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Volume 7: Issue 1, January–June, 2015

JFIA

Volume 7: Issue 1, January–June, 2015

Table of Contents


The Influence of Source Credibility and Attribution of Blame on Juror Evaluation of Liability of Industry Specialist Auditors | Full Article (PDF)
Blaise M. Sonnier
Walfried M. Lassar
Sharon S. Lassar
 
Abstract: This study uses a national sample of eligible jurors to examine the impact of source credibility and blame attribution on the decision making process of jurors in an audit malpractice suit. We use industry specialization to determine the influence of source credibility and blame attribution on juror’s verdict. Industry specialization increases the perceived credibility of the audit firm which in turn decreases the blame attributed to the firm for the audit failure. Industry specialization indirectly decreases jurors’ propensity to find an audit firm negligent by increasing its perceived credibility. Jurors also directly attribute more blame to industry specialist auditors, which increases the likelihood of a negligence finding. The impact of industry specialization is completely mediated by source credibility and blame attribution. Industry specialization indirectly decreases the award of compensatory damages by increasing attribution of blame but is compensated by the perceived credibility of the firm. Lastly, specialization has no impact on the award of punitive damages which is driven only by the direct effect of blame attributed to the firm. The results indicate that trial counsel for audit firms should emphasize the enhanced credibility of industry specialist auditors and that industry specialist auditors are subject to the same legal standard of care as non-industry specialist auditors.
 
Keywords: Accounting Jury Research; Attribution of Blame; Auditor Litigation; Industry Specialist; Source Credibility.

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Risk-Based Capital Analysis in Punitive Damages Litigation | Full Article (PDF)
Susan W. Lanham
Craig Barton
 
Abstract: This article introduces risk-based capital analyses as a new methodology for forensic accountants to consider when hired in punitive damages cases.  In addition, it performs a study to determine whether this analysis would be appropriate.  In this non-experimental quantitative study, the full population of insurance companies rated by A.M. Best Company and the full population of depository institutions operating from 2007 through 2011 were selected to examine.  Data was collected for the five year review period covering 2007 through 2011.  Logistic regression was used with archived data to determine whether insolvency rates or financial strength ratings are significantly related to an organization's risk-based capital position.  We show a significant relationship exists in each year between risk-based capital ratios and the insolvency status of property/casualty insurance companies, life/health insurance companies, and depository institutions as evidenced by a p-value in each analysis < 0.01.  We also report there is a significant relationship in each year between the risk-based capital ratios and the financial strength ratings of property/casualty and life/health insurance companies as evidenced by a p-value in each analysis < 0.01.  This study concludes that risk-based capital levels are a reliable foundation upon which to offer an opinion.  
 
Keywords: Risk-Based Capital; Punitive Damages; Forensic Accounting; Excessive Award; Award Calculation; Expert Testimony.

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Does Disclosure of D&O Liability Insurance Policies Influence Investor Perceptions of Earnings Management | Full Article (PDF)
Stephen Perreault
 
Abstract:  Unlike some foreign regulatory bodies, the Securities and Exchange Commission does not require U.S. registrants to disclose the existence or details of director’s and officer’s (D&O) liability insurance coverage. Although firms are permitted to voluntarily disclose this information, few choose to do so. In this study, I use an experimental approach to investigate how disclosure of D&O liability insurance details may affect investor perceptions regarding the propensity of managers to engage in earnings management. My results indicate that disclosing the existence of a D&O insurance policy can significantly decrease the perceived quality of a firm’s earnings; however, this disclosure does not necessarily lead to a decline in investor perceptions of firm value. That is, my findings suggest that when managers have observable incentives to manage earnings upward, firms may benefit from providing this disclosure because D&O insurance coverage provides investors with a source of redress that compensates them for the increased risk. 
 
Keywords: D&O Liability Insurance; Fraud; Disclosure; Securities Laws; Corporate Governance; Earnings Management.

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Audit Committee Material Weaknesses in Smaller Reporting Companies: Still Struggling | Full Article (PDF)
James F. Boyle
Audrey A. Gramling
Dana R. Hermanson 
Heather M. Hermanson
 
Abstract: This paper examines trends in audit committee-related material weaknesses in smaller public companies over the period 2008-2011. The audit committee is an essential component of quality corporate governance, protecting shareholders from reputational risks and decreased shareholder value that can arise from fraudulent financial reporting. Audit committees also are now finding themselves more focused on helping companies manage risks related to bribery and corruption. However, at many smaller reporting companies, the audit committee often has been a missing or ineffective link in the chain of corporate governance. We find that, for smaller reporting companies collectively, audit committee material weaknesses are not improving over time. The primary weaknesses cited in 2011 involve the lack of an audit committee or the lack of a functioning audit committee, lack of independent (or outside) board members or audit committee members, and lack of board members with financial expertise. We offer implications based on the results.
 
Keywords: Audit Committee; Material Weakness; Small Companies; COSO.

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GAAP Difference or Accounting Fraud? Evidence from Chinese Reverse Mergers Delisted from U.S. Markets | Full Article (PDF)
Yimiao Chen
Gang Hu
Ling Lin
Min Xiao
 
Abstract: In 2012, one in four federal securities class-action lawsuits filed in the U.S. involved Chinese Reverse Merger companies (CRMs). However, these lawsuits sometimes have encountered difficulties in court due to insufficient direct evidence of accounting fraud. We propose a new method for fraud detection: use Chinese companies dual-listed in the U.S. and China to establish a benchmark for the normal GAAP difference between the two countries. Using this methodology, we find that only a small fraction of the discrepancies between delisted CRM’s financial statements filed in the U.S. and those filed in China can be attributed to GAAP difference. This fact suggests that the remaining discrepancies, which are large and unexplained, are indeed due to accounting fraud. Therefore, it is reasonable to conclude that delisted Chinese Reverse Merger companies enticed U.S. investors with favorable and fraudulent accounting and financial data.
 
Keywords: Accounting Fraud; GAAP Difference; Chinese Reverse Mergers; Dual-Listed.

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The Effects of Emotions on the Moral Judgments and Intentions of Accountants | Full Article (PDF)
Lynn H. Clements
Tara J. Shawver
 
Abstract: Not all levels of earnings management are fraudulent.  The Stice and Stice continuum of earnings management identifies five levels of managing earnings, beginning with savvy transaction timing (which is prudent, ethical, and in conformity with GAAP) and ending with ‘fraud’ (2006). The current study examines four situations of earnings management which correspond to the last four levels of the Stice and Stice (2006) continuum of earnings management.  This study explores the effects of three emotions (relief, satisfaction, and regret) on the moral judgments and whistleblowing intentions of 220 professional accountants on these different cases of possible earnings management. We find that relief, satisfaction, and regret affect moral judgment, but that they do not affect whistleblowing intentions.
 
Keywords: Whistleblower; Emotions; Moral Judgment; Earnings Management.

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The Effects of Personality Traits, Ethical Position, and the Materiality of Fraudulent Reporting on Entry-level Employee Whistleblowing Decisions | Full Article (PDF)
Alisa G. Brink
Sandra J. Cereola
Karl Bryan Menk
 
Abstract: Given the numerous high-profile financial scandals involving fraudulent financial reporting, the recent regulatory acts including whistleblowing provisions, and the need for firms to establish a corporate tone that encourages employee whistleblowing, we examine whether an individual’s personality traits and ethical position are related to whistleblowing propensity when an entry-level employee encounters a superior engaging in fraudulent financial reporting. We further examine whether the materiality of the fraudulent act influences employees’ willingness to report the wrongdoing. Using hierarchical regression, we obtain a model of specific characteristics that are most important in predicting whistleblowing intent. Specifically, materiality, idealism, conscientiousness, and extraversion are found to be key predictors. A second analysis reveals that individuals with the ethical ideology of exceptionism are reluctant to blow the whistle. The study contributes to the extant literature by providing insight into the individual characteristics associated with whistleblowing propensity. Such information could be used to develop ethical compliance codes and training programs that promote activities that establish a corporate tone that encourages employee whistleblowing. 
 
Keywords: Ethical Position; Fraud; Materiality Level; Personality Traits; Whistleblowing.

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Using Non-Academic Multimedia Resources to Enhance Student Learning of Fact-Based Fraud Cases | Full Article (PDF)
Ronald J. Daigle
Jan Taylor Morris
Ross Quarles
 
Abstract: This paper discusses how non-academic multimedia resources can make the study of fact-based financial fraud cases more interesting and educational in financial statement auditing, fraud auditing, forensic accounting, and ethics courses. The Internet provides a wealth of readily available multimedia (particularly video) resources about many of the same instances of fraud that are addressed in commonly used textbook cases. Multimedia from non-academic sources can complement textbook cases to help students gain more interest and insight into a particular fraud and learn more than if the textbook case was the only resource used. The multimedia resources can also stand alone if a textbook is not used or if a textbook does not include that particular fraud case. We identify example multimedia resources that are available regarding the $65 billion Ponzi scheme by Bernard Madoff and provide a series of questions and answers based on the multimedia’s content. The approach for this one case can serve as an example for other commonly covered fraud cases for which multimedia is readily available, including Baptist Foundation of Arizona, Crazy Eddie, Enron, Phar-Mor, Tyco, World-Com, and ZZZZ Best. Example multimedia resources available for these cases are identified, with references to textbooks in which each fraud is currently covered.
 
Keywords: Multimedia; Fraud; Auditing Education; Bernard Madoff.

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Peregrine Financial Group Inc./Best Direct Securities LLC: Anatomy of A 21st Century Fraud | Full Article (PDF)
Steven A. Solieri
Joan Hodowanitz
 
Abstract: Despite continuous oversight by financial industry regulators and an independent auditor, Russell Wasendorf, Sr. succeeded in embezzling more than $215 million dollars over a 20-year period through his company, Peregrine Financial Group Inc./BEST Direct Securities LLC (PFG-BEST).  An analysis of the PFG-BEST fraud using David Cressey’s Fraud Triangle explains how Wasendorf was able to hide such an egregious crime for two decades.  Clearly there is a need to move from traditional paper-based audit processes to 21st century technology to reduce the risk of future frauds.  This case also demonstrates potential shortfalls in the training, licensing, and oversight of independent auditors and other financial watchdogs on whom we, the public, rely for audit assertions.  In short, when it comes to financial investments, let the buyer beware.  
 
Keywords: Fraud; Fraud Triangle; Audit Technology; Red Flags.

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Horseplay in Dixon: Lessons Learned from the Rita Crundwell Fraud | Full Article (PDF)
Barbara Apostolou
Nicholas G. Apostolou
Greg Thibadoux
 
Abstract: This case presents the details of the largest municipal fraud in U.S. history perpetrated by Rita Crundwell against the City of Dixon, Illinois. The fraud persisted over two decades and was complicated by the nature of the local government, the behavior of the individuals hired to complete the audit, the bank that held the City's accounts, and ultimately the trust everyone placed in Rita. She was a high school graduate who became Treasurer/Comptroller of a City of 16,000 while at the same time ran one of the most famous and well-respected quarter horse farms in the country. We present the facts of the case and then provide a series of discussion questions that require students to research and then report about and discuss auditor responsibilities. First, auditor independence may have been compromised by an inappropriate relationship. Second, the auditors did not engage in professional skepticism. Third, the auditor's responsibility for fraud detection was not understood. Fourth, government auditing standards specifically require attention to fraud risk assessment and reporting. Fifth and most importantly, the auditors knew that internal controls were ineffective as a result of management override and lack of segregation of duties, but failed to act on that knowledge.

Keywords: Rita Crundwell; Government; Fraud; Dixon; White Collar Crime.

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Case: Fighting International Fraud with the FCPA | Full Article (PDF)
Priscilla Burnaby
Susan Hass
Brigitte W. Muehlmann
 
Abstract: This case introduces students to the fraudulent acts committed by United States (U.S.) companies selling to international companies that fall under the Securities and Exchange Committee’s (SEC) Foreign Corrupt Practices Act (FCPA) of 1977. All but ignored from the mid 1970’s to the 1990’s, the SEC has increased enforcement of the FCPA against many companies since the year 2000. The four case objectives for student learning about the FCPA are to: perform research on the FCPA; examine reasons codes of conduct are difficult to enforce internationally; develop critical thinking skills to determine how identified frauds were committed; and develop business writing and speaking skills. The case objectives are accomplished by having students perform the following: studying the FCPA; selecting and researching a recent FCPA case that was brought by the SEC; reviewing and understanding this company’s code of conduct; and by preparing a report and presenting a comparative analysis of their findings to the class. This case can be used in a fraud, forensic, auditing, or international accounting class to introduce the students to the FCPA and to study how companies committed fraud in violation of the law. It can also be used to cover codes of conduct, governance, and accountability.
 
Keywords: Securities and Exchange Commission; Foreign Corrupt Practices Act; Codes of Conduct; Corruption Perceptions Index.

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Audit Firm Tenure, Audit Materiality, and Last-Minute Earnings Management | Full Article (PDF)
Li (Lily) Zheng Brooks 
Peng Guo
 
Abstract: This study investigates how audit firm tenure affects the propensity for firms to meet or beat earnings benchmarks within audit materiality thresholds. Auditors’ independence can be impaired by either raising quantitative materiality thresholds or neglecting qualitative materiality thresholds. Using tax expense as a proxy for last-minute earnings management (Dhaliwah et al. 2004), we find that the propensity for firms to meet or beat earnings benchmarks within quantitative materiality thresholds is decreasing as tenure lengthens, in contrast to regulator’s concern that extended audit firm tenure erodes auditor independence (PCAOB 2011). Further, we find that the moderating effect of long tenure on tax expense earnings management within materiality thresholds is further enhanced after the SEC’s guidance on materiality in SAB-99 and in the post-SOX period. Our study suggests that mandatory audit firm rotation may negatively affect an auditor’s ability to constrain earnings management, exactly opposite to its intended purpose to enhance audit quality.
 
Keywords: Audit Firm Tenure, Materiality, Earnings Management, Tax Expense.
 
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Books Reviews
Contemporary Auditing
Contemporary Auditing
Michael C. Knapp, 10th Edition, 2015, 560 pp.
Cengage Learning
20 Channel Center Street
Boston MA 02210
 
The Tenth Edition features 18 new cases. Three of the new cases are Comprehensive cases, including AA Capital Partners, DHB Industries, and Navistar International Corporation.
 
Overall the textbook contains the following eight sections of cases: Comprehensive Cases, Audits of High-Risk Accounts, Internal Control Issues, Ethical Responsibilities of Accountants, Ethical Responsibilities of Independent Auditors, Professional Roles, Professional Issues, and International Cases. This organizational structure is intended to help adopters readily identify cases best suited for their particular needs.
 
The casebook can be used in several different ways. Adopters can use the casebook as a supplemental text for the undergraduate auditing course or as a primary text for a graduate-level seminar in auditing. The instructor's manual contains a syllabus for a graduate auditing course organized around this text. This book can also be used in the capstone professional practice course incorporated in any five-year accounting programs. Customized versions of this casebook are suitable for a wide range of accounting courses as explained later.

Managerial Fruad
Managerial Fraud: Executive Impression Management, Beyond Red Flags
Terry A. Sheridan, 2014, 290 pp.
Gower Publishing Company
110 Cherry Street
Suite 3-1
Burlington, Vt. 05401-3818
 
The author states that there are two types of fraudster managers: the arrogant kind and the very different likeable ones. These two types are responsible for stealing billions of dollars from organizations around the world. Most of that money will be frittered or hidden away with only a small percentage returned. Through his research he found that these two kinds of managers ruin organizations and not only that, they wreck people’s lives.
 
The author provides the following eleven chapters:
Chapter 1 Introduction
Chapter 2 Mythological Causes of Fraud
Chapter 3 Impression Management
Chapter 4 The Makings of the Fraudster Manager Typology
Chapter 5 Eventual Destruction of the Illusion
Chapter 6 The Basis of the Types
Chapter 7 The Two Fraudster Typology
Chapter 8 Rehabilitation Possibilities
Chapter 9 Case applications
Chapter 10 Prevention
Chapter 11 Conclusion

Intro to Civil Litigation
Introduction to Civil Litigation
AICPA, Second Edition
CPA2 Biz
AICPA Service Center
Service@cpa2biz.com
(888) 777-7077
 
Consulting services that CPAs provide to their clients have evolved from advice on accounting-related matters to a wide range of services involving diverse technical disciplines, industry knowledge, and consulting skills.
 
In a consulting service, the practitioner develops the findings, conclusions, and recommendations presented, and therefore must have a broad range of knowledge and skills.
 
This special report is intended to be an educational and reference primer for the practitioner who provides, or is considering providing, civil litigation services in accordance with SSCS No. 1, Consulting Services: Definitions and Standards (AIPCA, Professional Standards, PS sec. 100).
 
This report is focused on the provision of certain services by the practitioner in connection with civil matter litigated in the federal court system of the United States of America.
 
Although certain material also may be applicable to state and local courts, alternative dispute laws; rules; and procedures may vary widely. Accordingly, practitioners are encouraged to consult with legal counsel about laws and local court requirements that may affect the material contained in this special report.

Serving as an Expert Witness
Serving As An Expert Witness or Consultant
AICPA, Second Edition
CPA2 Biz
AICPA Service Center
Service@cpa2biz.com
(888) 777-7077

This practice aid was developed to assist the practitioner who is serving as an expert witness or consultant. It is primarily relevant to litigation service engagements in the United States, though certain parts of the guidance are applicable to international assignments as well.
 
This product focuses primarily on the practitioner serving in a role in connection with civil litigation disputes but also includes limited guidance for serving as an expert witness or consultant in criminal proceeding matters.   Among the topics covered are:
  • Discovery
  • Overview of Alternative Dispute Resolution
  • Overview of Civil Litigation
  • Overview of Criminal Proceedings
This practice aid is not intended to apply to situations in which the practitioner may be required to testify as an official custodian of records, or as a fact or lay witness, although certain portions may be helpful.

Death Taxes
Death, Taxes, and Silver Spurs
Diane Kelly, $7.99
St. Martin's Paperback
 
Maybe it goes without saying that IRS Special Agent Tara Holloway is star-struck? In Diane Kelly's Death, Taxes, and Silver Spurs, she’s head over heels in trouble. A tax-evading pet groomer managed to buzz off a big chunk of Tara’s hair just in time for her meeting with country-music heartthrob Brazos Rivers. Of course Tara shouldn’t care. She’s devoted to Special Agent Nick Pratt, after all, “but Rivers does know how to steal a woman’s heart with a song.”
 
Meanwhile, Tara’s up to her fracking neck with another case: A natural-gas company with a money trail that is almost as suspicious as Brazos Rivers’ nonexistent tax returns. Tara figures the misdeeds of her celebrity crush must be an oversight. But will she dance to a different tune when her tax-evading idol starts evading her, too?

Financial Statement
Financial Statement Analysis & Valuation
P.D. Easton et al., 4th edition, 2015
Cambridge Business Publishers
(800) 619-6473
customerservice@cambridgepub.com
 
This book is intended for use in a financial statement analysis and/or valuation course in which profitability analysis and security valuation are emphasized. It accommodates mini-courses lasting several days as well as extended courses lasting a full semester. It incorporates real company data throughout each module to reinforce important concepts and engage students. The fourth edition teaches students how to read, analyze, and interpret financial statements, footnotes, and nonfinancial disclosures for business decisions including profitability and credit risk analysis. To the extent possible, the 15 modules that make up Financial Statement Analysis & Valuation are designed independently of one another; this modular presentation enables instructors to "customize" the book to fit their needs. The content of each module is explained and illustrated through analysis of the accounting practices of a real company. Business Insight boxes containing contemporary illustrations and discussions are incorporated throughout the book.
 

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