The Quarter-Million-Dollar Caper: A Fraudster Is Nipped in the Bud

Let's face it--conducting a routine audit of a good, stable client can be boring and repetitive. Every year seems much like the last: tracing and vouching, reconciling, ticking and footing, examining documents and ledgers, evaluating controls. But despite the humdrum, good auditors are always on the lookout for abnormalities. The following case study reveals how alert auditors uncovered a fraud and, by behaving with professional integrity, turned a potentially bad situation into a positive one. THIS DOESN'T COMPUTE An auditor for a Canadian firm in Westmont, Quebec, was performing an audit procedure at a client's business when she came across something that made no sense. involved comparing the aged accounts-receivable list with the current month's sales. Except for normal reconciling items such as cash sales, freight and insurance charges, the amount sold should equal that month's charges to accounts receivable. (Total sales for month + sales taxes + freight charges) - (Cash sales + payments on current accounts receivable during month + sales returns and allowances) = Current accounts receivable When she found the total reflected on current accounts receivable was higher than sales by nearly $250,000, she called the audit partner, Philip C. Levi, CPA, of Levi Katz, Montreal, who talked to us about his handling of the investigation. Levi, an experienced certified fraud examiner, quickly discovered entries that alerted him to a possible problem: charge-backs on two different delinquent customer accounts. The net effect of the two entries was to simultaneously debit and credit the accounts-receivable subsidiary ledgers, which removed the customer charges from the 90-day aging column and reinstated the amounts as current. That was the reason why there was a $250,000 discrepancy. DEVELOPING A FRAUD THEORY Levi was concerned. Why, he wondered, would the client be motivated to restate these two delinquent accounts as current? The business, an importer and distributor, was a closely held family enterprise. Using generally accepted fraud examination techniques, Levi applied the fraud theory approach to see whether he could solve the mystery. One possibility was that the charges in question were uncollectable. But he quickly discarded that theory; the amounts had been subsequently paid in full. Next, Levi reasoned that since the business was not public and the amounts involved did not affect profits or taxes, the overstatement of current receivables might have been done to satisfy the collateral requirements of a lender. Levi examined the client's bank loan documentation. Sure enough, the line of credit was limited to 80% of the company's receivables that were less than 90 days old. Had the accounts-receivable aging been stated correctly, the company probably would have been pressured by the bank to come up with money to correct the default. The client's cash position reflected that it did not have the funds to pay down the loan. A 1999 COSO study of 200 financial statement fraud cases found that the CEO and/or CFO were involved at least 83% of the time. In this case the charge-backs were actually made by a clerical employee, Levi said. However, it made sense the clerk was acting on orders from upper management. Because the CEO was on vacation at the time of the charge-backs, I theorized that Tim, the CFO, was the one who had authorized the transactions. The clerk confirmed this. When the CEO returned to the office, Levi interviewed him to determine whether he had any involvement in the scheme. It was clear he was shocked at what the CFO had done, Levi said. CONFRONTING THE SUSPECT Before interviewing the CFO, Levi consulted the client's legal representative to ensure both the company and he were on solid footing to avoid any exposure to legal action by the CFO. Experienced in fraud examination and interviewing techniques, Levi made sure he would violate no individual rights. …

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