Why Audits Fail to Find Fraud

I am reading Cynthia Cooper’s book, Extraordinary Circumstances, which documents her experiences uncovering the massive fraud at WorldCom. I want to finish reading the book so I can write a proper review here and elsewhere. But I admit I’m having a hard time finishing the book due to all the other demands on my time…

Nonetheless, I wanted to share this passage from the book because it illustrates so perfectly the main reason why audits fail to find fraud: Those committing fraud know how to hide it from the auditors. Because of that active concealment, there is little chance of the auditors finding the fraud.

Here’s part of the WorldCom fraud:

It’s a spider-web of amounts moving as many as three times and finally spread in smaller dollar increments across a multitude of assets, mostly telecom fiber and equipment. If the amounts are funneled through enough accounts and then spread out, someone seems to have thought, they’d come out on the other end less detectable by the external auditors.

The entries are “on-top” (made at the Corporate level) and “post-close” (made after the books are closed). As management will later admit, it compared results to the earnings guidance that had been given to Wall Street and then made adjustments to make up the difference. Because this was done at the Corporate level, employees within the business units whose number were being manipulated didn’t have access to the entries.

And as Cynthia goes on to explain a little later, the access of the auditors was restricted in a way which made it impossible for them to see these accounting entries. If management really wants to commit fraud and hide it from the auditors, it’s not that hard to do so.

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Comments (2)

  • Sam E. Antar (former Crazy Eddie CFO and a convicted felon)

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    It’s quite easy to commit fraud under the auditor’s noses. Much of the field work is done by relatively inexperianced staffers with little or no training in fraud detection or the mechanics of white collar crime.

    Audit work is boring, too. So all a criminal has to do is to be extra kind to his auditors (not to raise red flags) and distract (rather than obstruct) them from their work. Towards the end of the audit, we gave our auditors tons of paperwork to examine. However, they did not have enough time to examine all of our documents and rushed to complete the audit.

    That’s just a few of the reasons why the Crazy Eddie frauds went undetected for almost 20 years.

    Reply

  • Mike C

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    We provide our auditors with a full listing of on-top adjustments. It should be standard procedure for auditors to reconcile from the general ledger to the externally-reported numbers. I would hope that auditors have changed their ways since the Worldcom days.

    I am also reading Cynthia’s book and am about 1/3 of the way through it. I look forward to reading your review.

    Reply

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