Finding Fraud & Deception

1. Wichita State University Accounting & Audit Conference May, 18, 2011 Finding Fraud & Deception Presented by: Don Wengler, CPA/CFF, CFE, CVA

3. Lunch, Murthy, Engle 2009

4. Useful Research “Useful research reflects results that are belief changing” Uday Murthy lecture, March 4, 2011

5. Fraud Brainstorming SAS 99: Consideration of Fraud in a Financial Statement (AICPA 2002) Usually face-to-face audit team discussion Part of audit planning process Outcome affects audit procedures performed

6. Our Experiment Team Nominal Team Face-to-Face Team Content Facilitation

7. Fraud Brainstorming Fraud Idea Generation Not Relevant To Client Relevant to Client

8. Face-to-Face Brainstorming - Coordinate Schedules - Wait - Attend - Remember - Avoid Cog. Inertia

9. Computer-Mediated Advantages Members can input ideas simultaneously However, fraud brainstorming is more complex than simple idea generation Relevant fraud risks must be identified through the interaction regarding: Specialized auditing knowledge Industry-specific factors Client-specific factors

10. Florida Study Objectives--Relative effectiveness of: Electronic v. face-to-face Interactive v. Nominal With v. without content facilitation Whether participating in a fraud brainstorming session heightened auditor awareness of fraud risks when present

11. Florida Study 188 SAS 99 auditing students, teams of 4 Studied a company case study 5 question test assured case facts known 108 electronically/80 face-to-face Electronic interactive; electronic nominal; face-to-face, with/without facilitation.

12. Florida Study Reviewed case again Made initial fraud risk assessment alone 20 minutes of fraud brainstorming (1221) 5 prompts: Opportunity, pressure, rationalization, revenue recognition, management override of internal controls Face-to-face 2nd interaction

13. Florida Study: Measurement The number of relevant fraud factors identified from the case Change from the pre-brainstorming to post-brainstorming fraud risk assessment from 1% to 100% of estimated probability of material misstatement

14. Florida Study: Results

15. Florida Study: Conclusions Electronic fraud brainstorming is significantly more effective than face-to-face fraud brainstorming Interactive brainstorming is no more effective than “nominal” brainstorming Brainstorming effectiveness is significantly higher with content facilitation, than without

16. Is Abe Lincoln Honest?

17. Larcker & Zakolyukina 2010

18. Stanford Study Objective: Construct and test a linguistic model for detecting deceptive CEO and CFO communications in quarterly earnings call communications.

19. Stanford Study Reviewed prior psychological and linguistic research related to deception Identified words and uses of language that are believed to signal deception Built a statistical model designed to measure/predict deception in CEO/CFO Q&A communications, based on the words/usage

20. Stanford Study 4. Defined deceptive CEO and CFO communications in quarterly earnings call Q&A sessions Analyzed 16,577 full text Q&A sessions to test the success of the statistical model for predicting deception CEO and CFO communications Generalized conclusions

21. Prior Psychological/Linguistics Emotions perspective Cognitive effort perspective Control perspective Lack of embracement perspective

22. Reference Language Larcker & Zakolyukina 2010

23. Illustrative Data Table

24. Illustration of Positive Association

25. Illustration of Positive Association

26. Illustration of Negative Association

27. Illustration of Negative Association

28. Illustration of No Association

29. Illustration of No Association

30. Reference Language Larcker & Zakolyukina 2010

31. Positive/Negative Words Larcker & Zakolyukina 2010

32. Positive/Negative Words Larcker & Zakolyukina 2010

33. Cognitive Process Larcker & Zakolyukina 2010

34. Other Cues Larcker & Zakolyukina 2010

35. Self-constructed word categories Reference to general knowledge Shareholder value Value creation Hesitation expressions Extreme negative emotions Extreme positive emotions

36. Stanford Study: How Was Deception Measured? Subsequent: Form 8-K filings reflecting restatements of earnings (significant in size) Filings reflecting “material weaknesses” Auditor changes Late financial statement filings

37. Stanford Study: How Was Size of the Answer Uniformly Scaled? Median CEO answer: 1,811 words Median CFO answer: 987 words Typical CFO: (10/1,000) X 1,000 = 10 Talkative CFO: (10/3,000) x 1,000 = 3.3

38. Stan-ford Study: Model Output Larcker & Zakolyukina 2010

39. Stanford Study: Model Output Larcker & Zakolyukina 2010

40. Conclusions: Deceptive Executives More general knowledge references Fewer non-extreme positive emotions Fewer references to shareholder value and value creation

41. Conclusions: Deceptive CEOs Fewer self-references More 3rd person plural & impersonal pronouns More extreme positive emotions Fewer extreme negative emotions Fewer certainty & hesitation words

42. Our Survey

43. Joseph F. Fisher Indiana University James R. Frederickson Hong Kong University Sean A. Peffer University of Kentucky Budgeting: An Experimental Investigation of the Effects of Negotiation

44. Budget Setting Negotiation Process Unilateral Process

45. Negotiation Matrix

46. Budget Setting Consequences Budgetary Slack/Planning Subordinate Performance/Motivational

47. Conclusions Budgets set through a negotiation process where superiors have final authority are lower than budgets set unilaterally by superiors. Budgets set through a negotiation process where subordinates have final authority are not significantly different from budgets set unilaterally by subordinates.

48. Conclusions Budgets set through a negotiating process ending in agreement contain significantly less slack. A failed negotiation followed by superiors imposing a budget has a significant detrimental effect on subordinate performance.

49. Contact Information Don Wengler dwengler@bkd.com BKD, LLP Kansas City, MO 64105 816-701-0257 BKD, LLP Wichita, Kansas 316-265-2811