Journal of Forensic & Investigative Accounting
Senior Editor:  D. Larry Crumbley
 
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Journal of Forensic & Investigative Accounting

Senior Editor
D. Larry Crumbley

Louisiana State University
Department of Accounting
3106A Patrick Taylor Hall
Baton Rouge, LA 70803
Phone: 225-578-6231
Fax: 225-578-6201
dcrumbl@lsu.edu

Volume 4: No. 1, January-June, 2012

Table of Contents

+ Understanding a Ponzi Scheme: Victims’ Perspectives
    • Anne M. Wilkins
    • William W. Acuff
    • Dana R. Hermanson
       
Abstract: Ponzi schemes have received significant media coverage lately, due in large part to the Bernard Madoff scandal; however, there is limited academic research exploring investors’ decision-making processes when investing in what ultimately is discovered to be a Ponzi scheme. We conducted semi-structured interviews of 17 investors in a Ponzi scheme to better understand the investors’ decision-making processes, their perceptions of the fraud, and the mechanics of the fraud. Overall, the interviews reveal a fraud with the following characteristics: (a) older, educated victims; (b) a plausible story that traveled by word of mouth among people who knew each other well; (c) demonstrated returns over several months (people often watched others get checks for a few months before investing themselves); (d) low pressure (no urgency to invest); and (e) a “good guy” promoter who did charitable works. We discuss avenues for future research.

Keywords: Fraud, Ponzi scheme, decision-making, investment.
Download: Full article [pdf]
Abstract: There is a significant amount of research and models on ethical decision-making processes; however, there is limited research on how emotions affect ethical evaluations and decisions in an accounting context. Prior research suggests that emotions may shape ethical evaluations and choices made by individuals. This study contributes to the accounting literature by exploring the emotions an accountant may feel when evaluating earning manipulations. This study finds that accountants feel regret when evaluating earnings manipulations.

Keywords: Accounting ethics, ethical decision making, emotions.
Download: Full article [pdf]
Abstract: Using an experiment, this study examines the impact of industry specialization and firm size on juror evaluations of blame, findings of negligence, and damage awards in auditor malpractice cases.  The results indicate that jurors attribute less blame to industry specialist auditors and are less likely to find them negligent than non-industry specialists auditors. The study establishes that industry specialization increases the perceived competence of the auditor reducing the likelihood that jurors will hold it liable for an audit failure. While firm size was not found to effect evaluations of blame or negligence verdicts, it did have a significant impact on damage awards. Significantly greater damages were awarded against larger firms than against small firms in the experiment. Based on the results of the study, firms can reduce their litigation exposure by becoming industry specialist auditors. Additionally, small firms can benefit from the propensity of jurors to award less in damages.

 

Keywords: Industry specialist, audit firm size, auditor litigation, accounting jury research.

Download: Full article [pdf]
Abstract: This study examines the probability of fraud estimates of auditors from five firms to test the need to include multiple firms in empirical forensic accounting research. We used an older data set as sample sizes of about 500 auditors participating in a four-hour exercise are rare in today’s research environment. This research tested for differences among firms, staff levels, and gender to determine whether differences could occur among auditing firms. While our analysis indicated no difference among firms for managers, there were significant differences among firms on an overall basis and for seniors. Finally, we also found a significant difference between male and female auditors’ probability of fraud estimates. Although there were no difference between male-and-female seniors’ levels of moral development (ethical sensitivity), there were significant differences between male-and-female managers’ levels of moral development. Consequently, our premise of including multiple firms in empirical forensic accounting research was supported.
 

Keywords: Multiple firms, client integrity, red flags, auditors, gender difference.

Download: Full article [pdf]
Abstract: The forensic accounting profession may not be equipping its members with the necessary tools to conduct suspect interviews given their significant ethical, legal, and psychological challenges. The accounting profession should be at the forefront of developing an interviewing model by closely examining the leading interview models utilized by other professions, assessing their relative merits and deficiencies. The two leading police interview models are the REID and PEACE models. Psychologists utilize Motivational interviewing techniques to assist in dealing with patients that are ambivalent to change. A forensic accountant must be acutely aware of the roles that evidence, experience, and the interviewer's demeanor play in the interview's outcome. Academic studies demonstrate that using a humanitarian approach offers a greater chance to obtain a confession. There are legal and ethical considerations to consider when a forensic accountant selects his or her questioning techniques. An interviewer must be careful when offering promises to a suspect. A skilled interviewer arrives at the truth, whether the interview results in a confession or not.
 

Keywords: Interviewing, REID model, PEACE model, motivational interviewing, interrogation.

Download: Full article [pdf]
Abstract: Prior research has established that stock price declines are a significant driver for filing securities class action lawsuits. There is a continued debate as to the relative importance of case merit in the decision to file a case and the dispute outcome. The author used accounting quality variables as proxies for managerial wrongdoing and test whether accounting quality is a determinant of lawsuit filing decisions and if it can distinguish frivolous cases from those with merit. The results show that accounting quality, measured by accrual reliability, discretionary accruals, one-time charges, and reporting opacity in relation to R&D and intangible assets, significantly impact the decision to file a lawsuit and the magnitude of settlement. These ex ante measures of accounting quality serve as leading indicators of case outcomes even after controlling for return performance and hard evidence events such as restatements and SEC investigations. Findings suggest that accounting data is used by the legal system as a determinant of lawsuit filings and outcomes.
 

Keywords: Securities litigation, earnings management, corporate governance, accounting quality.
 
Download: Full article [pdf]
 

+ The Role of Related Party Transactions in Fraudulent Financial Reporting

    • Elaine Henry
    • Elizabeth Gordon
    • Brad Reed
    • Timothy Louwers
       
Abstract: Motivated by auditing regulators’ recent interest in related party transactions (RPTs), this study examines SEC enforcement actions that involved RPTs. Specifically, we compare fraud cases involving RPTs with comparable fraud cases that did not involve such transactions. We find that frauds involving RPTs had a lower impact on financial statements, but were more likely to involve misappropriation and to involve a top executive (CEO and/or CFO) in some aspect of the fraud. We also find weaker evidence that frauds involving RPTs persist for longer time spans. In addition, we provide a framework to document the types of related party transactions actually occurring in these fraud cases. Overall, the most frequent types of transactions in the enforcement actions were loans to related parties and payments to company officers for goods or services that were either unapproved or non-existent. Generally, related party transactions are not necessary as mechanisms for fraud, and their presence need not indicate fraudulent financial reporting. An implication is the importance of evaluating related party transactions within the broader corporate context. 
 

Keywords: Related party transactions, fraudulent financial reporting.

Download: Full article [pdf]
Abstract: This study evaluates fraud in China from the perspective of Chinese Nationals using an explorative, qualitative approach. This study finds that in order to understand fraud in China, societal-level influences – including philosophical and religious tradition, culture, social norms, and societal conditions such as rule of law, political climate, and socioeconomic factors – must be taken into consideration. There are significant societal-level factors that influence fraud in China that have no direct equivalent in the United States, where the Fraud Triangle Model was originally developed. As societal-level factors vary across nations, an expanded version of the Fraud Triangle Model has been provided to enhance usability of the Fraud Triangle Model internationally. Fraud is a global problem, and the Fraud Triangle Model should adequately explain fraud in different societies and be well-suited for international use. Giving credence to societal-level fraud factors can increase the effectiveness of fraud risk evaluations performed by external auditors, internal auditors, audit committees, managerial accountants, and management around the world.

Keywords: Fraud, China, international, culture, society, fraud triangle.

Download: Full article [pdf]
Abstract: Public accounting in the United States is a profession not only because it is defined as a profession by statute, but because it also fulfills a significant number of sociological criteria to be accepted as a profession. The recent increase in the demand for forensic accountants has resulted in a significant growth in the number of certifications in forensic accounting and also the number of corporations issuing certifications in forensic accounting. Forensic accounting is often referred to as a niche within the public accounting profession. But forensic accounting exhibits many of the same characteristics of a profession as public accounting. This article explores the possibility of forensic accounting as a profession in its own right.
 

Keywords: Forensic accounting, niche, profession, sociology of professions.

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Abstract: This case is based on an actual fraud related to a litigation support engagement that focused on an accounts receivable collateral reporting fraud (improper revenue recognition and asset overstatement) on the part of the management of a services company against its bank. The litigation support work was for the bank’s legal counsel. In addition to background and historical financial results, the case study presents the motivations for the fraud, and the various techniques used to falsify the accounting records and conceal the fraudulent nature of the transactions from the bank and the company’s independent auditors. Specifically, the case requires not only the investigation of accounting issues as to the proper timing of revenue recognition, but also auditing questions and fraud investigation techniques.

Keywords: Revenue recognition, collateral reporting fraud, accounts receivable fraud, litigation support engagement.

Download:  Full article [pdf]
Abstract: The purposes of this paper are to: 1) describe the integration of generalized audit software (GAS)—specifically, IDEA—in an information systems auditing course, 2) to illustrate the data mining capabilities of IDEA in two fraud detection cases, and 3) make recommendations regarding the effective integration of the software in other auditing or fraud/forensic classes. The first fraud case presented here illustrates the use of data mining techniques to detect unauthorized users in the system (Unauthorized Users), and the second illustrates detection of unauthorized payments (Unauthorized Payments).

Keywords: Generalized Audit Software (GAS), IS auditing, fraud detection, cases.
Download: Full article [pdf]

Books Received

Fraud-Related Interviewing
D. Rabon and T. Chapman, 2010, $20, 176 pp.
Carolina Academic Press
700 Kent Street
Durham, N.C. 27701

 
The authors cover the interview process as it relates to a fraud investigation, a fraud-related audit, or inquiry into a reported fraud. Their position is that the dynamics of fraud itself are inexorably connected to the subsequent fraud interview and ultimately the outcome of the investigation. The interview is not an isolated event but rather a part of the nagare (a Japanese word meaning “flow”) of the entire fraud dynamic from precursors, to the commission of the crime, to closure. In the fraud-related interview, the interviewer connects three different time periods--the past, the present, and the future. The past addresses the dynamics of the individual and his or her subsequent behavior resulting in the commission of the fraud. The forecasting of future events is sought after successful outcome of the fraud investigation. In the present, the interviewer seeks to connect the past and the future-- the flow, if you will, of all three.

The text utilizes interviews with convicted fraudsters to allow the reader to gain an understanding as to how fraudsters deliberate before, during and after the commission of fraud. This understanding is future enhanced within the text via application questions, practical exercises and additional relevant information can be used in the classroom.
Proli Footwear, Inc., 2nd Edition
An Audit and Fraud Simulation
P.J. Proctor and P.M. Poli, 2011
Prolifootwear.com or Amazon.com
The soft cover book is a team-based auditing and fraud simulation designed to reinforce auditing and fraud theory. When used with a traditional auditing text, this simulation provides a practical, hands-on team-based experience for the students. Excel templates are included to assist in the preparation of the audit documentation.

The simulation contains nine sections with 12 work modules for students to analyze and complete as they conduct the audit of Proli Footwear. This approach gives the students an excellent opportunity to integrate audit theory and practice and to be alert for fraudulent red flags. Throughout the modules students are engaged in solving challenging audit and fraud problems.

Work modules are designed to stand alone, which gives flexibility to the instructor to assign specific modules or the complete audit.

 

The 3rd Annual Midyear Forensic and Investigative Accounting Conference

The Third Annual Midyear Forensic and Investigative Accounting Conference will be held March 30-31, 2012, at the Loop Campus of DePaul University in Chicago, IL. The AAA meeting section is co-hosted by DePaul University and Roosevelt University. The conference will consist of keynote speakers, concurrent sessions dealing with a wide variety of fraud, forensic and investigative accounting topics, panel discussions, case work, and film previews.

The 9th Annual Fraud and Forensic Accounting Conference

Mark your calendar for July 23 and 24, 2012, for the Louisiana State University Fraud & Forensic Accounting Conference in Baton Rouge, LA. For more information about the 2011 conference, go to: http://www.bus.lsu.edu/academics/accounting/events/FF2011.asp.

Advertise in the JFIA

Would you like to advertise in this journal? Full page ad is $300. Half page ad is $150. Contact Larry Crumbley (dcrumbl@lsu.edu). Checks to be made out to Journal of Forensic and Investigative Accounting and sent to Larry Crumbley at 3106A Patrick Taylor Hall, Dept. of Accounting, L.S.U., Baton Rouge, LA 70803.

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