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When Illegal Acts Arise

A source of engagements for forensic accountants is the investigation of illegal acts or fraud situation within organizations.

Illegal acts are violations of laws or governmental regulations. In the private sector, trusted executives and employees in detriment of the victimized organization commit many instances of wrongdoing. Sometimes illegal acts are discovered by accident or during an external audit procedure. Determining whether an act is in fact illegal is beyond the auditor’s professional competence.

As stated by the AU Section 317 (Auditing –United States), the auditor is deemed to be proficient in accounting and auditing, however, the determination as to whether a particular act is illegal would be generally be based on the advice of an informed expert qualified to practice law or may have to await determination by a court of law. The following situations that an auditor encounters could raise a question concerning illegal acts, according to the AU Section 317, Illegal Acts by Clients:

o Unauthorized transactions, improperly recorded transactions, or transactions not recorded in a complete and timely manner in order to maintain accountability for assets

o Investigation by a governmental agency, an enforcement proceeding, or payment of unusual fines or penalties

o Violations of laws or regulations cited in reports of examinations by regulatory agencies that have been made available to the auditor

o Large payments for unspecified services to consultants, affiliates, or employees

o Sales commissions or agents’ fees that appear excessive in relation to those normally paid by the client or to the services actually received

o Unusually large payments in cash, purchases of blank cashiers’ checks in large accounts payable to bearer, transfers to numbered bank accounts, or similar transactions

o Unexplained payments made to governmental officials or employees

o Failure to file tax returns or pay government duties o similar fees that are common to the entity’s industry or the nature of its business.

In the governmental sector, the GAO-03-673G (Government Auditing Standards in its Chapter 6 General, Field Work, and Reporting Standards for Attestation Engagements -Detecting Fraud, Illegal Acts, Violations of Provisions of Contracts or Grant Agreements, and Abuse That Could Have a Material Effect on the Subject Matter), has set forth the procedures that identify risk factors. It also highlights the auditors’ response to those risk factors. Generally Accepted Government Auditing Standards (GAGAS), direct auditors to ascertain whether abuse has occurred. If so, the next step is to establish the effects of wrongdoing and the economic impact.

For example, in December, 2005, an individual pled guilty to conspiracy to defraud the Government with false and fraudulent claims. As president and Chief Operating Officer (CEO) of a government contractor, he, along with others conspired to defraud the U.S. Department of Defense by making false and fraudulent billings. According to prosecutors, the scheme was perpetrated when buyers and customer service representatives obtained multiple quotes from supplies and then to quoted at a much higher price. These supplies were used to make tools The tools would then be purchased at a lower cost allowing this company to realize a fraudulent profit. The government contractor then passed the cost of these fraudulently priced tools onto the Department of Defense as material monetary claims in the manufacturing overhead billings.

In order to cover up this activity when audits were performed, the fraudster and others under his direction created false invoices using a computer scanner to remove actual pricing data and substitute fictitious data to give the appearance of legitimate pricing. This CEO was able to control the audit sample of invoices as well so as to limit the possibility that a fraudulently priced part would be found. After the audits this individual ordered the fraudulently created documents and computer files to be destroyed.

The Government Accountability Office’s FraudNet was created with the purpose of facilitate the reporting of allegations of fraud, waste, abuse, or mismanagement of federal funds.

Investigations arising from fraud may end up in a legal proceeding. If it were the case, having a forensic accountant or a Certified Fraud Examiner (CFE) as a member of the investigative team highly increases the possibility of a successful outcome of the litigation process.

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Content copyright © 2013 by Consuelo Herrera, CAMS, CFE. All rights reserved.
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