Chapter 9
10. When searching public records, what are the four different types of information sources
available to investigators?
The four types of information sources are government, private, online databases, and internet searches.
11. What is the Gramm-Leach-Bliley Act? How does it apply to investigators?
The act requires financial institutions to explain their information-sharing practices to their customers
and to safeguard sensitive data. This allows financial institutions to share information with investigators
legally.
Short Case 8
1. Without calculating the amount of unknown income, indicate possible red flags or trends you notice
in the numbers above.
Financial statement red flags provide a general overview of the warning signs a company should
look out for. It does not a imply an absolute occurrence of financial statement fraud, but simply
signals that a detailed investigation must be done of the accounts in the financial statement. Some
of the red flags shown in this example are increase in assets while there is a decrease in liabilities.
Beginning with assets, you can see that there is a sharp increase in automobiles, starting in year 2
and year 3 for $45,000 as compared to year 1, which was $18,000. In addition, we can also see an
increase in CD’s for $15,000 in years 2 and 3, while year 1 showed $5,000. The stock portfolio also
showed a large increase in years 2 and 3 for $15,000 as compared to year 1 for $3,500. The
individual also added another asset by purchasing a boat costing $15,000 in year 2 and 3.
Similarly, there is a decrease in mortgage liability from $200k in year 1 to $180k in year 2 and $100k
in year 3. Furthermore, the auto loan showed an increase from $12,000 in year 1 to $30,000 in year
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2, but then the liability did not exist in year 3. Finally, there was another loan, shown as “other loan”
which was taken out in year 2 for $18,000, then paid off by year 3.
2. Now calculate the amount of total income and unknown income using the numbers given. Does it
appear that a possible fraud exists? Could there be other explanations for the unknown income?
Using the comparative net worth asset method indicates the following results:
Comparative Net – Worth Asset Method
Year End 1 Year End 2 Year End 3
Assets:
Residence $280,000 $280,000 $280,000
Automobile 18,000 45,000 45,000
CD 5,000 15,000 15,000
Cash 8,000 8,000 2,000
Stock Portfolio 3,500 15,000 15,000
Boat 15,000 15,000
Total Assets $314,500 $378,000 $372,000
Liabilities:
Mortgage 200,000 180,000 100,000
Auto Loan 12,000 30,000
Other Loan 18,000
Total Liabilities $212,000 $228,000 $100,000
Net Worth $102,500 $150,000 $272,000
Change in Net Worth $47,500 $122,000
Add: Living expenses 47,000 47,000
Total Income $94,500 $169,000
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Less: Known Income 90,800 130,800
Income from Unknown Sources $3,700 $38,200
There can be an explanation for income from unknown sources because this money may have been
inherited, received as a gift, or through gambling rather than fraud.
Chapter 10
Short Case 7
1. Describe the steps you would take to investigate the suspected embezzlement.
As an investigator, I would first try to investigate the large fluctuations in the financial statement
accounts. Next, I would verify whether the credits and debits done by Jane are correct or not. The
person speaking against Jane may also be providing misleading information. Therefore, to prove
whether each claim made by the anonymous person is true, a detailed investigation must be done
prior to meeting with Jane. Without thorough research and sufficient evidence, it would be
pointless to interview her. In addition, Jane may have climbed the ladder of success rather quickly
because of her hard work and excellent skill set, which in turn may have upset the anonymous
person to make false claims about her. Jane’s lifestyle may appear more lavish than her salary can
reach but that does not necessarily mean that she is involved in fraudulent activity. It would be wise
to interview Jane’s co-workers and close friends to obtain information about her and her activities.
2. As a first step in your investigation, would you interview Jane about the problem? Why or why
not?
As a first step in my investigation, I would not directly interview her about the problem, however,
I would interview her in a detailed manner starting with an introduction, followed by informative
questions, an assessment, and finally, a closing. At first, it would be best to ask Jane general
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questions. Then, I would begin to ask her more specific and informative type questions to see if
she provides accurate and consistent information. If Jane’s answers turn out to be misleading or
she is trying to lie throughout the interview process, then assessment and admission seeking
type of questions must be asked. It is imperative that the interview with Jane maintains a
respectful and professional tone. The questions made to Jane should not demoralize or
discourage her. The questions must not be biased. It is important that the investigator maintains
control throughout the entire period. Furthermore, careful observation, expertise in detecting
patterns and the ability to compare different responses are important attributes in detecting
fraud.
3. How would you conduct Jane’s admission-seeking interview in order to be most effective?
If I found sufficient evidence, then I would seek an interview with Jane but without reasonable
cause I would reframe from doing so. I would design direct and indirect questions, which could
support my evidence of fraud such as, the cause of self-balancing of accounts or changes in
behavior and lifestyle.
Chapter 13
10. In what ways could financial statement fraud result from a merger?
When two firms merge, there are specific accounting rules that dictate at what amounts acquired
assets should be recorded. Sometimes, merged companies manipulate these rules to overstate the
assets of the combined company and thus commit financial statement fraud. Another type of
merger-related fraud is to overstate merger reserves and then reverse those charges into income or
to hide operating expenses in the merger reserve.
12. What are the four kinds of analysis that can be used in searching for analytical fraud symptoms?
Method 1: Focusing on changes in recorded balances from period to period. Method 2: Focusing on
changes in relationships from period to period (one of the best ways to detect understatement of
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liability frauds). Method 3: Comparing financial statement information with other companies.
Method 4: Comparing financial statement amounts with assets they are supposed to represent or
with nonfinancial statement factors.
Short Case 10
1. What were the main types of financial statement fraud committed at Cutter and Buck? Do these
types of fraud occur often?
The main type of financial statement fraud committed at Cutter and Buck was revenue
recognition. Cutter and Buck improperly recognized revenue of $5.7 million in shipments to
distributors functioning as company warehouses and later concealed the improper transactions
from the auditors, board of directors, and shareholders. Improper revenue recognition is the
most common type of financial statement fraud.
2. What should have been the appropriate accounting treatments?
The shipments were made on a consignment basis since distributors had no obligation to pay for
the goods. Thus, shipments should not have been recorded as sales until the distributors had
resold the merchandise.
3. The three parts of the fraud triangle are pressure, opportunity, and rationalization. List some of
the pressures that may have led to this fraud.
Some of the pressures that may have led to this fraud are declining sales, tough competition,
slow economy, shareholders who demand a higher stock return, and threat to management of
being fired or demoted.
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