Frequent Frauds Found in Governments and Not-For-Profits

• Chapter 0 - A Roadmap for Today’s Course
• Chapter 1 - Case 1 – Interim Financial Reporting
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 2 - Case 2 – Misappropriation of Benefits
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 3 - Case 3 – Personnel Fraud
  • Learning Objectives
  • The Case
  • Exercises
• Chapter 4 - Case 4 – Grant Expense Allocations
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 5 - Case 5 – Management Override
  • Learning Objectives
  • The Case
  • Exercises
• Chapter 6 - Case 6 – Pledges and Contributions
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 7 - Case 7 – Bribes and Kickbacks
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 8 - Case 8 – Fictitious Employees
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 9 - Case 9 – Misappropriation of Assets
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 10 - Case 10 – Donated Assets
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 11 - Case 11 – Procurement Cards
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 12 - Case 12 – Off-site and Out of Sight
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 13 - Case 13 – Personal Use of Public Assets
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 14 - Case 14 – Overtime Fraud
  • Learning Objectives
  • Background
  • The Case
  • Exercises
• Chapter 15 - Latest Developments
• Appendix A - AU Section 316
• Appendix B - Excerpts from AICPA Audit and Accounting Guide State and Local Governments
• Appendix C - Excerpts from AICPA Audit and Accounting Guide Not-for-Profit Organizations
• Appendix D - Government Auditing Standards Excerpts
• Appendix E - Other Sources of Information
  • Other Guidance

733312

Chapter 1 - Case 1 – Interim Financial Reporting

Learning Objectives

• To study how various debt-related covenants may be possible indicators of fraud.

• To consider how the fraud triangle may impact interim reporting.

• To examine how interim fraudulent reporting may impact planned reliance on internal controls and any related audit procedures.

• To discuss how to communicate noted indications of interim fraudulent reporting and at what level of the organization.

Background

Balsa Wood County¹ is a full service, medium-sized county in the south. The county provides a number of services to the cities within its boundaries through various interlocal agreements. All cities use the County Tax Assessor and Collector to assess and collect their municipal taxes. The county remits collections, net of a 2% administrative charge, to the cities bi-weekly during peak collection periods (i.e., the first six months after taxes are levied) and monthly during non-peak collection periods. Some cities contract with the county to provide public safety services and the county bills for these services monthly.

Balsa Wood grew slowly until the mid 1950s when oil was discovered near its county seat. The county experienced a significant amount of consistent growth from that time until the mid 1970s. Growth in the state virtually halted in the late 1970s and did not resume until the early 1990s. Unfortunately for Balsa Wood County, the economic resurgence of the 1990s benefited the surrounding counties and those along the coast rather than Balsa Wood.

In an effort to compete with the surrounding areas for economic growth, Balsa Wood voters approved a $50,000,000 general obligation bond issue in the late 1990s. As part of the referendum, the voters approved an annual millage rate of 1.5 mills for debt service on the bonds. Growth and development projections prepared by the county’s consultants indicated the additional 1.5 mills would be adequate to meet the annual debt service requirements.

Proceeds of the bonds were used to fund road improvements and to build a major league baseball stadium, both in an attempt to attract economic investment to the county. Unfortunately, the county lost its bid for a major league baseball expansion team and the stadium facility is used mainly for area concerts and high school sporting events. Very little economic or population growth has occurred in the county since it issued the general obligation bonds. The county’s population has remained stable in total with more residents moving from the smaller cities in the rural portions of the county to the county seat rather than to neighboring counties.

The county and the trustee for the bonds entered into a number of covenants with respect to the general obligation bonds. Should any of the covenants be violated, the bonds may be called by the trustee. Specific relevant covenants include

• Annual assessment of the voter approved 1.5 mills for debt service requirements.

• Imposition of additional ad valorem taxes should taxes from the 1.5 mills be insufficient to meet annual debt service requirements.

• Any taxes generated by the 1.5 mills in excess of annual debt service requirements are required to be deposited into an interest and sinking fund for early retirement of the bonds.

• Maintenance of an average annual ad valorem tax collection rate of 95%.

• Maintenance of a cumulative ad valorem tax collection rate of 80% in the first two quarters after the tax levy.

• Adequate property insurance covering the replacement value of the stadium.

• Proper maintenance of the baseball stadium facility and equipment.

• Tri-annual appraisals of the baseball stadium facility and equipment.

• Annual audited financial statements prepared on the GAAP basis.

• Quarterly reporting including quarter and year-to-date

– Budget based financial statements for the General and Water/Sewer funds;

– Tax levies and collections;

– Certificate of insurance for the baseball stadium facility and equipment; and,

– Amounts spent to maintain the baseball stadium facility and equipment.

For the past four years, the county has had to increase its operating millage rate to provide sufficient funds to meet the annual debt service requirements on the general obligation bonds.

The Case

The following exchange occurs after the first quarter of the fiscal year between the County Manager, Diane Young, and the Finance Director, Robert Evans.

“Diane, I wanted to let you know I finished the annual and first quarter bond reporting package last night. We barely complied with our covenants last year and the first quarter does not look good. I am not sure we are going to meet the 80% ad valorem collection covenant next quarter. I know this is not good news but I wanted you to be aware of the situation.”

“Thanks, Robert. I certainly appreciate the heads up on this. As you know, the Commission is looking for something else to blame on me and I am not sure how much longer I will have a job here. Violating our bond covenants might be the excuse they need to get rid of me.”

“That would be a real shame, Diane. I do not see how they can blame you for their mistakes. You were not even here when we built that white elephant baseball stadium and the roads that lead to nowhere. I guess they do not give you any credit for the parks and recreation programs you created to keep people from leaving the county.”

“You and I know that but we also know a county manager is only as good as his or her last fiscal year. Things might work out for me if I can convince that big box store developer to build here. They are supposed to be making their decision sometime in the next several months. Hopefully, we will not violate any bond covenants between now and then. I do not think anyone would want to invest in a county that cannot even pay its bills!”

“I, and a lot of others around here, think you are doing a great job considering the mess you inherited from our last County Manager. Hopefully, things will work out with the big box people. I will certainly do every thing I can to help you keep your job.”

During the next few months, Robert monitors maintenance expenditures for the stadium and tax collections to make sure the county will meet its covenants.

Expenditures for maintenance of the stadium were delayed due to the medical leave of absence taken by the Public Works Director. Even though the county is evaluated annually as to its stadium maintenance covenant, Robert does not want to take any chances in the interim.

Robert calls the Public Works Superintendent, Ken Alda, to solicit his help.

“Hey Ken, this is Robert Evans over in Finance. I am working on something here and was wondering if you could help me with it.”

“I’ll try Robert. What do you need?”

“I know the painting of the stadium locker rooms is scheduled for the fourth quarter when the use is minimal. However, I need to show the analysts in New York that we are spending money on the stadium each quarter. With your boss being out on medical leave, we have delayed a lot of maintenance at the stadium. Do you think you could process a purchase order for the painting this quarter?”

“Well, Robert, that is not really my area of expertise. The boss is real funny about the quality of the work we have done at the stadium. I would hate to do something he would not like. Besides, the place is booked almost every weekend now that the playoffs have started. It would be pretty difficult to get things painted with all those kids running in and out every week.”

“Yeah, I know. I do not want to put you in a bad place but I am really looking for some help here. What if you process a purchase order but do not issue it? Then, after the quarterly reports are run, you can cancel it. This way, I will get what I need to show the folks in New York and you will not get in trouble with your boss.”

“You are the guy in charge of the numbers, if you say this will work, I do not have a problem with it. I will take care of it this afternoon.”

“Thanks a lot, Ken. I appreciate it.”

At the end of the second quarter, Robert prepares the financial statements and other information required in the bond covenants. As he had suspected, the cumulative 80% tax collection rate was not achieved for the first two quarters. The county collected only 70% of its tax levy in the first two quarters. Robert is very concerned not only for the County Manager’s job but also for his own if he is unable to show the county has complied with its bond covenants.

Muttering to himself, Robert says “There has to be a way to get these collections up to 80%. What can I do…wait, let me see what we collected the first week of this quarter!”

Looking at the collections made during the first week of the third quarter, Robert finds the additional collections bring the cumulative collection rate to 75%.

Still muttering, he says “I can journal entry the subsequent collections into the second quarter and then reverse them in the third quarter for reporting to the trustee. That will get me close, but still no cigar. What else can I do?”

After taking a break to walk the halls, Robert pumps his fist and says “Yes! I know what to do” and runs back to his office. Pulling up the tax collection information for the cities in the county, Robert determines that municipal collections during the last month of the second quarter were higher than in prior years. He also notes that the taxes collected during the last two weeks of the second quarter have not yet been remitted to the cities.

After making a few calculations, Robert determines that he can get his cumulative tax collection ratio to 81% by “borrowing” funds from the cities. Because of the higher than normal municipal calculations, the cities will still receive an amount that is comparable to that for the same period in the prior year. He prepares journal entries to make the second and third quarter adjustments and reversals and also prepares the bank draft requests to transfer the adjusted amounts to the...

1 All organization names used in this course are purely fictitious as are the individuals depicted therein. Any similarity to real organizations or persons is purely coincidental.

733312