Building on Our

Core Values
Fraud…Can Audit Committees
Make a Difference?

January 31, 2006

The Princeton Club

New York, NY
 The Issue – Fraud Perpetrated by Management

Moderator – Ronald L. Durkin, CPA, CFE; KPMG LLP

Panelist- George P. Fritz; Ret.,

PricewaterhouseCoopers; Auditing
Standards Board

Panelist- David A. Richards, CIA, CPA; The Institute of

Internal Auditors

Panelist- Thomas M. Stemlar; Ret., Arthur Andersen

Board and Audit Committee member

Building on Our Core Values

The Issue Fraud - Perpetrated by Management

 In case you forgot:

– Cendant
– Xerox
– Enron
– Adelphia
– Computer Associates
– Global Crossing
– HealthSouth
– Tyco International
– WorldCom
– AIG

Building on Our Core Values

The Issue – Fraud Perpetrated by Management

 Different companies, different industries, different

issues, different casts of characters
 All have two things in common:
– ALL ARE FRAUD INVOLVING MANAGEMENT
OVERRIDE OF AN OTHERWISE EFFECTIVE
SYSTEM OF INTERNAL CONTROL

– THE BOARD OF DIRECTORS AND AUDIT

COMMITTEES DID NOT DETECT THE OVERRIDE

Building on Our Core Values

The Issue – Fraud Perpetrated by Management

 Responsibilities with respect to fraud

detection
– Audit Committee
– Internal auditors
– Independent auditors
– Management
 How is fraud detected/not detected?
– Results of surveys
– What is the audit committee’s role?

Building on Our Core Values

The Issue – Fraud Perpetrated by Management

 What is fraud?
– Earnings management – what does that mean?
– What are illegal acts, excluding fraud?
 Quantitative vs. qualitative materiality

 How does management perpetrate fraud?

– Management override of an otherwise effective system
of internal controls
– Collusion, related parties, concealment

Building on Our Core Values

Earnings Management Example – Revenue
Recognition

Company has met sales goal for quarter/year and management wants to
postpone additional revenue. Customers have placed orders and want
shipments now.

How would the audit committee know if management:

– Stops shipping until next quarter
– Changes company’s standard shipping terms from FOB shipping to FOB
destination
– Ships under normal FOB, but adds acceptance condition – and asks the
customer not to “accept”
– Adds a customer right of return
– “Post-dates” the shipping documents
– Tailors the transaction so it is part of a multiple delivery commitment with a
pending element that cannot be estimated  

Building on Our Core Values

 Examples of Accounts Impacted by Critical
Accounting Policies, Judgments, and Estimates

 Revenue recognition
 Impairments of long-lived assets, investments,
and goodwill
 SFAS 5 reserves (i.e. insurance, warranties,
litigation)
 Restructuring charges/acquisition reserves
 Inventory reserves and allowance for doubtful
accounts
 Pension income and expense/retirement and
post retirement liabilities

Building on Our Core Values

 The Issue – Fraud Perpetrated by Management

 Who does the Audit Committee look to/rely on with

respect to areas in which management may be
aggressive?
– Independent auditors
– Internal auditors
– General counsel
– Management
 The Audit Committee should be able to be confident that
the above are capably performing their functions.
– Audit Committee asks questions of each
– Ask additional questions when first set of responses do not make
sense

Building on Our Core Values