Fraud Examination, 4E

Chapter 5: Recognizing the

Symptoms of Fraud

Albrecht, Albrecht, Albrecht, Zimbelman

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Learning Objectives

 Understand how symptoms help in the detection

of fraud.
 Identify and understand accounting symptoms of
fraud.
 Describe internal controls that help detect fraud.
 Identify and understand analytical symptoms of
fraud.

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives

 Explain how lifestyle changes help detect fraud.

 Discuss how behavioral symptoms help detect
fraud.
 Recognize the importance of tips and complaints
as fraud symptoms.

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Symptoms of Fraud

Can be separated into six groups:

1. Accounting anomalies
2. Internal control weaknesses
3. Analytical anomalies
4. Extravagant lifestyle
5. Unusual behavior
6. Tips and complaints

Albrecht, Albrecht, Albrecht, Zimbelman

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Elgin Aircraft Case

Accounting Anomalies
 result from unusual processes or procedures in the
accounting system
Example:
 the 22 phony doctors
 checks were sent to the same two common addresses

Why?
 managers trusted the perpetrator completely
 auditors merely matched claim forms with canceled checks

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Elgin Aircraft Case

Internal Control Weaknesses

Example:
 Manager had not taken a vacation in 10 years

 Employees never received payment confirmations

 Payments to new doctors were never investigated or

cleared

Albrecht, Albrecht, Albrecht, Zimbelman

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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Elgin Aircraft Case

Analytical Anomalies
 relationships in financial or
nonfinancial data that do not
make sense

$12 million be paid to only

22 doctors over a period of
four years

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Elgin Aircraft Case

Lifestyle Symptoms
The manager…
 took the employees to lunch in a limousine
 lived in a very expensive house
 drove luxury cars
 wore expensive clothes and jewelry
 was “independently wealthy”
 inherited a large sum of money
 yet never took a vacation!
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Elgin Aircraft Case

Behavioral Symptoms
 The manager had a “Dr. Jekyll and Mrs. Hyde”
personality
 Her highs and lows had become more intense and
more frequent in recent months

The Eligin Aircraft fraud was discovered because an

observant auditor noticed a fraud symptom.

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Accounting Anomalies

Common anomaly frauds

involve:
 Irregularities in source
documents
 Faulty journal entries
 Inaccuracies in ledgers

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Accounting Anomalies

Irregularities in Source Documents

Include the following:
 Missing documents
 Stale items on bank reconciliations
 Excessive voids or credits
 Common names or addresses of payees or customers
 Increased past-due accounts
 Increased reconciling items
 Alterations on documents
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Accounting Anomalies

Irregularities in Source Documents

Include the following (cont.):
 Duplicate payments
 Second endorsements on checks
 Document sequences that do not make sense
 Questionable handwriting on documents
 Photocopied documents

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Faulty Journal Entries

Fraud is hidden by using accounting language

Legal Expense .....................5,000
Cash ...................……………5,000
English:
 “An attorney was paid $5,000 in cash”
Accounting:
 “Debit Legal Expense; Credit Cash”

Was the attorney really paid $5,000?

Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Faulty Journal Entries

Do embezzlers leave the accounting

equation in balance??????

Albrecht, Albrecht, Albrecht, Zimbelman

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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Faulty Journal Entries
 An embezzler steals assets, such as cash or inventory

 Embezzler must decrease either liabilities or equities

 Decreasing liabilities is not a good concealment method

 Reasons not to change dividends, stock accounts, or

revenues
 Embezzler usually increases expenses

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Faulty Journal Entries

Common journal entry fraud symptoms:

 Journal entries without documentary support
 Unexplained adjustments to receivables,
payables, revenues, or expenses
 Journal entries that do not balance
 Journal entries made by individuals who would
not normally make such entries
 Journal entries made near the end of an
accounting period 
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Inaccuracies in Ledgers

Fraud symptoms relating to ledgers:

 Ledger that does not balance
 the total of all debit balances does not equal the total of
all credit balances

 Master (control) account balances do not equal

the sum of the individual customer or vendor
balances 

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Internal Control Weaknesses

Internal control fraud symptoms include :

 Lack of segregation of duties
 Lack of physical safeguards
 Lack of independent checks
 Lack of proper authorization
 Lack of proper documents and records
 Overriding of existing controls (most common)
 Inadequate accounting system

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Internal Control Weaknesses
 Three simple procedures to prevent small business
fraud
1. Owners should open and reconcile bank statements
2. Pay everything by check so there is a record
3. Owners should sign every check themselves

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Analytical Fraud Symptoms

Analytical Fraud symptoms include:

 Unexplained inventory shortages or adjustments

 Deviations from specifications
 Increased scrap
 Excess purchases
 Too many debit or credit memos
 Significant increases or decreases in account
balances, ratios, or relationships
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Analytical Fraud Symptoms

 Physical abnormalities
 Cash shortages or overages
 Excessive late charges
 Unreasonable expenses or reimbursements
 Excessive turnover of executives

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Analytical Fraud Symptoms
 Strange financial statement relationships, such as
 Increased revenues with decreased inventory
 Increased revenues with decreased receivables
 Increased revenues with decreased cash flows
 Increased inventory with decreased payables
 Increased volume with increased cost per unit
 Increased volume with decreased scrap
 Increased inventory with decreased warehousing costs

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Extravagant Lifestyles

Example
Kay…
 Embezzled $3 million from her employer
 Bought a $500,000 or more home
 Bought five luxury cars
 Filled home with artwork and glass
 Bought a boat
 Paid cash to have yard landscaped
 Served lobster flown in from the east coast
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Unusual Behaviors

Albrecht, Albrecht, Albrecht, Zimbelman

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Tips and Complaints
 Elements of fraud
 Theft act
 Concealment
 Conversion

 Company employees are

in the best position to
detect fraud

Albrecht, Albrecht, Albrecht, Zimbelman

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Tips and Complaints

Why are tips and complaints just symptoms?

 Many tips and complaints turn out to be unjustified
 Difficult to know what motivates a person to complain or
provide a tip
 Customers may feel taken advantage of
 Employee may have malice, personal problems, or
jealousy
 Spouses and friends may be motivated by anger,
divorce, or blackmail
 Individuals should always be considered innocent until
proved guilt
Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Tips and Complaints

Why people are hesitant to come forward:

 Impossible to know for sure that a fraud is taking place
 Fear of being the whistle-blower
 Intimidation by the perpetrator
 Feel that squealing on someone is wrong
 Not easy to come forward

Three frauds that were detected by tips and complaints or

that involved whistle-blowers are the GE fraud, the
Revere Amored Car Company fraud, and the fraud at
Enron. Albrecht, Albrecht, Albrecht, Zimbelman
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.