Governmental Fraud Statistics

It’s that time of the year when many local government auditors are gearing up for the new audit season. Consider using the following statistics when performing your fraud brainstorming sessions.

The 2012 Association of Certified Examiner’s Report to the Nations revealed a median loss of $81,000 per governmental fraud case; in the previous two surveys the median loss was $100,000 per case. Government and public administration is the second most commonly victimized industry (coming in second only to banking and financial services). That same survey reflects the following governmental fraud case statistics (based on 141 cases):

SchemePercent of Cases
Corruption (e.g., bribes)35.5%
Billing (e.g., fictitious vendor)23.4%
Non-Cash19.1%
Skimming (theft of cash before it is recorded on books)17.7%
Expense Reimbursement13.5%
Payroll12.8%
Check Tampering10.6%
Cash on Hand8.5%
Cash Larceny (theft of cash after it is recorded on books)7.1%
Financial Statement Fraud6.4%
Register Disbursement2.8%
(Note - Some cases involved more than one scheme.)

Click here to see the full ACFE report.

Missing Critical Clues in the Audit Process

In my college years, I worked as a cotton scout inspecting fields for insects and then advised the farmers as to the frequency of spraying. One hot summer day I walked through a cotton field stopping here and there to inspect plants for potential problems. Everything looked fine. While exiting the field, I was thinking, “no spraying needed here.”

iStock_000000282140XSmall

Courtesy of iStockphoto.com

But then the words of my father rang in my ear, “always look at the big picture.”

As I stepped up on the tailgate of my truck and scanned the entirety of the field, I saw what could not be seen up close: discoloration of a broad section of the field. Mites (very small insects) – sucking the life from plants in the back right-hand corner of the field. Left unchecked, they would destroy the crop.

Call me strange, but as I’ve performed audits through the years, I’ve often thought about this cotton field. I have not forgotten the lessons learned:

Patterns illuminate needs.

Look closely, but also look broadly.

A few years back, the then-new risk assessment audit standards brought appropriate attention to seeing the big picture. The Auditing Standards Board knew that auditors were too myopic. Consequently, they issued standards requiring that we understand the business and its environment – the broader picture.

Understanding the Business and Its Environment

When trying to understand the broader picture, I like to ask the following risk-assessment questions of management and board members:

*What keeps you awake at night?
*If you had a magic wand and could wave it over your business and fix one issue, what would that be?

I am trying to step into the shoes of the CEO, the CFO, and key board members. Management and those charged with governance already know what the risks are. They already know what the big picture is. As an auditor, I need to see the business as they do, and if I do, patterns (from the business as a whole) will illuminate needs (that which calls for detailed substantive procedures). Risk drives the audit plan.

For example, in a bank audit, a deteriorating economy (a pattern) adversely affects bank loan collections and real estate values. The auditor’s awareness of the pattern leads to more detailed substantive tests (a closer examination of the loan loss reserve calculations and greater scrutiny of real estate appraisals for foreclosed properties).

As I recently stated in my blog post titled Slaying the Sacred Cow: The Balance Sheet Audit, auditors will often gravitate to a balance sheet approach (without sufficiently performing risk assessment procedures), but if we do, we may miss important patterns that deserve additional scrutiny.

What audit questions do you ask to gain your client’s perspective (and see patterns)?

The Three-Day Audit

My old friend Rhett Harrell used to say, “if you had only three days to perform an audit, what would you do?” His rhetorical question was designed to make me think about efficiency. We all know an audit cannot be done in three days, but with that thought in mind, here’s an idea that may help.

Thinking outside the box

Courtesy of iStockphoto.com

Prior Year Audit Entries as a Risk Map

If you audit smaller entities where you ordinarily make 10, 20 – and sometimes even more – journal entries, consider the following. (This bit of thinking will not work for companies that customarily have one or two audit entries each year, as is the case with companies that have highly trained accounting personnel.)

I have noticed that for smaller entities, I usually make the same journal entries year after year – often with little variation (provided the entity has the same accountants). This seems particularly true of small governments and nonprofits.

If our goal is to determine that the financial statements are materially correct (and it is), then using the summary of prior year audit entries as a map will often – in audits of smaller entities – lead you to areas that need the most attention.

Here’s a sample work paper.

Summary of Prior Year Audit Entries For Last Five Years

Summarize the largest audit journal entries for the last five years.

Current year materiality = $225,000
Type of AdjustmentNumber of Times Entry Made During Last Five YearsAverage Audit Adjustment
Accounts Payable2$45,252
Allowance for Uncollectible Accounts4$175,122
Inventory Obsolescence2$55,000
Interest Rate Swap Adjustment to Fair Value5$185,777

This work paper points out higher risk areas, at least historically. As I previously stated, when you have the same accountants, history often repeats itself. I find that once I address these areas, the financial statements are often materially correct.

Your Efficiency Idea

What idea helps you be most efficient?

One Additional Thought

If your audit firm makes numerous audit journal entries and you prepare the financial statements, consider your independence – especially for Yellow Book engagements. A large number of journal entries may indicate that management does not have the requisite skill, knowledge, and experience for the audit firm to be independent.

Follow the Yellow Book Road

Does the Yellow Book change your audit approach?

iStock_000019443856_ExtraSmall

Courtesy of iStockphoto.com

Steven Covey, author of The Seven Habits of Highly Effective People, tells us when planning life, begin with the end in mind – then work backwards to create present goals. I know an audit is not your life (or even close to it), but the same logic makes sense. Begin with the Yellow Book report and work backwards to plan appropriately.

The Yellow Book report states “the purpose of the report is solely to describe the scope of our testing of internal controls and compliance and the results of the testing, and not to provide an opinion.”

The two main components of a Yellow Book report are as follows:

1. Internal Control Over Financial Reporting
2. Compliance and Other Matters

Internal Control Over Financial Reporting

image

GoalReport significant deficiencies and material weaknesses noted during the audit

Is the auditor required to design tests related to internal controls? No.

The Yellow Book report states “In planning and performing our audit…we considered…internal control…to determine the audit procedures.” There’s no goal to look for control deficiencies, but if we note significant deficiencies or material weaknesses, we are to report them.

Control deficiencies are normally noted in the planning stages of the audit, usually as we perform walkthroughs and fraud inquiries. Control deficiencies may also be noted as we audit balance sheet accounts and make journal entries – significant misstatements often result from control weaknesses.

Compliance and Other Matters

image

Goal – To report on material noncompliance with laws, regulations, grants, and contracts

Is the auditor required to design tests related to material noncompliance? Yes.

Government Auditing Standards require that transactions be tested for compliance with laws and regulations that may have a material effect on the financial statements.

The Yellow Book requires reporting on the following:

  • Instances of fraud and noncompliance with provisions of laws or regulations that have a material effect on the financial statements or other financial data significant to the audit objectives and any other instances that warrant the attention of those charged with governance
  • Noncompliance with provisions of contracts or grant agreements that has a material effect on the financial statements or other financial data significant to the audit objectives
  • Abuse that is either quantitatively or qualitatively material

End in Mind

Now with this basic understanding, we can plan our Yellow Book audit.

As we note significant or material control weaknesses, we will capture those for reporting.

Also we will design audit procedures to test for potential material noncompliance with laws, regulations, grant, and contracts. Any material (or other significant) noncompliance will be captured and reported.

Now let’s follow the Yellow Brick (that is… Book) Road.