Chapter 6

Data-Driven Fraud Detection

Sampling

ISA 240 emphasizes that Fraud is more difficult to detect than unintentional errors

• Errors - sampling is typically effective• Fraud - questionable

ISA: Responsibility

ISA 240: An auditor conducting an audit in accordance with ISAs is responsible for obtaining reasonable assurance that the financial statements are free from misstatement, whether caused by fraud or error.

Scope Paragraph - Standard Report

We conducted our audit in accordance with GAAS. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

2nd and 3rd standards of field work

The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, to design the nature, timing and extent of further audit procedures. The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit.

ISA 240: Objectives

• To identify and assess the risks of material misstatement of financial statements due to fraud;

• To obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatements due to fraud through designing and implementing appropriate responses; and

• To respond appropriately to fraud or suspected fraud identified during the audit.

Chapter 6: the data analysis process

• Understand the business• Identify possible frauds that could occur• Catalog possible fraud symptoms• Use technology to gather data• Analyze results• Investigate symptoms

the data analysis process

ISA 240 Objectives Stds of Field Work Data analysis process

assess RoMM 2nd Assess Romm 1- Understand Bus 2- ID possible frauds 3- Catalog fraud symptoms 2nd Design tests Sufficient evidence 3rd Suff evidence 4- Use Tech to gather data 5- Analyze results Repond Appropriately 6- Investigate symptoms I’m not sure this is a response

the data analysis process

Understand the business– Tour the business– Become familiar with competitors– Interview key personnel– Analyze financial statements

• Analyze other accounting information– Review documentation regarding processes

• Accounting • Information

– Observe employees performing their duties• Walkthrough

the data analysis process

• Catalog possible fraud symptoms ----- How will you recognize it if you see it

– Accounting anomalies– Internal control weaknesses– Analytical anomalies– Extravagant lifestyles– Unusual behavior– Tips and complaints

the data analysis process

Identify possible frauds that could occurAU 314.40 “Identify types of potential misstatements”

the data analysis process

• Use technology to gather data IDEA or ACL

• Analyze results• Investigate symptoms

Kickbacks Redflags page 171 Figure 6.2

Increasing pricesLarger order quantitiesIncreasing purchases from favored vendorDecreasing quality Unusual Behavior - we won’t likely see as external auditors Extravagant Lifestyle - we won’t likely see as external auditors All transactions from one buyerUse of unapproved vendors Anonymous complaints about buyerComplaints from unsuccessful vendorsQuality complaints from customers

IDEA section 3 -- kickbacksPayments to unauthorized suppliers ---

matching payments to list of authorized suppliersextract payments to payees not on list of authorized suppliers

Payments to individuals ---- searching for payees without Inc., Co., or Ltd. in their name

Test for duplicate invoices duplicate amount and supplier codeDuplicate amount and Purchase order number

Identify payments made on SundayPayments just below amount requiring approval (it seems to $80,000)Split invoicesVendors for whom payments have increased more than 25%Match supplier names with employee names

IDEA section3 - tomorrow

3.8 Stratify payments a lot $75,000 - $80,0003.9 Extract all payments between 75 -80,000

Extract all payments over $100,000

IDEA section 3 - tomorrow

3.10 Extract payments round numbers $xx,000Extract all payments authorized by HMVlots of $75-$80 payments were HMV’sExtract all Sunday paymentsExtract all payments with “CASH” in nameCould search for other common names,

addresses, PO boxes, phone nosBenford’s Law

IDEA section 3 - tomorrow

3.12 Duplicate Payments (Duplicate Key)same Amount and Supplier number extract all Supplier Numbers with > one Payee

3.13 Search for unrecorded checks(GAP Detection)3.15 Extract suppliers paid in less than 25 days

- policy to pay between 25-35 days

IDEA section 3 - tomorrow

3.16 Join Accounts Payable and Authorized Supplier Two Payees with the same Supplier NumberDuplicate KeyExtract payments to vendors not on Authorized Supplier

3.17 Summarize and Extract vendors for which payments increased more than 25%

IDEA section 3 - tomorrow

20 payments with CASH in vendor name 5 payments of $75,000 3 of which were potential duplicate payments 399 payments authorized by HMV 49 payments on Sunday – most authorized by HMV 5 missing checks 63 payments made in less than 25 days 6 of which were paid before the invoice was entered in the system 8 payments to unauthorized vendors 7 of which had CASH in their name All authorized by either HMV (5) or VST (3) 2 vendors have the same Supplier No.

Analysis

• Bedford’s Law

• Normal Distribution± 1.00 .6828 ± 1.28 .80

± 2.00 .9544 ± 1.645 .90

± 3.00 .9973 ± 1.96 .95

± 2.57 .99

Trend Analysis

Over time you seequantity purchased from vendor increasingprice per unit from vendor increasing

Match or Fuzzy Match

Employee names -- vendor namesCustomer names – vendor namesAddresses, PO Box, phone numbers

Why might you see

One vendor is always the last to submit a bid

The procurement specifications include a large number of specifications that do not seem necessary

Analyze Financial Statements

“change statements”Change current year from prior yearRatiosVertical analysis

% of Sales on Inc State----% of Total Assets on BS

Horizontal analysis% change from prior years

Statement of Cash Flows

Liquidity current ratioQuick ratio Acid Test ratio

Performance Accounts Receivable Turnover / Days in ReceivablInventory Turnover / Days in Inventory

Solvency Debt to EquityDebt PercentageTimes Interest Earned

Profitability Profit MarginReturn on Equity / Return on Assets / Return on ?Earnings per Share