Forensic Accounting Fraud and Financial Statements

							                 Forensic Accounting:
                 Fraud and Financial Statements




Greg Draper, CGA, CFE
March 27, 2008
Topics

• Forensic Accounting defined
• Scandals that Changed the Landscape
• Financial Statement Fraud - How and Why




Chartered Accountants and Business Advisors   mnp.ca
        Forensic Accounting
• No bullet holes or blood spatters
• Application of accounting in a legal context
• Combines
     – Professional accounting skills
     – Investigative skills
     – Investigative mindset




Chartered Accountants and Business Advisors   mnp.ca
                         Scandals
• Tyco
     – CEO and CFO took $100 - $200 million in
       loans at low or no interest without Board
       approval
     – CEO and CFO sell off millions of shares while
       telling the public they rarely do so
     – SEC sues, criminal charges laid
     – Sentenced to 8 – 25 years, fines,
       disgorgement

Chartered Accountants and Business Advisors   mnp.ca
                         Scandals
• WorldCom
     – CFO and Controller falsified statements to
       meet analyst expectations, inflating revenues
       with bogus accounting entries, back-dating
       contracts, inappropriately capitalizing
       expenses
     – Internal Audit identified $3.8 billion in fraud
       during routine review of capital expenditures
     – CEO (Bernie Ebbers of Edmonton) gets 25
       years


Chartered Accountants and Business Advisors   mnp.ca
                         Scandals
• Enron
     – Executives developed schemes to conceal
       debts and losses in off-shore entities that
       were not consolidated
     – Illusion of profits drove the stock up, while
       executives traded shares on inside
       information
     – Execs told public and employees to buy stock
       while they were selling


Chartered Accountants and Business Advisors   mnp.ca
                         Scandals
• YBM Magnex
   – Began as a Junior Capital Pool on the Alberta Stock
     Exchange, penny stock closely held
   – through reverse take-over moves up to TSX, primary
     business is the manufacture of industrial magnets,
     widely-held shares hit $20
   – sales were actually money laundering for Russian
     mafia, false revenues used to manipulate stock price
   – Auditors deny opinion, de-listed from TSX, FBI and
     IRS investigation



Chartered Accountants and Business Advisors   mnp.ca
                         Scandals
• Bre-X
     – Calgary-based gold mining company claims to
       find World’s largest ore deposit
     – Shares soar from pennies to $120+, many
       Alberta investors put their life savings in
     – World learns that the ore samples were
       “salted” - there is no gold
     – The stock price, and the geologist, plummet


Chartered Accountants and Business Advisors   mnp.ca
                         Scandals
• More trouble for Canadian companies
     – Livent
     – Norburg Financial
     – Nortel
     – Danier
     – Biovail




Chartered Accountants and Business Advisors   mnp.ca
        Regulatory Changes
• Sarbanes Oxley
• US anti-fraud legislation in direct response
  to scandals
• limits non-audit work that firms can provide
  to audit clients
• Required CEO/CFO certification of ICFR
• External audit opinion on ICFR


Chartered Accountants and Business Advisors   mnp.ca
        Regulatory Changes
• Changes to Canadian Federal laws
• Bill C-13 amending the Criminal Code
     – Made criminal offences of insider trading,
       tipping
     – Increased penalties for corporate fraud
     – Protected witnesses / whistleblowers from
       retribution



Chartered Accountants and Business Advisors   mnp.ca
        Regulatory Changes
• Canadian Securities Administrators
  adopted several Multi-Lateral Instruments
  to mirror Sox requirements
     – Basically adopted by all provinces
• Ontario passed Bill 198
     – Strengthens securities laws
     – Created statutory civil liability for secondary
       market disclosure (auditors can be sued)


Chartered Accountants and Business Advisors   mnp.ca
        Regulatory Changes
• CICA Handbook – s. 5135
• Clarifies auditors’ role regarding fraud
• Requires auditors to consider risks of
  fraud within the organization
• company as victim and perpetrator
• Obtain management’s assessment of risk



Chartered Accountants and Business Advisors   mnp.ca
       How Fraud Happens




Chartered Accountants and Business Advisors   mnp.ca
Financial Statement Fraud
Schemes
• Fictitious Revenues
• Timing Differences
• Improper Asset Valuations
• Concealed Liabilities and Expenses
• Improper Disclosures



Chartered Accountants and Business Advisors   mnp.ca
Financial Statement Fraud
Fictitious Revenues
• Sales of products or services that did not
  take place.
• Most often involve fake customers.
• An invoice is created but not mailed. Then
  entries are created on the books to help
  conceal the fraud.


Chartered Accountants and Business Advisors   mnp.ca
Financial Statement Fraud
Timing Differences
• Recording revenue or expenses in
  improper periods to increase or decrease
  earnings.
     – Premature revenue recognition
     – Long term contracts
     – Channel stuffing/ trade loading
     – Recording expenses in the wrong period


Chartered Accountants and Business Advisors   mnp.ca
Financial Statement Fraud
Improper Asset Valuations
• Inventory valuation
• Accounts receivable
• Business combinations
• Fixed assets
• “Window Dressing”



Chartered Accountants and Business Advisors   mnp.ca
Financial Statement Fraud
Concealed Liabilities and Expenses
• Omitting liabilities and expenses
• Capitalizing expenses
• Failing to disclose warranty costs and
  liabilities




Chartered Accountants and Business Advisors   mnp.ca
Financial Statement Fraud
Improper Disclosures
• Liability omissions
• Subsequent events
• Management fraud
• Related-party transactions
• Accounting changes



Chartered Accountants and Business Advisors   mnp.ca
                      Questions?
                       Greg Draper, CGA, CFE
                         Forensic Services
                      Meyers Norris Penny LLP
                           403.537.7679
                       greg.draper@mnp.ca




Chartered Accountants and Business Advisors   mnp.ca