NYU Accounting Essay

Description

Using case studies of your choice, critically evaluate the factors that led to financial fraud and examine how such frauds might have been prevented.In writing your essay you should follow these guidelines:1.Use one or more of the core topics from the lecture programme to inform your comparison, eg:a.Creative accounting and accounting manipulation, valuation and mis-valuationb.The motivation and psychology of the protagonistsc.Methods used to carry out the fraudd.Comparative institutional and regulatory frameworks in the same jurisdiction through timee.Comparative institutional and regulatory frameworks across international jurisdictionsf.Corporate governance and internal control2.Engage with the academic literature and relevant theory to inform your analysis and to evaluate your evidence.3.Include a bibliography of all works cited.4.Support your analysis with evidence, drawn where possible from multiple and corroborating sources.5.You should use a minimum of two case studies, but you can use more than two if you wish to inform your comparison and evaluation.6.Use an analytical model or models to structure your answer.7.Use a logical argument and structure.

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Leeds University Business School
Forensic Accounting
and Finance
Lecture 2: Creative Accounting and
valuation
Outline and overview
•
•
•
•
•
Explain the methods of creative accounting
Evidence of creative accounting
Motives for creative accounting
Tesco and other examples
Purposes of valuation for the forensic
accountant
• Approaches to valuation and practical methods
Leeds University Business School
Accounting fundamentals
• Creative accounting: A form of accounting which, while
complying with all regulations, nevertheless gives a biased
impression (generally favourable) of the company’s
performance (Chartered Institute of Management Accounting,
Official Terminology, cited Jones, 2011, p.6)
• Two major sources of creative accounting opportunity:
valuation and timing.
• Truth and fairness: Asset valuation. Original cost vs market
value vs current value of future income
• Accruals concept: Costs and revenues are recognised in the
accounts when incurred or earned – not when the money is
received or paid.
– Eg A company uses gas and electricity for the final quarter of 2019 but does
not receive the bills until Feb 2020.
– A construction firm is due to receive £500m at the end of a five year
contract and will incur costs of £80m per year.
Leeds University Business School
Fair value accounting
•
•
•
Fair value = rational unbiased estimate of the market value of an asset
Accounting standards use hierarchies of valuation inputs:
– Quoted market prices in an active market
– In illiquid or inactive markets:
• maximise use of available market inputs and recent arm’s length
market transactions,
• reference to the current fair value of similar assets,
• discounted cash flow analysis, and option pricing models.
– Cost less impairment.
Adjustments to fair value shown:
– In ‘other comprehensive income’ (ie excluded from reported profit)
– Movements in reserves: eg revenue reserves, hedging reserves,
revaluation reserves, other reserves etc.
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Carillion’s reported profits
Profit after tax (2016) shown as:
A. £151.7m for the purposes of headline ‘underlying’ earnings per
share
B. £129.5m per the income statement
C. -£205.0m per the statement of comprehensive income
c.f. D. -£204.0 ‘clean surplus’ income
A – B = redundancy and restructuring costs
B – C = revaluation of pension liabilities
D = total equity 2016 minus total equity 2015 plus
dividends paid [£729.9 – £1016.6 + £82.7]
See: Carillion Annual Report 2016, pp.92-95.
Leeds University Business School
Debits and credits
Valuation and timing judgements can be classified
according to basic accounting categories…
• Debit can be either:
– An asset, or
– An expense
• Credit can be either:
– A revenue, or
– A liability
• These distinctions are often unclear, and are the basis for
many creative accounting based frauds.
– Inappropriate distinction between capital and revenue
– Off balance sheet finance
– Eg lease accounting
Leeds University Business School
Creative accounting transactions:
Simple examples
Base case
NCA
Opening balances
Closing adjustment
Closing balances
CA
CL
LTL
EQ
200
100
-50
-50
200
100
-50
-50
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus
reserves)
ROE = Return on equity
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Income Expenses Check ROE %
-150
-400
350
0
-50
400
-350
0
-200
0
0
0 25.00
Memorandum to show:
debits (+ve) = credits (-ve)
EG 1: Increase depreciation
Opening
balances
Extra
depreciation
Closing
adjustment
Closing
balances
NCA
CA
CL
LTL
EQ
200
100
-50
-50
-150
Income Expenses
-400
-10
190
100
-50
-50
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus reserves)
ROE = Return on equity
Leeds University Business School
Check
350
0
10
0
-40
400
-360
0
-190
0
0
0
Effects:
Reduce Profit
Reduce Equity
Reduce ROE
ROE %
21.05
EG 2: Increase inventory valuationEG2: Increase
closing inventory
Opening
balances
Revision to
inventory
Closing
adjustment
Closing
balances
NCA
CA
CL
LTL
EQ
Income
Expenses
Check
200
100
-50
-50
-150
-400
350
0
-10
0
10
200
110
-50
-50
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus reserves)
ROE = Return on equity
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-60
400
-340
0
-210
0
0
0
Effects:
Increase Profit
Increase Equity
Increase ROE
ROE %
28.57
EG3: Increase bad debt provision
NCA
Opening
balances
Increase in
bad debt
provision
Closing
adjustment
Closing
balances
CA
200
CL
100
LTL
-50
EQ
-50
Income
-150
Expenses Check
-400
-10
200
90
-50
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus reserves)
ROE = Return on equity
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-50
ROE %
350
0
10
0
-40
400
-360
0
-190
0
0
0
Effects:
Reduce Profit
Reduce Equity
Reduce ROE
21.05
EG4: Recognise sales earlier
Opening
balances
Extra sales
Closing
adjustment
Closing
balances
NCA
CA
CL
LTL
EQ
Income
Expenses
Check
200
100
-50
-50
-150
-400
350
0
10
200
110
-10
-50
-50
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus reserves)
ROE = Return on equity
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ROE %
0
-60
410
-350
0
-210
0
0
0
Effects :
Increase profit
Increase equity
Increase ROE
28.57
EG5: Capitalise expenses
Opening
balances
Expenses
capitalised
Closing
adjustment
Closing
balances
NCA
CA
CL
LTL
EQ
200
100
-50
-50
-150
Income Expenses
-400
10
210
100
-50
-50
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus reserves)
ROE = Return on equity
Leeds University Business School
Check
350
0
-10
0
-60
400
-340
0
-210
0
0
0
Effects:
Increase profit
Increase equity
Increase ROE
ROE %
28.57
EG6: Off balance sheet finance
Opening
balances
asset moved
off balance
sheet
Closing
adjustment
Closing
balances
NCA
CA
CL
LTL
EQ
200
100
-50
-50
-150
-10
190
Income Expenses Check
-400
350
10
100
-50
-40
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus reserves)
ROE = Return on equity
Leeds University Business School
ROE %
0
0
-50
400
-350
0
-200
0
0
0
Effects:
No effect on profit?
No effect on equity
No effect on ROE
25.00
EG7: Revalue non current assets
NCA
Opening
balances
Revalution
Closing
adjustment
Closing
balances
CA
200
CL
100
LTL
-50
EQ
-50
10
210
Income
-150
Expenses Check
-400
350
-10
100
-50
-50
Key:
NCA = Non current assets
CA = Current assets
CL = Current liabilities
LTL = Long term liabilities
EQ = Equity (Capital plus reserves)
ROE = Return on equity
Leeds University Business School
ROE %
0
0
-50
400
-350
0
-210
0
0
0
Effects:
Reduce profit?
Increase equity
Reduce ROE
23.81
Summary: Methods of creative accounting
•
•
•
•
Increase income, eg:
– premature sales recognition (eg Tesco; for others see Jones, 2011,
pp.46-47)
– treat loans as income (Enron)
Decrease expenses, eg:
– Reduce depreciation charges (increase estimated useful lives of assets)
– Treat expenses as assets (Worldcom)
Increase assets, eg:
– Asset revaluations
– Goodwill and intangibles (eg Parmalat)
– Inventory valuations
Decrease liabilities, eg:
– Off balance sheet financing (eg Olympus)
Leeds University Business School
‘Clean’ vs ‘dirty’ surplus
•
•
•
•
•
•
In eg7, the reported profit = 50, which is the ‘dirty surplus’, ie because
it effectively conceals the 10 profit on the non-current asset
The ‘clean surplus’ profit is 60:
– Total equity c/fwd
210
– Total equity b/fwd
– 150
= 60
Clean surplus corresponds to:
– The net change in owners wealth from all sources
– What the profit would be if all gains and losses are put through the
income statement
Formal definition: Change in equity book value plus dividend
Clean surplus is a useful alternative profit measurement where
creative accounting occurs
Forms the basis for alternative valuation models
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General Motives for creative
accounting
• Personal incentives, eg: salaries, bonuses and options
• Threat of regulation
• Special circumstances, eg new share issues, initial public
offerings (IPOs), mergers and acquisitions. Specific features
of these transactions:
– Valuation is problematic, eg goodwill and intangible assets
– Accentuated information asymmetry
• To cover up fraud
• Market expectations: profit smoothing, analysts forecasts.
The amount of value destroyed by companies striving to hit
earning targets exceeds the value lost in high-profile fraud
cases (Graham, Harvey & Rajgopal, 2006)
(see Jones, 2011, ch3, & p.33, figure 3.1 for summary)
Leeds University Business School
Motives for earnings management:
Research evidence
Debt covenant =
obligation imposed by
lenders
• To avoid reporting losses or earnings decreases (Burgstahler
and Dichev, 1997)
• To meet analyst forecasts (Roychowdhury, 2006)
• To meet executive compensation targets (Cheng and
Warfield, 2005)
• Firms manipulate reported earnings upward (downward) to
avoid debt covenant violations (to restructure debt covenants)
(e.g., Jaggi and Picheng, 2002).
• Political costs, eg, By examining a sample of 76 oil and gas
firms during 1990, Han and Wang (1998) find evidence firms
use income-decreasing accrual accounting to decrease
reported earnings during the Persian Gulf crisis.
Leeds University Business School
Tesco case study
Summary of the scandal
• Bringing forward income (payments from suppliers
for favourable promotions)
• Secret deals between group of staff and suppliers
• Auditors identified potential risk (audit report 22nd
Feb 2014), but:
• Full scale of the problem highlighted by staff whistleblower
• Subsequently investigated by the Serious Fraud
Office (SFO) and sued by shareholders
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Period of
increasing
competition
Tesco PLC: Share Price
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£250m accounting
scandal, Sept
2014
Tesco: Pressure for creative accounting
Write down a list of reasons why Tesco management
might have engaged in creative accounting
1.
2.
3.
4.
5.
NB these are motives for creative accounting, not
necessarily motives for fraud (see Lecture 4)
Leeds University Business School
Valuation and forensic accounting
Valuation skills help:
• To assist the detection of earnings manipulation or
fraud
• To quantify legal damages or insurance claims
• To assist the resolution of disputes in legal process,
eg:
–
–
–
–
–
Creditor protection
Minority protection
Directors’ duties, eg fraudulent trading
Due diligence
Marital disputes, competing claims over estates etc
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Accounting
theory
Modelled
value
Real value
Asset based
models
Accounting
rate of return
(ARR)
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Efficient
markets
Current
market
value
Economic
theory
Equilibrium
market
value
Theory
axis
Forecast
income
based
models
Internal rate
of return
(IRR)
Practical Methods of Valuation
Examples of standard approaches:
• Asset, accrual based, separable assets + goodwill
• Forecast using accrual based accounting ratios
• Forecast based on cash flow, e.g. Dividend
Valuation Model (DVM)
Alternative approach:
• Clean surplus based models (see Carillion above)
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Separable asset based valuations
• Separable assets: entry, in use, or exit values
• Evaluating risk of fraud and error in asset valuations. Depends
on two factors:
– Materiality: How significant is the relative value of the asset?
– Risk: How subjective is the method of quantifying value
• Materiality and risk determined by business environment
factors, eg:
– Current trading conditions
– Firm profitability and performance
– Specific circumstances, eg changes in management, major
transactions etc.
• Materiality and risk vary according to asset classes in the
balance sheet
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Tangible and intangible assets
http://www.oceantomo.com/about/intellectualcapitalequity
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Examples of goodwill assets
Internally generated, legally enforceable:
• Brands, licences, patents
External/network based, legally enforceable:
• Franchises, distribution rights
Internally generated, intangible
• Human capital, skill, knowledge
External/network intangible
• Access to distribution, complementary assets
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Problems with valuing intangibles
• Goodwill arising on takeover transactions (IFRS 3).
– Under IFRS and US GAAP goodwill can be shown as an asset in
the balance sheet
– Determined with reference to the fair values of assets acquired
– Subject to annual impairment testing, not amortisation
• IAS 38 requires an entity to recognise an intangible asset,
whether purchased or self-created (at cost) if, and only if: [IAS
38.21]
– it is probable that the future economic benefits that are
attributable to the asset will flow to the entity; and
– the cost of the asset can be measured reliably.
• Intangibles increasingly dominate the balance sheets of firms
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Business entity valuation
• Goodwill assets can be valued with reference to their
ability to generate abnormal returns, by preventing
competitors replicating the asset
• Investment in tangible assets tends to lead to normal
profits
• Investment in intangibles tends to lead to sustained
competitive advantage, ie
– Faster growth
– Superior profits
• Where intangibles cannot be separated, estimates can be
made by valuing the whole business and comparing the
result to net book value
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Goodwill and the expected rate of
return
• Abnormal profit = Actual profit – normal profit
• Where actual profit is the clean surplus
• What constitutes ‘normal’ profit?
Ke = Rf + β (Rm – Rf)
The required rate of return or cost of equity (Ke) is the
market risk free rate plus the market risk premium (Rm – Rf)
multiplied by the security’s covariance with the market (β)
• Capital asset pricing model (CAPM), ie expected
return based on a given level of risk
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Abnormal profits and goodwill
• Actual profit measure:
– Accounting rate of return (ARR), eg return on equity (ROE):
– Profit after interest ÷ Equity capital (ie called up share capital plus
reserves)
• If assets = 100, ROE = 12% and ke = 10% and the abnormal
profit is expected to persist indefinitely, what is the value of
goodwill?
• Actual profit = 12, expected profit = 10, therefore abnormal
profit = 2. Goodwill = 2/0.1 = 20
• Assumptions:
– Product markets: persistence of entry and other barriers to replication
– Capital markets are reasonably efficient, ie CAPM assumptions
satisfied.
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Valuating unquoted companies
Use same methods as quoted companies, but two problems arise:
Control and minorities and lack of market data
• Control premium
– Many non-quoted family businesses, eg family firms, are closely
controlled, so:
– Share value > asset value
– Estimate using typical control premium in market takeovers
• Minority discounts
• Lack of market discount
• Key issue = difference in value arising from difference in
control
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Practical valuation methods
• Where market data is needed, eg a beta, use a
quoted firm in the same industry
• Eg: The Private Company Price Index
• Tracks the relationship between:
– Enterprise Value (EV) to
– Earnings Before Interest Tax Depreciation and Amortisation
(EBITDA)
• Price to earnings type multiple (EV/EBITDA) paid by
trade and private equity buyers when purchasing UK
private companies.
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Forecasts using accrual based accounting
ratios
• Valuation involves estimation of future profits and applying a
PE multiplier (see Taylor, 2011, p.414)
• Price/Earnings (PE) ratio = Share price ÷ Earnings
• Firms with significant intangibles may also have high PE ratios
• Recognised by the courts as a legitimate and credible approach
• But: earnings are accruals based, and may be problematic,
where certain transactions are accounted for directly through
reserves, eg:
• Goodwill revaluations
• Foreign currency gains and losses
• So, profit per accounts/retained profit = ‘dirty surplus’
• Can be avoided by using ‘clean surplus’ = total reserves
(current year) – total reserves (prior year) + dividends
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Summary
• Wide range of methods of representing a business using
accounts
• Rules sufficiently flexible to allow significant and wide
ranging methods of manipulation
• Creative accounting is widespread and can arise from
financial pressures on the firm
• Valuation is subjective and certain assets are highly
problematic
• Potentially giving further scope for creative accounting.
• Relevance to assessment: Consider how and why
creative accounting and asset value manipulation
occurred in your chosen case study.
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References and further reading
•
•
•
•
•
•
•
•
BDO Private Company Price Index: http://www.bdo.co.uk/news/private-companyprice-index-pcpi
Burgstahler, D. and Dichev, I. (1997) Earnings management to avoid earnings
decreases and losses, Journal of Accounting and Economics, 24, 99-126.
Cheng, Q. and Warfield, T.D. (2005) Equity incentives and earnings management, The
Accounting Review, 80, 441-76.
Dechow, P.M., Sloan, R.G. and Sweeney, A.P. (1995) Detecting earnings management,
The Accounting Review, 70, 193-225.
Graham, J., Harvey C. & Rajgopal, S. (2006), Value destruction and financial reporting
decisions”, Financial Analysts Journal, Vol 62 No 6.
Han, J. C. Y. & Wang, S.-W. 1998. Political Costs and Earnings Management of Oil
Companies during the 1990 Persian Gulf Crisis. The Accounting Review, 73, 103-117.
Jaggi, B. & Picheng, L. (2002), Earnings Management Response to Debt Covenant
Violations and Debt Restructuring. Journal of Accounting, Auditing & Finance, 17, 295324.
Roychowdhury, S. (2006) Earnings management through real activities manipulation,
Journal of Accounting and Economics, 42, 335-70.
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Pressure for creative accounting
at Tesco
• Culture of continuous growth and profit orientated
management objectives
• Slow down in consumer spending and pressure from
new market entrants (Aldi and Lidl)
• Disastrous attempt at international diversification
(US venture)
• Pressure from city/shareholders
• Pressure on cash flow, leading to…
• Increased borrowing
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Leeds University Business School
Forensic Accounting
and Finance
Lecture 3: Analytical methods
Overview
A selection of analytical approaches to researching
cases, including:
• Complex group structures, including:
– Tax evasion
– Transfer pricing
•
•
•
•
Social network analysis
Ratio analysis
Timelines
Research and data sources
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Complex group structures
• Complex group structures are a common feature of
many frauds, eg:
– Slater Walker
– Enron
• What is a subsidiary?
• What is a related or associated company?
• When should they be consolidated?
(IFRS 10 Consolidated Financial Statements)
Key point: What constitutes control?
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Group structures
20-50%
Holding
company
50%
Associate
Subsidiary 1
50%
Subsidiary 2
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Special
Purpose
Entity
(SPE)
Outside
investor(s)
Special purpose entities (SPEs)
Enron: 3% rule no consolidation needed if at least 3%
of SPE capital owned by third party investors
Purpose of SPE:
– Consortium or joint venture structures
– Based on specific project
– Ring fencing of risk
Avoid consolidation where:
• None of its owners object
• Shares/debt instruments are not traded in a public market
• A higher-level parent produces publicly-available IFRS
consolidated financial statements.
(see IFRS10)
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Enron Example: Avoid
Consolidation
Enron
Big River
$383m
Chewco
CALPERS
JEDI
1993 Enron joined
with Calpers to
create the JEDI
fund
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3%
Loans
Little
River
Barclays
Bank
Parmalat Example: Use
unregulated tax havens
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Transfer pricing
Holding
company (UK)
Subsidiary 1
(Luxembourg)
Subsidiary 2
(UK)
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Holding company can determine:
• Price at which S1 sells goods
to S2
• Price at which S1 purchases
goods from H
and therefore the profit earned by
S1 and the tax paid
Other egs/ opportunities:
• ‘Management’ fees
• Assets
• Liabilities
Tax evasion
• Not formally part of our syllabus, but:
– Tax evasion is frequently a feature of wider frauds, that may
involve offshore jurisdictions
– Tax evasion/avoidance can lead to complex group structures
that are associated with fraud
• Tax avoidance
– Legal measures to reduce tax liabilities
• Tax evasion
– Illegal measures (based on non-disclosure) to reduce tax
liabilities
• Aggressive tax avoidance
– Schemes devised with the sole purpose of reducing tax liabilities
– eg Barclays and HSBC
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Google and the ‘Google tax’
• Key features of the Google scheme:
– Based on agreement with Internal Revenue Service (IRS)
– Google Ireland Holdings:
• Not resident in Ireland (managed in Bermuda)
• Unlimited liability: no accounting disclosure
–
Google Ireland Ltd:
–
Revenues, minus royalty payments (licence fee) = negligible profits
– Google Netherlands
• No employees
• No withholding taxes on royalty payments
– Lobbying of US government against changes to tax rules (with
General Electric, Starbucks etc)
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Trading
revenues
Untaxed
royalty
payments
Collects untaxed
royalties
1.
Licensing the rights (intangible properties) related to the foreign business (or cost-sharing
agreement)
2. Payment of license fee ( or sharing the Research and Development cost)
3. (Sub) Licensing
4. 5. Payment of license fee
Source: http://www.cosmos-international.co.jp/english/library/1012.html
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Social network analysis
• Complex group structures resemble
networks
• In fraud cases generally, social network
analysis can be a useful:
– Method of mapping relationships, and
– For detecting points of interest for further
investigation
• Between organisations or within them
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Network patterns differ
according to the type of fraud
Screen Shot 2013-04-23 at 09.51.08
Source: CGI (2011)
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Social Networks
Networks
consist of:
• Nodes
• Edges
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Detection measures: Centrality
Centrality: Measures the importance of a node in the
network, and is measured in 3 ways:
• Degree = number of connections a node has to other
nodes. Higher value compared to peers denotes
higher influence in the network.
• Closeness = distance between the node and all
other nodes in the network
• Betweenness = extent to which a node’s is on the
shortest path between other pairs of network nodes
Centrality can lead investigators to concentrate on
specific nodes likely to be important to the fraud.
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Detection measures: Density
• Density: The number of edges in a portion of a social
network to the maximum number of edges that
theoretically make up the network
Where:
C = number of observed edges and n the total number of nodes in
the social network.
n(n-1)/2 = the theoretical maximum number of edges that are
possible in a given social network.
Density measures used to identify likely patterns of
fraud.
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Limitations of network analysis
• In common with most analytical procedures, social
network analysis can be used to identify likely fraud,
but does not provide proof.
• It is a potentially cost effective guide to further
action
• Must be used in conjunction with other techniques
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Ratio analysis:
Global Crossing case
‘
‘We are no
Enron’
John Legere:
CEO
Dan Cohrs: COO
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Global Crossing
• Telecommunications company
• Filed for bankruptcy in January 2002.
• JPMorgan Chase and a group of major banks, which loaned the
company > $2 billion, filed a lawsuit alleging that company
executives initiated fraudulent transactions prior to the
bankruptcy filing to inflate earnings and conceal the company’s
true financial position.
• Key aspect of the fraud: “capacity swaps”, in which carriers
exchange capacity in complementary parts of the world without
actually exchanging money – then the swap is shown as
revenue.
• For a summary, see:
http://news.bbc.co.uk/1/hi/business/1886014.stm
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1998
$m
1999
$m
420
178
242
1665
850
815
Depreciation & amortisation
1
124
Balance sheet extracts
Intangible assets
Tangible non current assets
1228
434
10733
6026
71
100
806
977
967
347
1633
2947
2639
19706
240
16
256
1713
140
1853
Income statement extracts
Sales
Cost of sales
Gross margin
Accounts receivable
Sundry current assets
Cash
Current assets
Total assets
Sundry current liabilities
Taxes payable
Current liabilities
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Global Crossing,
Accounts extracts
Global Crossing
As senior partner preparing the audit of the 1999
Global Crossing accounts, list areas for further specific
attention arising from your review of the above
financial statements:
1
2
3
4
5
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Beneish ratios
• Used to examine financial statements forensically
for fraud
• Derived by Beneish (1999) by examining
characteristics of firms investigated for financial
manipulation
• We can use his approach to analyse the Global
Crossing fraud (see also Taylor, pp.330-332).
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Components of Beneish ratios
•
•
•
Based on changes in account balances between the year in which the
first reporting violation was uncovered and the prior year.
On average, those identified as manipulators had significantly larger
increases in days sales in receivables, greater deterioration of gross
margins and asset quality, higher growth, and larger accruals than
non manipulators.
Leads to the following measures:
– Days’ sales in receivables index (DSRI)
– Gross margin index (GMI)
– Asset quality index (AQI)
– Sales growth index (SGI)
– Total accruals to total assets (TATA)
• The examples in this section are taken from Golden et al
(2006, pp.378-383)
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Beneish ratio definitions: DSRI
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Beneish ratio definitions: GMI
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Beneish ratio definitions: AQI
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Beneish ratio definitions: SGI
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Beneish ratio definitions: TATA
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Source: Golden, Skalak and Clayton (2006)
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Timelines
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Research and data sources
• See case study advice and tips (VLE student advice
page)
• Choice of case study
• Library sources:
– Nexis (on line database of press articles)
– Westlaw (on line Law reports)
– Other online sources, eg The Economist, Financial Times
including historical archives.
– Textbooks and academic journal articles (use Google Scholar for
keyword searches)
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Summary
• We have considered some analytical methods and
tools, including
–
–
–
–
Complex group structures: Tax evasion and transfer pricing
Social network analysis
Timelines
Ratio analysis
• And introduced factors governing case study
selection and choices of research data sources
• Relevance to assessment: To assist your case study
research, so that you can build knowledge for
presentations that can subsequently be used for the
coursework.
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References and Reading
Beneish, M. D. (1999). The detection of earnings manipulation. Financial Analysts
Journal, 55(5), 24-36.
CGI (2012) Implementing social network analysis for fraud prevention
http://www.cgi.com/sites/cgi.com/files/white-papers/Implementing-social-networkanalysis-for-fraud-prevention.pdf
Golden, T., Skalak, S. and Clayton, M. (2006) A Guide to Forensic Accounting, New
Jersey: Wiley
Access the full text here:
http://160592857366.free.fr/joe/ebooks/Corporate%20Finance/Wiley%20A%20Guide
%20to%20Forensic%20Accounting%20Investigation.pdf
Barclays Bank tax schemes:
www.theguardian.com/business/2009/mar/16/revenue-investigates-barclays-taxmole-claims?CMP=share_btn_tw
IFRS10:
http://www.grantthornton.ca/resources/insights/adviser_alerts/Under_control_a_pr
actical_guide_to_IFRS10_final_August2012.pdf
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LUBS5019M Forensic
Accounting and Finance
Lecture 4: The Psychology of Fraud
Overview
• The lecture will analyse the circumstances giving rise to fraud
using the elements of the fraud triangle:
– Opportunity
– Motivations
– Rationalisations
• It will characterise fraud in relation to internal control
• It will then examine how fraud arises for different individuals
depending on their organisational context:
–
–
–
–
Employees
Managers
Entrepreneurs
Corporations and corruption
• Providing suggestions for further reading and research
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Generic explanations of fraud
Like other crime, fraud can best be explained by three factors:
– A supply of motivated offenders
– the availability of suitable targets
– and the absence of capable guardians
(Cohen & Felson 1979; Krambia-Kapardis 2001; cited in Duffield,
& Grabosky, [2001]):
http://www.anatomyfacts.com/Research/fraud.pdf
Motivation: reason for an action
= individual personality (intrinsic motivation) + situation (extrinsic
motivation)
Psychology: how the individual interprets the situation (Duffield,
& Grabosky, 2001)
Gives rise to the fraud triangle (Cressey, 1953)
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The fraud triangle
Opportunity
Pressure
Motivations/(pressure
or incentive)
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Context/Opportunity
Rationalisation
Neutralisation/Rationalisation
Contexts and opportunities
•
•
•
•
Weak internal controls – eg Leeson fraud
Reliance on trust
Triggering event – eg insurance claim
Contexts:
– Periods of losses or low returns
– Periods of bubble and speculation
(ie cases of market disequilibrium)
– Apparent regulatory failure
– Eg financial crisis 2007/08
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Effects of the financial crisis
Source: FBI Financial Crimes Report to the Public http://www.fbi.gov/stats-services/publications/financial-crimes-report2010-2011
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Common motivations
Individual, moral motivations
– Bondsman’s hypothesis (some individuals cannot be satisfied with the
rewards of a legitimate career)
– Auditor’s assumption (meeting of desire and opportunity)
Individual psychological motivations:
• Greed
• Financial strain or pressure
• Threat of loss, eg of status, valuable asset etc.
• Satisfaction arising from:
– Manipulating others
– Control or mastery of a situation
Narcissiscm (personality disorder leading to obsession with power and
success)
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Neutralisations
• The individual or organisational victim is unethical
• The crime is victimless
• ‘Everyone else does it’ eg tax, insurance, expense
fraud (eg UK MPs expenses scandal)
• ‘They can afford