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Volume 1: No. 1, January–June, 2009

JFIA

Volume 1: No. 1, January–June, 2009

Table of Contents:

 

Bernard Madoff and the Solo Auditor Red Flag | Full Article (PDF)
Ross D. Fuerman
 
Abstract: In the wake of the disclosure of the Bernard Madoff fraud, attention has been drawn to the use of a solo auditor by Bernard L. Madoff Investment Securities LLC. Some claim that the use of a solo auditor was a red flag, or a symptom of fraud, that was ignored by investors, regulators, feeder fund operators, and auditors of the feeder funds. This motivates empirical research to determine whether evidence suggests that solo auditors are lower quality auditors than other auditors, and thus really a red flag.
 
Using an audit failure auditor litigation outcome metric, based on 396 observed auditor outcomes in financial reporting litigation commenced from 1996 through 2008, this paper focuses on the analysis of the relative auditor quality of solo auditors. Because one may argue that the relevant auditing services market for this analysis should include 1) all auditors other than the Big 4, 2) all auditors other than the Big 4 or Medium 2, or 3) just the Very Small (2 to 9 accountants) CPA firms and the solo auditors, the investigation uses three different models and samples. Similar results are obtained regardless which approach is used. The findings suggest that solo auditors are lower quality auditors, and further suggest that the use of a solo auditor is a red flag.

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Auditor Consideration of Tone-at-the-top in Audit Planning: An Experimental Investigation | Full Article (PDF)
David Kerr
Michelle C. Diaz
 
Abstract: This paper reports the results of an experiment that investigates the manner in which auditors integrate the client’s tone-at-the-top, an important element of the internal control system, with other information during audit planning. Four factors relevant to planning an audit are examined: (1) the client’s tone-at-the-top, (2) the results of tests of controls, (3) the results of planning-phase analytical procedures, and (4) stability of the client company. Results of the experiment reveal a significant three-way interaction among the client’s tone-at-the-top, the auditor’s planning-phase analytical procedures, and tests of controls.
 
This study extends prior audit planning research by examining the main and interactive effects of tone-at-the-top on audit planning decisions. This study also extends prior research by including a greater number of constructs relevant to audit planning decisions, allowing investigation of the interactive relationships among the constructs, as well as the generality of prior results in a more complex context that enables examination of previously unexplored interactions.
 
Keywords: Tone-at-the-top, control environment, audit planning, fraud risk, auditor judgment and decision making.

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Medicare Billing Risk Perceptions of Hospitals Operating Under Corporate Integrity Agreements | Full Article (PDF)
David B. Pariser
Ashok B. Abbott
 
Abstract: Between 1987 and 2006, the federal government recovered $18.1 billion in settlements under the False Claims Act (FCA), of which $11.5 billion or 63 percent arose from settlements in the healthcare industry. False Claims Act has become a favorite tool for the Health and Human Services/Office of Inspector General (HHS/OIG) to deter fraudulent billing practices. Under this act, healthcare providers who knowingly submit false or fraudulent claims are liable for three times the government’s loss plus a civil penalty of $5,000 to $11,000 for each false claim. HHS/OIG has issued compliance guidelines to encourage healthcare providers to develop voluntary compliance programs capable of detecting and preventing fraudulent billing practices. When the HHS/OIG investigates a healthcare provider that has allegedly submitted false or fraudulent claims to Medicare, it frequently negotiates a settlement with the provider to resolve potential liability arising from violations of the False Claims Act. The settlement usually obligates the provider to adhere to an involuntary Corporate Integrity Agreement (CIA), usually lasting five years, more restrictive and onerous than voluntary compliance programs. This paper describes HHS/OIG’s voluntary compliance guidelines, components of Corporate Integrity Agreements, and six billing schemes.
 
The primary purpose of the paper is to compare hospital management risk perceptions toward common and longstanding unacceptable billing schemes. The risk perceptions of hospitals operating under CIAs are compared to those not operating under CIAs. The six billing fraud schemes found to show significant differences between the two groups are billing for medically unnecessary services, upcoding, unbundling, billing for discharge in lieu of transfer of patient, over-utilization, and submission of false cost reports. The findings suggest that operating under a CIA may appropriately sensitize management about unacceptable (risky) behavior, making management more likely to identify unacceptable billing schemes than management of hospitals not operating under a CIA. These finding have important implications for internal auditors and fraud investigations engaged in planning and conducting risk assessments of hospitals.

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Pre and Post-SOX Association between Audit Firm Tenure and Earnings Management Risk | Full Article (PDF)
Santanu Mitra
Donald R. Deis
Mahmud Hossain
 
Abstract: This study investigates the effect of audit firm tenure on earnings management risk. We perform multivariate regression analyses to examine the empirical relationship between auditor tenure and the probability of earnings manipulation using Beneish’s (1999) framework. The analysis covering a five year time-period surrounding the enactment of SOX produces evidence of a negative relationship between the length of auditor tenure and the probability of earnings manipulation (termed as earnings management risk). Additional analysis reveals that the risk of financial misreporting is more likely to be present in the first three years of auditor tenure in the pre-SOX period. This result is consistent with similar studies prior to SOX (e.g., Carcello and Nagy 2004, Myers et al. 2003, Johnson et al. 2002, Bartov and Cohen 2007, Cohen et al. 2007). Further analyses show that the negative association between audit firm tenure and earnings management risk is substantially moderated in the post-SOX period. We posit that heightened scrutiny over audits (e.g., PCAOB inspections) and the perceived threat of additional regulations to limit auditor tenure explain this finding. Our main results are robust to alternative specifications of earnings management risk and auditor tenure, and in the presence of additional controls for heavily represented industries, mergers and acquisitions, restructuring, issue of new equity and debt securities, change of auditor from Arthur Andersen, and extreme financial performance. 
 
Keywords: Audit firm tenure; Earnings management risk; M-SCORE; M-FACTOR; Sarbanes-Oxley Act; SOX transition period; Pre-SOX; Post-SOX. 
Data: Data used in the study is obtained from publicly available sources described in the text. 

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Data-Driven Fraud Detection Using Detectlets | Full Article (PDF)
Conan C. Albrecht
Chad O. Albrecht
 
Abstract: This paper describes an architecture that makes the data-driven fraud detection method practical and efficient through the creation of a worldwide repository of fraud detection routines called Detectlets. A detectlet encodes background information about a scheme, its symptoms, programming scripts to detect it, and results interpretation. Detectlets mitigate many of the limitations faced by modern-day auditors: lack of time, lack of fraud methodology and supporting tools, lack of technical knowledge, and lack of scheme and symptom knowledge. The goal is to create a worldwide repository of detectlets that serves as a training center and downloadable tool resource for professional auditors and students. In addition, this detectlet repository could be the foundation of a ‘detective in a box’ system that could detect fraud using semi-autonomous methods. 
 
Keywords: Fraud Detection, Detectlets, Computer-Aided Fraud Detection, Picalo. 

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An Empirical Examination of Whistleblowing Policies and Mechanisms at Universities | Full Article (PDF)
Michael D. Akers
Tim V. Eaton
 
Abstract: This study empirically examines whistleblowing policies and mechanisms at universities using a survey of Internal Audit Directors. In conducting this analysis, we developed five research themes for investigation: (1) extent, (2) development, (3) characteristics, (4) communication and training, and (5) investigation and follow-up. Our results document how universities have been impacted by the passage of Sarbanes-Oxley in the implementation of their whistleblowing policies and mechanisms. 

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An Examination of Frequencies of Prosecuted Crimes in Selected Gaming Industry Establishments (Casinos) | Full Article (PDF)
Steve Wells
Tim Wilson
William Pinney
 
Abstract: This paper examines the frequencies of prosecuted crimes in selected gaming industry establishments (casinos) to confirm or reject the expectation that prosecuted crimes are equally likely to occur in any casino in the geographical area included in the study. Differences discovered may be key issues of concern for forensic accountants and others and thus worthy of future research. Public records of the Circuit Clerk of Tunica County, Mississippi, were used to identify the frequency of prosecutions of felonies occurring in the ten casinos operating in that county over a four-year period from 2000 to 2003. Differences in observed and expected rates of prosecutions were tested for statistical significance using chi-square and two-tailed Z-tests with a five percent acceptable error rate. The study focused on five types of crime: attempted forgery, forgery, embezzlement, gaming, and miscellaneous crime. One statistical test, the chi-square test, detected statistically significant differences in rates of prosecution of three of the five crimes. The Z-test detected statistically significant differences in rates of prosecutions of four of the five types of crimes. Tables are included to assist in the possible explanations of the findings. The analysis of the data, conclusions drawn, and suggestions for future research should be of value to forensic accountants, internal auditors, members of management of casinos, law enforcement officials, and the staff and members of the Mississippi Gaming Commission. They could also serve as the foundation for a case study for use in appropriate academic courses in forensic accounting/auditing. 

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An Historical Perspective on Fraud Detection: From Bankruptcy Models to Most Effective Indicators of Fraud in Recent Incidents | Full Article (PDF)
Mary Jane Lenard
Pervaiz Alam
 
Abstract: Why are auditors unable to detect fraudulent financial reporting in some audits? Should auditors be able to anticipate when fraud is likely to occur? Various studies have discussed not only the need for experience and supervision of auditors, but also the effect of decision models, and even expert systems, on fraud detection and the study of internal controls. This paper presents a discussion of regulation regarding fraud and the evolution of statistical models in the accounting and auditing literature designed to measure financial difficulties and fraudulent financial reporting. We test selected models using company data from two different time periods representing recent incidents of fraudulent financial reporting. Our results show high accuracy rates of fraud detection on both datasets, supporting the fact that a combination of accounting rules, regulation and government enforcement has contributed to the development of successful decision models to detect fraud. 

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Data Mining Techniques for Auditing Attest Function and Fraud Detection | Full Article (PDF)
John Wang
G.S. Young
 
Abstract: Data mining technique is a newly developed tool for statisticians, data analysts, and the management information systems community. It involves searching information through databases for correlations and other non-random patterns. In making business decisions, it is important to recognize patterns of data and relationships among variables in order to discover valuable information. The results will best minimize costs, maximize returns, and promote operating efficiency. In the field of accounting and auditing, there is a vast amount of data accumulated in electronic form, and therefore data mining technique is proving to be extremely useful. It allows accountants to analyze the data in many different ways. It can sort through the data, summarize the relationship and reveal the information that the accountants need. This paper explores some applications of data mining techniques as an auditing tool, fraud detection scheme and as an instrument for investigating improper payments. It also compares the general auditing software with the data mining software, for the purpose of showing the superiority of the modern data mining technology. This paper further offers guidance to auditors in the use of data mining software. 

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Beliefs of Forensic Investigators Regarding Bi- and Uni-directional Behavior Analysis | Full Article (PDF)
Philip Beaulieu
 
Abstract: In bi-directional behavior analysis, investigators look for changes in behaviors to detect deceit by interviewees, regardless of whether the result may be more or less of a behavior. Uni-directional analysis requires that either more or less of a behavior is observed, for example deceivers’ eye contact may be expected to decrease. Forensic investigation training materials refer to both approaches, bi- and uni-directional, and it is an empirical question whether a majority of investigators believes in either approach. A survey of 55 investigators’ beliefs with regard to 13 verbal and non-verbal behaviors found that the majority opinion sided with the uni-directional approach. This result held whether or not investigators had a background in policing. Implications for education and practice are discussed. 
 
Keywords: Deceit, fraud, interview.