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Volume 8: Issue 3, July–December, 2016

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Volume 8: Issue 3, July–December, 2016
Table of Contents

Forensic Approaches to Transfer Pricing Compliance and Enforcement | Full Article (PDF)
Stephen L. Curtis
Abstract: Finding common ground between corporate tax compliance and enforcement appears difficult and expensive, judging by the current inventory of almost $200 billion in proposed IRS transfer pricing tax adjustments, and projections of as much as $100 billion or more in annual U.S. federal corporate tax underpayments via international tax and transfer pricing transactions.  Emerging techniques in forensic accounting and economics, together with data analytics may hold a key to bridging this “compliance-enforcement” or C-E gap.  These new capabilities can benefit both enforcement and compliance in the same way that advances in forensic investigative technology revolutionized the practice of law enforcement, by improving the certainty and consistency of both examination and compliance efforts, reducing the number of IRS audits of compliant taxpayers, shortening the intensity and duration of IRS examinations and improving the efficiency of scarce taxpayer and tax authority resources.  These advances are also consistent with recent OECD guidance on base erosion and profit shifting (BEPS), which places more emphasis on economic reliability versus rote procedural compliance.  Two forensic models are illustrated: a model of risk and return analytics for transfer pricing risk assessment, and a value chain contribution analysis for use in cost sharing and profit split arrangements.  Forensic technology and approaches could reduce controversy between taxpayers and the IRS regarding what constitutes acceptable transfer prices, and provide the basis for more efficient use of both IRS and taxpayer resources.  
Key Words: Transfer pricing; auditing; forensic economics; tax compliance and enforcement

The Effects of the Existence and Financial Expertise of Audit Committees on Firms’ Controversial Activities—Evidence From IPOs | Full Article (PDF)
Yang Xu
Ji Yu
Joseph H. Zhang
Abstract: This article investigates the impact of the existence and financial expertise of the audit committee on corporate social responsibility (CSR) at a unique point in time: the initial public offering (IPO).  The U.S. SEC and major exchange rules allow IPOs to have a one-year transition period to establish a fully independent audit committee.  In our sample from 2001–2010, about ten percent of IPOs do not have audit committees when they are first listed on stock exchanges.  This study aims to shed light on regulators’ concerns about the cost and benefit related to the requirement that a firm has an audit committee at the time of the IPO.  Our results show that the existence and financial expertise of the audit committee are associated with higher CSR scores.  We further find that the existence of the audit committee and its financial expertise are more effective in reducing IPOs’ controversial activities than improving their public image.  This asymmetric role of the audit committee may be due to its risk-averse nature.  We also find that the narrowly defined financial expertise of the audit committee strongly impacts IPOs’ CSR activities.
Key Words: Audit committee; financial expertise; IPO; corporate social responsibility

Pressure on Internal Auditors to Alter Findings | Full Article (PDF)
Heather M. Hermanson
Dasaratha V. Rama
Abstract: Research suggests that the internal audit function (IAF) has a positive influence on corporate governance, including the deterrence of accounting irregularities and employee theft.  In order to strengthen corporate governance, the IAF must be able to do its job free from pressure to change or withdraw its findings.  The Institute of Internal Auditors’ Common Body of Knowledge study (CBOK 2010) reports that seventeen percent of U.S. Chief Audit Executives (CAEs) faced some form of coercion to change or withdraw a finding.  Using the CBOK data, we explore factors associated with U.S. CAEs who reported being subject to coercion (extreme pressure).  Overall, the results suggest that factors associated with good corporate governance (i.e., strong IAFs and strong audit committees) reduce the likelihood of CAEs experiencing pressure.  In addition, IAF performance incentives that focus on the number of findings or number of recommendations implemented are associated with an increased likelihood of pressure.  Future research may examine the source and type of pressure being applied.  In addition, future research could measure and incorporate more board and audit committee characteristics into a model for CAE pressure.
Key Words: Pressure; coercion; internal audit; corporate governance; performance incentives

Anti-Fraud Measures in U.S. Local Governments | Full Article (PDF)
Ellen L. Landgraf
Laurence E. Johnson
Abstract: Fraud surveys (e.g., as conducted by the ACFE and some large CPA firms), and events such as the recent Dixon, Illinois embezzlement case, show that local governments have appreciable fraud exposure.  We assess the current state of fraud risk awareness and fraud mitigation practices in the U.S. local government sector through a survey of finance directors of selected U.S. municipalities.  We find that awareness of, and interest in, COSO 2013 is limited, as is the use of anonymous fraud hotlines.  These results suggest ready opportunities for improving formal anti-fraud programs in the local government sector.  The survey finds that the most prevalent specific anti-fraud measures include management review and sign-off, and internal audits.  Also, finance directors consider the most effective anti-fraud measures to be internal audits, management review, surprise audits, and external audits.
Key Words: Anti-fraud measures; fraud risk; risk assessment; COSO 2013; municipalities; U.S. local governments

Considerations Beyond the Fraud Triangle in the Fraud at Société Générale | Full Article (PDF)
C. Richard Baker
Bruno Cohanier
Nancy J. Leo
Abstract: On January 24, 2008, Société Générale, the second largest bank in France, issued a press release which revealed that Jérôme Kerviel, a low-level derivatives trader, had lost €4.9 billion (U.S. $7.2 billion) as a result of engaging in unauthorized trading practices.  This paper addresses the question whether there may have been factors beyond those of the traditional “fraud triangle” which led to breakdowns in internal controls at one of the world's largest banks.  Among the additional factors considered are: 1) certain cultural and ideological differences specific to France which may have motivated the fraud; 2) the possibility of collusive behavior; 3) the possibility of willful blindness on the part of bank management even though there were well-designed controls in place; 4) certain capabilities of the fraud perpetuator related to knowledge about how internal controls might be overridden.  The contribution of the paper is to extend prior research focusing on the fraud triangle through a study of the fraud at Société Générale.
Key Words: Fraud; internal controls; bank trading information systems

Fraud Triangle and Ethical Leadership Perspectives on Detecting and Preventing Academic Research Misconduct | Full Article (PDF)
Donald L. Ariail
D. Larry Crumbley
Abstract: Student cheating continually attracts research attention.  However, faculty misconduct in the form of plagiarism, falsification, and fabrication of data (research misconduct) is also prevalent.  Given that academic research misconduct is a form of white-collar crime, that faculty members serve as ethical role models for students, that the discovery of research misconduct can damage the reputation of a college or university, and that research misconduct negatively reflects on the perceived validity of all academic research, these unethical behaviors have surprisingly garnered a minimum of research interest.
In this article, the SAS 99 fraud triangle model is used as a framework to explore the drivers of research misconduct.  Literature on the fraud triangle elements of pressures/incentives, opportunity, and attitude/rationalization, which are used primarily to address business frauds, are reviewed and related to the academic fraud environment.  The authors posit that higher education leaders can use the fraud triangle model to improve their ethics policies and procedures, and thereby minimize or mitigate future occurrences of research misconduct.  While policies and procedures targeted at the fraud triangle elements are necessary, they may not be sufficient.
For leadership initiatives to be effective, policies and procedures regarding academic misconduct must be accompanied by the development of an ethical culture.  The ethical tone-at-the-top in higher education is also a primary driver of ethical faculty behavior.  Therefore, higher education leaders should develop and implement rigorous research standards and procedures, while at the same time striving to develop an ethical climate that discourages all unethical conduct (including research misconduct).  Based on a review of the fraud triangle and ethical leadership literature, we provide suggested leadership strategies for preventing and detecting this serious problem, along with suggestions for future research.

Key Words: Faculty misconduct; academic misconduct; research misconduct; plagiarism; data falsification; data fabrication; fraud triangle; ethical leadership; tone-at-the-top; ethical culture

Data Mining Journal Entries for Fraud Detection: A Replication of Debreceny and Gray’s (2010) Techniques | Full Article (PDF)
Poh-Sun Seow
Gary Pan
Themin Suwardy
Abstract: There is limited published research to detect financial statement fraud using digital analysis to analyze journal entry data.  As far as we are aware, Debreceny and Gray’s (2010) study is the first and only such study.  In this study, we replicated and extended Debreceny and Gray’s (2010) work by examining generalizability of their techniques beyond subjects from USA.  Besides Chi-Square test, we also explored the use of mean absolute deviation method during digital analysis.  We found Debreceny and Gray’s (2010) techniques useful in facilitating cross-sectional analysis for journal entry data sets that are based on multiple organizations.  Our results confirmed that their techniques offered a comprehensive and systematic way of applying digital analysis on journal entries in a new setting.  Our analysis also found that researchers should not rely solely on Benford’s Law during digital analysis because of potential false alarms.
Key Words: Fraud; journal entries; data mining; digital analysis; Benford’s Law

Current Availability of Forensic Accounting Education and State of Forensic Accounting Services in Hong Kong and Mainland China | Full Article (PDF)
Jim Wang
Grace Lee
D. Larry Crumbley
Abstract: This study first investigates the availability of forensic accounting education in Hong Kong and Mainland China.  The results show that only three of the eighteen universities/colleges in Hong Kong offer forensic accounting courses, and there is no forensic accounting program.  Also, nineteen of around 2,800 universities/colleges in Mainland China offer forensic accounting courses or programs.  Forensic accounting education in Hong Kong and on the Mainland China lags far behind the U.S. where currently 422 universities and colleges in the U.S. offer forensic accounting courses, while ninety-seven offer forensic accounting programs. 
This study further investigates the impact of environmental factors on forensic accounting services.  We find that economic, legal, social cultural, political, and professional factors affect forensic accounting services in Hong Kong and Mainland China, but conclude there is an increasing demand for forensic accounting services.  This demand leads to a need for further development of forensic accounting education in both Hong Kong and Mainland China. 
Key Words: Mainland China; Hong Kong; forensic accounting education; accounting profession

Uncovering Majority Shareholder Fraud in a Closely Held Corporation: A Case Study to Develop Investigation Skills | Full Article (PDF)
Cynthia E. Bolt
Richard W. Powell
Abstract: Special fraud issues arise in closely held businesses.  If a majority shareholder controls the accounting records, employs family members, controls all legal and accounting transactions, and manages the operations of the business, then opportunities are abundant for self-dealing, fraud, and breach of fiduciary duty. 
This case study focuses on a minority shareholder owning fifteen percent of a closely held construction company and employed in the company’s sales and operations department.  Eighty-five percent of the company is owned by related parties, who are each employed in company administration.  The company president informs the minority shareholder that cash flow is weak, and the company cannot make its payroll obligations.  The minority shareholder, familiar with the strong level of sales and increasing market share, seeks help from an accountant.  
Students are to assume the role of the investigating accountant.  The minority shareholder expresses concerns regarding suspicious activities, including company cars, cell phones, extensive travel, and seemingly unnecessary employment of family members.  A subsequent examination of the Form 1120 S reveals deductions for expenses that appear unrelated to corporate business.  When questioned, the majority shareholders initially refuse to provide information to support the tax deductions and expenses incurred. 
The purpose of the case is to improve the student’s research and investigation skills with respect to issues in tax and ethics that can arise early on in the career of a tax professional.  The case is designed to be taught in one class period.
Key Words: Closely held corporations; fraud; minority shareholder rights; fiduciary duty; tax fraud

Designing a Case Study: Adding a Real-World Fraud Risk Assessment to Your Class | Full Article (PDF)
Mary Jepperson
Abstract: This experiential learning experience helps bring fraud concepts to life and enables students to apply critical thinking to real world risks.  After teaching students the basics about these areas of fraud—how they are committed and covered up, as well as the tracks these frauds leave behind—students analyze the processes of a volunteer company, identify fraud risks, and make specific recommendations for improvement.  This case study guide includes practical suggestions, project guidelines, and a grading rubric that form the basis for a successful fraud risk assessment project.

Key Words: Fraud risk assessment; critical thinking; experimental learning; fraud; grading rubrics

Adding Mathematical Statistics to the Auditor’s Tool Box | Full Article (PDF)
Eddward Herron
Joseph Kastantin
Jack Knorr
Abstract: This case was an actual fraud discovered by the lead author.  Auditors already have many procedures and practices to ferret out errors and fraud—but, lest they become too predictable, should always retain some “element of surprise” in their work.  The surprise, non-standard audit procedures used in this case, caught the perpetrators completely off-guard.  Unlike the fraudulent evidence submitted to the auditors, which was always carefully crafted and promptly provided, the perpetrators were unprepared for surprise questioning.  After observing certain social and quantitative anomalies, however, a simple-to-use probability model was used to determine whether certain observations of teller and loan activities were likely.  The results of those tests provided a more focused framework for making use of limited sampling resources that included the identified anomaly.  Notably, the multiple and extensive frauds were apparently not carried out strictly for pecuniary gain—but as part of some elaborate intellectual game.  

Key Words: Auditing; bank supervision; fraud; forensic accounting; alternative audit procedures

Books Reviews
BookAl Capone: A Biography
Luciano Iorizzo, 2003, 133 pp.
Greenwood Press
88 Post Road West
Westport, CT 06881

For more than 70 years, Al Capone has been equated with wealth, violence, and corruption.  This concise biography has two chapters appropriate for forensic accountants that are about his trial to put him away for income tax evasion based upon trumped-up charges.  Elliott Ness and his untouchables were unable to lock him up for murders and peddling booze and beer.

Using the net worth method (e.g., he spent more than $30,000 in phone calls in 1929) and switching the jury at the last moment, Judge Wilkerson was able to sentence Capone to eleven years imprisonment and fine him $50,000 plus court cost of $30,000.  In 1990, the American Bar Association staged a mock trial and the jurors in the mock trial voted Al Capone not guilty.  The jurors believed the government did not document his earned income.

BookComputer Forensics: Cybercriminals, Laws, and Evidence, 2nd Edition
Marie-Helm Marsas, 2015, 408 pp.
Jones & Bartlett Learning
5 Wall Street
Burlington, MA 01803-9820

This textbook is written for students in computer forensics courses and covers core topics, including defining the different types of cybercrime, conducting an investigation, the process of retrieving and analyzing digital evidence, network forensics, laws relevant to electronic evidence, and many more.  The soft cover book is also ideal for students in legal courses who are seeking an introduction to the technology involved in computer forensics investigations and the technical and legal difficulties involved in searching, extracting, maintaining, and storing electronic evidence, while simultaneously looking at the legal implications of such investigations and the rules of legal procedure relevant to electronic evidence.

The author provides an excellent chapter on cybercrime laws, entitled “Which Statute for Which Crime.”  Other key features:
  • Include a new chapter on cyberterrorism as well as new coverage on social engineering
  • Feature information on “Red October,” “Aurora,” and “Night Dragon” operations
  • Provides comprehensive coverage of civil, criminal, and corporate investigations as well as the legal issues that arise with such investigations
  • Includes case studies, discussion, review questions, practical exercises, and links to relevant websites, to stimulate the critical thinking skills of students
  • Downloadable instructor resources include an Instructor’s Manual, Test Bank, and PowerPoint Lecture Outlines

Skeptics: Viewing the World with a Rational Eye
Michael Shermer, 2016, 283 pp., $28.00
Henry Holt & Company
175 Fifth Avenue
New York, N.Y. 10010

The PCAOB complains that external auditors are not skeptical enough.  Of course, forensic accountants and internal auditors are trained to be skeptical.  This author turns a critical eye toward questions big, small, and trivial, according to a Kirkus Review.

Seventy-five of his columns are available together for the first time, covering a wide range of subjects, from psychology and human nature to religion and pseudoscience.  The book is a welcome addition for Shermer’s fans and provides a stimulating introduction for new readers.  This book is an excellent collection from a leading science commentator.

These columns appear in his skepticism section:
  • Fox’s Flapdoodle: Tabloid television offers a lesson in uncritical thinking
  • Baloney Detection: How to draw boundaries between science and pseudoscience, Part I
  • More Baloney Detection: How to draw boundaries between science and pseudoscience, Part II
  • Hermits and Cranks: Fifty years ago Martin Gardner launched the modern skeptical movement Unfortunately, much of what he wrote about is still current today
  • Skepticism as a Virtue: An inquiry into the original meaning of the word “skeptic”
  • The Exquisite Balance: Science helps us understand the essential tension between orthodoxy and heresy in science
  • The Enchanted Glass: Francis Bacon and experimental psychologists show why the facts in science never just speak for themselves
  • Fahrenheit 2777: 9/11 has generated the mother of all conspiracy theories

Phantom Billing, Fake Prescriptions, and the High Cost of Medicine: Health Care Fraud and What to Do about It
Terry L. Leap, 2011, 237 pp., $32.95
U.S. health care is a $2.5 trillion system that accounts for more than seventeen percent of the nation’s GDP, which is highly susceptible to fraud.  Estimates vary, but some observers believe that as much as ten percent of all medical billing involves some type of fraud.  In 2009, New York's Medicaid fraud office recovered $283 million and obtained 148 criminal convictions.  In July 2010, the U.S. Justice Department charged nearly 100 patients, doctors, and health care executives in five states of bilking the Medicare system out of more than $251 million through false claims for services that were medically unnecessary or never provided.  These schemes only hint at the scope of the problem.

The author discusses medical fraud and its economic, psychological, and social costs.  He provides illustrations throughout the book by dozens of specific and often fascinating cases.  He covers a wide variety of crimes: kickbacks, illicit referrals, overcharging and double billing, up coding, unbundling, rent-a-patient, and pill-mill schemes, insurance scams, short-pilling, off-label marketing of pharmaceuticals, and rebate fraud, as well as criminal acts that enable this fraud (e. g., mail and wire fraud, conspiracy, and money laundering).  After assessing the effectiveness of the federal laws designed to fight health care fraud and abuse—the anti-kickback statute, the Stark Law, the False Claims Act, HIPAA, and the food and drug laws—the author suggests a number of ways that health care providers, consumers, insurers, and federal and state officials can bring health care fraud and abuse under control, and hopefully reducing the overall cost of medical care in the U.S.

A Consensus View: Q&A Guide to Financial Valuation
J.R. Hitcher; S.P. Pratt; and J.E. Fishman, 2016, 337 pp.
Valuation Products and Services
6601 Ventnor Avenue, Suite 101
Ventnor City, N.J. 08406
The three respected appraisers provide four chapters:
  • The Income Approach
  • Cost of Capital/Ratio of Return
  • Discounts and Premiums
  • Business valuation standards and ethics.
Z. Christopher Mercer summaries the four valuable chapters as follows:
  1. Chapter 1: The Income Approach.  When should the discounted cash flow method be used?  When might it be preferable to use a capitalization of cash flow method instead?  What should the relationship be between capital expenditures, depreciation, and amortization in a multi-year forecast and for the terminal value estimation?  These and many other questions are addressed with clarity and, generally, with consensus.
  2. Chapter 2: Cost of Capital/Rates of Return.  My former partner often said about cost of capital: “It is like a great big, dark room.  Many enter and few ever come back out.”  The authors provide guidance on the components of the cost of capital that will be helpful to readers.  The entire discussion is informative and provides critical background about databases and publications that address what I call the “pieces of WACC.”  This section is quite informative.  Let’s all be informed about the pieces, but let’s not forget that the goal is always to develop reasonable estimates of the cost of capital, in spite of how we might disagree about components.
  3. Chapter 3: Discounts and Premiums.  The authors begin the discussion of discounts and premiums with an overview of the “level of value.”  Their distinction between “marketable” and “liquid” seems a bit forced to me.  So their consensus might not include me.  But that’s okay!  When looking at valuation discounts and premiums, I ask readers to focus on the economic factors that give rise to discounts and premiums.  Those factors are the valuation triumvirate of expected cash flow, risk, and growth.  Having said that, the Q&A Guide provides a good overview of the various methods currently employed to develop marketability discounts.  I was quite pleased, for example, with their answers to questions posed about the Quantitative Marketability Discount Model (QMDM)
  4. Chapter 4: Business Valuation Standards and Ethics.  Standards are a topic of great interest to me.  Their overview of the major sets of business valuation standards will be helpful for every dual-or multi-credentialed appraiser.  The discussion of compliance with standards in litigation situation is also enlightening.  And inclusion of Carla Glass’s article, “The Question of Calculations and USPAP-Another Round,” is highly formative.  If you want a quick view of business valuation standards overall, the O&A Guide is the place to go.

Computer Forensics: InfoSec Pro Guide
David Cowen, 2013, 318 pp.
McGraw-Hill Education
This book is written to help those already in IT to cross ours to a career in computer forensics, the reader should be in the IT field and have a working technical knowledge of computer, including how they work and how to repair them.

In seventeen chapters the book covers:
  • Investigating careers in computer forensics
  • Getting trained and keeping current
  • Starting a forensic lab
  • Preserving evidence
  • How to approach an investigation
  • How to investigate the most common cases
  • Documenting your finding and presenting them

2016 Valuation Handbook:Guide to Cost of Capital
R. J. Grabowski et al., 2016
John Wiley & Sons
111 River Street
Hoboken, N.J. 07030-5774
This volume is the third years of publication.  In chapter 2, the authors have added a new exhibit (Exhibit 2.4) which presents summary statistics of total returns, income returns, and capital appreciation returns of basic asset classes, as measured over the time period 1963-2015.  The 1963-2015 time horizon matches the time horizon over which the size premia, “risk premia over the risk-free rate”, and other statistics in the Risk Premium Report Study exhibits are calculated.  The new Exhibit 2.4 is the equivalent to the existing Exhibit 2.3, which presents summary statistics of total returns, income returns, and capital appreciation returns of basic U.S. asset classes, as measured over the time period 1926-2015.  The 1926-2015 time period matches the time horizon over which the size premia, equity risk premia, and other statistics in the CRSP Deciles Size Study exhibits are calculated.

They have updated and added to the discussion in Chapter 3 of the risk-free rate and the equity risk premium with analyses of the effects of flight to quality and massive central bank monetary interventions on these two important costs of capital inputs.

In Chapter 4, “Basic Building Blocks of the Cost of Equity Capital-Size Premium”, the authors have expanded their discussion of liquidity as a predictor of returns, with a summary of Roger Ibbotson and Daniel Y.-J. Kim’s 2016 update to their 2013 article “Liquidity as an investment Style”.

They also added to Chapter 12, “Answers to Commonly Asked Questions.”  More questions received from valuation analyst.
Blacklegs, Card Sharps, and Confidence Men: Nineteenth-Century Mississippi River Gambling Stories
Thomas R. Smith, editor, 2010, 271 pp.
There are fraudsters in every profession and in many organizations, whether its VW and Mitsubishi Motors emission frauds.  This editor provides twenty-eight stories about the rascals who rode the steamboats up and down the Mississippi River.  Mr. Smith has collected nineteenth-century stories, sketches, and book excerpts by a gallery of authors to create a comprehensive collection of writing about the river-boat gambler.  Long an iconic figure in American myth and popular culture but, strangely, one that has never until now received a book-length treatment, the Mississippi River gambler was a favorite character throughout the nineteenth century-one often rich with moral ambiguities that remain unresolved to this day.