1. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-1 Today’s Topics n Transparency Barriers n Nature of Financial Fraud n Detection of Financial Fraud n Shenanigan #3

2. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-2 Barriers to Transparency n Transparency defined n WYSIWYG n Management bias n Measurement bias

3. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-3 The 7 Shenanigans- Revisited n Premature recording of revenue n Bogus revenue n One time “recurring” gains n Shifting current expenses n Unrecorded liabilities n Revenue shifting n Shifting future expenses

4. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-4 Financial Fraud Statistics n Key players n COSO n The Treadway Comm.-NCFFR n SEC’s AAERs n Accounting & Auditing Enforcement Releases n Treadway Commission: 1987 n Infrequent but costly n COSO Update: 1999 n 300 AAERs 1987-1997

5. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-5 18 Key Tidbits n Average period: 23.7 months n Revenue frauds were #1 n Asset misstatement-spread around n Mean misstatement = $25 M n CEO involved in 72% of the cases n Last audit was unqualified in 55% of the cases n Mean assets = $532 M; revenues = $232 M n S/W and manufacturing involved in 12% of the cases n NASDAQ had 78% n 36% filed for bankruptcy n Non-existent or uninvolved audit committees n Insiders on Boards of Directors n Family relationships were common n Financial pressures were high n 56% of auditors were Big 6 n Auditors named in 30% of cases n 25% changed auditors after the fraud n Relatively few executives went to prison

6. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-6 Financial Fraud Motivation n Greed n Fear of failure n Lack of accounting expertise n Scope of operations—too broad

7. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-7 Financial Fraud Detection n KTT is the key n Use the Fraud Exposure Rectangle n Management & Directors n Background, motivation & influence n Company relationships n Obligations, related party transactions & compliance n Nature of organization & industry n Financial results & operations n GAAP, attitude

8. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-8 Shenanigan #3- Boosting (Operating) Income n Technique #1: n Selling of undervalued assets n Technique #2: n Including investment gains in ops. income n Technique #3: n Reducing opex by investment gains n Technique #4: n Reclassifying balance sheet accounts

9. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-9 Transparency is Key n Are the #s telling the story or making the story? n Is the company managing the business or managing the #s? n What is, is? versus What is. Is! n Recall SFAC #1 n Improved decision making n Insight into future cash flows n Resource information

10. FORENSIC ACCOUNTING - BA124 - Fall 2009Slide 10-10 Shenanigan #3 Specifics n Table 6-1 n Lets consider each item n Table 6-2 n Weaselotomy 101 n Don’t over-react to pension issues n Technique #4 n Mark-to-market games