RELEVANCE EXCELLENCE RESULTS

Financial Auditing for Internal Auditors

Unit 4: Recipes for Cooking the Books
Objectives
Identify the basic elements of an accounting
scandal (fraud).
Discuss the five most common financial
“games.”
Calculate financial indices to use in analyzing
data.
Scandals
What Is “Cooking the Books”?

The process of falsifying financial records

and statements to misrepresent the
company’s operating results and financial
position.
Fraud in Financial Statements - Standard

• Standard 1210.A.2 • Risk attributes

• “Consideration of Fraud – Type of risk
– Significance (materiality)
in a Financial Statement
– Likelihood of material
Audit”: misstatement
– Be professionally skeptical.
– Pervasiveness
– Communicate with
management.
– Randomize audit tests.
– Investigate management
overrides of controls.
Fraudulent Financial Reporting

• Falsified reporting: • Three ways:

– Manipulation of accounting
Usually by understating
records and supporting
expenses and/or liabilities
documents
and/or overstating revenues
– Omission of events,
and/or assets
information, transactions

– Intentional misapplication of
accounting principles
Why do FS Fraud Exist?

◼ It pays to do it (greed factor)

◼ It may boost performance-related bonuses
◼ It may prevent negative outcomes (fear
factor)
◼ It may help organization obtain financing
◼ It may dispel negative market perceptions
◼ It may help company financing covenants
◼ It is easy to do it
◼ It is unlikely you will get caught
The Accounting Continuum
What makes a recipe?
Earnings Management
Income Smoothing
Aggressive Accounting
Creative Accounting
Fraud
Belajar dari Kasus ENRON (2001)
• Pada bulan April 2001, Majalah Fortune mencantumkan
ENRON sebagai perusahaan terbesar ke-7 di AS dan
Perusahaan paling Inovatif.
• Enam bulan kemudian, ENRON mengajukan pailit.
• Penipuan akuntansi terbesar abad ke-20.
• 12.000 orang langsung kehilangan pekerjaan, tunjangan
pensiun, dan tabungan seumur hidup.
• Pensiunan yang membeli saham Enron rugi US $ 70 miliar
saat harga saham anjlok hingga NOL.
• Disebabkan oleh "Lax Auditing" oleh kantor akuntan Arthur
Andersen, salah satu dari “Big 5" (85.000 orang dan
Enron (2001) pendapatan tahunan lebih dari US $ 9 miliar) runtuh.
• Orang yang harus disalahkan: CFO Andrew Fastow (6 tahun
hukuman penjara), CEO Jeff Skilling (hukuman penjara 24
tahun), analis saham yang terus mendorong saham Enron,
manajemen senior karena menyembunyikan kerugian dalam
kemitraan off-balance-sheet yang meragukan, media yang
berlebihan dan membuat gaduh.
BREAKOUT: Garuda Indonesia
Work individually.
Review the article, “OJK Berikan Sanksi
Kasus PT Garuda Indonesia (Persero) Tbk.”
Prepare to discuss.
Special Case Study: Duniatex Group

Source: https://finansial.bisnis.com/read/20191014/90/1158622/digugat-pkpu-duniatex-dapat-perlindungan-hukum-luar-negeri
Special Case Study: Duniatex Group

Source: https://finansial.bisnis.com/read/20190724/90/1128362/fitch-ratings-kembali-pangkas-peringkat-surat-utang-duniatex
Special Case Study: Duniatex Group

Source: https://www.cnbcindonesia.com/market/20190731110121-17-88815/pinjaman-lpei-ke-duniatex-tembus-rp-3-t-ini-sebarannya
BREAKOUT: Garuda Indonesia &
Duniatex
What if you found something like this in your
organization?
Fraud As Defined By IIA

Any illegal act characterized by deceit, concealment, or violation of trust.

These acts are not dependent upon the threat of violence or physical force.
Frauds are perpetrated by parties and organizations to obtain money,
property, or services; to avoid payment or loss of services; or to secure
personal or business advantage.

Source: The Institute of Internal Auditors International Standards for the Professional Practice of Internal Auditing. www.t heiia.org
Error vs Fraud
▪ Error are unintentional misstatements or omission in
financial statements

▪ Fraud, in contrast, arises from deceitful financial

reporting and from misappropriation of assets

▪ Intent is the primary difference between an error and

fraud
The Fraud Tree / Classification System

Sumber: 2020 Association of Certified Fraud Examiners (ACFE) Report to the Nation on Occupational Fraud & Abuse.
The Fraud Triangle
• Greed
• Higher stature
• Personal debt, financial losses
• Personal problems
• Market expectation
• Compulsive habits: gambling,
drugs, alcohol, cars, shopping,
affairs…etc
• Family/peer/other pressure

• Lack of controls (preventive and

detective)
• Poor compliance with controls
• Revenge • Lack of monitoring and
• I deserve more oversight
• Wealth will gain me • Absence of visible disciplinary
recognition policies
• Rules are for others • Failure to investigate
allegations of fraud and
• Everyone does it
misconduct
• No one will get hurt
• Failure to discipline perpetrators
• Failure to recruit collateral staff
for their observation of subtle
behavior
 Corruption Perception Index 2020
Menurun 3 poin dibandingkan tahun sebelumnya, Indonesia saat ini masih berada di bawah nilai rata-rata
region Asia Pacific (45/100).

Year Score
2012 32
2013 32
2014 34
2015 36
2016 37
2017 37
2018 38
2019 40
Sumber: https://www.transparency.org/en/cpi/2020/index/idn
2020 37
The Corruption Perceptions Index ranks 180 countries and territories by their perceived levels of public sector
corruption, according to experts and business people.
List of Fraud in Indonesia
Financial Games
Materiality – The Appetizer
Revenue Recognition – The Main Course
Expense Shifting – Dessert
Big Bath Restructurings – Leftovers
Creative Acquisitions – The Wine List
Materiality
Considerations that may make an immaterial
item material include whether it:
Is from precise measurement or an estimate.
Masks a change in earnings or other trends.
Hides a failure to meet analysts’ expectations.
Changes a loss into income or vice versa.
Concerns a segment of the business significant
to the registrant’s operations or profitability.
Materiality (cont.)
Considerations that may make an immaterial
item material include whether it:
Affects compliance with regulatory
requirements.
Affects compliance with loan covenants or other
contractual requirements.
Increases management’s compensation.
Involves concealment of an unlawful
transaction.
Revenue Recognition
Understating allowance for doubtful accounts =
overstated receivables
Ignoring or delaying write-offs or returns
Fictitious sales
Early recognition
Overstating amount
Ignoring or delaying returns
Recording bank transfers as cash
Failure to recognize discounts
Unreasonably extended payment terms
Recording revenue when future services
remain to be provided

Source: https://www.wsj.com/articles/under-armour-is-
subject-of-federal-accounting-probe-11572819835
Recording revenue when future services
remain to be provided (Cont’d)

Source: https://www.nasdaq.com/market-activity/stocks/ua
Expense Shifting
Estimating reserve liabilities to reach a
predetermined number
Capitalizing normal operating expenses
Delaying capitalization of fixed assets
Overestimating asset life
Prepayment of operating expenses
Delaying recognition of asset or inventory write-
down or write-off
Failure to accrue for service/product
Expense Shifting (cont.)
Asset reserves are maintained
Premature recognition of supplier rebates to
reduce accounts payable
Overstating returns to suppliers or discounts
Overestimating inventory quantity or value
Recording fictitious inventory
Shifting Future Expenses to Current
Period
Shifting Future Expenses to Current
Period (Cont’d)

Source: https://www.marketwatch.com/story/wr-grace-reaches-settlement-with-sec-on-accounting-measures
Big Bath Restructuring
Restructuring charges typically result from:
Consolidation of operations.
Relocation of operations.
Disposal of operations or productive assets.
Big Bath Restructuring
“Exit Costs” and plan should:
Reflect most likely expected outcome.
Identify all significant actions and a timetable.
Evaluate performance.
Be documented in sufficient detail.
Use calculations with a supportable basis.
Creative Acquisitions
Purchased in-process research and
development:
If there is a future use, amount should be
capitalized.
If it is unclear if there is a future use, the
amount should be expensed.
Analytical Procedures
The Check
Statement on Auditing Standards (SAS) 99 –
AU Section 316 related Consideration of
Fraud in a Financial Statement Audit
Analytical Procedures (Index Analysis)
Statement on Auditing Standards
(SAS) 99
Key Components of SAS 99 – AU Section 316:
Description of fraud and its characteristics
Requires brainstorming sessions to discuss
fraud
Requires auditors to evaluate fraud-related
risks and controls through:
- Inquiry
- Analytical procedures
- Consideration of fraud risk factors
Identifies fraud “red flags”
Source: https://pcaobus.org/oversight/standards/archived-standards/pre-reorganized-auditing-standards-interpretations/details/AU316
Index Analysis
Sales Growth Index
Gross Margin Index
Asset Quality Index
Days’ Sales in Receivable Index
Sales, General, and Administrative Expenses
Index
Sales Growth Index (SGI)
Higher growth = higher risk

Current Year Sales

SGI = Prior Year Sales
Gross Margin Index
GMI > 1 indicates gross margin deterioration

(Prior Year Gross Margin/

Prior Year Sales)
(Current Year Gross Margin/
Current Year Sales)
Asset Quality Index
AQI > 1 indicates increased cost deferral

Asset Quality = 1 — (Current Assets + net PPE)

Total Assets

AQI = Current Year Asset Quality

Prior Year Asset Quality
Days’ Sales in Receivables Index
Index > 1 is a potential red flag

(Current year AR/

DSRI = Current Year Sales)
(Prior Year AR/
Prior Year Sales)
Sales General and
Administrative Expenses Index
An SGAI > 1 could point to overstated
revenues

(SG&A Current year/

SGAI = Sales Current Year)
(SG&A Prior Year/
Sales Prior Year)
Days’ Sales in Receivables Index
Sales and receivables should trend together,
so index > 1 is a red flag.
(current year AR/current year sales) divided
by (prior year AR/prior year sales)
FS Fraud – Warning Signs

Growth of
Weakinternal industry doesn’t Organizationunder
controls match with financial pressure
organization’s

Complex
organization Smal fast-growth Background
structures, useof or highly management
SPV acquisitivefirms raisesquestions

Aggressive
accounting
policies

Source: Antje Seiffert-Murphy, CFA, FCIB Webinar - 24 August2017

Audit Procedures to Detect FS Fraud

◼ Fraud Brainstorming Session

◼ Journal Entry Testing & Vouching
◼ Accounting Estimates
◼ Significant Unusual Transactions
FS – How to Detect in Accounts?

Source: Antje Seiffert-Murphy, CFA, FCIB Webinar - 24 August2017

How to Mitigate FS Fraud with FRM

❑ FS Fraud risk can never be eliminated entirely; more

effective organizations employ a risk-based
approach to mitigating FS fraud risk.
❑ Fraud Risk Management (FRM) is an ongoing and
evolutionary process that changes as the
organization and the environment change.
❑ Regular Fraud Risk Management (FRM) process
evaluation and measurement assists continuous
improvement.
❑ Fraud Risk Management (FRM) is a collaborative
effort that involves everyone within an organization.
 A COSO - Consistent Approach for FRM
•Tone at the top
•Code of • Identify fraud risk
Conduct/Ethics factors, fraud risks
•Whistleblower and fraud schemes
Creating
Hotline a Control
Environment

Performing
Monitoring Fraud Risk
Activities Assessments
AFPC
• Monitoring
effectiveness of
antifraud Sharing Designing and
programs and Information and Implementing
controls Communication Antifraud
Control
Activities
• Effective • Link or map
communication of identified fraud
antifraud programs risks to control
and controls AFPC: Anti Fraud Programs & Controls activities
throughout the
Organization Source: Committee of Sponsoring Organizations of the Treadway Commission, Anti Fraud Program & Controls (AFPC)
Three Lines Model in Fraud Deterrence
Setiap lini memiiki tugas dan Untuk memastikan efektivitas implementasi Tata Kelola Perusahaan yang baik, organisasi perlu
peran berbeda – beda meningkatkan peran dari masing – masing lini secara memadai. The Institute of Internal Auditors (IIA)
terkait pencegahan FS fraud memperbaharui Three Lines Model sebagai cara untuk menjelaskan hubungan serta peran antara lini
dan tanggung jawab setiap lini di perusahaan.

Accountability,
reporting

Delegation,
direction,
resources,
oversight

Alignment
communication,
coordination,
collaboration

Source: https://www.theiia.org/globalassets/site/about-us/advocacy/three-lines-model-updated.pdf
WIIFM
Record any new ideas you picked up.
How will you use what you learned on
the job?
Q&A?

Questions?
 End-of-Unit-4- - - -

THANK YOU!