September 18, 2014

Accountant’s Responsibility to Detect Fraud in Audit, Non-Audit and Tax EngagementsPresentation To:Main Line Association For Continuing EducationPresentation By:Leon A. LaRosa, Jr., CPA, CFE, CFF, MSTMember September 18, 2014

Objectives of Session • Improve Client Service • Clarify Understanding of the CPA’s Client Expectations • Clarify Understanding of the CPA’s Professional Responsibilities • Develop a Better Understanding of the Fraud Environment • Provide Practical and Economic Fraud Prevention Strategies • Improve Client Service

Occupational Fraud and Abuse • $3.7 Trillion Problem • $154 K Per Scheme – Companies With Under 100 Employees • 5.4% Detected by External Audit - < 100 Employees • 1.9% Detected by External Audit - > 100 Employees • 34.2% Detected by Tip - < 100 Employees • 45.2% Detected by Tip - > 100 Employees • Typical Scheme – 30-32 months

Most Common Frauds • Employees Fraudulently Writing Company Checks • Revenue Skimming • Processing Fraudulent Invoices • Misuse of Company Credit Cards • Payroll • Financial Statement

Company downsizing is weakening Internal controls - segregation of duties Company budgets are decreasing – do the same work with less people Layoffs increasing Increased pressure and decreased controls people may explore more ways to commit fraud Declining stock prices Credit crisis The Perfect Storm Source: Association of Certified Fraud Examiners Internal Controls The Potential for Fraud Internal/External Pressure Opportunity to Commit Fraud

Standard of Care “Degree of care, skill or competence exercised by reasonably competent members of the profession under the circumstances.” MEASUREMENT APPROACH Compliance with Rule 201 of the AICPA Code of Professional Conduct Conformity with Professional Standards What another competent accountants would have done in the circumstances.

RULE 201:AICPA Code of Professional Conduct Professional Competence – Undertake only those professional services that the member or the member’s firm can reasonably expect to be completed with professional competence. Due Professional Care – Exercise due professional care in the performance of professional services. Planning and Supervision – Adequately plan and supervise the performance of professional services. Sufficient Relevant Data – Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to ANY professional service performed.

Corporate Governance Board of Directors Senior Management Management Employees

Responsibilities:BOARD OF DIRECTORS • Select, regularly evaluate, and, if necessary, replace the CEO; determine management compensation; and review succession planning. • Review, and, where appropriate, approve the major strategies and financial and other objectives and plans for the corporation. • Advise Management on significant issues facing the corporation. • Oversee processes for evaluating the adequacy of internal controls, risk management, financial reporting, and compliance, and satisfy itself as to the adequacy of such processes. • Nominate directors and ensure that the structure and practices of the board provide for sound corporate governance.

Responsibilities:MANAGEMENT • Design and implement programs and controls to prevent, detect, and deter fraud • Ensure that the company complies with applicable laws and regulations • Safeguard assets • Establish and maintain sound accounting information systems in compliance with GAAP or other comprehensive bases of accounting. • Use appropriate and reasonable accounting estimates • Ensure that financial statements are free from material misstatements cause by errors or fraud.

Responsibilities:AUDITORS • Plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement whether caused by error or fraud. • Be knowledgeable of the red flags of fraud. • Consider the opportunities and motivations for the occurrence of fraud. • Conduct discussions among engagement personnel regarding the risks of material misstatements due to fraud • Assess the engagement and control environment risks factors that may result in a material misstatement due to fraud. • Assess management’s response regarding the risk of fraud. • Document the auditor’s consideration of fraud. • Communicate to senior management, the audit committee or others, whether the auditor has determined there is evidence that fraud may exist.

CPA Responsibilities:REVIEW • Possess a level of knowledge of the accounting principles and practices of the industry in which the entity operates. • Possess a general understanding of the entity’s organization and operating characteristics to include knowledge of the entity’s production, distribution, and compensation methods, types of products and services, operating locations, and material transactions with related parties. • Perform inquiry and analytical procedures.

CPA Responsibilities:REVIEW • Obtain a representation letter signed by the chief executive officer and chief financial officer. • Obtain additional or revised information or perform additional procedures when the accountant becomes aware that information supplied by the entity is incorrect, incomplete or otherwise unsatisfactory to achieve limited assurance that there are no material modifications that should be made to the financial statements in order for the statements to be in conformity with generally accepted accounting principles (GAAP).

CPA Responsibilities:REVIEW • SSARS-12 states that the accountant is not required to plan a review engagement specifically to discover fraudulent financial statements. • Does NOT relieve an accountant of responsibility if incorrect, incomplete, or otherwise unsatisfactory information comes to his/her attention during the engagement. • The accountant is required to establish an understanding with the client, preferably in writing, which includes a statement that the accountant will inform the appropriate level of management of any fraud or illegal acts that come to his/her attention. • The accountant need not report any matters regarding illegal acts that may have occurred that are clearly inconsequential. • The accountant is required to report all matters involving fraud.

CPA Responsibilities:COMPILATION • Possess a level of knowledge of the accounting principles and practices of the industry in which the entity operates. • Possess a general understanding of the nature of the entity’s business transactions, the form of its accounting records, the stated qualifications of its accounting personnel, the accounting basis on which the financial statements are to be presented, and the form and content of the financial statements. • Obtain additional or revised information when the accountant becomes aware that information supplied by the entity is incorrect, incomplete, or otherwise unsatisfactory for the purpose of compiling financial statements. • Read the compiled financial statements to assure they are appropriate in form and free from obvious material errors.

CPA Responsibilities:COMPILATION • SSARS-12 states that the accountant is not required to plan a compilation engagement specifically to discover fraudulent financial statements. • Does NOT relieve an accountant of responsibility if incorrect, incomplete, or otherwise unsatisfactory information comes to his/her attention during the engagement. • The accountant is required to establish an understanding with the client, preferably in writing, which includes a statement that the accountant will inform the appropriate level of management of any fraud or illegal acts that come to his/her attention. • The accountant need not report any matters regarding illegal acts that may have occurred that are clearly inconsequential. • The accountant is required to report all matters involving fraud.

CPA Responsibilities:TAX PREPARATION • May in good faith rely, without verification, on information furnished by the taxpayer or by third parties. • May not ignore the implications of information furnished and should make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known. • Should refer to the taxpayer’s returns for one or more prior years whenever feasible. • Must exercise due diligence in preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters (Treasury Department Circular No. 230).

Professional Skepticism Complete Distrust Complete Trust Neutrality

Professional Skepticism Complete Distrust Current Mindset Complete Trust Neutrality

Professional Skepticism

Fraud Triangle Opportunity FRAUD Rationalization Pressure/Need

Opportunities • Lack of Controls that Prevent and/or Detect Fraudulent Behavior • Loose Controls (No Separation of Duties) • Lax Controls (Unenforced) • Inability to Judge Quality of Performance • Failure to Discipline Fraud Perpetrators • Lack of Access to Information • Ignorance, Apathy, and Incapacity • Lack of an Audit Trail • No Documentation of Systems, Procedures or Policies

Motivations/Pressures/Needs • Economic Need or Greed • Living Beyond One’s Means • Desire for Social Acceptance • High Bills or Personal Debt • Poor Credit • Personal Financial Losses • Gambling and/or Drug Additions • Failing Marriages/Multiple Partners • Unexpected Financial Needs • Failing Health Needs

Rationalizations • The Rewards Outweigh the Risks of Apprehension and Punishment • Stealing is Easier Than Working • Nobody Will Get Hurt • It’s For a Good Purpose • We’ll Fix the Books as Soon as We Get Over This Financial Difficulty • Everybody’s Doing it • I’m Just Borrowing, Not Stealing • I’m Not Stealing, the Money is Owed to Me

Fraud – Employee Red Flags Changes in behavior Changes in lifestyle Irritability, suspiciousness or Defensiveness Instability in life Circumstances Excessive family or peer pressure for success Unexpected financial needs Past legal problems Divorce or family problems Living beyond one’s means Poor credit Wheeler-dealer attitude Addiction problems Control issues/unwillingness to share duties Refusal to take vacations Unusually close association with vendor or customer Excessive pressure from within organization Complaining about lack of authority Complaining about inadequate pay Past employment – related problems Anticipating future layoff

The Non – Profit High Risk Environment • Enhanced credibility and trust by virtue of being a nonprofit. • Motivated by their mission and, not necessarily by making a profit. • Often place excessive control in their founder, executive director or substantial contributor. • Often allocate limited resources to accounting, internal controls and financial oversight. • Often have many volunteers working in the organization who are privy to confidential information. • Frequently have an all-volunteer Board of Directors with little or no financial oversight expertise. • Typically have non-reciprocal transactions, such as charitable contributions, which are easier to steal than other sources of revenue where there is consideration exchanged. • Often have large amounts of cash flow from donations, fundraisers, etc. • Often lack benchmarks or typical ratio analysis as a means of monitoring performance. • Highly susceptible to the effects of negative publicity and, therefore, reluctant to report, or even discuss fraud, when it occurs.

The Fraud Environment

Stages of a Troubled Company

Employee Embezzlement Examples

Fraud Prevention Strategies • Clearly Communicate Behavior Expected Of Employees • Be Alert To Changes In Employee Attitude, Behavior, And Lifestyle • Perform Background Checks On All Employees • Require Uninterrupted Vacations And Rotation Of Responsibilities For All Employees • Limit Number Of Authorized Check Signers • Account For Sequences • Establish Budget And Monitor Actual Results Monthly • Obtain Fidelity Bond Coverage • Don’t Limit Focus To Financial Fraud • Set The Example For High Ethical Standards • Owner/Chief Executive Approval For Any changes To Master Files

Anti-Fraud Best PracticesWhistleblower Hotline “A key defense against management override of internal controls is a process for anonymous submission of suspected wrongdoing…Various forms of fraud are detected 40 percent of the time by tips which [makes] this the leading method of detecting fraud.”

Whistleblower HotlineAdvantages • Minimizes the fear of retaliation by either informal peer groups or supervisors. • Earlier detection is the best way to limit the loss. Fraud losses are generally 50% less when detected through a hotline tip. • Can be used to early report discrimination or harassment claims. • Interactive communication generates significantly more information than a one-way communication. • An outside complaint mechanism provides a second means of handling issues not previously addressed by those close to the problem.

Anti-Fraud Best PracticesCode of Business Ethics and Conduct • Guide to acceptable and appropriate behavior Employees – Vendors – Customers. • Expectation of full compliance within the letter and spirit of the rules presented. • Guide to disciplinary action for violators. • Not a substitute for common sense.

Code of Business Ethics and ConductContents • Fair competition • Compliance with laws and regulations • Conflicts of interest • Gifts and entertainment • Outside employment • Relationships with suppliers and customers • Confidential information and privacy of communication • Cash and bank accounts • Expense reimbursement • Company credit cards • Software and computers • Political contributions • Conduct on company business • Violation reporting • Discipline • Annual representations in writing of no known violations

September 18, 2014