Financial Statement Fraud

ZABIHOLLAH REZAEE, PHD, CPA, CFE, CIA, CGFM, CMA, is the Thompson-Hill Chair of Excellence and Professor of Accountancy at the University of Memphis and served a two-year term on the Standing Advisory Group (SAG) of the Public Company Accounting Oversight Board (PCAOB). He has published over 175 articles in a variety of accounting and business journals and six books, including Corporate Governance and Ethics (Wiley). RICHARD RILEY, PHD, CPA, CFE, is a Louis F. Tanner Distinguished Professor of Public Accounting at West Virginia University. He was recognized as the 2008 ACFE Educator of the Year and by the American Accounting Association in 2009 for his innovations in accounting education. He is a forensic accountant and a Certified Fraud Examiner who has developed and implemented educational programs for the United States National Institute of Justice and the Internal Revenue Service. In addition to his distinguished academic career, he was employed as a senior accountant in the accounting firm of Deloitte & Touche.

• Foreword xiPreface xiiiAcknowledgments xixPart One: Financial Reporting and Financial Statement Fraud 11 Financial Statement Fraud Defined 3Will History Repeat Itself? 3A Closer Look 4Definition of Financial Statement Fraud 4Nature of Financial Statement Fraud 8High-Impact Fraud Cases 11Cost of Financial Statement Fraud 13Fraud Studies and Regulatory Responses 16Antifraud Programs 19Occurrence, Prevention, and Detection 22Lessons Learned and Applications for Practice 25Notes 282 Financial Reporting Structure 31Introduction 31Financial Reporting System 31Importance of Financial Information 33Annual Financial Reporting Requirements 38High-Quality Financial Reports 39Six-Legged Stool of the Financial Reporting Process 41Corporate Financial Reports 42Corporate Reporting Challenges 44Financial Restatements 45Fair Value 46Stock Options Accounting 46XBRL-Generated Financial Reports 47Antifraud Applications for Practice 48Notes 52Part Two: Financial Statement Fraud Profile, Taxonomy, and Schemes 553 Cooking the Books Equals Fraud 57Introduction 57Why Does Financial Statement Fraud Occur? 57Profile of Financial Statement Fraud 58Waste Management, Inc.: Financial Statement Fraud Analysis 70Antifraud Applications for Practice 72Notes 764 Realization, Prevention, and Detection 78Introduction 78Realization 78The 3Cs Model 79Financial Statement Fraud Prevention 84Financial Statement Fraud Detection 86Correction Procedures 87Prevention, Detection, and Correction Strategies 87Antifraud Applications for Practice 89Notes 965 Taxonomy and Schemes 97Introduction 97Symptoms of Financial Statement Fraud 97Common Fraud Schemes 101Common Revenue Fraud Schemes 103Financial Statement Fraud Red Flags 105Whistle-blower Regulations 112Antifraud Applications for Practice 114Notes 117Part Three: Corporate Governance and Its Role in Preventing and Detecting Financial Statement Fraud 1196 Role of Corporate Governance 121Introduction 121Definition of Corporate Governance 122Role of Corporate Governance 122Corporate Governance Structure 125Characteristics of Corporate Governance 127Corporate Governance Functions 128Global Corporate Governance 132Antifraud Applications for Practice 134Notes 1367 Board of Directors’ Oversight Responsibility 138Introduction 138Role of the Board of Directors 138Composition of the Board of Directors 139Functions of the Board of Directors 142Attributes of Boards of Directors 145Antifraud Applications for Practice 151Protocol: A Plan for Reaction to Allegations of Misconduct 152Notes 1558 Audit Committees and Corporate Governance 157Introduction 157Audit Committee 157Audit Committee Attributes 166Audit Committee Roles and Responsibilities 168Audit Committee Charters 172Chairperson of Audit Committees 173Audit Committee Report 173Audit Committee Roles in Preventing and Detecting Financial Statement Fraud 177Antifraud Applications for Practice 178Notes 1839 Management Responsibility 184Introduction 184Management Financial Reporting Responsibilities 184Management’s Role in Financial Statement Fraud Prevention and Protection 190Management Motives and Incentives 191Management Override of Internal Control 192Gamesmanship 194Risk Management 196Antifraud Applications for Practice 200Notes 20410 Role of the Internal Auditor 206Introduction 206Internal Auditors and Corporate Governance 206Internal Auditors’ Responsibilities 208Internal Audit Fraud Standards 212Efficacy of Internal Audit in Financial StatementFraud Prevention and Detection 214Cooperation between External and Internal Audit 215Internal Audits and the Audit Committee 217Internal Control 218Antifraud Applications for Practice 225Notes 22711 Role of External Auditors 229Introduction 229Independent Audit of Financial Statements 229Independent Auditor and Financial Statement Fraud 234Independent Audit and Internal Control 237Report on Internal Controls 238Fraud Detection Audit Procedures 240Materiality Guidance 246Risk Factors of Financial Statement Fraud 249Communication of Fraud 253Antifraud Applications for Practice 254Notes 25612 Governing Bodies 258Introduction 258Role of Regulation in Corporate Governance 259Sarbanes-Oxley Act of 2002 260Securities and Exchange Commission 263SEC’s Regulation Fair Disclosure 267Financial Fraud Detection and Disclosure Act of 1992 268Private Securities Reform Act of 1995 268SEC and Financial Statement Fraud 269SEC Fraud Prevention Activities 269SEC Fraud Detection Activities 270SEC Fraud Enforcement Activities 270Role of the Financial Accounting Standards Board 273Antifraud Applications for Practice 276Notes 279Part Four: Digital (Computer) Approaches to Fraud and Forensic Accounting 28113 Fraud in a Digital Environment 283Introduction 283Digital Economy 284Electronic Commerce 285Changes in Business Environment 288Electronic Financial Reporting 292Antifraud Applications for Practice 302Notes 30514 Fraud Examination Practice, Education, and Research 306Introduction 306The Interrelationship: Auditing, Fraud Examination, and Forensic Accounting 307Forensic Accounting Practice 308Fraud Examination 310Certification in Financial Forensics 313Training Competent and Ethical Fraud Examiners and Forensic Accountants 313Fraud Examination and Forensic Accounting Education 315Role of Research in a Profession 316Antifraud Applications for Practice 318Notes 321Appendix: Summary of Six Recent Fraud Studies 323About the Authors 327Index 329