1.

FEATURE
2. FRAUD

What’s your fraud IQ?

This month: Combating contract and procurement fraud By Andi McNeal, CPA - February 1, 2019

FEB 2019 - Question 1 of 5

Joshua, a government auditor, is auditing his agency’s contracts, and he notices some unexpected patterns in the procurement
process. The lowest bidders on a series of contracts keep withdrawing their bids at the last minute. Often, these same bidders
become subcontractors for the winning contractor. Additionally, the winning bid is consistently higher than cost expectations. Based
on these findings, which of the following is most likely occurring?

a. A government employee is leaking confidential information to the bidding contractors.

b. One of the bidding contractors is extorting a government employee to tailor the bid specifications so that it wins each

contract. c. The contractors are colluding with each other to manipulate the procurement process.

d. The winning contractor is abusing the change-order process to overbill the government agency.

Correct! – IS B- In bid-rigging schemes, contractors who would typically have to compete with one another agree among
themselves to circumvent the procurement process while maintaining the appearance of competition. Examples of common types of
bid-rigging schemes include bid rotation, in which contractors conspire to alternate contracts on a rotating basis, and bid
suppression, in which contractors enter an illegal agreement whereby at least one of the conspirators refrains from bidding or
withdraws a previously submitted bid. A pattern of low bidders withdrawing their bids at the last minute and then becoming
subcontractors for the winning contractor can indicate that the bidders are colluding to manipulate the bidding process. This type of
situation typically results in the contracting organization paying a higher price than it should have to the winning bidder, which then
splits the inflated proceeds with the other contractors that colluded in the scheme

Question 2 of 5 -Which of the following best indicates that a vendor invoicing scheme might be occurring?

a. The same type of item is regularly purchased from more than one vendor. b. The item descriptions on an invoice do

not match the items on the related purchase order. c. A certain employee approves substantially more change orders than

other similar employees do. d. Multiple payments are made to the same vendor on various dates.

Correct! – B- In an invoicing scheme, the vendor manipulates its invoices to generate false payments from the customer. Such schemes might be
perpetrated by the vendor alone or might involve collusion with an employee of the victim organization. Common examples of invoicing schemes
include submitting completely fictitious invoices, submitting inflated legitimate invoices, and submitting duplicate invoices for payment. Red flags of
these schemes include:

 A lack of supporting documents (e.g., purchase order, receiving records) for an invoice.
 Supporting documents that appear to be copied, altered, or forged.
 Invoiced goods or services that cannot be located in inventory or accounted for.
 Invoices that exceed or do not match purchase orders, contract items, receiving records, inventory, or usage records.
 Invoices for an even amount (round number) that is not expected or reasonable.
 Invoices that lack detail.
 Invoices that frequently fall just below purchasing or approval threshold levels.
 Multiple invoices that contain the same item description.
 Multiple invoices for the same amount on the same date.
 Multiple invoices for the same purchase order authorization.
 Multiple payments for the same invoice number.
 Multiple payments made to the same vendor on the same date.
Question 3 of 5 - The hotline for Red Sunbeam Inc. receives a call claiming that an employee in the procurement department received kickbacks from
a contractor in exchange for sharing confidential information about the bidding process. Which of the following would best support these allegations?

a. The first party to bid won the contract., b. The winning bid did not align with the contract specifications. , c. The bidding process

was closed without selecting a contractor. , d. The winning bid was just below the next lowest bid
The correct answer is (d). Dishonest employees of a procuring entity might leak confidential information to a favored bidder, giving that bidder an unfair
advantage in the bidding process. Typically, these schemes involve the company insider receiving a kickback in exchange for this information.
Information that might be valuable to a bidder — and thus worth paying for — includes details about proposals submitted by other bidders and
confidential information about how the selection process works, such as how bids are scored (e.g., how technical and pricing factors are weighted,
etc.). Warning signs that an employee might be leaking bid data to a bidder include:

 The winning bid is just below the next lowest bid.

 The winning bid is unusually close to the procuring entity’s estimates.
 The last party to bid wins the contract.
 The contract is unnecessarily rebid.
 A contractor submits false documentation to get a late bid accepted.
 A procurement employee socializes with contractors.
 A procurement employee experiences an unexplained increase in wealth or outside income.

Question 4 of 5 - Amanda, a purchasing agent for CCM Inc., has the authority to independently approve purchases of up to $5,000. She knows the
company is about to undertake a project with a projected value of $18,000, and she wants to direct the business to a specific vendor. Therefore, she
divides the contract into four separate contracts worth $4,500 each and awards them to her preferred vendor. What type of scheme did Amanda
undertake?

 a. A shell company scheme. ,, b. Bid splitting./ , ,c. Duplicate invoicing.,, ,d. Cost mischarging.

The correct answer is (b). Bid splitting occurs when a procuring employee splits a large contract into several smaller contracts to circumvent
procurement policies and thresholds. In many bid-splitting schemes, the perpetrating employee is either receiving a kickback from, or possesses a
hidden interest in, the preferred contractor. To help protect against such procurement abuse, management should periodically review and evaluate
purchasing activity, looking for:

 Employees who purchased identical items in different amounts simultaneously or within short periods.
 Contracts split by type of work (e.g., one purchase order for labor and another for material).
 Recurring patterns of activity that fall close to purchasing thresholds or other policy limits.
 Question 5 of 5
 Which of the following controls would be most helpful in mitigating the risk of contract and procurement fraud involving shell companies?


 a. Refrain from doing business with vendors without a physical presence. ,

 b. Assign the duties of authorizing purchases and confirming purchases to the same employee.,

 c. Only allow the employee approving payments to add or delete a party from the approved vendor list.,
 d. Do not use purchase orders.

Correct! A - A shell company is an entity that has no significant assets of its own and no physical presence. While some shell companies can be used
for legitimate business purposes (e.g., holding the intellectual property rights of another company), they can also be used to commit fraud. In the
context of contract and procurement fraud, shell company schemes involve the submission of invoices from shell companies for products and services
never delivered or rendered, in order to receive a fraudulent payment from the procuring company. To prevent shell company schemes, purchasing
companies should:

 Conduct thorough due diligence on all vendors.

 To the extent possible, refrain from dealing with any vendor that does not have a physical presence.
 Separate the duties for authorizing purchases, confirming purchases, and authorizing payment.
 Require purchase orders for payment.
 Create an approved vendor list and prohibit payment of invoices to any company not on the list.
 Not allow the employee approving payments to add or delete names from the approved vendor list.
 Have prospective vendors fill out a vendor data form that includes company information such as owner name(s), address, phone numbers,
articles of incorporation, and references.
  Prior to making payments, verify the authenticity of contractors by comparing unknown names to the agency listing of approved contractors.
 Periodically compare vendor addresses with employee addresses.

 This month: Combating fraudulent financial reporting - By Andi McNeal, CPA - November 1, 2018

Question 1 of 5 Which of the following would be a red flag of potential financial statement fraud for a nonpublic company that would require further
investigation?

a. The company issued the financial statements on Feb. 28 even though the books were closed by Jan. 15. b. The financial statements

have been reviewed by a CPA, but the company has never undergone a financial statement audit. , c. The company has changed auditors

annually for the last four years because of disagreements regarding accounting principles. d. The financial statements present only the
current year’s statements instead of comparative statements for previous years.
Correct! C -
In general, nonpublic companies are not required to undergo annual financial statement audits; many nonpublic companies need only to
have their financial statements compiled or reviewed by a CPA. If such a company does have its financial statements audited, periodic
auditor rotation can help increase auditor independence and objectivity. However, annual changes in auditors, particularly when the
changes are due to disagreements over applied accounting principles, might indicate that deeper problems exist — specifically that
management is not adhering to appropriate financial reporting standards. Auditors make recommendations when they find something amiss
and, if material enough, may walk away from an engagement if management chooses to not take corrective action. In extreme cases,
company management might fire the external auditors if they are concerned that the auditors suspect that the company is engaging in
fraudulent reporting practices. Consequently, if there are frequent changes in auditors, ascertaining the reason may uncover other potential
warning signs of fraud.

Issuing the financial statements a few weeks after the books are closed is generally not a red flag of fraud; most financial statements
require additional time to prepare to ensure that they are complete, accurate, and thorough. It is not unusual for a company to issue its
financials 60 to 90 days after the close of the reporting period. Additionally, nonpublic companies are not required to issue comparative
statements. While most do, and comparative statements certainly can be useful in spotting concern areas, the absence of them is not in
and of itself a red flag.

Question 2 of 5 You have been hired to audit the financial statements of Notreal Industries, a large, multi-industry company that plans to go public.
Which of the following observations about Notreal’s financial statement disclosures might be a red flag of inappropriate financial reporting?

a. The financial statements do not include a disclosure regarding a well-publicized, high-dollar-value employment lawsuit that is currently

under settlement negotiations. b. The financial statements include a disclosure regarding a material transaction with another company that is

owned by one of Notreal’s directors. c. The financial statements include a disclosure explaining a large variance in depreciation expense as due

to changes in the estimated lifetime of a major asset.

d. The financial statements do not include a disclosure regarding sales to a foreign government that make up 5% of Notreal’s total revenue.

Correct! – A Among the disclosures required in the financial statements are any material related-party transactions (such as those with a company
that is owned by a director), information about material changes in depreciation calculations, and contingent liabilities, such as lawsuits, that are
reasonably possible or estimable. If a lawsuit is under settlement negotiations, there is a reasonable possibility that a loss will be incurred. Thus, even
though the final loss amount may not be known, the lawsuit and the negotiations should be included in the disclosures. If the liability on the lawsuit is
probable and the amount is estimable, an accrual of the potential loss should be recorded in the financial statements as well. Additionally, according to
FASB ASC Paragraph 280-10-50-42, companies must disclose sales to any single customer — including a foreign government — that account for 10%
or more of total revenue; thus, sales to a foreign government that account for 5% of total revenue do not need to be disclosed.

Question 3 of 5 - While auditing the financial statements of your client LT Acme Corp., you notice a few things that you believe might be warning signs
of improper revenue recognition. Which of the following procedures would be most helpful in determining whether the company has included any
fictitious sales in its reported revenues?

a. Analyzing customer credits recorded shortly after the close of the accounting period. b. Performing a search for unrecorded

customer payments. c. Examining whether the sales records were closed before the end of the accounting period. d. Analyzing the
change in the quick ratio from prior years.
The correct answer is (a).

The corresponding debit to a fictitious sales entry is often a fictitious increase in accounts receivable. As the resulting fake receivables will obviously
never be collected, management must make another adjustment to remove them, typically soon after the original fraudulent entry, or risk their being
noticed as they age. Consequently, reviewing credits to customer accounts, such as returns and allowances, soon after the financial statement date
can help identify any reversals of fictitious sales from the prior period. In addition to examining individual credit memos issued, comparing the total
amount of such adjustments against past periods and against expected amounts (e.g., based on sales and overall accounts receivable levels) can help
highlight potential anomalies.

In contrast, unrecorded customer payments would be a sign of payments against actual receivables balances not being applied in a timely manner,
which is not normally a byproduct of a fictitious revenues scheme. Similarly, holding the books open after the end of the accounting period, rather than
closing them too soon, is more indicative of management’s artificially inflating sales revenue. And analyzing the change in the quick ratio over time
might help uncover liquidity concerns, which can be an incentive to falsify the financial statements, but typically does not directly help identify potential
fictitious revenues.

Question 4 of 5 - Financial statement ratio analysis can be helpful in identifying the warning signs of financial statement fraud. Which of the following
results of a ratio analysis of your client’s income statement would raise a red flag and merit further investigation?

a. Industry average gross margin is 55%, and the client’s gross margin is 58%. b. Lease expense has accounted for 10% of general

administrative expenses in previous years, but it is at 12% this year. c. Payroll expense increased by 6% last year, while previous years’

increases in the same expense averaged 10%. Since last year, sales revenue has increased 25% and cost of goods sold has increased
5%.

Correct! – D Certain financial statement accounts should move in tandem; for example, when a company sells a product, both sales revenue and cost
of goods sold should increase. While the rate of growth in these accounts may not be identical due to factors such as cost and price fluctuations, a
notable discrepancy in the rates should raise a red flag. A 25% increase in sales in a period when cost of goods sold increased only 5% might indicate
the books were manipulated to dishonestly boost reported gross margin.

Minor changes to the growth rates and relationships in general administrative expenses occur frequently and can often be explained by a number of
internal and external factors. For example, the slight increase in lease expense might be in relation to a scalable rent or perhaps additional services
provided by the landlord. Similarly, payroll increases usually result from pay increases or staff additions, both of which do not always get awarded in a
linear fashion; some years’ increases will likely be higher and lower than others. Absent additional information, the observed variances in these
accounts are within expected amounts and are not likely to raise red flags.

In addition, while comparisons to industry peers can provide helpful analytical benchmarks, specific ratios are rarely perfectly aligned. It is feasible for a
company to be slightly ahead or behind an industry peer for various reasons, such as negotiated contracts with customers and/or vendors. A 58%
gross margin when industry average is 55% is not, on its own, likely to be a strong signal that something is amiss.

Question 5 of 5 - During the audit of Higgins Inc., a public company, the auditors uncover evidence that indicates several midlevel managers are
conspiring in a nonmaterial asset misappropriation scheme. Which of the following best describes the auditors’ required reporting of this evidence
under Auditing Standard (AS) No. 2401, Consideration of Fraud in a Financial Statement Audit?

a. Because the scheme is nonmaterial, the audit team has no obligation to report the evidence of this fraud to the audit committee. b.

The audit team should report the evidence of the fraud directly to the SEC. ,,,,, c. The audit team should report the evidence of the fraud

directly to the appropriate level of management. ,,,,, d. Because the fraud is an asset misappropriation scheme and does not involve senior
management, the auditors do not have any obligation to report it to any party.

Correct! –C -According to AS 2401, when auditors discover evidence of potential fraud, they should report the situation to the appropriate level of
management. The standard notes that “[t]his is appropriate even if the matter might be considered inconsequential,” such as a nonmaterial asset
misappropriation committed by a lower-level employee.

The audit team also has an obligation to report the evidence of fraud to the audit committee under certain circumstances. AS 2401 specifically notes
that the auditor should reach an understanding regarding the expected communications about misappropriations committed by lower-level employees;
depending on the understanding reached, the audit team might have a responsibility to report a nonmaterial asset misappropriation scheme involving
midlevel managers, such as if the scheme involves potentially sensitive assets, such as customer data, or affects other risks that the audit committee
should remain informed about. The audit team should also report all fraud involving senior management and all fraud that causes a material
misstatement of the financial statements, regardless of who is involved, directly to the audit committee.

In addition, AS 2401 states that, under certain conditions, the auditor has a responsibility to report potential fraud directly to the SEC. Such conditions
include:

 “[R]eports [made] in connection with the termination of the engagement, such as when the entity reports an auditor change and the fraud or
related risk factors constitute a reportable event or are the source of a disagreement.”
 “Reports that may be required … relating to an illegal act that the auditor concludes has a material effect on the financial statements.”
This month: Best practices for protecting personally identifiable information ---july – 1 2018

Question 1 of 5

1. Which of the following is LEAST likely to be considered personal information that is protected by privacy or data protection laws?

a. An individual’s Social Security number. b. An individual’s birthplace. c. An individual’s business address.

d. An individual’s credit card number.
 2. In the context of protecting personal information, which of the following is the best description of the principle of least
privilege?


 a. Personal information should not be collected unless the company has a specific business need for the information.


 b. Personal information should be kept for only as long as it is needed.


 c. The creation of a data retention policy should be a collaborative effort, incorporating input from employees at all levels of the company.


 d. Access to personal information should be restricted to those employees who need the information to perform their jobs.

 Question 3 of 5
 3. Which of the following is NOT a best practice for protecting physical documents that contain personal information?


 a. Shred all documents containing personal information with a strip-cut shredder.


 b. Store documents containing personal information in locked rooms, file cabinets, or desk drawers.


 c. Use access controls to limit access to buildings or areas where personal information is kept.


 d. Prohibit employees from leaving sensitive documents unattended and in plain sight, such as on top of desks.
 Question 4 of 5
 4. Which of the following is a best practice for protecting personal information that is on a computer or in digital form?

 a. Install security updates and patches for all operating systems, software, and firmware at least once a year.


 b. Use passphrases, rather than passwords, to control access to computer networks.



 c. If possible, store personal information on laptops rather than desktop computers.



 d. If possible, store personal information on a computer or drive that is connected to the internet.
 5. Sherri is a CPA and the sole proprietor of an accounting firm. She recently purchased new computers for her business, and
she plans to donate her old computers to Goodwill. What should Sherri do before donating the old computers?

 a. Delete all information on the hard drives. b. Erase all the hard drives. c. Destroy the hard drives.

 d. Devices containing personal information should never be sold or donated; they should be destroyed.