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
2833 Business Education Complex
Baton Rouge, LA 70803
Phone: 225-578-6231
Fax: 225-578-6201
dcrumbl@lsu.edu

Volume 5: No. 1, January - June, 2013

Table of Contents

+ Summary Witness Testimony in Federal Tax Litigation Cases as Identified in Court Opinions

    • Brigitte W. Muehlmann

    • Priscilla Burnaby

    • Martha Howe

Abstract: In U.S. tax litigation, there are three types of summary witnesses that may be called by both parties in a case. Their use provides insights into how large volumes of evidence and empirical research complex issues are presented in tax cases. To determine how witnesses are used during tax trials, this is the first to review the 109 tax opinions published through 2010 that disclose the use of summary witnesses. This paper first discusses the Federal Rules of Evidence related to summary witnesses: Rule 1006 primary evidence, Rule 611 pedagogical device and hybrid or secondary-device summary witnesses. Then the court cases are surveyed to determine: the trends in the use of summary witnesses; who presents the summary witness; how many cases are Rule of evidence 1006 versus Rule 611; the demographics of the summary witnesses; if they serve as more than one type of expert during the trial; and the reasons for which their testimony was challenged in courts of appeals. A detailed review of the opinions led to the master list of 109 cases. The majority of the summary witnesses (57.1%) presented Rule 611 pedagogical-device summaries, 26.5% presented Rule 1006 primary-evidence summaries, and only10.2% provided the hybrid 1006 and 611 secondary-evidence summaries. The vast majority of the summary witnesses (65.3%) were IRS revenue agents or IRS special agents (10.2%). Fifty percent of the summary witnesses served dual roles before the introduction of the Daubert standard, but only one summary witness did so after the standard was introduced. The summary witnesses’ testimony was challenged in 22 court cases and six verdicts were overturned due to problems with their testimony.

 Keywords: Tax, summary witness, expert witness, primary evidence summary, pedagogical-device summaries, secondary-evidence summaries.

+ Validating Early Fraud Prediction Using Narrative Disclosures

    • Chih-Chen Lee

    • Natalie Tatiana Churyk

    • B. Douglas Clinton

Abstract: This study documents a model building and validation process for the purpose of early fraud prediction based on asynchronous communication contained in the narrative disclosures of annual reports. Following Churyk et al. (2009), we apply content analysis to the management discussion and analysis section of the annual report to determine and examine significant qualitative fraud risk factors. Using both discriminant analysis and a holdout sample, we confirm the accuracy of a robust, early fraud prediction model. Our model provides two significant contributions to fraud prediction. First, the model can be applied earlier than conventional models (i.e., potentially prior to the incidence of catastrophic consequences as a result of the fraud); and second, the model provided an overall fraud/non-fraud prediction rate of 64.8 percent using a cross validation method and 55.9 percent using holdout sample. This overall classification accuracy compares to conventional model accuracy of only 30 to 40 percent (Skousen and Wright 2008).

Keywords: Fraud, prediction, content analysis.

+ Fraudsters and the Form 1099 Technique

    • Christine Crawford Cheng

    • D. Larry Crumbley

Abstract: This paper discusses a technique employed by firms to recoup money and property stolen from a business by employees. Under the Form 1099 technique the firm supposedly uses the threat of filing a Form 1099 with the IRS for the amount stolen, unless the fraudster signs an installment note agreeing to a payback. This article discusses various aspects of this Form 1099 technique, including anecdotal evidence regarding the use of this technique, and the incentives of the firm, the employee who committed the fraud, and the IRS perspective of this technique.

In general, a company prefers the Form 1099 technique as a recoupment method when the probable amount collected from the employee exceeds the amount the firm would receive through insurance and tax recoupment. The employee should prefer to have the amount stolen reported to the IRS, unless the employee’s potential tax liability exceed the amount stolen from the firm. The IRS should prefer delayed reporting of the fraud when the company has sufficient net income to offset the amount of the fraud. The IRS should prefer the immediate reporting of the fraud when the company does not have sufficient net income to offset the amount of the fraud. Based upon our discussions and the unlikelihood of full repayment by a fraudster, the Form 1099 technique may not be a valuable approach. However there are instances where the Form 1099 technique is preferable to immediate tax reporting. Congress may wish to consider a tax rule which would protect a firm’s ability to use this technique for these instances.
 

Keywords: Form 1099, fraud, incentives, illegal income, embezzlement.

+ Influence of Leadership Positions on Internal Controls and Reported Fraud In Religious Organizations

    • Robert M. Cornell

    • Carol B. Johnson

    • William C. Schwartz, Jr.

Abstract: This study examines the extent to which particular leadership positions and governance bodies within churches are associated with the presence of internal controls and/or the absence of fraud. Our study is motivated by Marquet’s (2011) chronicle of 21 high-profile church embezzlements in the first half of 2011; Ventura and Daniel’s (2010) finding that church members tend to trust their leaders in spite of the absence of internal controls; and discoveries by Booth (1993) and Conway (1999) that clergy tend to be ill-disposed to utilize secular accounting and internal control practices. We surveyed 131 individuals who were responsible for financial management within their respective churches. The survey was conducted through in-person, structured interviews. After removing duplicate interviews, we analyzed a sample of 129 responses. The subjects were affiliated with churches that varied widely in size, age, and denomination. Our results indicate that the leadership position most closely associated with the presence of internal controls in the church is a financial expert on the board of directors. Consistent with the findings of Booth (1993) and Conway (1999), paid clergy tend to traverse in the opposite direction. We fail to find any indication that presence of the leadership positions or governance bodies we examined are associated with a reduced incidence of reported fraud. These results suggest that future research should go beyond simply looking for internal controls in churches and should establish whether there are characteristics or viable practices of churches (internal controls or otherwise) that can indeed reduce the incidence of fraud.

Keywords: Fraud, governance, internal audit, internal control, nonprofits, religious organizations.

+ Effects of Alternative Short-Session Training Methods on Fraud Detection: A Performance and Efficiency Assessment

    • W. Eric Lee

    • Vairam Arunachalam

    • Dennis Schmidt

Abstract: Many novice accounting professionals and current accounting students receive limited training in fraud detection, often restricted to a short CPE course or a short module in an accounting course. Therefore, it is important to investigate the effects of alternative short-session training methods on fraud detection. This study reports the results of a short-session experiment that employed two widely used training methods: lecture and experiential. By comparing to a control group who received no training, we assess the relative performance effectiveness of the two training methods with respect to both fraud cue identification and fraud cue justification. We also assess efficiency, in terms of effort and time, relative to performance. Except for the experiential group, with no significant identification performance improvement, we find that either training method increases performance and efficiency compared to no training. Regarding both performance and efficiency for fraud cue identification, we observe slightly better results for lecture training over experiential training, but no significant difference between the two methods. With respect to both performance and efficiency for fraud cue justification, we find significant support for experiential training over lecture training. Our results should help accounting educators decide which approach to use when designing a short-session fraud detection training module.

Keywords: Fraud detection training, fraud cue identification, fraud cue justification, efficiency.

+ Using Forensic Analytics to Evaluate the Reliability of Fair Value Reporting

    • Stan Clark

    • Charles Jordan

    • Mike Dugan

Abstract: A fundamental argument that has persisted throughout the modern history of accounting concerns whether the primary measurement basis in financial reporting should be input-based (historical cost) or outcome-based (fair value).  The key issue hinges on the trade-off between the relevance and reliability of the numbers reported under these two measurement bases, with fair value measures viewed as more relevant, but historical cost measures considered more reliable.  This article provides a background and discussion of these two measurement bases and explains the FASB’s gradual shift from historical cost toward fair value reporting.  More importantly, though, through the application of Benford’s Law, which has become an important forensic analytical tool for detecting earnings management and other forms of fraudulent financial reporting, the study provides an empirical examination of the reliability of all three levels of fair value disclosures required by SFAS No. 157.  The findings suggest a significant amount of manipulation occurs in each of the three levels of fair value disclosure, including Level 1, which should be based on objectively determined external marketplace data.  Thus, the results of the forensic procedures performed in this study call into question the reliability and credibility of the fair value information currently reported in the financial statements.

Keywords: Fair value reporting, SFAS No. 157, reliability, manipulation, Benford’s Law.

+ Forensic Accountant, Forensic Accounting Certifications, and Due Diligence

    • Wm. Dennis Huber

Abstract: Previous research has established that some corporations that issue certifications in forensic accounting fail to disclose their legal status and the qualifications of their Officers and Board of Directors. Previous research also established that a significant number of forensic accountants have inaccurate beliefs about the legal status of the corporations and the qualifications their Officers and Directors. This study investigates whether forensic accountants exercised due diligence in investigating the corporations that issued their certifications prior to obtaining their certifications. The results of a survey show that forensic accountants failed to exercise due diligence in their investigation of the corporations that issued their certifications. The failure of forensic accounting corporations to disclose important information coupled with the failure of forensic accountants to exercise due diligence in investigating the corporations suggests there is a need for reform within the forensic accounting profession. 

Keywords: Forensic accountants, forensic accounting certifications, due diligence, forensic accounting corporations.

+ Auditors' Responsibility for Fraud Detection: New Wine in Old Bottles?

    • Lawrence Chui

    • Byron Pike

Abstract: We observe a historical trend that standard setters often resort to issuing additional auditing standards as a response to restore public trust after widely publicized fraud. Despite the standard setters’ intention, auditors are generally poor at fraud detection. Auditors are not fraud examiners. We contend the failure of auditors to detect fraud is attributable to the differences in skill sets and task objectives between financial statement audits and fraud auditing. Our paper provides a brief overview of the changes in auditors’ responsibility for fraud detection over the years. We highlight the differences between auditors and forensic specialists based on prior literature and an expert panel. Without proper and adequate forensic training, expecting auditors to detect fraud is similar to pouring new wine into old bottles. We conclude by identifying changes in the current audit model and research opportunities that can be used to improve auditors’ fraud detection performances.

Keywords: Auditors' responsibility, fraud detection, forensic specialists, audit standards, expert panel.

+ Compensatory Damages for Patent Infringement: TEXAHOMA HIGHWAY CONSTRUCTION CASE

    • Les Livingstone

Abstract: This case involves damages for the infringement of two patents owned by Salsa, Inc. The patents are for (a) the design and (b) the method of manufacture of concrete walls for containing construction noise caused by the building or widening of highways. By containing this noise, the state highway construction authority saves on the cost of compensation paid to nearby business owners and homeowners disturbed by the noise of highway construction. This patent has been infringed by other highway construction companies. Therefore Salsa has sued the infringing companies in order to recover compensatory damages for its lost profits due to patent infringement. The case requires students to calculate compensatory damages for lost profits from lost sales, lost profits from margin erosion, lost profits (if any) from convoyed sales, and interest on all lost profits.                                                                      

Keywords: Patent, infringement, compensatory, damages, lost profits, lost sales, margin erosion, convoyed sales

Books Reviews

Cyber Forensic
A. J. Marcella, Jr., F. Guillossoi, 2012, $80                                                        John Wiley                                        201.748.6358


 

The authors begin by explaining the origins of data. From there, the authors address concepts related to data storage, boot records, partitions, volumes, and file systems and how each of these is interrelated and essential in a cyber forensic investigation. They then analyze the roles these concepts play in an investigation and what type of evidential data may be identified within each of these areas.

Ronelle Sawyer and Jose McCarthy – two fictional characters – are used throughout the book to illuminate specific IT and cyber forensic concepts and discuss critical cyber forensic processes. Their activities and actions bring cyber forensic concepts to life by providing you with specific examples of the applications. Cyber Forensics also examines endianness and time - two important yet often overlooked topics – that drastically impact almost every cyber-based investigation.

Providing a through foundation to this emerging field, this step-by-step reference covers:

  • Converting binary to decimal

  • The power of HEX

  • Forensics and encrypted files

  • Master Boot Record (MBR)

  • Volume versus Partition

  • FAT filing system limitations

  • New technology file system

  • Forensic Investigative Smart Practices

  • MS-DOS 32-bit time stamp: date and time

  • Characteristics of a good cyber forensic report

  • A cyber forensic process summary

Essentials of the Reid Technique Criminal Interrogation and Confessions
F.E. Inbau et al., 2005
Jones and Bartlett Publishers
40 Tall Pine Drive
Sudbury, MA 01776
info@jbpub.com
criminaljustice.jbpub.com

 

This book teaches readers how to identify and interpret verbal and nonverbal behaviors of deceptive or truthful people, and how to move toward obtaining solid confessions from guilty persons using the Reid Technique. The Reid Technique is built around basic psychological principles and presents interrogation as an easily understood nine-step process. Separated into two parts, What you Need to Know About Interrogation and Employing the Reid Nine Steps of Interrogation, this book will help readers understand the effective and proper way that a suspect should be interrogated and the safeguards that should be in place to ensure the integrity of the confession.

Key Features

  • An abridged book covering the state-of-the-art technique of interviewing and interrogation.

  • Designed for criminal investigation students, law enforcement personnel, corporate security officers, and attorneys.

  • Includes real-world scenarios and examples.

  • Contains fascinating insights into how people behave when they are trying to lie.

  • Teaches proper and effective ways to interrogate and safeguard against false confessions.

Safeguarding                                           Critical E-Documents                            Robert F. Smallwood, 2012,                $75                                                       John Wiley & Sons                201.748.6358

The author identifies the sources of electronic document leakage in terms non-techies can understand, as well as the many threats to confidential e-documents across a wide range of digital platforms, including e-mail, instant messaging, mobile devices, cloud computing, and social networks. Then he offers proven solutions for proactively defending against each of those threats.

While Smallwood describes proven technological fixes that can be implemented right away, he is careful to explain why technology alone cannot fix the problem. Real e-document security, the author explains, begins at the top, with clear, rigorously enforced Information Governance (IG) policies. Drawing upon his more than a quarter-century of experience, Smallwood provides step-by-step guidance on how to establish a set of IG protocols appropriate to your organization and for developing an organization-wide program of total life-cycle security for critical electronic documents, from their creation to their eventual archiving or destruction.

The 3rd Annual Midyear Forensic and Investigative Accounting Conference

The Annual Mid-Year Forensic and Investigative Accounting Conference will be held March 22-23, 2013, jointly with the Public Interest Section in New Orleans, LA. The conference will be 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 29 and 30, 2013, for the Louisiana State University Fraud & Forensic Accounting Conference in Baton Rouge, LA. For more information about the 2013 conference, go to: http://business.lsu.edu/Accounting/fraud/Pages/2012-Fraud-and-Forensic-Accounting-Conference.aspx

Advertise in the JFIA

Would you like to advertise in this journal? Full page advertisement is $300; Half page advertisement is $150. Contact Larry Crumbley (dcrumbl@lsu.edu). Checks are to be made out to Journal of Forensic and Investigative Accounting and to be sent to Larry Crumbley at 2833 Business Education Complex, Dept. of Accounting, L.S.U., Baton Rouge, LA 70803

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