. 68
( 82 .)


Exhibit 11.7 Representative Questions for Postaudit Meeting”Fraud Risk Areas

• To what extent did the actual scope of the fraud risk audit findings differ from the
preaudit plan? What were the causes for the difference?
• Did management restrict the scope of the audit or access to requested information?
• Were there disagreements with management on accounting policies and practices,
including estimates and assumptions?
• What recommendations were made to management to improve the system of internal
• What assessment was given to the entity™s policies and procedures for detecting con-
flicts of interests (e.g., related party transactions) and management override of con-
trols, including directives of the board of directors?
• Was there any incidence of noncompliance with laws and regulations, including the
provisions of Sarbanes-Oxley?
• Was there any incidence of noncompliance with the corporate code of conduct?
• What were the accounting treatments with respect to complex transactions, unusual
transactions, and material contracts?
• Were there any proposed accounting adjustments, including immaterial uncorrected

In sum, the new fraud standard will affect the audit committee™s pre- and
postaudit meetings and related agendas and presumably will help engender a high
degree of integrity in both the audit processes and the financial reporting process.

SEC Financial Fraud and Disclosure”Cases in Point
The following summary of selected SEC cases and alleged violations provide
illustrations of fraudulent techniques. For additional reading, the reader should
review the appropriate SEC Litigation Release or Accounting and Auditing
Enforcement Release.

Date Release
Filed No. Nature of Alleged Violation
10/28/99 LR-16344 The SEC alleged that the defendants engaged in
a fraudulent scheme to recognize revenues pre-
maturely by improperly recording purported
“bill and hold” sales. The alleged purpose of this
activity was to meet sales projections. As a re-
sult, the firm overstated accounts receivable,
sales, pretax income, net income, and earnings
per share.
The Audit Committee™s Oversight Approach to Fraud Risk Assessment 345

5/15/01 LR-17001 The Commission alleged that the defendants en-
gaged in a scheme to fraudulently misrepresent
the firm™s results of operations in connection
with a purported “turnaround” of the firm. Inap-
propriate accounting reserves””cookie jar re-
serves””were created to overstate quarterly
income and growth.
3/27/02 AAER-1533 The SEC alleged inaccurate quarterly financial
statements (3/31/96 to 3/31/99) and annual fi-
nancial statements (12/31/95 to 12/31/98). Such
inaccuracies arose in connection with $1.44
billion restructuring charges in a postmerger pe-
riod. The firm materially overstated this restruc-
turing charge by accruing $354 million that
did not constitute restructuring liabilities under
GAAP. The firm voluntarily restated its finan-
cial statements.
7/24/02 AAER-1599 The Commission alleged that the firm fraudu-
lently excluded billions of dollars in liabilities
from its consolidated financial statements by
hiding them in off-balance sheet affiliates, falsi-
fied operations statistics, and inflated earnings
to meet Wall Street expectations.
9/12/02 AAER-1627 The SEC filed action against three former top
executives, alleging that they failed to disclose
the multimillion-dollar, low-interest, and inter-
est-free loans from the firm for personal ex-
penses. Also, they covertly caused the company
to forgive tens of millions of dollars in outstand-
ing loans without proper disclosures.

Thus audit committees need to review and discuss with the internal and exter-
nal auditors and financial management:

1. Premature revenue recognition situations, such as those related to unshipped
products and bill and hold sales not at the customer request
2. Unrealistic assumptions related to accounting estimates “cookie jar reserves”
3. Big Bath restructuring charges in which certain expenses belong to future
4. The key provisions of the Sarbanes-Oxley Act of 2002 that relate to such mat-
ters as personal loans to executives (Section 402) and disclosure of off-balance
sheet transactions and other relationships (Section 401).

Exhibit 11.8 shows the number of SEC enforcement cases initiated during the past
five years.
346 A Perspective on Fraud and the Auditor

Exhibit 11.8 SEC Enforcement Cases

Number of Issuer Financial Statement and Reporting Cases Initiated by the SEC
Issuer 2002 2001 2000 1999 1998

Financial Disclosure 141 103 100 89 75
Reporting Other 22 9 3 5 4
“““ “““ “““ ““ ““
Total 163 112 103 94 79

Source: Securities and Exchange Commission, Annual Reports (Washington, DC: U.S. Government
Printing Office, 1998“2002).

American Institute of Certified Public Accountants, The CPA Letter 59, No. 5 (March 12,
1979), pp. 1“6.
American Institute of Certified Public Accountants, Management Antifraud Programs and
Controls. For more information on fraud prevention and deterence, visit the AICPA™s An-
tifraud Resource Center, www.aicpa.org/antifraud.
Association of Certified Fraud Examiners, Annual Fraud Conference, www.CFEnet.com.
Association of Certified Fraud Examiners, Fraud Statistics Fact Sheet (Austin, TX: ACEF,
Association of Certified Fraud Examiners, Report to the Nation on Occupational Fraud
Abuse (Austin, TX: ACEF, 1996, 2002).
Beasley, Mark S., “An Empirical Analysis of the Relation Between the Board of Director
Composition and Financial Statement Fraud.” Accounting Review 71, No. 4 (October
1996), pp. 443“465.
Brandt, Allen, “The Biggest Computer Frauds: Lesson for CPA™s,” Journal of Accountancy
143, No. 5 (May 1977), pp. 52“62.
Carmichael, Douglas R., “The Auditor™s New Guide to Errors, Irregularities and Illegal
Acts,” Journal of Accountancy 166, No. 3 (September 1988), pp. 40“48.
Causey, Denzil Y., “The CPA Guide to Whistle Blowing.” CPA Journal 58, No. 8 (August
1988), pp. 26“37.
Ernst & Young, Fraud: The Unmanaged Risk, An International Survey of the Effect of
Fraud on Business (London: Ernst & Young, 1998).
Institute of Internal Auditors bookstore, visit the web site at www.theiia.org for information
on fraud, ethics, law.
Marsh, Hugh L., and Thomas E. Powell, “The Audit Committee Charter: Rx for Fraud Pre-
vention.” Journal of Accountancy 167, No. 2 (February 1989), pp. 55“57.
Menkus, Belden, “Eight Factors Contributing to Computer Fraud.” Internal Auditor 47, No.
5 (October 1990), pp. 71“73.
National Commission on Fraudulent Financial Reporting, Report of the National Commis-
sion on Fraudulent Financial Reporting (Washington, DC: NCFFR, 1987).
Sources and Suggested Readings 347

Neebes, Donald L., Dan M. Guy, and O. Ray Whittington, “Illegal Acts: What Are the Au-
ditor™s Responsibilities?” Journal of Accountancy 171, No. 1 (January 1991), pp. 82“84, 86,
88, 90“93.
Public Oversight Board, A Special Report by the Public Oversight Board of the SEC Prac-
tice Section, AICPA (Stamford, CT: POB, 1993).
Sawyer, Lawrence B., Albert A. Murphy, and Michael Crossley, “Management Fraud: The
Insidious Specter.” Internal Auditor, 36, No. 2 (April 1979), pp. 11“25.
Statement on Auditing Standards No. 54, “Illegal Acts by Clients” (New York: AICPA, 1988).
Statement on Auditing Standards No. 55, “Consideration of the Internal Control Structure
in a Financial Statement Audit” (New York: AICPA, 1988).
Statement on Auditing Standards No. 99, “Consideration of Fraud in a Financial Statement
Audit” (New York: AICPA, 2002).
Stice, James D., W. Steve Albrecht, and Leslie M. Brown, “Lessons to be Learned”ZZZZ
Best, Regina, and Lincoln Savings.” CPA Journal 61, No. 4 (April 1991), pp. 52“53.
United States v. Weiner, 578 F. 2d 757 (9th Cir), cert. denied, 439 U.S. 981 (1978).
Wells, Joseph T., “Six Common Myths About Fraud.” Journal of Accountancy 169, No. 2
(February 1990), pp. 82“88.
Williams, Timothy L., and W. Steve Albrecht, “Understanding Reactions to Fraud.” Inter-
nal Auditor, No. 4 (August 1990), pp. 45“51.
The reader also may wish to visit the web sites of other organizations as noted
in Appendix B.

Additional Suggested Readings
Albrecht, W. S., M. B. Romney, D. J. Cherrington, I. R. Payne, and A. J. Roe, How to De-
tect and Prevent Business Fraud (Englewood Cliffs, NJ: Prentice-Hall, 1982).
American Institute of Certified Public Accountants, “Fraud Beat.” Journal of Accountancy
(published monthly).
Association of Certified Fraud Examiners, Professional Standards and Practices for Cer-
tified Fraud Examiners (Austin, TX: ACFE, 2002).
Association of Certified Fraud Examiners, The White Paper (Austin, TX: ACFE, published
Bloom Becker, Buck, Spectacular Computer Crimes (New York: Dow Jones Irwin, 1990).
Bologna, G. Jack, and Robert J. Lindquist, Fraud Auditing and Forensic Accounting (New
York: John Wiley & Sons, 1987).
Bologna, G. Jack, Robert J. Lindquist, and Joseph Wells, The Accountant™s Handbook of
Fraud & Commercial Crime (New York: John Wiley & Sons, 1992).
Davia, Howard R., Patrick C. Coggins, John C. Wildeman, and Joseph T. Kastantin, Man-
agement Accountants™ Guide to Fraud Discovery and Control (New York: John Wiley &
Sons, 1992).
Domanick, Joe, Faking It in America (Chicago: Contemporary Books, 1989).
Elliott, Robert K., and John J. Willingham, Management Fraud: Detection and Deterrence
(New York: Petrocelli Books, 1980).
Glover, Hubert D., and James C. Flagg, Effective Fraud Detection and Prevention Tech-
niques (Altamonte Springs, FL: IIA, 1993).
348 A Perspective on Fraud and the Auditor

Institute of Internal Auditors, “Fraud Findings.” Internal Auditor (published monthly).
Institute of Internal Auditors, The Professional Practice Framework (Altamonte Springs,
FL: IIA, 2002.
Jacobson, Alan, How to Detect Fraud Through Auditing (Altamonte Springs, FL: IIA, 1990).
Kellogg, Irving, Fraud, Window Dressing, and Negligence in Financial Statements (New
York: McGraw-Hill, 1991).
Levy, Marvin M., Computer Fraud: A Basic Course for Auditors (New York: AICPA, 1990).
Levy, Marvin M., Detection of Errors, Fraud, and Illegal Acts (New York: AICPA, 1990).
Merchant, Kenneth A., Fraudulent and Questionable Financial Reporting (Morristown,
NJ: Financial Executive Research Foundation, 1987).
Securities and Exchange Commission, Annual Reports (Washington, DC: U.S. Government
Printing Office, 1998, 1999, 2000, 2001, 2002).
U.S. General Accounting Office, Government Auditing Standards, Standards for Audit of
Governmental Organizations, Programs, Activities, and Functions (Washington, DC: U.S.
Government Printing Office, 1988).
White, Richard, and William G. Bishop, “The Role of the Internal Auditor in the Deter-
rence, Detection, and Reporting of Fraudulent Financial Reporting,” The Institute of Inter-
nal Auditors Reports on Fraud (Altamonte Springs, FL: IIA, 1986).

Association of Certified Fraud Examiners, Cooking the Books: What Every Accountant
Should Know About Fraud (1991); The Corporate Con: Internal Fraud and the Auditor
(1992); and Beyond the Numbers: Professional Interview Techniques (1994) Austin, TX;
length of videos: 50 minutes.
Institute of Internal Auditors, A New Look at Ethics and Fraud. Altamonte Springs, FL,
1988; length of video: 60 minutes.
For additional videos, visit the Association of Certified Fraud Examiners™ web
site, www.cfenet.com.
Chapter 12
Reviewing Certain
General Business

In Chapter 1, it was established that corporate boards of directors and their audit
committees have a major role in establishing and maintaining corporate account-
ability and governance. In addition, it was noted that the boards and their com-
mittees have encountered increasing pressure from the SEC and Congress as
evidenced particularly by the passage of the Foreign Corrupt Practices Act (See
Appendix D on this book™s website) and the Sarbanes-Oxley Act. Such pressures
have created an environment whereby the audit committee should review and
monitor certain corporate policies and practices regarding sensitive payment areas.
The purpose of this chapter is to examine those areas, such as questionable foreign
payments, conflicts of interest, corporate perquisites, and corporate contributions.
This chapter will discuss the nature of these sensitive matters and identify ways to
assist the committee with its review.

Nature of Questionable Foreign Payments
In view of the Foreign Corrupt Practices Act, many accounting practitioners and
corporate executives have been studying the legal and ethical implications of the
foreign bribery provision.1 Their examination of this provision includes not only
a definitional analysis of the questionable foreign payments but also corporate pol-
icy and compliance matters. As discussed in Appendix D on this book™s website,
the primary purpose of the bribery provision is to prohibit all U.S. companies, both
private and public, foreign companies registered with the SEC, and directors, of-
ficers, stockholders, employees, and agents to bribe foreign government officials.
Furthermore, the act states that any direct or indirect payment or offer intended to

With respect to the antibribery section of the act, the Criminal Division of the Justice Department has
adopted review procedures to assist management. In short, the Justice Department will review the pro-
posed transactions only on written request, and it will issue a review letter to determine whether dis-
closure is required. This matter should be discussed with the executive audit partner, the chief
financial officer, and legal counsel. For further reference, see the Department of Justice™s “Foreign
Corrupt Practices Act Option Procedure,” Code of Federal Regulations, Sec. 28, Part 77.

350 Reviewing Certain General Business Practices

promote business constitutes foreign bribery. Equally important, the act prohibits
the use of mails or any means or instrumentalities of interstate commerce to
make corrupt payments or authorization of the payments regarding “anything of


. 68
( 82 .)