Fraud Tree system, how does a scheme in which an employee fraudulently orders merchandise for his personal use differ from a scheme in which an employee steals merchandise from his company’s warehouse?

Answer: Even though both schemes involve an employee taking merchandise, the first scheme is classified as a billing scheme, whereas the second is classified as a theft of inventory (as will be discussed in Chapter 9). This is because when a person steals inventory from a warehouse, he is stealing an asset that the victim organization needs, that it has on hand for a particular reason. The harm to the victim company is not only

the cost of the stolen asset, which will have to be replaced, but also the loss of the asset itself.

In contrast, when an employee fraudulently buys merchandise with company funds, the asset he acquires is superfluous. The perpetrator causes the victim company to order and pay for an item which it does not really need, so the only damage to the victim organization is the money lost in purchasing the particular item. The victim organization suffers no harm in the loss of the asset that was purchased, because the victim had never designated a need for that asset in the first place.

Chapter 5 Review Questions 5-1 (Learning objective 5-1) Assume there are two thefts of checks at ABC Company. In the first case, an employee steals an outgoing check that is drawn on ABC’s account, and is payable to “D. Jones.” The perpetrator forges the endorsement of “D. Jones” and cashes the check. In the second case, an employee steals an incoming check from “D. Jones” that is payable to ABC Company. The employee fraudulently endorses the check and cashes it. Which of these schemes would be classified as check tampering? Why? Answer: Only the first scheme would be classified as check tampering, because check tampering is a form of fraudulent disbursement, and the first scheme involved a disbursement of the victim organization’s funds, whereas the second scheme did not.

Check tampering applies only to checks drawn on the victim organization’s accounts. If an employee steals an incoming check that is payable to the victim organization, then this theft will be classified as either skimming or cash larceny, depending on whether the check was recorded by ABC Company before it was stolen or afterward.

5-2 (Learning objective 5-2) There are five principal categories of check tampering frauds. What are they?

Answer: The five principal categories of check tampering are: (1) forged maker schemes, (2) forged endorsement schemes, (3) altered payee schemes, (4) concealed check schemes, and (5) authorized maker schemes.

5-3 (Learning objective 5-3) What are the methods discussed in this chapter by which fraudsters gain access to blank company checks as part of a forged maker scheme?

Answer: Most forged maker schemes are committed by employees whose duties include the preparation of company checks, so in most cases the fraudster has legitimate access to blank check stock. When an employee does not have access to blank checks through his

job duties, he may be able to steal checks that are not properly safeguarded. For example, a company’s checkbook or blank check stock might be stored in an open, unlocked area that is not always supervised. The perpetrator might also obtain a key or combination to a restricted area where checks are stored. When check stock is properly safeguarded and the fraudster does not have access, he might be able to obtain blank checks from another employee who does have legitimate access, typically in return for a portion of the stolen funds. If unused checks are not properly disposed of after they have been voided, an employee may be able to use them in a forged maker scheme. Finally, a fraudster might produce counterfeit check stock and use this to draw funds from the organization’s accounts.

5-4 (Learning objective 5-4) Perpetrators of check tampering schemes must obtain a signature on the check. What are methods used to affix a signature to the check?

Answer: The perpetrator can simply write an authorized person’s name on the check. A more elaborate method is to create a legitimate signature on a transparency and use it to place a signature on blank checks. Some companies use signature stamps or computerized signatures that a perpetrator can gain access to. The perpetrator may be an authorized signer and will simply sign a check himself. Finally, he may hide a tampered check in a group of legitimate checks and present them for signing by an authorized signer.

5-5 (Learning objective 5-5) How can the type of paper on which an organization’s checks are printed be a factor in preventing and detecting forged maker schemes?

Answer: The type of paper a check is printed on can sometimes help distinguish a legitimate check from a counterfeit. Organizations should print their checks on watermark paper supplied by a company independent of its check printer. (This will prevent a dishonest employee of the printer from using the company’s watermarked paper). Security threads or other markers can also be incorporated to help verify that company checks are legitimate. If an organization uses high-quality, distinctly marked paper for its checks, counterfeits will be easier to detect. In addition, it is a good idea to periodically rotate check printers and/or check stock to help make counterfeits stand out.

5-6 (Learning objective 5-6) What are the differences between a forged maker and a forged endorsement scheme?

Answer: A forged maker scheme is one in which an employee misappropriates a check and fraudulently affixes the signature of a legitimate check signer to authorize

disbursement of funds. In a forged endorsement scheme, the employee intercepts a signed company check intended for a third party and fraudulently endorses the check in order to obtain the funds that were intended for someone else.

An important distinction is that the two schemes attack an organization’s control structure at different points. A forged maker scheme typically involves the falsification of a blank check. The key to this kind of scheme, from the fraudster’s perspective, is in obtaining a blank check, producing a signature that appears to be authentic, and in some cases, recording the check in such a way that the fraud will not be detected. In a forged endorsement scheme, by contrast, the perpetrator is working with a check that has already been prepared, so the issues are different. Instead of gaining access to blank check stock, the perpetrator must find a way to gain access to a check after it has been signed but before it has been delivered. Typically, this means the fraudster must steal the check before it is sent out in the mail, although in some cases the fraudster might alter the mailing address of a legitimate payee.

From a concealment standpoint, forged endorsement schemes present different challenges than forged maker schemes. In a forged endorsement scheme, the stolen check was intended for a real payee, so the perpetrator must be concerned with the probability that the intended payee will complain about not receiving the check that has been stolen.

In a forged maker scheme this is not generally a concern because the check is originally written for a fraudulent purpose; there is no legitimate payee.

5-7 (Learning objective 5-7) What are some methods of intercepting a check intended for a third party?

Answer: A perpetrator may be an employee authorized to mail or deliver a check but who diverts it for his own benefit. Checks that are signed but are left unattended instead of being immediately mailed can be stolen by a fraudster. Checks that are returned because they could not be delivered to the addressee could be intercepted or a perpetrator could change the address of a legitimate payee to his own address prior to mailing. After a check has been intercepted, the payee name can be altered by adding a second payee to the payee line, or the perpetrator can use erasable ink to prepare the check, then change the payee (and amount) on the check after it has been signed.

5-8 (Learning objective 5-9) What is an authorized maker scheme, and why are these frauds especially difficult to prevent through normal internal controls?

Answer: An authorized maker scheme is a type of check tampering fraud in which an employee with signature authority on a company account writes fraudulent checks for his

own benefit and signs his own name as the maker. The perpetrator in these schemes can write and sign fraudulent checks without assistance. He does not have to alter a preprepared instrument or forge the maker’s signature.

This may be the most difficult form of check tampering to defend against because in most cases check signers are owners, officers, or otherwise high-ranking employees, and thus have or can obtain access to all the blank checks they need. Even if a company’s control structure ostensibly prohibits check signers from handling blank checks, the perpetrator typically has enough influence and authority to override this control.

5-9 (Learning objective 5-7) How can a perpetrator conceal check tampering activity from others in the organization?

Answer: If the perpetrator is responsible for bank reconciliations he can remove fraudulent canceled checks, mark fraudulent checks as void on the reconciliation, force balance the reconciliation, or physically alter the bank statement to conceal the fraudulent checks. If a fraudster has committed an altered payee scheme, he might realter the canceled checks during the reconciliation (by inserting the name of the intended payee and the proper amount) so that they correspond to the disbursements journal. The fraudster can also falsify disbursement journals, hide the tampered disbursements in an account where they are unlikely to draw attention, or falsify supporting documents to make the bogus checks appear legitimate. In forged endorsement or altered payee schemes, which involve the theft of outgoing checks intended for a third party, the fraudster may reissue the intercepted checks to avoid having the intended payee complain to others in the organization.

5-10 (Learning objectives 5-5, 5-8, and 5-10) There are several duties that should be segregated among employees to minimize the opportunity for check tampering. List these duties.

Answer: Duties that should be segregated among employees include: (1) check cutting and posting, (2) check signing, (3) check delivery, and (4) bank statement reconciliations.

5-11 (Learning objective 5-11) What measures can companies can take to prevent and detect fraudulent electronic payments?

Answer: Companies can best defend against fraudulent electronic payments through a combination of solid internal controls and bank security services. Separation of duties (e.g., segregating duties for creating, approving, and releasing wires) is one of the most important internal controls for preventing and detecting electronic payments fraud.

Other essential internal controls include segregation of bank accounts (e.g., using separate accounts for paper and electronic transactions), daily account monitoring and reconciliation, and management and protection of user access and account information.

Bank security services that can help business account holders mitigate electronic payment fraud include ACH blocks and filters, positive pay for ACH, multi-factor authentication tools, dual authorization, transaction limits, and software access restrictions.

Discussion Issues 5-1 (Learning objectives 5-5 and 5-10) In the case study of Melissa Robinson, she was able to steal over $60,000 from her employer. Why was she able to commit her fraud without detection?

Answer: Melissa Robinson was given check signing authority and sole control of the bookkeeping function. She was given large amounts of cash that were not verified by a second person. External audits that may have uncovered the fraud were never completed.

In addition, she was not challenged when she failed to allow others access to the books and records and failed to provide financial information.

5-2 (Learning objectives 5-5, 5-8, and 5-10) Assume you are a new hire in the accounting department of an organization. One of your responsibilities is the reconciliation of the operating account. After the end of the month you are given a copy of the bank statement and the canceled checks and instructed to perform your reconciliation. You notice there are some faint markings on a portion of the bank statement that could be alterations. What steps would you take in performing the reconciliation?

Answer: The first oddity that should be noticed is that you were given a copy of the bank statement, not the original. This is an indication that the bank statement may have been manipulated. This is further evidenced by the faint markings noted on the copy. These could be from tape, correction fluid, or some other method used to hide the true data on the original bank statement. You should add the individual items on the statement and reconcile the totals to the amounts reported on the bank statement (e.g., add deposits and compare the total to the “total deposit” amount on the bank statement). Each canceled check should be compared to the bank statement to ensure all canceled checks reported on the statement are included with the statement. A request should also be made to review the original bank statement and determine why you were given only a copy. A review of the age of reconciling items should be made and any old or unusual items

investigated. A comparison should be made between each canceled check and the corresponding listing in the check register and the account to which it was posted.

Finally, a review of endorsements may be prudent.

5-3 (Learning objective 5-3) If a fraudster does not have legitimate access to check stock, he must obtain access to the check stock in order to commit a forged maker scheme. What are some ways blank checks can be fraudulently obtained and what measures could an organization take to prevent this from occurring?

Answer: Blank check stock may be poorly protected by those who have legitimate access.

Organizations should make sure that the blank checks are always under lock and key and that the key is closely guarded. Computer-generated check stock should also be safeguarded. Employers should allow access to computerized check-writing applications by password only and change the password on a frequent basis. Finally, these internal controls should be tested on a periodic basis to ensure they are properly working.

5-4 (Learning objectives 5-3 and 5-5) Access to an organization’s funds can be gained through counterfeiting the organization’s check stock. What types of controls would help detect a counterfeit check?

Answer: The use of watermark paper or paper with security threads would help identify counterfeit checks. Use of multiple types of check stock and check printers that are periodically rotated would also help identify counterfeits as would a search for out-ofsequence or duplicate check numbers on bank reconciliations.

5-5 (Learning objectives 5-4 and 5-5) Checks can be forged by several methods: freehand forgeries, photocopies of legitimate signatures, and by obtaining access to an automatic check-signing mechanism. What are some controls an organization could institute to minimize the chance a forgery will occur?

Answer: A list of authorized check signers should be prepared and a rotation schedule for signers set up. Canceled checks should then be reviewed each period to ensure the correct signer’s name appears on each check. A periodic comparison of the authorized signer’s signature should be made with canceled checks to spot obvious forgeries.

Finally, access to any automatic check-signing mechanisms should be severely restricted and the related internal controls tested on a surprise basis to ensure the internal controls are being followed by employees.

5-6 (Learning objectives 5-6, 5-7, and 5-8) Forged endorsement schemes and altered payee schemes both involve the theft of outgoing checks that are intended for third parties for some legitimate purpose (e.g., a check payable to a vendor for services rendered). In this respect, these schemes differ from other forms of check tampering, in which the check is usually drafted by the perpetrator for a fraudulent purpose. Discuss how this distinction affects the way in which forged endorsement and altered payee schemes must be concealed.

Answer: When an employee steals an outgoing check that was intended for a third party, this creates a concealment problem because the third party presumably expects the check and will in all likelihood complain if it is not received. Therefore, a fraudster who engages in a forged endorsement or altered payee scheme must often find a way to issue a check to the intended recipient to cover for the stolen payment. This is not a necessary step in other types of check tampering, such as a forged maker scheme, because in these cases the stolen check was originally written for a fraudulent purpose; it has no intended payee other than the fraudster.

In addition, when a fraudster attempts to convert a stolen check that was payable to a third party, this may leave clues that will later have to be concealed. For example, in an altered payee scheme, the fraudster inserts his name (or that of an accomplice) onto the payee line of the check. This information will not match the check register and should be a red flag. Therefore, the perpetrator may have to re-alter the canceled check (by replacing the original information) when it is returned with the bank statement.

If a fraudster uses a dual endorsement to convert a check as part of a forged endorsement scheme, the second endorsement (in the name of an employee) would be a clear red flag of fraud. The perpetrator may have to destroy the canceled check to prevent detection.

5-7 (Learning objective 5-8) In altered payee schemes, the perpetrator changes the name of the intended third party and negotiates the check himself. This can be done by adding a second payee or changing the original payee’s name. What is the best method for detecting this type of fraud?

Answer: The best way to detect an altered payee scheme is to include as part of the bank reconciliation process a comparison of canceled checks to the check register to ensure both payees are identical. Implied in this statement is the understanding that the person who performs the reconciliation must be independent of the check-cutting process. Most altered payee schemes are successful only when the perpetrator is in charge of reconciling the bank statement.

5-8 (Learning objectives 5-5 and 5-10) In the Ernie Philips case, $109,000 was stolen through check tampering. How was this scheme accomplished and what could management have done differently to prevent the scheme from occurring?

Answer: Ernie wrote unauthorized checks, forged the authorized signers’ names, and then manipulated the bank statements to hide the disbursements. He also obtained access to the signature stamp and included unauthorized checks with legitimate checks when submitting them for signing. Finally, he used his position of authority to deflect questioning about unidentified disbursements. Mr. Sell had implemented some good internal controls but Ernie did not respect them. For example, Ernie fraudulently obtained bank statements after being warned by Mr. Sell that he was not to receive or review them. This procedure should not have been tolerated in-house, and the bank should not have been permitted to send bank statements directly to Ernie in the first place (this kind of change should have required Sell’s authorization). A stronger control over comparing checks presented for signing to supporting documentation and a stronger control over the signature stamp could have been implemented. If the organization had required Sell to spot-check his signature on canceled checks, it is possible some of Ernie’s forgeries could have been detected.

Chapter 6 Review Questions 6-1 (Learning objective 6-1) According to this chapter, what are the three main categories of payroll fraud?

Answer: A payroll scheme is an occupational fraud in which a person who works for an organization causes that organization to issue a payment by a making false claim for compensation. There are three main categories of payroll fraud: ghost employee schemes, falsified hours and salary schemes, and commission schemes.

6-2 (Learning objective 6-2) In terms of median losses, which is larger: billing schemes or payroll schemes? Can you offer a possible explanation?

Answer: According to the statistics from the 2011 Global Fraud Survey, billing schemes have larger median losses than payroll schemes. One possible explanation is that disbursements to vendors are typically larger than those to employees; therefore, it would be easier to conceal a large fraudulent disbursement by concealing it as a payment to a vendor.

6-3 (Learning objective 6-3) What is a “ghost employee”?

Answer: The term ghost employee refers to someone on the payroll who does not actually work for the victim company. The ghost employee may be a fictitious person or a real individual who simply does not work for the victim employer. When the ghost is a real person, he or she is often a friend or relative of the perpetrator. In some cases the ghost employee is an accomplice of the fraudster who cashes the fraudulent paychecks and splits the money with the perpetrator.

6-4 (Learning objective 6-3) There are four steps that must be completed in order for a ghost employee scheme to be successful. What are they?

Answer: The four steps to making a ghost employee scheme work are: (1) adding the ghost to the victim company’s payroll records, (2) collecting and maintaining timekeeping and wage information, (3) issuing a company payroll check to the ghost, and (4) delivering the ghost’s check to the perpetrator or his or her accomplice.

6-5 (Learning objective 6-3) Within a given organization, who is the individual most likely to add ghost employees to the payroll system?

Answer: Regardless of how the hiring of new employees is handled within a business, it is the person or persons with the authority to add new employees to the company’s records who are in the best position to put ghosts on the payroll.

6-6 (Learning objective 6-6) The key to a falsified hours scheme in a manual system is for the perpetrator to obtain authorization for the falsified timecard. There were four methods identified in this chapter by which employees achieved this. What were they?

Answer: The four ways an employee can obtain authorization for a falsified timecard are: (1) forging a supervisor’s signature on a fraudulent timecard, (2) colluding with a supervisor, (3) relying on a “rubber stamp” supervisor to approve the timecard without review, and (4) altering a timecard after it has been approved by a supervisor.

6-7 (Learning objectives 6-7 and 6-8) What is meant by the term “rubber stamp” supervisor and how are these individuals utilized in a payroll fraud scheme?

Answer: The term rubber stamp supervisor refers to a manager who approves timecards without reviewing their accuracy. This is a very serious breach in controls, because the role of the manager in verifying hours worked and authorizing timecards is critical to preventing and detecting payroll fraud. Obviously, rubber stamp supervisors play a part in payroll fraud in the sense that they fail to detect crimes that are otherwise detectable.

In addition, the fact that a manager is known to approve timecards without reviewing them may provide the perceived opportunity that convinces an employee to attempt a payroll fraud scheme.

6-8 (Learning objective 6-8) List at least three tests that could be performed to detect falsified hours and salary schemes.

Answer: Several tests were discussed in this chapter, including the following: • Comparisons of overtime expenses by employee and by department • Comparisons of payroll expenses to budget projections or prior year totals on a company-wide and departmental basis • Exception reports showing any employee whose compensation has increased from the prior period by a disproportionately large percentage • Verification of payroll taxes to federal tax forms • Comparison of net payroll to payroll checks issued In addition to the preceding, several proactive audit tests were recommended at the end of the chapter.

6-9 (Learning objective 6-9) There are two ways that an employee working on commission can fraudulently increase his pay. What are they?

Answer: A commissioned employee’s wages are based on two factors, the amount of sales he generates and the percentage of those sales he is paid. In other words, there are two ways an employee on commission can fraudulently increase his pay: (1) falsify the amount of sales made (either by creating fictitious sales or by overstating the amount of legitimate sales), or (2) increase his rate of commission.

Discussion Issues 6-1 (Learning objective 6-1) List and explain at least three computer-aided audit tests that can be used to detect a ghost employee scheme.

Answer: There are several suggested tests listed at the end of this chapter. For example, a comparison of payroll data files to human resource data files could be performed to look for differences. Employees that show up on the payroll register but not in the employee master file should be verified. Another possible test is to extract all employee payments with no deductions or taxes withheld from the payroll register. These types of payments are more prone to fraud and are often associated with ghost employee schemes.

The payroll register can also be matched against the employee master file to extract employees with no name, no employee number, no social security number, or whose

payment dates occur after their termination dates. All of these conditions would be consistent with a ghost employee scheme.

6-2 (Learning objectives 6-4 and 6-5) The ability to add ghost employees to a company’s payroll system is often the result of a breakdown in internal controls. What internal controls prevent an individual from adding fictitious employees to payroll records?

Answer: The most effective method of preventing an individual from adding fictitious employees to a company’s payroll records is to segregate duties for payroll preparation, disbursement, distribution, and payroll account reconciliation. As long as these duties are separated, it is very difficult for a single individual to add ghosts to the payroll system.

6-3 (Learning objective 6-7) In the case study of Jerry Harkanell (“Say Cheese!”), what internal controls could have prevented the falsification of his timesheet?

Answer: Harkanell should not have been allowed to deliver the signed timesheets to the payroll department. Additionally, procedures should have required him to complete his timesheet using permanent ink, rather than pencil (which can be erased).

6-4 (Learning objective 6-7) In terms of preventing payroll fraud, why is it important for hiring and wage rate changes to be administered through a centralized and independent human resources department?

Answer: There are several ways in which a centralized human resources department can help to prevent payroll fraud. By having all hiring be conducted through its human resources department, an organization can limit its exposure to ghost employee schemes.

This control would prevent a rogue manager from adding ghosts to her staff and pocketing their paychecks. Absent collusion, a human resources employee would also not be able to add a ghost, because there would be no line manager to approve the ghost’s timecards, and therefore payroll would not issue a check to the ghost. The human resources department and the line manager would act as independent checks on one another.

In addition, if all wage rate changes must be independently administered through human resources, this would tend to prevent an employee from falsely obtaining an increase in his wage rate or salary, and it would prevent a payroll employee from overpaying himself. Absent collusion with a human resources employee, these individuals would be unable to authorize the increase.

6-5 (Learning objective 6-10) If you suspect a salesperson is inflating his commissions, what would you do to determine if this were occurring?

Answer: If a salesperson is suspected of inflating his commissions, an examiner should compare the salesperson’s commissions to those of other salespeople and to his sales figures to determine whether there is an appropriate correlation. Rates at which the salesperson is paid should be determined and verified with personnel or other company records. Proper segregation of duties should also be confirmed.

6-6 (Learning objective 6-10) Beta is one of 10 salespeople working for ABC Company.

Over a given period, 15 percent of Beta’s sales are uncollectable, as opposed to an average of 3 percent for the rest of the department. Explain how this fact could be related to a commission scheme by Beta.

Answer: Commissions are a form of compensation calculated as a percentage of the amount of sales a salesperson generates; therefore, one of the ways a salesperson could create fraudulent commission payments for himself is by overstating the amount of sales he generates. As was explained in this chapter, one way employees falsify the amount of sales they make is by creating fictitious sales to nonexistent customers. The employee collects the commission on the sales but no payment is ever made by the “customer.” The receivables associated with these fake sales age and eventually are written off as uncollectible.

Chapter 7 Review Questions 7-1 (Learning objective 7-1) Explain what constitutes expense reimbursement fraud and list the four categories of expense reimbursement schemes.

Answer: Expense reimbursement schemes, as the name implies, occur when employees make false claims for reimbursement of fictitious or inflated business expenses. This is a very common form of occupational fraud and one that, by its nature, can be extremely difficult to detect. Employees who engage in this type of fraud generally seek to have the company pay for their personal expenses, or they pad the amount of business expenses they have incurred in order to generate excess reimbursements. The four categories of expense reimbursement fraud are: (1) mischaracterized expense reimbursements; (2) overstated expense reimbursements; (3) fictitious expense reimbursements; and (4) multiple reimbursements.

7-2 (Learning objective 7-3) Alpha is a salesperson for ABC Company. In July, Alpha flies to Miami for two weeks of vacation. Instead of buying a coach class ticket, he flies business class, which is more expensive. A few weeks later, Alpha prepares an expense report and includes the Miami flight on it. He lists the reason for the flight as “customer development.” What category of expense reimbursement fraud has Alpha committed?

Answer: Alpha has committed a mischaracterized expense reimbursement scheme, which occurs when an employee seeks to be reimbursed for personal—rather than businessrelated—expenses.

7-3 (Learning objective 7-5) Why is it important to require original receipts as support for expenses listed on a travel and entertainment expense report?

Answer: One of the ways in which employees commit expense reimbursement fraud is by overstating business expenses. This is often accomplished when an employee alters supporting documentation to reflect a higher cost than what he actually paid. These alterations are less noticeable on a photocopy than on the original document. Therefore, by requiring original support an organization will be more likely to detect this kind of fraud, and employees will be less likely to attempt it.

7-4 (Learning objective 7-5) What is meant by the term “overpurchasing”?

Answer: Overpurchasing is a method of overstating business expenses in which a fraudster buys two or more business expense items at different prices (such as airline tickets). The perpetrator returns the more expensive item for a refund yet still claims reimbursement for this item. As a result, he is reimbursed for more than his actual expenses.

7-5 (Learning objective 7-7) Provide two examples of how an employee can commit a fictitious expense reimbursement scheme.

Answer: An employee can document wholly fictitious items for reimbursement by producing her own fictitious receipts and/or bogus support documentation, which are used to support nonexistent items on an expense report. Additionally, an employee may steal or otherwise obtain blank receipts from common vendors, such as hotels or restaurants, and fill these in to justify fictitious expenses. Another method is for an employee to claim expenses that were paid by someone else, such as a case in which a client pays for a business lunch but the employee submits an expense report for the lunch.

7-6 (Learning objective 7-9) How is a multiple reimbursement scheme committed?

Answer: This type of fraud involves the submission of a single expense several times to receive multiple reimbursements. The most frequent example of a duplicate reimbursement scheme is the submission of several different types of support for the same expense, such as submitting an airline ticket stub and the travel agency invoice on separate expense reports. Alternatively, the same expense report may be submitted more than once. Typically, the perpetrator will have the duplicate reports approved by separate supervisors and will also allow a time lag between the two reports to help avoid detection.

7-7 (Learning objective 7-5) Beta is an auditor for ABC Company. He runs a report that extracts payments to employees for business expenses incurred on dates that do not coincide with scheduled business trips or that were incurred while the employee was on leave time. What category or categories of expense reimbursement scheme would this report most likely identify?

Answer: Beta’s report would most likely detect a mischaracterized expense scheme. Since the report targets expenses that were incurred on leave time or apart from scheduled business trips, it most likely would highlight personal expenses that are being claimed as business expenses. Beta’s report could also catch a fictitious expense scheme because a fraudster who creates hypothetical expenses might inadvertently use dates that do not correspond to actual business trips.

Beta’s test would be unlikely to detect overstated expenses or multiple reimbursements, because these two schemes both seek to create extra reimbursement for actual business expenses. These expenses would typically be incurred on scheduled business trips or meetings, not on personal or leave time. Thus, they would not be highlighted by Beta’s report.

Discussion Issues 7-1 (Learning objective 7-4) What internal controls can be put into place to prevent an employee from committing a mischaracterized expense scheme?

Answer: If a company wishes to prevent employees from charging their personal expenses to the company, there are several things it can do. The company should require detailed expense reports for all reimbursable expenses. Expense reports should include the following information: original support documents, dates and times of business expenses, methods of payment, and descriptions of the business purpose for expenses. All travel and entertainment expenses should be independently reviewed by a direct

supervisor who is familiar with the employee’s schedule and duties. High-level managers should not be exempt from this monitoring.

Organizations should also develop a policy on expenses that clearly explains what types of expenses are reimbursable and sets reasonable limits for expense reimbursements. This policy should be disseminated to all employees, who should be required to sign a statement acknowledging that they have received and understood its provisions.

Additionally, vacation and business schedules should be compared to the dates for which reimbursement is requested. This can help to prevent someone from claiming his or her vacation expenses as business related.

7-2 (Learning objectives 7-4, 7-6, and 7-8) In the case study “Frequent Flier’s Fraud Crashes,” what internal controls could have detected the fraud earlier?

Answer: Clarification and better enforcement of the policy that travel for the entire company must be booked through the company travel agent using a designated company credit card could have helped to detect Marcus Lane’s fraud sooner, and likely would have prevented it altogether.

7-3 (Learning objectives 7-4, 7-6, 7-8, and 7-10) Discuss how establishing travel and entertainment budgets can help an organization detect expense reimbursement fraud.

Answer: Expense reimbursement fraud is very common and can be very difficult to detect.

One detection method that is often employed is to compare expense reimbursement levels to budgeted amounts and prior years’ expenses. This enables an organization to see if reimbursed expenses have significantly increased over expected and/or historical amounts, which may be a sign of fraud. In addition, establishing budgets is a good way to control costs, regardless of fraud. Finally, if employees know this kind of comparison is made, they may be less likely to attempt expense reimbursement schemes, at least on a large scale.

7-4 (Learning objectives 7-5 and 7-6) ABC Company has three in-house salespeople (Red, White, and Blue) who all make frequent trips to Santa Fe, New Mexico, where one of the company’s largest customers is based. A manager at ABC has noticed that the average airfare expense claimed by Red for these trips is $755 round trip. The average airfare expense claimed by White is $778. The average airfare expense claimed by Blue is $1,159. What type of expense reimbursement fraud might this indicate, and what controls would you recommend to the company to prevent this kind of scheme?

Answer: These facts point to an overstated expense scheme. While all three salespeople have legitimate, business-related purposes for their trips, it appears that Blue might be inflating the costs of his airfare on his expense reports, given the fact that his flight costs are significantly higher than those claimed by the other two employees, even though they all have the same destination. (Note that additional investigation would be required to make sure there was not a legitimate reason for the discrepancy. For example, maybe Blue’s flights coincided with busy travel dates or had to be booked at the last minute, which might have caused the extra expense).

Assuming this is an overstated expense scheme, the company should make sure to establish proper controls for the review of expenses, including detailed expense reports and independent review by direct supervisors. Furthermore, the company should specify that it will accept only original support for expenses, and should specify the type of support that is allowable (e.g., airline ticket receipts, not travel agency itineraries). It would be advisable for the company to have all travel booked through a centralized inhouse department, or through a specified travel agency using a company credit card.

This would help ensure consistency in travel costs and should prevent an employee from exaggerating his expenses.

7-5 (Learning objectives 7-7 and 7-8) Baker is an auditor for ABC Company. He is reviewing the expense reports that Green, a salesperson, has submitted over the last 12 months. Baker notices that Green’s expenses for “customer development dinners” consistently range between $160 and $170, and the amounts are almost always a round number. ABC Company has a policy that limits reimbursement for business dinners to $175 unless otherwise authorized. In addition, most of the expense reports show that Green paid for the meals in cash, even though he has been issued a company credit card that he usually uses for other travel and entertainment expenses. What kind of expense reimbursement scheme is most likely, based on these circumstances?

Answer: These facts are all consistent with a fictitious expense scheme, particularly because the expenses are just below the reimbursement limit and were ostensibly paid in cash, which is not how Green normally pays for business expenses. Fraudsters who commit fictitious expense schemes often claim to have paid in cash because this explains the lack of an audit trail for the expense. It is also possible that this is a mischaracterized expense scheme (involving personal expenses) or an overstated expense scheme in which Green is inflating the costs of real business dinners.

7-6 (Learning objective 7-10) What internal controls would help to prevent an employee from claiming an expense more than once?

Answer: Employees should be allowed to submit only original receipts for expenses. They should be required to submit all documentation of expenses, including receipts showing charge totals, and that includes details of what exactly was purchased. Photocopies of receipts should not be allowed. Additionally, expense reports should identify the budget from which the reimbursement should be paid, to help prevent multiple reimbursements being made from two different budgets. All expense reports should be closely reviewed by both the supervisor and accounting personnel for potential fraud.

Chapter 8 Review Questions 8-1 (Learning objective 8-1) What is a register disbursement scheme?

Answer: A register disbursement scheme is a type of occupational fraud in which an employee processes a fraudulent reversing transaction on a cash register to justify the removal of cash from that cash register.

8-2 (Learning objective 8-2) How do register disbursement schemes differ from skimming and cash larceny, both of which frequently involve thefts of cash from cash registers?

Answer: Register disbursements schemes differ from other types of cash register frauds in that in these schemes the removal of money is recorded on the cash register as though it were a legitimate disbursement of funds. This is why these schemes are referred to as register disbursements. In skimming and cash larceny, by contrast, there is no record of the disbursement.

8-3 (Learning objective 8-3) What are the two main categories of register disbursement schemes?

Answer: The two basic fraudulent disbursement schemes that take place at the cash register are false refunds and false voids.

8-4 (Learning objective 8-4) What is the difference between a fictitious refund scheme and an overstated refund scheme?

Answer: In a fictitious refund scheme the fraudster processes a refund as if a customer were returning merchandise, even though there is no actual return. The perpetrator then steals cash from the register in the amount of the false return. The disbursement appears legitimate because the register tape shows that a merchandise return has been made.

Because the money that was taken from the register was supposed to have been removed and given to a customer as a refund, the register tape balances with the amount of money in the register. This scheme differs from an overstated refund scheme in which the fraudster overstates the amount of a legitimate refund and skims off the excess money.

8-5 (Learning objective 8-5) How are fraudulent void schemes used to generate a disbursement from a cash register?

Answer: Normally, when a sale is voided, an honest employee attaches a copy of the customer’s sales slip to a completed void slip and asks a manager to initial the transaction for approval. To process a falsified void slip, a fraudster must first get access to a customer’s sales slip and then get the approval of the transaction from a manager. A customer’s sales slip can be obtained by simply “forgetting” to give it to a customer. The fraudulent transaction is completed when the dishonest employee takes the cash from the register. The copy of the customer’s receipt is used to verify the authenticity of the transaction.

8-6 (Learning objective 8-6) How do register disbursement schemes cause shrinkage?

Answer: When a false refund or void is recorded on a cash register, two things happen.

The first is that the employee committing the fraud removes cash from the register, and the second is that the item allegedly being returned is debited back into inventory. The result is shrinkage: The amount of inventory that is actually on hand will be less than the amount that should be on hand.

8-7 (Learning objective 8-7) How can the processing of low-dollar refunds help a fraudster conceal a register disbursement scheme?

Answer: Companies often set limits below which management review of a refund is not required. When this is the case, fraudsters are sometimes able to avoid detection by processing numerous refunds that fall below the review limit, as opposed to processing a smaller number of high-dollar transactions.

8-8 (Learning objective 8-8) Why is it important for all cashiers to maintain distinct login codes for work at the cash register?

Answer: If all cashiers are required to log into a cash register before using it, this enables an organization to trace fraudulent reversing transactions back to the employee who processed them. It also enables organizations to run tests for various red flags such as employees who process an inordinate number of reversing transactions, process transactions for unusually large amounts, process recurring transactions for the same amount, and so on.

Discussion Issues 8-1 (Learning objective 8-4) In the case study involving Bob Walker at the beginning of this chapter, what type of register disbursement schemes did he commit? Discuss the role his recent demotion played in the scheme.

Answer: Bob Walker committed fictitious refund and overstated refund schemes. In both cases, he took money from the cash register and wrote fake cash refunds by recording either fictitious or real names and telephone numbers in the refund log. With the use of real names, he simply altered legitimate refunds that he had issued earlier in the day.

Shortly before the scheme began, Walker was demoted and received a pay cut.

This likely provided the rationalization Walker needed to commit the scheme. Recall that under the Fraud Triangle model, there are three factors that are typically present when an employee commits fraud. A non-shareable financial need, a perceived opportunity, and a rationalization. Wanting to get even with one’s company for perceived unfair treatment is a common rationalization that is used to justify fraud. Indeed, when confronted about his crime, Walker referred to his managers who had “unjustly” demoted him.

The pay cut may also have created a non-shareable financial need for Walker. In his interview with the investigators he stated that he had financial problems that were exacerbated by the pay cut, and that proceeds from the fraud initially went to his mortgage payments.

8-2 (Learning objective 8-2) In the 2011 Global Fraud Survey, register disbursements were reported far less frequently than any other fraudulent disbursement scheme. Discuss some reasons why this result might not reflect the true frequency of register disbursements.

Answer: Although register disbursement schemes accounted for a small percentage of the reported fraudulent disbursement schemes, it must be remembered that the respondents to the survey were only asked to report one case they had investigated; the study was not designed to measure the overall frequency of various types of schemes within a particular organization. So the low response rate for register disbursements does not necessarily reflect how often these schemes occur. Furthermore, the type of fraud that occurs within an organization is to some extent determined by the nature of business the organization conducts. For example, register disbursement schemes would tend to be much more common in a large retail store that employs several cash register clerks than in a law firm where a cash register would not even be present.

8-3 (Learning objectives 8-8 and 8-9) What are some tests that can help detect fictitious refund schemes that involve the overstatement of inventories?

Answer: When a customer returns merchandise, a journal entry is normally made to increase the merchandise inventory account and decrease the cost of goods sold account for the cost of the returned merchandise. In a fictitious refund scheme, no merchandise is actually returned. Nevertheless, the same journal entry is made as if a real refund were taking place. Because no merchandise was returned, the merchandise inventory account is overstated and will not agree with the actual inventory on hand. This scheme may be detected by periodically taking a count of the physical inventory and comparing it to the perpetual inventory records, which measure the amount of inventory that “should be on hand.” An unusual discrepancy may indicate that a fictitious refund scheme is occurring.

However, in many register disbursement cases the level of shrinkage is not large enough to raise a red flag. Other tests that could be used to detect fictitious refund schemes include running audit tests for the following conditions: • Locations with unusually high levels of refunds or voids • Employees who process unusually high levels of refunds or voids • Unsupported adjustments to inventory, particularly those entered by employees who also record refunds or voids 8-4 (Learning objective 8-4) In the “silent crime” case study mentioned in the chapter, how did Joe Anderson involve other individuals in his credit card refund scheme?

Answer: Joe eventually used over 200 credit cards belonging to 110 individuals to steal from his employer. Each week he would credit over $2,000 in fake returns to the credit cards of his friends, neighbors, and relatives. In return, he was paid up to 50 percent of the amount charged to the credit card.

8-5 (Learning objectives 8-8 and 8-9) Explain how each of the following three conditions could be a red flag for a register disbursement scheme.

1. Able, a cash register teller, is authorized to approve sales refunds and she is also authorized to make inventory adjustments.

2. Baker is a cashier who, in the last week, processed 15 refunds. No other cashier processed more than 5 over that same period. Each of the transactions was for between $13.50 and $14.99.

3. Over 70 percent of the refunds processed by Chase, a cash register clerk, were run on the same date as the original sale.

Answer: The conditions under which Able works are ripe for fraud. Able is a cash register teller, which means she is in a position to enter refunds, but she also has the authority to approve refunds, meaning there is an inadequate separation of duties. In addition, Able is authorized to make inventory adjustments, which could enable her to conceal any shrinkage that would result from a register disbursement scheme. Even though this scenario does not contain any evidence that Able is actually committing fraud, the conditions are such that if she did commit fraud, she would most likely be successful.

The fact that Baker processed three times more refunds than any other cashier over the relevant period does not prove that he is involved in a register disbursement scheme, but it is consistent with that type of scheme and there is sufficient reason to conduct further inquiry. The fact that all of the refunds were for amounts in a very narrow range just under $15.00 is also suspicious. It would be worth checking to see whether Baker’s company has a review limit for refunds at or near $15, since the pattern of his transactions suggests he may be structuring false refunds to avoid review.

The scenario involving Chase contains less hard evidence than the other two, but the fact that most of the refunds Chase processes occur on the same date as the underlying sales could point to fraud. It would make sense for an employee to run fraudulent refunds close to the time of the original sale, since he would be more likely to remember the details from the sales transaction, such as the amount, the customer’s name, the item purchased, etc. There is no information here that would tell us whether it is typical for a customer to return merchandise on the same date he or she purchased it, but that is something that should be tested, given the information here.

Chapter 9 Review Questions 9-1 (Learning objective 9-1) What are the five categories of schemes used to misappropriate non-cash tangible assets identified in this chapter?

Answer: The five categories identified in this chapter are misuse, unconcealed larceny, asset requisitions and transfers, purchasing and receiving schemes, and fraudulent shipments.

9-2 (Learning objective 9-2) According to the 2011 Global Fraud Survey, how do noncash misappropriations compare with cash misappropriations in terms of frequency and cost? What two types of non-cash assets were most commonly misappropriated?

Answer: According to the 2011 Global Fraud Survey, cash schemes were much more common than non-cash schemes. Eighty-two percent of asset misappropriations involved the theft of cash, whereas only 20 percent involved the theft or misuse of non-cash assets.

In terms of median loss, cash schemes were also costlier: cash schemes had a median loss of $100,000, while non-cash schemes had a median loss of $58,000. Physical assets, such as equipment and inventory, were the most frequently targeted type of non-cash asset in the study, with 75 percent of non-cash cases involving the misappropriation of a physical asset.

9-3 (Learning objective 9-3) What are some examples of asset misuse? Give at least three.

Answer: There are many ways in which non-cash assets are misused by employees without being stolen. Company vehicles can be used for personal trips. Computers, supplies, and office equipment can be used by employees for personal work on company time. Employees might also take home tools or equipment for a personal project, then return them.

9-4 (Learning objective 9-4) What is an “unconcealed larceny” scheme?

Answer: An unconcealed larceny scheme is one in which an employee takes property from the organization without attempting to conceal the theft on the organization’s books and records.

9-5 (Learning objective 9-6) Able is a job-site supervisor for ABC Construction. Able is responsible for overseeing the construction of a number of residential homes, and for making sure each of his crews has sufficient materials to complete its work. All of ABC’s lumber and other building materials are stored in a central warehouse and are released upon signed authorization from job-site supervisors as needed. Able requests twice the amount of lumber that is actually needed for a particular job. He uses the excess materials to build a new deck on his home. How would Able’s scheme be categorized?

Answer: Able has committed an asset requisition and transfer scheme. He falsified internal materials requisitions in order to gain access to lumber that he then stole. This is not a case of unconcealed larceny because Able falsified documentation (the materials requisition) to conceal the theft (by justifying the removal of the lumber from the warehouse).

9-6 (Learning objective 9-9) What is “shrinkage”?

Answer: Shrinkage is the unaccounted-for reduction in an organization’s inventory that results from theft. When inventory is stolen, shrinkage is generally the key concealment issue for the fraudster.

9-7 (Learning objectives 9-8 and 9-10) Baker works in the sales department of ABC Company, which manufactures computer chips. Baker creates false documentation indicating that XYZ, Inc. (a nonexistent company) has agreed to purchase a large quantity of computer chips. The computer chips are shipped to XYZ, Inc. “headquarters,” which is really Baker’s house. How would Baker’s scheme be categorized and what are some red flags that might occur as a result of the scheme?

Answer: Baker’s scheme would be classified as a fraudulent shipment. The fake sale he generated resulted in the unauthorized shipment of inventory to a nonexistent customer.

Several red flags could show up in this scheme: • The “customer” has the same address as Baker, an employee.

• •

•

The “sale” was fabricated, meaning any support documents and/or authorization for the sale were bogus.

Since the customer does not exist, no credit check could have been done on XYZ prior to the issuance of this sale on credit. (The sale had to have been on credit since XYZ, a nonexistent company, could not have paid for the chips.)

Presumably, XYZ’s account will age and eventually need to be written off as uncollectible.

9-8 (Learning objective 9-7) How do employees use falsified receiving reports as part of schemes to steal inventory?

Answer: Falsified receiving reports are sometimes used as part of a purchasing and receiving scheme. The perpetrator—typically a warehouse employee—falsifies records of incoming shipments by marking them “short” (meaning that items were missing) or by listing certain items as being damaged or substandard. The perpetrator then steals the unaccounted-for items. For instance, if 1,000 units of an item are received, the fraudster indicates that only 900 are received, then steals the 100 “missing” units.

9-9 (Learning objective 9-10) What is meant by the term “physical padding”?

Answer: Physical padding is a method for concealing inventory theft in which fraudsters attempt to create the physical appearance of extra inventory in a warehouse or stockroom to compensate for the inventory they have stolen. For example, empty boxes may be stacked on top of existing inventory or merchandise may be moved from one storage location to another so that it is counted twice.

9-10 (Learning objective 9-10) What are the four methods identified in this chapter by which employees conceal inventory shrinkage?

Answer: The four methods are: (1) altering inventory records (or forced reconciliation); (2) creating fictitious sales and debiting fictitious or existing accounts receivable (and in some cases writing off the fictitious accounts); (3) writing off non-cash assets as scrap, lost, damaged, obsolete, and so on; and (4) physically padding the warehouse or storeroom.

9-11 (Learning objective 9-11) Provide an example of a misappropriation of intangibles scheme.

Answer: An example of an intangibles scheme is an employee who, out of a sense of entitlement, steals a building plan he helped design from his former employer to attempt to get ahead in his new job with a competitor. Another example is a disgruntled employee who retaliates against his employer, for perceived unfair treatment, by selling a trade secret of his employer to a competitor.

Discussion Issues 9-1 (Learning objective 9-3) Jones is the manager of ABC Auto Repair. Unbeknownst to his employer, Jones also does freelance auto repair work to earn extra cash. He

sometimes uses ABC’s facilities and tools for these jobs. Discuss the costs and potential costs that ABC might suffer as a result of Jones’s actions.

Answer: Jones is engaged in a misuse scheme that could cause losses to ABC in a number of ways. First, Jones is making unauthorized use of tools that could damage them or shorten their lifespan. Second, ABC may suffer from a loss of productivity since Jones is performing freelance repairs at ABC’s facilities. He is occupying space, equipment, and labor that could be used for legitimate business. The company may even have to buy new equipment or hire additional labor to make up for the shortfall. Third, ABC may be losing customers as a result of Jones’s scheme. Presumably, at least some of the customers who have hired Jones to fix their cars would have come to ABC if he were not freelancing. Jones also has an unfair competitive advantage in this respect. His expenses are significantly lower than ABC’s, since he is getting free use of facilities and equipment that most likely required a significant investment by ABC. Therefore, he is probably undercutting ABC’s prices in order to attract customers, which is common in this type of scheme.

9-2 (Learning objectives 9-4 and 9-5) Discuss how establishing a strong system of communication between employees and management can help deter and detect inventory larceny.

Answer: As was discussed in this chapter, employees often know that others in the organization are stealing assets, yet they refrain from reporting the crimes. This can occur for a number of reasons, such as a sense of duty to friends, a “management versus labor” mentality, intimidation, poor channels of communication, or simply not knowing how to report a crime. When management makes an effort to foster open communication with employees, this removes many obstacles that may otherwise keep thefts from being reported. Employees should be educated on how fraud hurts everyone in the organization, and they should be made aware that crimes can be reported anonymously and without fear of retribution. In addition, a clear means of reporting crimes (such as a hotline) should be specified so that employees know how and to whom they can make their reports. Remember that according to the 2011 Global Fraud Survey, employee tips are one of the most common methods for detecting occupational fraud. Organizations that do not make use of employees as a fraud detection tool are shortchanging themselves.

9-3 (Learning objectives 9-5 and 9-6) In the case study “Chipping Away at High-Tech Theft,” do you believe the procedures and controls maintained by the manufacturer contributed to the theft? Why or why not?

Answer: While the company’s controls and procedures (or lack thereof) did not cause the theft, they certainly contributed to its success. There were a number of deficiencies that aided Larry Gunter in his scheme. First, the company had no internal transfer documentation, which meant that product could be moved from one building to another without being accounted for. Employees were simply moving the inventory across an open, unmonitored parking lot without boxes being checked or documented. To compound the problem, the company’s security cameras were set up improperly so that they did not deter theft, and security tapes were not saved long enough, which made the security cameras useless in trying to determine who had committed the thefts. In addition, security guards were inattentive and did not do a good job of checking the product that left the building. Finally, the fact that the company verified its product inventory only once a month meant that it took longer for the company to detect the missing inventory.

9-4 (Learning objective 9-5) Discuss the controls that an organization should have in place to effectively prevent and detect larceny of inventory.

Answer: As with most forms of asset misappropriation, the first key to preventing and detecting non-cash larceny is to make sure the organization has adequately separated duties. To prevent inventory larceny, it is crucial that the duties of requisitioning, purchasing, and receiving inventory should be separated. In addition, physical controls should be in place. All merchandise should be physically guarded and locked, with access restricted to authorized personnel only. Access logs should be used to track those who enter restricted areas, including their entry times. Any removal or transfer of inventory to another location should be properly documented. Security cameras also can be effective at deterring theft of inventory. To maximize the deterrent effect of security cameras, employees should be made aware of the presence of the cameras. Physical inventory counts should be conducted on a periodic basis by someone independent of the purchasing and warehousing functions. Shipping and receiving activities should be suspended during physical counts to ensure a proper cut-off, and the physical counts should be subject to recounts or spot-checks by independent personnel. It is also important for organizations to have in place a mechanism for receiving customer complaints, to help detect cases in which employees steal merchandise from outgoing shipments. An employee who is independent of the purchasing and warehousing functions should be assigned to follow up on complaints.

9-5 (Learning objective 9-7) Baker was in charge of computer systems for ABC Company. As part of a general upgrade, the company authorized the purchase of 20 new computers for the employees in its marketing department. Baker secretly changed the order so that 21 computers were purchased. When they were delivered, he stole the extra computer. Later, 10 more new computers were purchased for the 10 employees in the company’s research and development department. Baker also stole one of these computers. How should these two schemes be classified under the fraud tree?

Answer: The first scheme should be classified as a billing scheme (personal purchases), and the second scheme should be classified as a non-cash misappropriation (purchasing and receiving). The difference in the two frauds is that in the first, Baker caused the company to buy a computer it did not need. The harm to the company was that it overpaid for what it received. The fact that Baker took the computer is inconsequential because the company did not need and did not order the computer; Baker could have purchased anything with the excess funds and the harm to the company would have been the same.

In the second scheme, Baker stole an asset that was intentionally purchased by the company. All 10 computers were needed for the 10 employees in the research and development department. Now, the company has not only lost the money it paid for the computer, but it has lost the computer itself and will presumably have to replace it. This scheme is classified as a non-cash misappropriation because the harm to the company is that it has been deprived of a non-cash asset.

9-6 (Learning objectives 9-8 and 9-12) Baker is an auditor for ABC Company. As part of a proactive fraud audit, Baker runs the following tests: (1) a review of the Sales Register for dormant customer accounts that posted a sale within the last two months; and (2) a comparison of the Sales Register and the Shipment Register for shipping documents that have no associated sales order. Taken together, what type of non-cash scheme is Baker most likely to find with these tests? Explain how each one might identify fraud.

Answer: The tests Baker is performing were both identified in this chapter as proactive audit tests for false shipments. The first test may identify cases in which employees have posted fraudulent sales to justify the false shipment of inventory. Frequently, these fraudulent sales are charged to dormant accounts and then allowed to age or are subsequently written off. The second test would tend to identify cases in which inventory was fraudulently shipped offsite without a corresponding sale, a clear indicator of fraud.

9-7 (Learning objective 9-8) Explain why the following circumstances might indicate that one or more employees are stealing merchandise: (1) an increase in uncollectible sales from previous periods and (2) an increase in damaged or obsolete inventory from previous periods.

Answer: The conditions listed above are consistent with two techniques that are sometimes used to conceal the theft of merchandise. As was explained in this chapter, employees sometimes create fictitious sales to justify the shipment of merchandise, then later write off those sales as uncollectible. Similarly, employees sometimes designate merchandise as damaged or obsolete, either to justify the fact that it is missing, or to make it easier to steal (because some organizations do not maintain strict controls over scrap items). Keep in mind that neither of these conditions provides concrete proof that fraud has occurred; there may be legitimate reasons to explain them. But they may be sufficient to warrant further investigation, particularly if combined with other indicators of fraud, such as missing inventory.

Chapter 10 Review Questions 10-1 (Learning objective 10-2) What are the four categories of corruption?

Answer: The four categories of corruption schemes are bribery, illegal gratuities, economic extortion, and conflict of interest.

10-2 (Learning objective 10-4) How are bribery, extortion, and illegal gratuities different?

Answer: While bribery seeks to influence a decision, an illegal gratuity rewards such decision, after the fact. Extortion schemes use coercion by demanding payment from another to prevent harm or loss of business.

10-3 (Learning objective 10-5) What are the two classifications of bribery schemes?

Answer: Bribery schemes fall into two broad categories: kickbacks and bid-rigging schemes.

10-4 (Learning objective 10-6) What are some of the different types of kickback schemes?

Answer: Kickback schemes may take the form of diverting extra business to a certain vendor, approving inflated or fictitious invoices for payment, or allowing the acceptance of substandard product.

10-5 (Learning objective 10-7) What is a bid-rigging scheme?

Answer: Bid-rigging occurs when an employee of a purchasing company illegally assists a certain vendor to win a contract by compromising the competitive bidding process.

10-6 (Learning objective 10-7) How are bid-rigging schemes categorized?

Answer: Generally, bid-rigging schemes are categorized according to the stage of bidding at which the fraud occurs. This may be at the pre-solicitation phase, the solicitation phase, or the submission phase in the competitive bidding process.

10-7 (Learning objective 10-8) How might competition be eliminated in the solicitation phase of a bid-rigging scheme?

Answer: A corrupt contractor may pay an employee of the purchasing company to ensure that one or more of the contractor’s competitors are not allowed to bid on the contract.

This might occur by requiring bidders to be represented by certain sales or manufacturing representatives. Other ways of limiting or eliminating competition may include bid pooling or soliciting bids from fictitious suppliers.

10-8 (Learning objective 10-8) What types of abuses may be found in the submission phase of a bid-rigging scheme?

Answer: Some types of abuses found in the submission phase include compromising the confidentiality of the sealed-bid process, giving information to certain vendors on how to prepare their bid, or falsifying the bid log.

10-9 (Learning objective 10-11) What is a conflict of interest?

Answer: A conflict of interest occurs when an employee, manager, or executive has an undisclosed economic or personal interest in a transaction that adversely affects the company. The key word in this definition is undisclosed. The crux of a conflict case is that the fraudster takes advantage of his employer; the victim organization is unaware that its employee has divided loyalties.

10-10 (Learning objective 10-12) What is meant by the term “turnaround sale”?

Answer: In this type of purchasing scheme, an employee is aware that his company plans to purchase a specific asset, such as land, so the employee then takes advantage of his knowledge by purchasing the asset himself. The asset is then sold to the company by the employee at an increased rate.

10-11 (Learning objective 10-12) How are underbillings usually accomplished?

Answer: In this type of sales scheme, an employee undercharges a vendor in which he has a hidden interest. The victim company then ends up selling its goods or services at less than fair market value, resulting in a diminished profit margin or even a loss on the sale.

10-12 (Learning objective 10-12) What is the difference between business diversions and resource diversions?

Answer: While both are considered conflicts of interest in which “favors” may be performed, business diversions tend to involve cases in which the employee undercuts his own employer through activities such as steering potential clients toward the employee’s business and away from the company’s business, resulting in unfair competition and a loss to the victim company. Comparatively, resource diversions consist of the actual manipulation of a company’s funds or monetary resources to the benefit of the employee.

Discussion Issues 10-1 (Learning objective 10-3) Offering a payment can constitute a bribe, even if the illegal payment is never actually made. Why? Answer: Because the purpose of a bribe is “to influence,” the mere offering of a bribe may serve that end.

10-2 (Learning objective 10-1) What is the common ingredient shared by the four classifications of corruption?

Answer: Bribery, illegal gratuities, economic extortion, and conflicts of interest each involve the exertion of an official’s or employee’s influence to the detriment of his constituency or company.

10-3 (Learning objective 10-3) What is the difference between official bribery and commercial bribery?

Answer: While official bribery seeks to influence an official act, that is, the decisions of government agents or employees, commercial bribery attempts to influence a business decision.

10-4 (Learning objectives 10-6 and 10-9) If you suspected someone of being involved in a kickback scheme, what would you look for?

Answer: Kickback schemes often involve diverting business to a certain vendor, overbilling for goods or services, or paying for fictitious goods or services. Therefore, some of the indications of a kickback scheme may include goods being ordered repeatedly from the same vendor, established bidding policies not being followed, and higher costs of materials than normal.

10-5 (Learning objective 10-6) An employee can implement a kickback scheme regardless of whether she has approval authority over the purchasing function. How might this be accomplished?

Answer: An employee might be able to circumvent accounts payable controls by filing a false purchase requisition. If the person with the authority to approve this requisition relies on the corrupt employee and does not exercise proper judgment and responsibility, this type of scheme may be accomplished without the fraudster having purchasing approval authority.

10-6 (Learning objectives 10-7, 10-8, and 10-9) What are some clues that might alert you to possible fraudulent activity at the different stages of a bid-rigging scheme?

Answer: Suspicions of a bid-rigging scheme might arise when seemingly unnecessary restrictions that artificially limit competition are placed in the solicitation documents. At the pre-solicitation phase, this includes: • Tailoring specifications of a contract to fit the capabilities of a single contractor • Providing confidential information about the contract on a preferential basis • Splitting the contract into several smaller parts in order to circumvent mandatory bidding thresholds At the solicitation phase, this includes: • Allowing only companies that are represented by a certain sales representative to submit bids • Bid pooling, whereby several bidders conspire to split the contract up and ensure that each gets a certain piece • Soliciting bids from fictitious suppliers At the submission phase, this includes: • Abuse of the sealed-bid process • Providing information to certain vendors on how to prepare their bid • Falsifying the bid log • Extending the bid opening date

10-7 (Learning objective 10-11) How do conflicts of interest differ from bribery?

Answer: Conflicts of interest and bribery are both distinct forms of corruption. A typical bribery case involves a fraudster who approves an invoice and receives a kickback in return, whereas a conflict case generally involves a fraudster who approves an invoice because of his own hidden interest in the vendor. Although the two schemes are very similar, the fraudsters have different motives. In the bribery case, the fraudster approves the invoice because he receives some form of payment from a third party. In the conflict case, the fraudster approves the invoice because of his secret interest in the vendor; in a sense, the fraudster is the third party.

10-8 (Learning objective 10-12) Compare the characteristics of purchasing schemes to sales schemes.

Answer: Purchasing schemes are the most common type of conflict of interest. In purchasing schemes, the victim company unwittingly buys something at a high price from another company in which one of its employees has a hidden interest. Comparatively, sales schemes take place when a victim company sells something at a low price to a company in which one of its employees has a secret hidden interest.

10-9 (Learning objectives 10-10 and 10-12) Assume an employee is responsible for purchasing an apartment complex on behalf of his company. The employee owns stock in the management company that operates the apartment complex. The employee does not let his company know about his stock ownership, and proceeds to make the purchase.

Why does this example represent a conflict of interest?

Answer: This case is an example of a purchasing scheme. Because the employee owns stock in the management company that operates the apartment complex and will profit from the sale of the complex, the employee may not negotiate to get the best price for his employer. This is a conflict of interest because it violates the employee’s duty of good faith to his company.

10-10 (Learning objectives 10-9 and 10-13) What are some of the ways organizations can determine whether a particular vendor is being favored?

Answer: Companies can review tips and complaints from competing vendors. Companies can also compare the addresses of their vendors to the addresses of their employees to determine whether a match exists, indicating a possible conflict of interest. Vendor ownership information should also be kept on file and updated whenever an ownership

change takes place. Purchasing personnel can also be interviewed and asked whether any vendors are receiving favorable treatment.

Chapter 11 Review Questions 11-1 (Learning objective 11-1) Why are the fraudulent statement methods under discussion referred to as “financial statement fraud”?

Answer: They are referred to as financial statement fraud because the fraudster participates in falsification of a company’s financial statements, typically either by overstatement of revenue/assets or understatement of expenses/liabilities.

11-2 (Learning objective 11-2) There are three main groups of people who commit financial statement fraud. Who are they?

Answer: The three main groups of people who commit financial statement fraud are organized criminals, mid- and lower-level employees, and senior management.

11-3 (Learning objective 11-3) What are the three primary reasons people commit financial statement fraud?

Answer: The three main reasons people commit financial fraud are to conceal true business performance, to preserve personal status/control, and to maintain personal income/wealth.

11-4 (Learning objective 11-4) What are the three general methods commonly used to commit financial statement fraud?

Answer: The three general methods commonly used to commit financial statement fraud are playing the accounting system, beating the accounting system, and going outside the accounting system.

11-5 (Learning objective 11-5) What is meant by the term “overstatement”?

Answer: “Overstatement” refers to a financial statement fraud in which the perpetrator purposely inflates a company’s financial information (assets or revenues) to provide a false picture of the company’s performance.

11-6 (Learning objective 11-6) What is meant by the term “understatement”?

Answer: “Understatement” refers to a financial statement fraud in which the perpetrator provides a lowered value of a company’s financial information (liabilities or expenses).

11-7 (Learning objective 11-7) What are the components of the conceptual framework for financial reporting?

Answer: The components of the conceptual framework for financial reporting include recognition and measurement concepts—the economic entity, going concern, monetary unit, and periodicity assumptions; the historical cost, revenue recognition, matching, and full disclosure principles; and the cost-benefit, materiality, industry practice, and conservatism constraints—as well as the qualitative characteristics of relevance, reliability, comparability, and consistency.

11-8 (Learning objective 11-8) Define the term “financial statement” and provide examples of types of financial statements used in companies.

Answer: The term financial statement refers to almost any financial data presentation that is prepared in accordance with generally accepted accounting principles. Some common types of financial statements include balance sheets, statements of cash flows, summaries of operations, proxy statements, and registration statement disclosures.

Discussion Issues 11-1 (Learning objective 11-1) Why is financial statement fraud commonly referred to as “cooking the books”?

Answer: Financial statement fraud is commonly referred to as “cooking the books” because it involves the false presentation of a company’s financial data. Records (or books) are manipulated by the fraudster to overstate or understate a company’s financial information.

11-2 (Learning objectives 11-2 and 11-3) Compare the three main groups of people who may commit financial statement fraud, and describe their potential reasons for the fraud.

Answer: Financial statement fraud may be committed by organized criminals, who may engage in the fraud as part of a scheme to obtain fraudulent loans from a financial institution. A second group that may commit financial statement fraud is mid- and lowerlevel employees, who may falsify financial statements for their own area of responsibility for purposes of concealing their true business performance. The third group that may commit financial statement fraud is senior management. This group may have varied motives, but some common reasons include to maintain their own personal wealth or salary, or to preserve their status and control.

11-3 (Learning objective 11-4) Although three general methods of committing financial statement fraud have been identified, one of these methods is typically used first. Which method is this, and why is it more likely to be selected first as opposed to the other two?

Answer: In committing financial statement fraud, the method referred to as “playing the accounting system” is usually committed first. In this method, the fraudster uses the company’s accounting system to produce desired results (e.g., to increase or decrease earnings to a desired dollar amount), taking advantage of regular practices such as reporting of genuine sales. The other two methods (beating the accounting system and going outside the accounting system) require more direct manipulation to achieve desired results.

11-4 (Learning objective 11-7) What is the generally accepted accounting principle known as matching? Describe how a company may be involved in fraud that violates this principle.

Answer: The concept of matching refers to the standard that books and records from a given time period must coincide with the revenue and expenses in the same time period.

Fraud can take place when a company purposely counts revenue from the subsequent year in the current year, or when it records the current year’s expenses in the following year.

11-5 (Learning objective 11-7) Management of a cellular phone company learns that a new technological advance will occur within the next year that will make the company’s current phones and related products obsolete. As a result, there is a strong chance that the company will close. When financial statements appear for auditors, management does not reveal its knowledge of the new technology. In this case, what accounting concepts are involved?

Answer: In this example, management has reason to question the “going concern” assumption with regard to this business. This concept assumes that a business can continue indefinitely; however, when evidence reveals otherwise, management has a duty to report negative information that will affect a company’s future ability to earn revenue.

Therefore, the principle of “full disclosure” has been violated.

11-6 (Learning objective 11-8) In an organization, who is generally responsible for the financial statements, and how can those responsible help to deter financial statement fraud?

Answer: Financial statements are the responsibility of a company’s management, which means that financial statement fraud is rarely committed without the knowledge of members of management. In the instances in which management is not responsible for investigating suspected frauds, it is critical that a code of conduct is in place. This will provide an ethical standard for all employees to follow, which in turn will decrease the likelihood of financial statement fraud.

Chapter 12 Review Questions 12-1 (Learning objective 12-1) What is financial statement fraud?

Answer: Financial statement fraud is the deliberate misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users.

12-2 (Learning objective 12-2) List five different ways in which financial statement fraud can be committed.

Answer: Five ways in which financial statement fraud can be committed are (1) fictitious revenues, (2) timing differences, (3) concealed liabilities and expenses, (4) improper disclosures, and (5) improper asset valuation.

12-3 (Learning objective 12-3) What are the two methods of engaging in fictitious revenues?

Answer: Fictitious revenues schemes can involve making fictitious sales, which involves the use of fake or phantom customers and/or legitimate customers. The second method of recording fictitious revenues is to utilize legitimate customers and artificially inflate or alter invoices reflecting higher amounts or quantities than actually sold.

12-4 (Learning objective 12-3) What are the two most common pressures and motivations to commit financial statement fraud?

Answer: Owners may feel pressured by bankers, stockholders, and even family and community to exceed financial analysts’ earnings forecasts. Additionally, departmental budget requirements may place pressures on managers to meet income and profit goals.

12-5 (Learning objective 12-4) List three methods of engaging in timing differences.

Answer: Schemes involving timing differences usually take the form of one of three methods: (1) failing to match revenues with expenses, (2) early revenue recognition, or (3) recording expenses in the wrong period.

12-6 (Learning objective 12-4) What is the motivation for violating the generally accepted accounting principle of matching revenues with expenses? What is the result of committing this fraud?

Answer: Typically, the motivation for this type of timing difference scheme is to boost net income for the current year. The result is the overstatement of net income of the company in the period in which the sales were recorded. However, it also has the effect of understating net income in the subsequent year when the corresponding expenses finally are reported.

12-7 (Learning objective 12-4) What is the motivation of early revenue recognition?

What is the result of engaging in this type of fraud?

Answer: The motivation for early revenue recognition is to show additional profit. This fraud leads to earnings misrepresentation and frequently serves as a catalyst to further fraud.

12-8 (Learning objective 12-5) List the three common methods for concealing liabilities and expenses.

Answer: The three common methods for concealing liabilities and expenses are (1) omitting liabilities/expenses, (2) capitalizing expenses, and (3) failing to disclose warranty costs and liabilities.

12-9 (Learning objective 12-5) What is the motivation for concealing liabilities and expenses?

Answer: The motivation for concealing liabilities and expenses is to report inflated financial results. Concealing liabilities improves the company’s balance sheet, and concealing expenses results in a higher reported net income.

12-10 (Learning objective 12-6) List five common categories of improper disclosures.

Answer: Five common categories of improper disclosures are liability omissions, significant events, management fraud, related-party transactions, and accounting changes.

12-11 (Learning objective 12-7) What are the four common forms of improper asset valuation?

Answer: Improper asset valuations usually take of one of the following forms: inventory valuation, business combinations, accounts receivable, and fixed assets.

12-12 (Learning objective 12-7) What is the likely result of committing an improper asset valuation?

Answer: This type of fraud tends to inflate the current assets at the expense of long-term assets, and thus falsely improves financial ratios, such as the current ratio and quick ratio.

12-13 (Learning objective 12-8) What is the difference between fraudulent financial reporting and misappropriation of assets?

Answer: Fraudulent financial reporting frequently involves a pressure or incentive to commit fraud and a perceived opportunity to do so. In general, fraudulent reporting occurs through intentional fraudulent omissions or inclusions in the financial statements.

Asset misappropriation involves the theft or misuse of company assets.

12-14 (Learning objective 12-9) Describe three analytical techniques for financial statement analysis.

Answer: Horizontal analysis is a technique for analyzing the percentage change in individual financial statement items from one year to the next. Vertical analysis is the expression of the relationship or percentage of financial statement components to a specific base item. Ratio analysis is a means of measuring the relationship between two different financial statement amounts.

Discussion Issues 12-1 (Learning objective 12-3) What is the most effective way to prevent fictitious revenue from being fraudulently reported in the financial statements?

Answer: FASB Concepts Statement No. 6 defines revenue as “inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.” Implementing controls to ensure that the criteria inherent in this definition are met prior to recording revenue will assist in mitigating the problem of fictitious revenue.

12-2 (Learning objective 12-3) How can fictitious revenue be created through the use of false sales to shell companies? Discuss the method and result of committing this fraud.

Answer: A company’s management can utilize several shell companies as customers in a number of favorable sales transactions. The sales transactions are fictitious, as are the

supposed customers. An example entry from this type of case is detailed below. A fictional entry is made to record a purchase of fixed assets: Date Description Debit Credit 12-01-X1 Fixed Assets 300,000 Cash 300,000 A fictitious sales entry is then made for the same amount as the false purchase: Date Description Debit Credit 12-01-X1 Accounts Receivable 300,000 Sales 12-01-X1 Cash Accounts Receivable

300,000 300,000 300,000

From the above journal entry, we can see that the cash outflow that supposedly covered the purchase of assets is returned as payment on the receivable account to cover the fictitious sale. The result of the completely fabricated sequence of events is an increase in both company assets and yearly revenue.

12-3 (Learning objective 12-4) How might a company utilize timing differences to boost revenues for the current year? Discuss and analyze the method and result of committing the fraud.

Answer: Suppose at the end of the year, the following journal entry was made: Date Description Debit Credit 12-01-X1 Accounts Receivable 20,000 Sales—Project A 20,000 In January of next year, the project is started and completed. The entries below show accurate recording of the 15,000 of costs associated with the sale: Date Description Debit Credit 1-31-X2 Cost of Sales—Project A 12,000 Inventory 12,000 1-31-X2 Labor Costs—Project A 3,000 Cash 3,000

From the above journal entries we can see that a company may accurately record sales that occurred in the month of December, but fail to fully record expenses associated with those sales. This error overstates the net income of the company in the period in which the sales were recorded, and also understates net income when the expenses are reported.

12-4 (Learning objective 12-4) In the case study, “The Importance of Timing,” what kind of fraud did the accountant commit? How could this fraud have been discovered?

Answer: He committed a fraud involving a timing difference. In this fraud, he made payment for materials and supplies in one year, even though they were not received until the next year. He also recognized the repair in the year that the actual repair occurred.

Division management asked Isbell to conduct an examination. He found $150,000 in repair invoices without proper documentation. The records for materials and supplies, which were paid for in one year and received in the next year, totaled $250,000. A check of later records and an inspection showed that everything paid for had, in fact, been received, just some days later than promised.

12-5 (Learning objective 12-5) Liability/expense omission is the preferred and easiest method of concealing liabilities/expenses. Why? Discuss how to detect this type of fraud.

Answer: Failing to record liabilities/expenses is very easy to conceal and very difficult to detect. The perpetrators of liability and expense omissions believe they can conceal their fraud in future periods. They often plan to compensate for their omitted liabilities with visions of other income sources such as profits from future price hikes. For example, the perpetrators may have planned to conceal the fraud by increasing the sales price in future periods when the expense would actually be recorded. These frauds can be discovered through a thorough review of all post-financial-statement-date transactions, such as accounts payable increases and decreases.

12-6 (Learning objective 12-7) What internal control activities and related test procedures can detect or deter overstated inventory?

Answer: When an overstated inventory scheme is suspected, the use of analytical procedures can help uncover suspicious activity. Red flags of overstated inventory include unusual growth in the number of days’ purchases in inventory and an allowance for excess and obsolete inventory that is shrinking in percentage terms or that is otherwise out of line with industry peers.

Additionally, a review of the accounts receivable (A/R) aging report and bills of lading can help detect this fraud. For example, in one case described in this chapter, an A/R aging report indicated sales of approximately $1.2 million to a particular customer in prior months. The aging showed that cash receipts had been applied against those receivables. An analysis of ending inventory failed to reveal any improprieties because the relief of inventory had been properly recorded with cost of sales. Copies of all sales documents to this particular customer were then requested. The product was repeatedly sold FOB shipping point, and title had passed. But bills of lading indicated that only $200,000 of inventory had been shipped to the original purchaser. There should have been $1 million of finished product on hand for the food processor. However, there was nothing behind the facade of finished products. An additional comparison of bin numbers on the bill of lading with the sales documents revealed that the same product had been sold twice.

12-7 (Learning objective 12-9) What financial reporting analysis techniques can help to detect fraudulent financial statement schemes?

Answer: Three primary financial statement analysis techniques are available to the fraud examiner. The first is vertical analysis, which is a technique for analyzing the relationships between the items on an income statement, balance sheet, or statement of cash flows by expressing components as percentages. This method is often referred to as “common sizing” financial statements. In the vertical analysis of an income statement, net sales are assigned 100 percent; for a balance sheet, total assets are assigned 100 percent, and so are total liabilities plus owner’s equity. All other items in each of the statements are expressed as a percentage of these numbers. It is the expression of the relationship or percentage of component items to a specific base item. Vertical analysis emphasizes the relationship of statement items within each accounting period. These relationships can be used with historical averages to determine statement anomalies.

The second financial statement analysis technique is horizontal analysis, also known as trend analysis. This technique is used to determine changes (i.e., increases or decreases) in a series of financial data over a period of time. The first period in the analysis is considered the base, and the changes in the subsequent period are computed as a percentage of the base period. If more than two periods are presented, each period’s changes are computed as a percentage of the preceding period.

The third financial reporting analysis technique is ratio analysis. It is a means of measuring the relationship between two different financial statement amounts. The relationship and comparison are the keys to the analysis. Traditionally, financial

statement ratios are used in comparisons to an entity’s industry average. They can be very useful in detecting red flags for a fraud examination.

12-8 (Learning objectives 12-3, 12-5, and 12-7) In the case study, “That Way Lies Madness,” what kind of fraud did Eddie Antar commit? How was the fraud committed?

How could the fraud be discovered?

Answer: Eddie Antar committed fictitious revenues, concealed liabilities and expenses, and improper asset valuation frauds. The schemes used by Crazy Eddie include the following: •

• • • • •

Listing smuggled money from foreign banks as sales. Through these fictitious sales, he generated fictitious revenues. This fraud resulted in the increase of assets and yearly revenue.

Making false entries to accounts payable.

Overstating Crazy Eddie, Inc.’s inventory by breaking into and altering audit records.

Taking credit for merchandise as “returned,” while also counting it as inventory.

“Sharing inventory” from one store to boost other stores’ audit counts.

Arranging for vendors to ship merchandise and defer the billing, besides claiming discounts and advertising credits.

•

Selling large lots of merchandise to wholesalers, then spreading the money to individual stores as retail receipts.

There were many clues: Stores were alarmingly understocked, shareholders were suing, and suppliers were shutting down credit lines because they were paid either late or not at all. An initial review showed that the company’s inventory had been overstated by $65 million—a number later increased to over $80 million.

12-9 (Learning objective 12-10) During the audit of financial statements, an auditor discovers that the financial statements might be materially misstated due to the existence of fraud. Describe (1) the auditor’s responsibility according to AU 240 for discovering financial statement fraud; (2) what the auditor should do if he or she is precluded from applying necessary audit procedures to discover the suspected fraud; and (3) what the auditor should do if he or she finds that the fraud materially affects the integrity of the financial statements.

Answer: According to AU 240, 1. The auditor should (a) exercise professional skepticism in conducting the audit by discussing among the audit team members the risks of material misstatement due to

fraud; (b) consider the implications for other aspects of the audit and discuss the matter with an appropriate level of management; and (c) obtain sufficient and competent evidential matter to determine whether material fraud exists and what its impact is on the fair presentation of financial statements.

2. If the auditor is precluded from applying necessary audit procedures to find out about the existence of fraud, the auditor should (a) discuss the matter with the legal counsel; (b) disclaim or qualify an opinion on the financial statements; and (c) communicate audit findings to the audit committee or the board of directors.

3. If the auditor concludes that financial statements are materially affected by discovered frauds, the auditor should (a) require that financial statements be revised to correct the fraud; (b) issue a qualified or an adverse opinion if management refuses to revise the fraudulent financial statements; (c) consider withdrawing from the audit engagement and inform the audit committee, the board of directors, or the authorities about the fraud.

Chapter 13 Review Questions 13-1 (Learning objective 13-1) What are the three types of external parties that present a serious fraud threat to organizations?

Answer: The three types of external parties that present a serious fraud threat to organizations are customers, vendors, and unrelated third parties.

13-2 (Learning objective 13-3) Customers can pose many different fraud threats to the organizations they patronize. What are some of the fraud threats posed by customers?

Answer: While there are many fraud threats posed by customers, some of the more common threats include check fraud and credit card fraud.

13-3 (Learning objective 13-5) Describe the type of organization that a paperhanger would likely target.

Answer: A paperhanger is an expert in check fraud. Any organization that accepts checks as payment and does not have strict controls over ensuring that checks from customers are legitimate would be a good target for a paperhanger.

13-4 (Learning objective 13-7) What is credit card fraud? Briefly describe the three types of credit card fraud presented in the chapter.

Answer: Credit card fraud is the misuse of a credit card to make purchases without authorization, or counterfeiting a credit card. There are many different types of credit card schemes, including unauthorized use of a lost or stolen card, stolen card numbers, and counterfeit cards.

13-5 (Learning objective 13-8) List some of the red flags of a customer using an unauthorized credit card.

Answer: Some red flags of a customer using an authorized credit card include: •

A customer purchases a large item, such as a television, and insists on taking it at the time, even when delivery is included in the price.

•

A customer becomes argumentative with the sales representative while waiting for the transaction to be completed, or appears to be very rushed.

•

A customer charges several expensive items on a newly valid card.

•

A customer pulls the card directly out of his pocket rather than his wallet.

•

A customer claims to have forgotten or lost his identification when asked for it by the cashier.

13-6 (Learning objective 13-8) What are some ways vendors might collude to commit fraud against clients?

Answer: There are several fraud schemes that involve vendors colluding amongst themselves to win a contract. The most common forms of collusion between competitors involve complementary bids, bid rotation, and phantom bids.

13-7 (Learning objective 13-9) What types of schemes do vendors often perpetrate during the performance phase of a contract?

Answer: In general, there are two basic schemes perpetrated during the performance phase: product substitution and cost mischarging.

13-8 (Learning objective 13-10) List some common product substitution schemes.

Answer: Some examples of common product substitution schemes include: •

Delivery of inferior/substandard material

•

Delivery of materials that have not been tested

•

Falsification of test results

•

Delivery of used, surplus, or reworked parts

•

Delivery of counterfeit products

•

Submission of false certifications (certifications are statements that parts or materials are new, domestically manufactured, and meet the contract specifications concerning quality and quantity, or that the company is minority owned)

13-9 (Learning objective 13-11) Why should an organization conduct a vendor audit?

Answer: Vendor audits are an effective way to prevent and detect fraud in the procurement process. The first response to the suggestion of vendor audits is often that they are unnecessary because contracts are in place to safeguard the organization in the event of fraud. However, it is imperative that vendors undergo a thorough vetting process initially followed up by continuous monitoring after the contract has been awarded and work has begun. Doing so will help improve controls, identify fraud, and save the company money.

13-10 (Learning objective 13-12) Identify two major fraud threats posed by unrelated third parties.

Answer: Two major fraud threats posed by unrelated third parties include computer fraud and corporate espionage.

13-11 (Learning objective 13-12) Why are computer fraud cases often more difficult to examine than traditional fraud cases?

Answer: Unlike traditional fraud cases, computer fraud cases can be difficult for the fraud examiner because they: •

Lack a traditional paper audit trail.

•

Require an understanding of the technology used to commit the crime.

•

Usually require an understanding of the technology of the victim computer.

•

Typically require the use of one or more specialists to assist the fraud examiner, even when the fraud examiner is computer literate.

13-12 (Learning objective 13-12) How do computer hackers gain unauthorized access to a target company’s network? Describe some of the methods they might use.

Answer: Some common methods that computer hackers use to gain unauthorized access to a company’s network include: •

Password cracking - Password cracking is an automated process by which an attacker attempts to guess the most likely passwords of a system user.

•

Social Engineering - In a social engineering scheme, the attacker deceives victims into disclosing personal information or convinces them to commit acts that facilitate the attacker’s intended scheme.

•

Phishing - Often, fraudsters hijack business names to execute phishing attacks.

Phishing scams occur when a fraudster dupes victims into providing sensitive information by falsely claiming to be from an actual business, bank, vendor, or other entity with which the target does business.

•

Wire Tapping - Wire tapping into a computer’s communication links is another technique used by hackers. This method enables perpetrators to read the information being transmitted between computers, or between computers and terminals.

13-13 (Learning objective 13-14) Which departments of a company are popular targets of corporate spies?

Answer: Some of the favorite targets of intelligence gatherers include research and development, marketing, manufacturing and production, and human resources.

DISCUSSION ISSUES 13-1 (Learning objectives 13-6 and 13-8) Companies accept a variety of forms of payment from customers, and sometimes these payment methods are illegitimate. When a customer uses an illegitimate form of payment, it might never receive the cash it is due.

What types of policies, procedures, and controls could a company put in place to mitigate the risk of payment fraud by its customers?

Answer: The best solution for financial institutions and merchants is to educate employees to recognize forged and fraudulent checks and the schemes behind them.

Merchants and financial institutions should have a strict check acceptance policy with which all employees are familiar. When accepting checks, employees should always ask for identification and make sure it is valid. Many check passers mollify store personnel by showing them a small laminated rectangular document with a picture. After looking at several hundred of these, most employees tend not to scrutinize them. Check passers count on this. It is important for employees to examine each piece of identification closely every time they are presented with one.

When conducting transactions online, merchants should be wary of customers who pay with checks and should consider adopting a no-check policy. There are many secure person-to-person payment methods, such as Paypal, and it is not unusual for a vendor to exclusively accept this type of payment.

13-2 (Learning objective 13-11) What are some analytical tests that can be performed to detect fraudulent activity by vendors, and what are some ways to prevent vendor fraud from occurring in the first place?

Answer: Some analytical tests that can be performed to detect fraudulent activity by vendors include: •

Checking for vendors and employees with matching addresses

•

Looking for more than one vendor with the same address

•

Vendors who only have PO Box addresses

•

Unusual or one-time extra charges

•

Complaints about specific vendors

•

Higher prices and/or substandard quality

•

An excessive amount of change orders made by the vendor

Vendor fraud can be prevented by thoroughly vetting vendors in the procurement process and even after by using vendor audits. Beware of contractors with a history of fraudulent conduct, a reputation for dishonesty, or involvement in prior complaints or legal actions.

13-3 (Learning objective 13-Computer security controls are an integral part of any modern organization’s defense system. What are some processes, systems, and controls companies should have in place with regard to their IT structure to mitigate the risk of penetration by unrelated third parties?

Answer: It is essential for an organization to establish formal security policies. These policies should include training for all employees, customers, vendors, contractors, and consultants who access the network. These policies should also address the strength of employees’ passwords used to access the network. Firewalls are also an essential component of a cyber security system. Firewalls are software programs that block unauthorized or unverified access to a computer system. To supplement firewalls, IT departments should implement an intrusion detection system. Intrusion detection systems are designed to detect malicious activity coming across the network or on a host. Finally, security software is an invaluable way to mitigate the risk of computer fraud.

Organizations should implement up-to-date security software packages and implement them to the highest level possible.

13-4 (Learning objective 13-13) Why do companies resort to corporate espionage to get information about their competitors, when there is a wealth of information available in the public domain?

Answer: The first reason comes down to the difference between facts and intelligence.

Even if the intelligence gatherer adheres strictly to using only open sources, mere facts do not constitute intelligence or knowledge. Collecting raw data brings one only to the threshold of the process. Data must then undergo analysis to be turned into a useful product. Analysis involves summarizing, comparing, and explaining the data. The craft of intelligence lies in the provider’s ability to distill mountains of facts from diverse sources into a concise product that is actionable by its consumer. To be actionable means the product has depth, character, and quality, allowing an executive to make sound decisions.

The second reason organizations use intelligence professionals is that, while there is a wealth of valuable information available in the public domain, there remains needed

information that is proprietary. This last segment often becomes critical to competitive survival, and organizations or individuals are sometimes willing to sidestep the law to obtain it. Intelligence professionals know the “tricks of the trade” for gathering sensitive proprietary information that can give their clients a competitive edge.

13-5 (Learning objective 13-16) What are some countermeasures a company can implement to protect its premises and assets from espionage?

Answer: Of course, it is not possible to completely eliminate the threat of corporate espionage. However, there are several measures any organization should take to ensure it is sufficiently protected against this threat: •

Materials bearing proprietary data should not be stored in areas visible to the public.

If no other option exists, the organization should only use unlettered, color-coded containers as opposed to labeling a particular file drawer “Confidential.” This will make it more difficult for spies to tell where sensitive information can be found.

•

Security should establish a procedure for tracking and locking up sensitive data.

•

Cleaning personnel should be properly bonded and identified, and their access to the facility should be controlled.

•

Vendors should have verified credentials and must be escorted by a company representative during their visit.

•

There should be someone who sits at the entrance of the premises responsible for vetting any visitors. All guests to the building should be preapproved, registered, and able to identify the employee they are visiting by first and last name.

•

Employees should be instructed as to what information they may disclose over the telephone.

•

Employees should sign nondisclosure agreements. In addition, the legal department should be consulted about integrating vendor and supplier nondisclosure agreements into standard contracts.

Chapter 14 Review Questions

14-1 (Learning objective 14-1) What are four factors that influence the level of fraud risk faced by an organization?

Answer: Four factors that influence the level of fraud risk faced by an organization are (1) the nature of the business, (2) its operating environment, (3) the effectiveness of its internal controls, and (4) the ethics and values of the company and the people within it.

14-2 (Learning objective 14-2) What is the difference between preventive controls and detective controls?

Answer: Preventive controls are designed to stop an undesirable event from occurring, whereas detective controls are designed to identify an undesirable event that has already occurred.

14-3 (Learning objective 14-3) What is the objective of a fraud risk assessment?

Answer: The objective of a fraud risk assessment is to help management recognize the factors that make the organization most vulnerable to fraud so that management can address those factors to reduce the exposure.

14-4 (Learning objective 14-4) What can an effective fraud risk assessment help management to accomplish?

Answer: An effective fraud risk assessment can help management to accomplish the following: (1) improve communication and awareness throughout the organization about fraud; (2) identify what activities are the most vulnerable to fraud; (3) know who puts the organization at the greatest risk for fraud; (4) develop plans to mitigate fraud; (5) develop techniques to determine whether fraud has occurred in high-risk areas; (6) assess internal controls; and (6) comply with regulations and professional standards.

14-5 (Learning objective 14-5) What characteristics constitute a good fraud risk assessment?

Answer: The following are characteristics of a good fraud risk assessment: (1) it involves a collaborative effort of management and auditors; (2) it is sponsored by a competent and respected individual; (3) those leading and conducting the work are independent, objective, and open-minded; have a good working knowledge of the business; and engender the trust of management and employees; (4) it includes the perceptions of people at all levels of the organization; (5) it is kept alive and relevant.

14-6 (Learning objective 14-6) What are three considerations for developing an effective fraud risk assessment?

Answer: One consideration for developing an effective fraud risk assessment is presenting it in a manner to which people can relate. Another consideration is tailoring the approach and execution to the individual organization. Finally, the fraud risk assessment should be kept simple to ensure ease of execution.

14-7 (Learning objective 14-7) What can management do to prepare a company for a fraud risk assessment?

Answer: In order to prepare a company for a fraud risk assessment, management can build a fraud risk assessment team, consisting of individuals with diverse knowledge, skills, and perspectives, to lead and conduct the assessment. Also, management can determine the best techniques to use in performing the assessment and obtain the sponsor’s agreement on the work to be performed. Finally, management can openly promote the fraud risk assessment process to encourage employee participation.

14-8 (Learning objective 14-8) What steps are involved in conducting a fraud risk assessment using the sample framework discussed in the chapter?

Answer: The steps involved in conducting a fraud risk assessment using the sample framework discussed in the chapter are as follows: 1. Identify potential inherent fraud risks.

2. Assess the likelihood of occurrence of the identified fraud risks.

3. Assess the significance to the organization of the fraud risks.

4. Evaluate which people and departments are most likely to commit fraud and identify the methods they are likely to use.

5. Identify and map existing preventive and detective controls to the relevant fraud risks.

6. Evaluate whether the identified controls are operating effectively and efficiently.

7. Identify and evaluate residual fraud risks resulting from ineffective or nonexistent controls.

14-9 (Learning objective 14-9) Describe four approaches for responding to an organization’s residual fraud risks.

Answer: In responding to an organization’s residual fraud risks, management can choose to avoid, transfer, mitigate, or assume each risk. Management may decide to avoid a risk by eliminating an asset or exiting an activity if the control measures required to protect the organization against an identified threat are too expensive. To transfer some or all of a risk, management may purchase fidelity insurance or a fidelity bond. Management can mitigate a risk by implementing appropriate countermeasures such as prevention and detection controls. If management determines that the probability of occurrence and

impact of loss are low, management may choose to accept a risk. Finally, for certain risks, management may elect a combination of these approaches.

14-10 (Learning objective 14-10) What are four important considerations to keep in mind when reporting the fraud risk assessment results?

Answer: In reporting the fraud risk assessment results, the fraud risk assessment team should stick to the facts, focus on the most important points, identify actions that are clear and measurable, and present information in an easy-to-understand manner.

14-11 (Learning objective 14-11) What actions can management take to make the most impact with the fraud risk assessment?

Answer: In order to make the most impact with the fraud risk assessment, management can use the results in its ongoing anti-fraud efforts. By using the results to begin a dialog across the company that promotes awareness, education, and action planning, management can reduce fraud risk. Also, by using the results to identify high-risk areas, management can better focus its anti-fraud efforts. Management must ensure that the fraud risk assessment stays current and relevant, and that someone in the organization is assigned ownership of the process.

14-12 (Learning objective 14-12) How can a fraud risk assessment inform and influence the audit process?

Answer: The results of a fraud risk assessment can help auditors design programs and procedures in a way that enables the auditors to look for fraud in known areas of high risk.

Discussion Issues 14-1 (Learning objective 14-1) How is fraud risk influenced by a company’s internal controls? How is fraud risk influenced by a company’s ethics, values, and expectations?

Answer: A good system of internal controls, with the right balance of preventive and detective controls, can greatly reduce an organization’s vulnerability to fraud by reducing the fraudster’s opportunity to commit fraud and by increasing the likelihood of detection of a fraud that is committed. Any gap in alignment between a company’s ethics, values, and expectations and those of the individuals that make up the organization can significantly increase an organization’s fraud risk.

14-2 (Learning objective 14-6) Why is it important that management and auditors collaborate on a fraud risk assessment?

Answer: By collaborating on a fraud risk assessment, management and auditors can increase the effectiveness of the assessment. Each party brings a unique perspective to the assessment. Management has intricate familiarity with the day-to-day business operations, responsibility for assessing business risks and implementing organizational controls, authority to adjust operations, influence over the organization’s culture and ethical atmosphere, and control over the organization’s resources. Auditors are trained in risk identification and assessment, and have expertise in evaluating internal controls, which is critical to the fraud risk assessment process.

14-3 (Learning objective 14-6) What qualities and characteristics should be considered when choosing a sponsor for a fraud risk assessment?

Answer: A sponsor for a fraud risk assessment should be senior enough in the organization to command the respect of the employees and to elicit full cooperation in the process. The sponsor must be someone who is committed to learning the truth about where the company’s fraud vulnerabilities are. In addition, he must be independent and open in his evaluation of the situation and response to the identified risks.

14-4 (Learning objective 14-6) Green is an internal auditor and the lead on the company’s fraud risk assessment. In the past, he and Blue, an accounts receivable clerk, have had several heated disagreements over accounting procedures. What risk would Green be taking by having Blue perform the fraud risk assessment work related to the accounts receivable department’s activities? How might this risk be best addressed?

Answer: Because Green and Blue have had some bad past experiences, by having Blue perform the work related to the accounts receivable department’s activities, Green risks allowing those bad experiences to affect his evaluation of the fraud risks related to that area of the business. To preclude this possibility, someone else should perform the fraud risk assessment work related to the activities of the accounts receivable department.

14-5 (Learning objective 14-7) Who should be included on a fraud risk assessment team?

Answer: The fraud risk assessment team should consist of individuals with diverse knowledge, skills, and perspectives. The team members can include accounting and finance personnel who are familiar with the financial reporting process and internal controls; nonfinancial business unit and operations personnel who have knowledge of day-to-day operations, customer and vendor interactions, and industry issues; risk management personnel who can ensure that the fraud risk assessment process integrates with the organization’s enterprise risk management program; the general counsel or other members of the legal department; members of any ethics and compliance functions

within the organization; internal auditors; external consultants with fraud and risk experience; and any business leader with direct accountability for the effectiveness of the organization’s fraud risk management efforts.

14-6 (Learning objective 14-8) What topics should be discussed in identifying fraud risks that could apply to the organization?

Answer: The following topics should be discussed in identifying fraud risks that could apply to the organization: incentives, pressures, and opportunities to commit fraud; and risk of management’s override of controls. In addition, information should be gathered about the business itself, including its business processes, industry, and operating environment.

14-7 (Learning objective 14-8) What risks related to each of the three primary categories of fraud should the fraud risk assessment team consider?

Answer: Fraud risks can be classified according to the three major categories of fraud: fraudulent financial reporting, asset misappropriation, and corruption. The fraud risk assessment team should consider the following fraudulent financial reporting risks: inappropriately reported revenues, expenses, or both; inappropriately reflected balance sheet amounts, including reserves; inappropriately improved or masked disclosures; concealed misappropriation of assets; concealed unauthorized receipts, expenditures, or both; and concealed unauthorized acquisition, use, or disposition of assets. The team should also consider asset misappropriation risks, including the risks of misappropriation of tangible and intangible assets, and proprietary business opportunities. Potential corruption risks that the team should consider include payment of bribes or gratuities to companies, private individuals, or public officials; receipt of bribes, kickbacks, or gratuities; and aiding and abetting of fraud by outside parties such as customers or vendors.

14-8 (Learning objective 14-8) What risks should the fraud risk assessment team consider in addition to the specific risks related to each of the three primary categories of fraud?

Answer: In addition to the specific risks related to each of the three primary categories of fraud, the fraud risk assessment team should consider risks related to regulatory and legal misconduct, reputation risk, and risk to information technology.

14-9 (Learning objective 14-9) When might an organization choose to avoid a risk rather than assume, transfer, or mitigate it?

Answer: Rather than assume, transfer, or mitigate a risk, management might choose to avoid it—by eliminating an asset or exiting an activity—if the control measures required to protect the organization against an identified threat are too expensive.

Chapter 15 Review Questions 15-1. (Learning objective 15-1) What are some of the reasons a fraud examination should be commenced?

Answer: A fraud examination may be undertaken to determine the source of and losses from an alleged fraud, and to gather evidence for a criminal prosecution or civil trial.

Examinations may also be conducted to comply with federal statutes, to fulfill the professional duties of loyalty and reasonable care, to protect against allegations of wrongful termination, and to mitigate the company’s liability related to employee misconduct.

15-2. (Learning objective 15-2) Who are some of the professionals that should be included on a typical fraud examination team?

Answer: Professionals from a variety of fields can provide valuable assistance to the examination. A typical investigation team might include Certified Fraud Examiners, legal counsel, internal auditors, security personnel, IT and computer forensics experts, human resources personnel, a management representative, and outside consultants.

15-3. (Learning objective 15-2) Under what circumstances might the fraud examination team include outside consultants?

Answer: In some cases, particularly when the suspect employee is especially powerful or popular, it might be useful to employ outside specialists who are relatively immune to company politics or threats of reprisal. Such experts might also have greater experience and investigative contacts than insiders. In addition, some investigatory procedures, such as forensic document analysis, require a high level of proficiency and expertise and should therefore only be undertaken by professionals specifically trained in that field.

15-4. (Learning objective 15-3) What is evidence? What types of things can be considered evidence?

Answer: Evidence is anything perceivable by the five senses, and includes any proof, such as testimony of witnesses, records, documents, facts, data, or tangible objects, that

is legally presented at trial to prove a contention and induce a belief in the minds of a jury.

15-5. (Learning objective 15-4) What are some of examples of evidence gathering techniques that might be utilized in a fraud examination?

Answer: Fraud examinations frequently employ a wide variety of investigative techniques to gather evidence. Some of these include interviewing witnesses, examining public sources of information, conducting covert and surveillance operations, using informants, “dumpster diving,” acquiring subpoenas and search warrants, and obtaining voluntary consent.

15-6. (Learning objective 15-5) When handling documentary evidence, what types of precautions should a fraud examiner take?

Answer: Original documents should be obtained where feasible. However, the originals should not be touched more than necessary, as they may later need to undergo forensic analysis. Therefore, the investigator should make working copies for review, and keep the originals segregated. Additionally, a good filing system for the documents is essential.

Losing a key document may irreparably damage the case.

So that it can be identified later, all documentary evidence received should be uniquely marked, either by initialing and dating the items or by making small tick marks or other nondescript identifiers on them. Other than these identifiers, the examiner should never write or make markings on the original documents. The investigator should also never add new folds to, staple, place paper clips on, crumple, or do anything else to documents that would affect or change them from their original condition. Finally, if fingerprint examinations are anticipated, gloves should be used to handle the documents.

15-7. (Learning objective 15- 7) What types of information can be obtained by examining internal documentation?

Answer: An investigator can learn a great deal about an individual by examining routine in-house information on file at his or her place of employment. Internal sources can provide the framework necessary for continued investigation from other sources. For example, personnel files can provide full names, addresses, social security numbers, dates of employment, previous employers, and salary information. Phone, voicemail, and email records can provide information about communication between parties. Access codes and user identification codes can identify when employees entered buildings and

logged onto and off of computer systems. Security videos provide evidence of employee location and activity.

15-8. (Learning objective 15-8) What are three characteristics/objectives of a good investigation report?

Answer: The way in which the information is presented at the end of an investigation can often make or break the case. Therefore, a good investigation report should 1) convey all evidence necessary for thorough and proper evaluation of the case, 2) add credibility to the investigation and corroborate earlier facts, and 3) accomplish the objectives of case.

15-9. (Learning objective 15-8) What are five sections that should be included in a standard investigation report? What information is found in each of these sections?

Answer: A standard report should include the following sections: • Summary. This section sets out the main points of the report in a few sentences and should include the subject, basis, findings, and outcome of the investigation.

• Introduction/purpose. This section provides more detail on what the report is about and prepares the reader for what is to come, as well as explaining the purpose of the report along with any background information that may be required.

•

•

•

Body. This section identifies the employee(s) and other individuals implicated or involved in the matter and provides any background information that may have been obtained about the employee(s) or other parties. This section also details the methods used to investigate the matter.

Results. This section will range from a sentence or two to a narrative supplemented by spreadsheets or graphics, depending on the nature of the investigation and the information collected.

Follow-up/recommendations. This section identifies any investigation procedures that remain outstanding and outlines any recommendations related to procedures and controls.

Discussion Issues 15-1. (Learning objective 15-2) Who should be responsible for directing an internal fraud investigation? Why? Answer: Typically, the company’s legal counsel should be involved in and, in most cases, charged with “directing” an internal investigation, at least as far as the legal aspects are concerned. Investigations can raise countless legal questions, and if certain legal

precautions are not taken, the case can be severely damaged. The investigation team must have legal counsel on hand to sort out these issues; otherwise, the company risks exposing itself to greater danger than the threat it is investigating. In addition, by having an attorney directing the investigation, the company may be able to protect the confidentiality of its investigation under the attorney-client privilege.

15-2. Learning objectives (15-2, 15-6, and 15-7) How can computers and technology help in investigating a fraud? What kinds of challenges can the involvement of technology present to a case?

Answer: Just as computers are being used increasingly in the committal of fraud, investigators are making extensive use of technology in preventing, detecting, and investigating fraud. Because most frauds now involve the use of a computer in some capacity, IT professionals may need to be part of an investigation to safeguard data until it can be analyzed. Additionally, computer forensics professionals should be used to capture and analyze digital data. Electronic data can be easily altered; therefore, only trained professionals should be used to secure such data so that it can be analyzed more thoroughly without disturbing the original files.

The Internet has been an enormous tool in the fraud examiner’s repertoire, as investigators now have a wealth of public records information at their fingertips. A number of resources and online search services are available to help investigators locate individuals, research financial information, identify business relationships and transactions, and uncover litigation history. Additionally, several software programs exist specifically to help investigators in organizing and managing evidence, and in reporting the results of their investigations.

15-3. (Learning objective 15-4) Jim Block, CFE, is investigating Randy Smith for his role in a potential kickback scheme. Gathering evidence about Randy’s financial activity has been difficult. While on a stakeout at Randy’s home, Jim sees Randy’s wife take out the garbage and place it on the curb. Jim steals the trash bag, sorts through its contents, and discovers multiple bank statements that provide detail of some of Randy’s illicit financial transactions. Is Jim’s acquirement of the bank statements legal even though there was no search warrant?

Answer: Yes. Jim’s use of “dumpster diving” to obtain evidence about Randy’s financial dealings is legal. The courts have upheld that investigators may sift through trash without a search warrant, provided that the trash has left the suspect’s possession. At that point, there is no longer the reasonable expectation of privacy, and thus it is fair game.

15-4. (Learning objective 15-6) What are some considerations a fraud examiner should keep in mind when organizing documentary evidence? Which method of evidence organization is preferred?

Answer: Keeping track of the amount of paper generated is one of the biggest problems in fraud investigations. Therefore, documents should be continuously reorganized and reevaluated as to importance and relevance to the case. Investigators should make a “key document” file for easy access to the most relevant documents and periodically review the key document file, moving the less important documents to back-up files and keeping only the most relevant paper in the main file.

A database of documents should be established early on in the case, and should include, at a minimum, the date of the document, the individual from whom the document was obtained, the date it was obtained, the subject to which the document pertains, and a brief description. Documents should be segregated and organized by either witness or transaction. Chronological organization is generally the least preferred method.

15-5. (Learning objective 15-7) An investigator is looking for information about some vacant land that may be owned by a suspect in a fraud case. What source(s) of public records would be a good place to find this information?

Answer: The investigator would find the information he is seeking in the public records of the county in which the land is located. The county should have on record a deed verifying the transfer of the property. Additionally, information about the land will be reflected in the county real property indexes. A search of the county real property records will reveal the residency and addresses of buyer and seller of the land, the purchase price of the property, and the title companies involved in the transaction. If the property was financed, the records will also list the mortgage company and amount originally financed.

The investigator should also search the county property tax records, which contain information about the estimated value of the property listed for tax purposes, the identity of the owner of the vacant piece of land, and the name of the last person to pay taxes on the property.

15-6. (Learning objective 15-8) When reporting the results of an investigation, why is it important that fraud examiners do not express opinions in their professional report?

Answer: The fraud examiner’s job is to present the evidence in his report. Opinions regarding technical matters are permitted if the fraud examiner is qualified as an expert

in the matter being considered. No opinions of any other kind should be included in the written report. In particular, opinions should not be voiced regarding the guilt or innocence of any person or party, as forming this type of opinion is the job of the judge and jury.

Chapter 16 Review Questions 16-1 (Learning objective 16-1) What are the five types of interview questions?

Answer: The five types of interview questions are introductory, informational, closing, assessment, and admission seeking.

16-2 (Learning objective 16-2) What four steps are involved in introductory questions?

Answer: The steps involved in the introduction are provide the introduction, establish rapport, establish the interview theme, and observe reactions.

16-3 (Learning objective 16-3) What topics should be covered during informational questioning?

Answer: Once the introductory questions are out of the way, the informational phase is used to gather the appropriate facts in a nonaccusatory way. Generally, the interviewer should begin with background questions, and then proceed logically to the facts that are already known.

16-4 (Learning objective 16-4) When should open questions be used?

Answer: Open questions should be used during the informational phase of the interview.

16-5 (Learning objective 16-4) When should closed questions be used?

Answer: Closed questions should be used principally during the closing of the interview in order to sum up facts learned during the informational phase.

16-6 (Learning objective 16-4) When should leading questions be used?

Answer: Leading questions should generally be used during the admission-seeking phase of the interview.

16-7 (Learning objective 16-5) What are the purposes of closing questions?

Answer: Closing questions have three purposes: to reconfirm the facts gathered, to obtain additional information, and to conclude the interview.

16-8 (Learning objective 16-6) What is the purpose of assessment questions, and when are they asked?

Answer: The purpose of assessment questions is to establish the credibility of the respondent. They are asked only when the interviewer has a reason to doubt the truthfulness of the interviewee.

16-9 (Learning objective 16-7) What are some nonverbal clues to deception?

Answer: Nonverbal clues to deception include the following: full-body motions, changes in anatomical physical responses, changes in the rate of illustrators, placing the hands over the mouth, increased use of manipulators, fleeing positions, crossing the arms, inconsistent reactions to evidence, and fake smiles.

16-10 (Learning objective 16-8) What are some of the verbal clues to deception?

Answer: Verbal clues include to deception include the following: changes in speech patterns, repetition of the question, comments regarding the interview environment, displaying a selective memory, making excuses, increased use of oaths, excessive character testimony, answering with a question, overuse of respect, increasingly weaker denials, failure to deny wrongdoing, avoidance of emotive words, refusal to implicate other suspects, tolerant attitudes toward wrongdoing, reluctance to terminate the interview, and feigned unconcern about the issue at hand.

16-11 (Learning objective 16-9) What are the steps used in admission-seeking questions?

Answer: The following steps are used in admission-seeking questions: Make a direct accusation of wrongdoing, observe the subject’s reaction, repeat the accusation, interrupt denials, establish a rationalization for the wrongful conduct, diffuse alibis, present an alternative question, obtain a benchmark admission, obtain a verbal confession, and reduce the confession to a written statement.

16-12 (Learning objective 16-10) What are the key elements of a signed statement?

Answer: The key elements of a signed statement are state that the accused knew the conduct was wrong; include facts known only to the accused; estimate the number of instances involved; establish a motive for the offense; state when the misconduct began and concluded; detail others involved; describe any physical evidence; explain how the proceeds were used, along with the location of any assets accumulated; and give specifics for each offense.

Discussion Issues 16-1 (Learning objective 16-1) Why are all five types of interview questions not used in all interviews?

Answer: Introductory, informational, and closing questions are used in all interviews.

Most interviews are conducted with ordinary witnesses for the purpose of information gathering. Assessment and admission-seeking questions are used only in cases involving possible deception and for the purpose of confronting the suspect of a fraud.

16-2 (Learning objective 16-2) Why are introductory questions so important to an interview’s success?

Answer: The introduction establishes the tone of the interview. If the witness feels comfortable, he or she is likely to provide information. If the witness feels threatened, this will inhibit fact-finding. Additionally, only when the person is relaxed can you observe nonthreatening behavior and calibrate the witness.

16-3 (Learning objective 16-3) If during the informational phase of an interview, the witness becomes difficult, how should this be handled?

Answer: There are three specific techniques that can be used. The first is not to react to hostility. The second technique is to attempt to disarm the witness by surprise. The third is to change tactics.

16-4 (Learning objective 16-4) Why does the interviewer not use closed or leading questions during the information-gathering phase of the interview?

Answer: Closed or leading questions inhibit the flow of information from the witness. An open question does not restrict the subject’s response. The interviewer’s job is to allow the witness to convey as much information as necessary about the topic at hand.

16-5 (Learning objective 16-5) Why is establishing goodwill with the witness important during the closing phase of the interview?

Answer: In the case of most witnesses, you may have additional questions at some future point. By establishing and maintaining goodwill, the witness will be more likely to cooperate in any subsequent inquiry.

16-6 (Learning objective 16-6) What is the theory behind how assessment questions work?

Answer: The whole notion is that honest people will answer questions one way and dishonest people will answer them differently.

16-7 (Learning objectives 16-7 and 16-8) What is the connection between calibrating a witness and the verbal and nonverbal clues to deception?

Answer: In order to assess the verbal and nonverbal clues to deception, the interviewer must first observe the witness when the questioning is not threatening.

16-8 (Learning objective 16-9) Why are admission-seeking questions asked in a specific order?

Answer: The questions are designed to clear the innocent person and encourage those culpable to confess. People confess when they perceive that the benefits of confessing outweigh the disadvantages.

16-9 (Learning objective 16-10) Why is the excuse clause used in preparing a signed statement?

Answer: The confessor is usually more willing to sign a statement of responsibility if it includes information portraying him or her in a more favorable moral light.

Chapter 17 Review Questions 17-1 (Learning objective 17-1) What is “abusive conduct”?

Answer: Behaviors by employees of organizations that are counter to the entity’s goals.

Examples include “gold-bricking,” excessive absenteeism, tardiness, theft, pilferage, and fraud.

17-2 (Learning objective 17-2) Why is attempting to achieve perfection in the workplace not desirable?

Answer: Standards regarding employee conduct should be reasonable. If they are not, employees may be forced to fail or lie in order to achieve unreasonable goals.

17-3 (Learning objective 16-3) Why is it difficult or impossible to measure the actual level of occupational fraud and abuse within organizations?

Answer: Not all occupational fraud is uncovered. For those frauds that are discovered, not all are reported. Furthermore, there is no organization or government agency that tracks comprehensive data for occupational fraud.

17-4 (Learning objective 17-4) Why is greed an inadequate explanation as the motive for occupational fraud?

Answer: Greed is a natural human trait. Many “greedy” people do not lie, cheat, and steal to achieve their goals.

17-5 (Learning objective 17-5) What is meant by “wages in kind”?

Answer: If employees feel underpaid or mistreated, they may be tempted to right their perceived wrongs through fraud and abuse.

17-6 (Learning objective 17-6) What is the difference between fraud prevention and fraud deterrence?

Answer: Fraud prevention implies removing the root causes of fraudulent behavior.

Fraud deterrence is the modification of behavior through the threat of negative sanctions.

17-7 (Learning objective 17-7) What is the significance of the “perception of detection”?

Answer: Employees who believe that their fraudulent conduct will be detected are less likely to commit it.

17-8 (Learning objective 17-8) What are some of the factors that may help increase the perception of detection?

Answer: Factors that may help increase the perception of detection include: employee education, proactive fraud policies, a higher stance for management and auditors, increased use of analytical review, surprise audits, and adequate reporting programs.

17-9 (Learning objective 17-9) Why are adequate reporting programs so important to fraud deterrence?

Answer: Many employees who are aware of possible illegal conduct are fearful of being “dragged into” the investigation. An adequate reporting program provides anonymity to those who report fraudulent activity. This serves to encourage reporting and, therefore, increases the perception of detection.

17-10 (Learning objective 17-10) What are the key elements of the Corporate Sentencing Guidelines?

Answer: Corporations convicted of criminal offenses will be held liable for the illegal acts of their employees even if those in management had no knowledge of, or participation in, the acts. The liability can be limited if the company voluntarily discloses the illegal conduct and has taken specific steps to mitigate it.

17-11 (Learning objective 17-11) What is ethics?

Answer: Ethics is the branch of philosophy that focuses on the systematic study of reflective choice, of the standards of right and wrong by which a person is to be guided, and of the goods toward which it may ultimately be directed.

Discussion Issues 17-1 (Learning objective 17-1) Why do employees engage in abusive conduct against organizations?

Answer: The principal reason that employees engage in abusive conduct is to express dissatisfaction with their employer or terms of employment. This dissatisfaction leads to abusive conduct as a retaliatory measure.

17-2 (Learning objective 17-2) How are employees likely to react to unreasonably restrictive rules in the workplace?

Answer: The more rules that an organization sets, the greater the likelihood that employees will run afoul of them, especially if the rules make little or no sense to them. In that case, employees will usually ignore the rules or make their own.

17-3 (Learning objective 17-3) What are some of the ways an organization might improve measurement of the level of occupational fraud and abuse?

Answer: In order to measure the level of occupational fraud and abuse, the first step would entail detecting it. Methods for improving detection include instituting and enforcing internal control procedures and mechanisms for individuals to report, anonymously, instances related to fraud and abuse.

In addition, an organization should keep good records of the company history as it pertains to fraud-related matters. This may provide some insight into the company’s risk of fraud as well as its areas of vulnerability.

17-4 (Learning objective 17-4) Since everyone is greedy to some extent, why do only some individuals engage in fraudulent activity?

Answer: Greed is only one factor in occupational fraud and abuse. Fraudulent activity, like any crime, depends on motive and opportunity. Although some individuals may have the motive, certain controls may be in place to diminish the opportunity. Alternately, if the opportunity is present, the motive may not exist.

17-5 (Learning objective 17-5) What actions might an organization take to prevent “wages in kind”?

Answer: Since wages in kind depends on the employees’ perception that they are justified in committing fraud, the employer must confront this judgment from a moral and legal perspective. Additionally, educating employees as to the repercussions involved may reduce the likelihood of such occurrences.

Good personnel policies are also important in preventing this type of fraud. These policies should include (1) adequate personnel screening procedures, (2) antifraud training, and (3) equitable employee compensation.

17-6 (Learning objective 17-6) Why should fraud examiners seek to deter fraud rather than prevent it?

Answer: Since we are unable to control the societal factors that motivate the fraudster, we can attempt only to modify the behavior of these individuals. This may be accomplished by imposing the threat of detection and the negative repercussions associated therewith.

17-7 (Learning objectives 17-7 and 17-8) How do internal controls impact the “perception of detection”?

Answer: Internal controls, such as the segregation of duties, serve as a deterrent to fraud, because they increase the perception in the employee’s mind that her fraudulent activity will be discovered. Controls that are not in place, but are perceived to be, can have the same deterrent effect.

However, internal controls alone are not sufficient to effectively fight fraud.

Employee education, proactive fraud policies, increased use of analytical review, surprise audits, and adequate reporting programs should all be utilized to enhance the perception of detection.

17-8 (Learning objective 17-9) What is the most essential element of an adequate reporting program? Why?

Answer: According to most professionals, hotlines provide the best source of information for fraud detection. In fact, many of the schemes reported through hotlines probably would not have been discovered by any other method. In addition to providing anonymity for the employee reporting the fraud, hotlines assist organizations in complying with the federal Corporate Sentencing Guidelines and the Sarbanes–Oxley Act. 17-9 (Learning objective 17-10) What basic procedures should an organization follow in order to fulfill its due diligence responsibility as it relates to the Corporate Sentencing Guidelines?

Answer: Proactively, a corporation should establish and communicate policies, standards, and procedures regarding any criminal conduct by its employees in the course and scope of their employment. Furthermore, monitoring compliance and enforcement of those policies, standards, and procedures is also a necessary component. Criminal and civil sanctions against the organization may be reduced as a result of appropriate preventative measures taken.

17-10 (Learning objective 17-11) What is meant by “tone at the top”?

Answer: According to the Treadway Commission, tone at the top is a determining factor for the ethical environment of an organization. It indicates that employees take their cues from the leadership of an enterprise. Tone at the top reflects more than just a formal ethics policy; it involves leading by example.