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Volume 14: Issue 3, Special Issue, 2022

Table of Contents

The Danger of Assessing Management Attitudes: An Examination of the Dilution Effect in Auditors’ Fraud Risk Assessments
The Ethics of Transfer Pricing: Insights from the Fraud Triangle
The Effects of Tax Law Information, Deterrence, and Tax Morale on “High-Opportunity” Taxpayers’ Intentions to Report Income
Business Combination v. Asset Acquisition: KPMG’s Earnings Management and Subsequent Litigation Involving Miller Energy Resources
The Effect of Auditor Busyness and Audit Report Signing Experience on Constraining Earnings Management: Evidence from China
Creativity in Auditing: Theoretical and Practical Concepts to Enhance Auditors’ Recognition of and Responses to Fraud Risk
Cybersecurity and Data Privacy: The Rising Expectations within Internal Audit
Capital Market Penalties and Corporate Violations of the Three Pillars (Operations, Reporting, and Compliance) After COSO 2013 Internal Controls: Integrated Framework
An Exploration of Internal Controls and Their Impact on Fraud in Protestant Churches
Keeping an Investigative Eye on the Financial Pulse of a Company Using Data Analytics
Prescription for Fraud: NMC Health Group
Book Reviews

The Danger of Assessing Management Attitudes: An Examination of the Dilution Effect in Auditors’ Fraud Risk Assessments | Full Article (PDF)
Erin Nickell
Kelsey Brasel
Melanie Millar

Abstract: We explore the dilution effect of management attitudes toward fraud on auditors’ fraud risk assessments. Despite auditing standards that explicitly caution auditors not to reduce fraud risk assessments when management attitudes toward fraud are low risk, we find that low-risk attitude cues cause auditors to make lower overall fraud risk assessments and subsequently reduce planned audit procedures. Our results are the first to empirically demonstrate the dilutive effect of low-risk management attitudes toward fraud, an effect that prior studies assume but do not test, and to provide evidence of the path through which auditors incorporate the dilutive information in fraud risk assessments and audit procedures. In an experiment with experienced auditors, we find that the dilution effect specifically operates through a reduced sensitivity to high-risk pressure cues rather than high-risk opportunity cues. Contrary to prior research, we find that auditors also are less likely to adjust the nature, timing, or extent of procedures in a clearly high-risk environment. We consider whether high trait professional skepticism mitigates this effect and, unfortunately, do not find evidence to suggest it does. Our results have implications for practitioners, academics, and regulators as they seek best practices for fraud risk assessment and planning of audit procedures.

Keywords: Auditing; fraudulent financial reporting; fraud risk assessment; professional skepticism; dilution; AS 2110

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The Ethics of Transfer Pricing: Insights from the Fraud Triangle | Full Article (PDF)
Lorraine Eden
L. Murphy Smith

Abstract: The semi-globalized nature of the world economy provides a variety of external motivations for multinational enterprises (MNEs) to engage in transfer price manipulation (TPM) by arbitraging regulatory differences across countries. Governmental concerns over profit shifting by MNEs through TPM have resulted in a complex network of national laws and regulations governing the pricing of cross-border related-party transactions. Despite (or perhaps due to) these regulatory differences and complexities, transfer pricing is a highly controversial area, especially in international tax law. In this article, we discuss the ethical implications of transfer pricing, focusing on abusive transfer pricing, which we define as unethical and/or illegal pricing of transactions among controlled entities. We draw insights from the fraud triangle (opportunity, motivation, and rationalization) to explain why abusive transfer pricing occurs and use this framework to provide policy recommendations to recognize and deter abusive transfer pricing.

Keywords: Transfer pricing; fraud triangle; arm’s length standard; tax planning; profit shifting; abusive transfer pricing

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The Effects of Tax Law Information, Deterrence, and Tax Morale on “High-Opportunity” Taxpayers’ Intentions to Report Income | Full Article (PDF)
Chenchen Huang
Marsha Huber
Karl Bryan Menk
Qiongyao Zhang

Abstract:This study examines the tax compliance of high-opportunity taxpayers. Using a quasi-experimental design, researchers ask high opportunity taxpayers, in this case restaurant servers, how much of their cash tips they would report before and after assigned to one of three interventions. The first intervention presents servers with the tax laws on tip reporting, the second intervention adds a tax deterrence message about penalties for underreporting, and the third intervention adds a moral appeal message to encourage tax compliance. Researchers find that learning tax law increased the reporting of cash tips by 26.4 percent. The combined effect of tax information and deterrence increased tip reporting by 33.5 percent, although not statistically different when compared to the first intervention. However, the total effect of tax information, deterrence, and moral appeal significantly increased cash tips reporting by 40.8 percent. The findings of this study can serve as a guide for policymakers in developing strategies to increase tax compliance in the United States.

Keywords: High-opportunity taxpayers; tax compliance; tax ethics; tax training; tax morale

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Business Combination v. Asset Acquisition: KPMG’s Earnings Management and Subsequent Litigation Involving Miller Energy Resources | Full Article (PDF)
D. Larry Crumbley
Steven D. Grossman

Abstract: In 2009, Miller Energy Resources purchased nonoperational assets of an Alaskan company for $2.25 million in cash along with the assumption of approximately $2 million of liabilities. Miller then vastly overvalued the assets and recorded a bargain purchase gain of over $277 million. The transaction was correctly recognized as an asset acquisition, not the purchase of a separate business; however, a bargain purchase gain should not have been shown in the financial statements. KPMG encouraged Miller to change its accounting treatment to a business combination, because bargain purchase gains can be recognized in earnings in business combinations. For several reasons, including Miller’s lack of oil experience in deep water wells and lack of financing ability to make these assets operational, KPMG should have considered Miller a high-risk client and not accepted the engagement. The SEC charged Miller with fraud and penalized KPMG for its actions. A class action lawsuit against KPMG is in progress, and information about litigation support is provided in the article.

Keywords: Asset acquisition; business combination; bargain purchase gain; fraud; earnings management

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The Effect of Auditor Busyness and Audit Report Signing Experience on Constraining Earnings Management: Evidence from China | Full Article (PDF)
Zhaoyan Shang
Candice T. Hux
Chih-Chen Lee
Min Wang

Abstract: Prior research shows that incentives and pressures on management to meet earnings targets can lead to earnings manipulation, and that firms with earnings manipulation are more likely to commit financial statement fraud. Auditors play an important role in constraining clients’ earning manipulation, but their “busyness” throughout the year may not catch management’s deviant behavior. Nevertheless, auditors’ exposure of leading more engagements in the signatory role increases auditors’ experience, which could reduce the busyness effect. In China, the audit report is signed by two auditors who jointly manage the engagement. Using hand-collecteddata of individual auditors in China, westudy the effects of auditor busyness (total number of audit reports signed per year) and experience (total number of audit reports signed during one’s career) on constraining clients’ earnings management. We find that audit partner busyness is associated with higher earnings management, particularly among male partners and partners older than age 40. However, their experience in a signatory role attenuates this adverse effect of busyness on earnings management. Auditors serving in a manager role are less busy than partners, and their signing experience also constrains earning management. Given increased audit partner disclosures globally, these results are timely and of interest to scholars, regulators, auditors, and investors.

Keywords: Earnings management; earnings manipulation; auditor busyness;auditor experience

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Creativity in Auditing: Theoretical and Practical Concepts to Enhance Auditors’ Recognition of and Responses to Fraud Risk | Full Article (PDF)
Eddward T. Herron
Robert M. Cornell

Abstract: This article provides a theoretical foundation for how individual and environmental creativity enhances auditors’ recognition of and responses to fraud risk. In the absence of an element of surprise amidst increasingly standardized audit procedures, fraud has become more sophisticated and nuanced, yielding questions of adequacy of fraud discovery among auditors. Given the limitations of traditional brainstorming, we discuss theoretical and practical concepts to enhance auditors’ creative ideation and encourage creativity within the audit environment. Based upon evidence that individual and environmental creativity is related to fraud cue recognition and effective audit plan adjustments, we present foundational concepts for research and practical ideas to improve audit quality.

Keywords: Creativity; fraud; fraud detection; ideation; standardization

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Cybersecurity and Data Privacy: The Rising Expectations within Internal Audit | Full Article (PDF)
Liahona R. Hepworth
Cindy Greenman
Derrick Esplin
Ross Johnston

Abstract: This article is a qualitative case study focusing on the changing role of the internal auditor. The purpose is to assist in better understanding the expectations and responsibilities of internal auditors. Internal auditors are an essential part of risk management, and they must provide an independent assurance on the entity’s effectiveness of governance and internal control process along with risk management. With the ever-increasing issues surrounding cybersecurity, the expectations of internal auditors and their roles and responsibilities have grown. Results show that with the growing problem of cybersecurity, the role of the internal auditor has evolved where they must have more technical knowledge about cybersecurity threats. Implications are discussed and suggestions for further research are given in this article.

Keywords: Cybersecurity; internal audit; data privacy; auditing; management auditing

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Capital Market Penalties and Corporate Violations of the Three Pillars (Operations, Reporting, and Compliance) After COSO 2013 Internal Controls: Integrated Framework | Full Article (PDF)
Jesus Rodolfo Jimenez-Andrade

Abstract:The Committee of Sponsoring Organizations (COSO) issued an updated version of the Internal Control-Integrated Framework in 2013. Proper documentation and a higher control environment are the major updates to the three pillars of internal controls (operational safety, reporting quality, and regulatory compliance). To dissipate some of the cost-benefit-debate on whether these enactment implementation costs are justified, this study explores the role of this guidance in moderating the relationship between market penalties and corporate failures in executing such controls. Relying on asymmetric information principles, a sample of 370 violations to these pillars between 2008 and 2018 (-5,+5 years) documents the findings. Results support a positive moderation effect of this new guidance in the three-day (and not eight-day) window after the violation that attenuates the market penalties in operational safety and reporting quality controls failures (absent in the regulatory compliance pillar). Consequently, the costs of implementing and executing such a framework are justified with 33 percent (average) lower stock returns penalties compared to the previous enactment. Compelling supplementary analysis enriches the quality of the findings.

Keywords: Corporate violations; market penalties; internal control pillars

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An Exploration of Internal Controls and Their Impact on Fraud in Protestant Churches | Full Article (PDF)
Kent Lachney

Abstract: This qualitative study ascertains the current practices of internal control systems of Protestant churches and examines their system’s effectiveness when compared with anti-fraud activities recommended by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).The participants for this study were drawn from Protestant churches in the Central Louisiana (CENLA) area. The researcher used convenience/purposeful sampling to select five small to medium-size churches and interviewed each church financial administrator. Also, the researcher created 63 interview questions based on the five elements of the COSO model and analyzed and organized responses concerning a number of variables. Finally, the researcher offered recommendations to improve the effectiveness of the churches’ internal controls. When suitable internal controls are present, churches have a greater opportunity of efficiently safeguarding their assets and achieving their missions.

Keywords: Fraud; internal controls; churches; COSO

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Keeping an Investigative Eye on the Financial Pulse of a Company Using Data Analytics | Full Article (PDF)
Christie L. Comunale
David C. Hayes
James H. Irving

Abstract: Arecent survey of accounting professionals indicated that 78 percent of the 458 respondents analyze financial ratios and financial information in their current or previous accounting role(s). Survey respondents also noted that their employers continue to make significant investments in data analytics training, tools, and technologies, and that data analysis skills are an expected competency in accounting practice at all experience levels and specializations. Given the growing importance of data analytics in the accounting profession, and in an effort to better prepare students for their future careers, this article provides an educational case that introduces students to data analytic tools and techniques using financial statement information. Guided by instructional videos and using real public company data as well as an assortment of data visualization graphs, students apply four data analytic tools—ratio analysis, common-size analysis, horizontal analysis, and related accounts analysis—to identify and investigate unusual and unexpected changes (financial pulses) in a company’s financial statements. Results from the case show that students in both undergraduate and graduate accounting courses significantly increased their proficiency in applying the data analytic tools and techniques presented.

Keywords: Data analytics; financial statement analysis; AACSB Accreditation Standard A5; case study

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Prescription for Fraud: NMC Health Group | Full Article (PDF)
Yass Alkafaji
Kimberly Gleason
Yezen Kannan

Abstract: NMC, a medical service company listed on the London Stock Exchange, grew to become one of the largest healthcare providers in the Middle East. A short seller raised suspicions of NMC regarding hidden assets, improper asset valuation, and insufficient disclosure of related party transactions. This case study helps students understand the relationship between governance quality and fraud in the context of a company headquartered in a developing country that is subject to UK listing status. Students learn how auditors and forensic accountants incorporate procedures for fraud risk assessments and use financial statements to flag suspicious transactions to identify accounts affected by fraud schemes.

Keywords: Financial statement fraud; governance; forensic accounting; auditing; UAE

Book Reviews

Ethics Playbook: Winning Ethically in Business

Aaron Beam (Author), Greg Womble (Editor), Marianne Jennings (Foreword), 2015, 180 pp.
Aaronbeam.net

With the major ethical problems two Big Four CPA firms are having with ethics, Aaron Beam’s Ethics Playbook should be required reading for accounting firms’ employees. I have been given a couple of ethics books by authors, and quite honestly, I could not finish them. They were dry, much too scholarly, and read like classroom textbooks.

Beam and Womble’s book flows well and is easy and enjoyable to read. Organizationally, I like the four parts into which the book is divided, and the book makes its points and provides examples to elaborate on the major points. The “Fraud Ecosystem” is organized and explained well. As for “the enablers,” I would point out that sometimes they are useful idiots for the leaders who recognize them for what they are and leverage them for nefarious purposes.

The authors’ analysis of Arthur Andersen’s scandal is spot-on, because the lead partner on the Enron accounting engagement was corrupted in that he accepted a couple of Enron paid trips to high-profile sporting events, including the Masters golf tournament.

I am glad the authors included a portion on the “fudge factor,” and the inclusion of Robert Prentice’s Dark Forces of Unethical Decision Making is effective.

They discuss pressures by CEOs to manipulate the numbers. I do not remember how many times I have heard comments from prosecutors that the CFO or other business executives should have done this or that. In my mind, I thought they obviously never worked in corporate America. Their comments were incongruent with the realities of corporate pressures and culture. Thereafter, I would attempt to explain the realities without telling them they did not know what they were talking about.

Beam and Womble discuss gray areas and that “If you are not careful, you’ll tend to see and define things as gray as you can so you can rationalize your own unethical behavior.” In my speeches about gray areas and loopholes, I emphasize there is a fine line between unethical behavior and criminal conduct. Operating in the gray areas and exploiting loopholes can put a person on the wrong side of that fine line between unethical behavior and fraud.

Ethical Play #24 on page 158 is very much Enron. The company and its employees were extremely philanthropic with both time and money. Unquestionably Enron tried to buy goodwill through their philanthropic efforts. The Ethical Plays included in your book are much like the ethical takeaways I use in my speeches. Your plays are great.

Lastly, I like the idea of teaching ethics in high school. The earlier we can get people thinking ethically, the greater the likelihood they will act ethically throughout their lives. It’s not easy being ethical, but it is the right thing to do. In summary, I found the book worthwhile reading.

Michael E. Anders, Retired Special Agent of the FBI

Cloud Money: Cash, Cards, Crypto, and the War for Our Wallets

Brett Scott, 2022, 288 pp.
HarperCollins Publishers
195 Broadway
New York, NY 10007

Is the end of cash the end of privacy? The author tells the merger story of how Big Finance and Big Tech are combining with the banking sector to replace physical cash with digital money China is already experimenting with a digital yuan which may force the U.S. to go the same route. Scott “explains the technical, political, and cultural differences between our various forms of money and shows how the cash system has been under attack for decades, as banking and tech companies promote a cashless society under the banner of progress.” In the end he explains how we will lose our freedom.

Black Swan: Impact of the Highly Improbable

Nassim Taleb, 2010, 434 pp.
Random House
penguinrandomhouse.com

Most accountants and forensic accountants understand that they should be skeptical, but PCAOB is constantly complaining that auditors are not skeptical enough. This older book covers what Dr. Glenn Sumners at Louisiana State University calls the Big R—the huge risk that can destroy a person or business.

The author quotes Yogi Berra who said, “it is tough to make predictions especially about the future.” Taleb defines a black swan as “an event positive or negative, that is deemed improbable yet causes massive consequences.” He shows in a playful way that Black Swan events explain almost everything about our world, and yet we—especially the experts—are blind to them. Taleb has a philosophical and empirical essay in his “On Robustness and Fragility” section, which offers tools to navigate and exploit a Black Swan world.

Valuation analysts and often forensic accountants have to predict the future, and this book could help make us more skeptical.

Tell Me Everything: A Story of a Private Investigation
Erika Krouse, 2022, 273 pp.
Flatiron Books
120 Broadway
New York, NY 10271

Many years ago a CPA drove me to JFK airport from possibly one of the first forensic accounting conferences in New York City. His old car was cluttered, and I believe he was a smoker. But he told me that a forensic accountant (or accountant) has to be an excellent detective, looking at individuals first (e.g., life styles) before looking at records, invoices, checks, and other financial evidence.

This novel is about a female private investigator who helped crack open a landmark sexual investigation. She became an investigator because of her ordinary-looking fact that caused strangers to confess to her—a storage locker for people’s secrets. She was hired to investigate a lawyer’s lawsuits, PI work, talk to witnesses, and get them to open up.
She accepted a job with a lawyer, Grayson, to investigate a sexual assault of a college student by football players and recruits at a party. Over the next five years, Erika learns everything she could about PI technique, tracking down witnesses, and investigating a culture of sexual assault and harassment ingrained in the university’s football program. She would get people to talk to the attorney and could show how the “turtle got onto the stump.”

The author indicates that football players (like executives and employees) are a collection of personalties. Each football position has its own culture.

If you like football or want to learn about football, check out this novel. Novelist Charles D’Ambrosio indicates “it’s a tale of detection, a mystery, a legal thriller, a whodunit, but it’s hardly escapist fare.” A forensic accountant does need some legal skills to be successful as a consultant or expert witness. Learn some investigative skills from the book, such as the four-dog defense and the three types of evidence.

The Lords of Easy Money: How the Federal Reserve Broke the American Economy
Christopher Leonard, 2022, 374 pp.
Simon & Schuster
1230 Avenue of Americas
New York, NY 10020

There are 12 members of the Federal Open Market Committee of the Federal Reserve (which can create dollars at will). The Federal Reserve (Fed) creates new dollars by printing them and depositing them in vaults of 24 big banks. On November 4, 2010, the Fed introduced “quantitative easing,” whereby they increase the money supply by purchasing newly-created bank reserves to provide banks with more liquidity. They are buying debt or thin air money printing.

The author shows how in just a few years, the Fed more than quadrupled the money supply with one goal: to encourage banks and other investors to extend more risky debt. Members of the Fed knew that they were undertaking a bold experiment that would produce few real jobs, with long-term risks that were hard to measure. But the Fed proceeded anyway and then found itself trapped. Once it printed all that money, there was no way to withdraw it from circulation. The Fed tried several times, only to see the market start to crash, at which point the Fed turned the money spigot back on. That is what it did when COVID hit, printing three hundred years’ worth of money in two short months, thereby lowering interest rates.

The gap with unconventional and risky quantitative easing between the rich and the poor has grown dramatically, stock prices are trading far above what is justified by actual corporate profits, corporate debt in America is at an all-time high, and this debt is being traded by big banks on Wall Street, leaving them vulnerable—just as they were during the mortgage boom. Middle-class wages have barely budged in a decade, and consumers are buried under credit card debt, car loan debt, student loan debt, and inflation is exploding.

Events

2023 LSU Annual Fraud & Forensic Accounting Conference
LSU is having their two-day Fraud & Forensic Accounting Conference on July 25–26, 2023. Please mark your calendars! https://www.lsu.edu/business/accounting/newsevents/ffac/index.php

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