Preventing Fraud and Mismanagement in Government (eBook)

JOSEPH R. PETRUCELLI is a founding partner of PP&D Accounting Services Inc. and Fraud Forces Inc., where he provides forensic accounting, tax, and consulting services. A recognized expert in forensic accounting, he is the author of Detecting Fraud in Organizations. JONATHAN R. PETERS is a professor of finance in the business school at the College of Staten Island of The City University of New York.

Cover???????????????????????? 1
Title Page?????????????????????????????????? 5
Copyright???????????????????????????????? 6
Contents?????????????????????????????? 7
Foreword?????????????????????????????? 9
Acknowledgments???????????????????????????????????????????? 11
About the Authors???????????????????????????????????????????????? 15
Preface???????????????????????????? 17
Introduction?????????????????????????????????????? 21
People are Your Greatest Risk and Your Greatest Asset 22
Focus of the Book 25
Rules: Do They Stop Fraud and Mismanagement? 28
Mird: The Four Criteria to Prove Fraud 30
Judgment 32
Structures and Systems 36
Developing Systems in Structure by Asking the Right Questions 38
Agfot (Assisted Gorilla Fraud Observation Techniques) 40
Notes 43
Chapter 1: Government and How It Works 45
Types and Forms of Local Government: An Example from New Jersey???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 47
Politics, Public Operations, and Loss???????????????????????????????????????????????????????????????????????????????????????? 51
Global Forms of Government?????????????????????????????????????????????????????????????????? 57
Revenue Functions within Governmental and Public Entities???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 67
The Federal Government?????????????????????????????????????????????????????????? 71
Fiscal Discipline???????????????????????????????????????????????? 81
Structure of Federal Debt???????????????????????????????????????????????????????????????? 82
State Governments???????????????????????????????????????????????? 85
Local Governments???????????????????????????????????????????????? 87
Public Agencies???????????????????????????????????????????? 90
Public Authorities?????????????????????????????????????????????????? 92
Government via Concessions, Franchises, and Contract Work???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 94
Public-Private Partnerships???????????????????????????????????????????????????????????????????? 95
Conclusion?????????????????????????????????? 102
Notes 103
Chapter 2: Public Finance and How Government Creates Cash Flow 105
Government Finance 101?????????????????????????????????????????????????????????? 106
Case Study: Transportation Finance?????????????????????????????????????????????????????????????????????????????????? 107
The Basic Rules of Forensic Accounting?????????????????????????????????????????????????????????????????????????????????????????? 113
Cost of Collection?????????????????????????????????????????????????? 115
Tax Collection Example-Fuel Taxes???????????????????????????????????????????????????????????????????????????????? 120
Enforcement and Compliance: Tax Evasion???????????????????????????????????????????????????????????????????????????????????????????? 121
Burden of Taxation?????????????????????????????????????????????????? 122
Maturity Mismatching?????????????????????????????????????????????????????? 126
Fiscal Federalism???????????????????????????????????????????????? 128
PFDA?????????????????????? 129
User Fee versus Tax???????????????????????????????????????????????????? 130
Pigouvian Taxes and Subsidies???????????????????????????????????????????????????????????????????????? 131
Government Revenue Sources?????????????????????????????????????????????????????????????????? 133
Taxes???????????????????????? 133
Excise Taxes?????????????????????????????????????? 135
Property Taxes?????????????????????????????????????????? 136
Personal Income Taxes???????????????????????????????????????????????????????? 138
Sales Taxes???????????????????????????????????? 143
Fine Revenues???????????????????????????????????????? 143
Fees?????????????????????? 144
Transfer Payments???????????????????????????????????????????????? 145
Bonding and Borrowing???????????????????????????????????????????????????????? 146
Bond Structure?????????????????????????????????????????? 153
Revenue Bonds???????????????????????????????????????? 154
General Obligation Bonds?????????????????????????????????????????????????????????????? 155
Core Issue: Government Spending???????????????????????????????????????????????????????????????????????????? 155
Conclusion?????????????????????????????????? 156
Notes 159
Chapter 3: Accounting for Government 161
Service Efforts and Accomplishments (SEA) Reporting???????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 163
Expectation Gaps?????????????????????????????????????????????? 164
Management-Driven Motivations???????????????????????????????????????????????????????????????????????? 165
Double-Entry Accounting???????????????????????????????????????????????????????????? 165
Modified Accrual Basis?????????????????????????????????????????????????????????? 165
Government Final Reporting?????????????????????????????????????????????????????????????????? 167
Operational and Fiscal Accountability???????????????????????????????????????????????????????????????????????????????????????? 168
Management Discussions and Analysis???????????????????????????????????????????????????????????????????????????????????? 169
Government Employees' and Officials' Responsibility to Find Inconsistencies and Irregularities?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 171
Parallel Interest Conflicts???????????????????????????????????????????????????????????????????? 172
Asset and Liability Recognition in Government???????????????????????????????????????????????????????????????????????????????????????????????????????? 172
Statement of Net Position???????????????????????????????????????????????????????????????? 173
Gordon Gecko Accounting???????????????????????????????????????????????????????????? 178
Interfund Transfers???????????????????????????????????????????????????? 179
Inflow and Outflow of Cash?????????????????????????????????????????????????????????????????? 180
Related Statements?????????????????????????????????????????????????? 180
Budgeting and One-Shot Accounting in Government???????????????????????????????????????????????????????????????????????????????????????????????????????????? 183
Budget Manipulations?????????????????????????????????????????????????????? 185
Public and Private Sector???????????????????????????????????????????????????????????????? 187
Monopolistic Control?????????????????????????????????????????????????????? 189
Government Intervention (Override)?????????????????????????????????????????????????????????????????????????????????? 191
The Odd and Unsettling Mix of Public and Private Capital?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 191
AVERT Tool?????????????????????????????????? 194
Governmental Funds?????????????????????????????????????????????????? 195
Government Funds?????????????????????????????????????????????? 197
Proprietary Fund?????????????????????????????????????????????? 202
Fiduciary Fund?????????????????????????????????????????? 204
Case Study: Multiple Jobs and Double Dipping?????????????????????????????????????????????????????????????????????????????????????????????????????? 206
Future Pension Issues???????????????????????????????????????????????????????? 207
Fixed Assets and Long-Term Debts: Self-Balancing Accounts???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 210
Assumption Based?????????????????????????????????????????????? 212
Principle Based???????????????????????????????????????????? 217
Judgment Based?????????????????????????????????????????? 219
President Obama's 2015 Proposed Spending?????????????????????????????????????????????????????????????????????????????????????????????? 221
Ratio and Tables from a Government Perspective?????????????????????????????????????????????????????????????????????????????????????????????????????????? 223
Financial Ratios?????????????????????????????????????????????? 223
Government-wide Financial Statements Summary?????????????????????????????????????????????????????????????????????????????????????????????????????? 226
Reconciliation of Government-wide and Government Funds Financial Statements (GFFS)?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 228
Financial Statement Communications?????????????????????????????????????????????????????????????????????????????????? 229
Know Management???????????????????????????????????????????? 229
OMB Circular A-123?????????????????????????????????????????????????? 229
Conclusion?????????????????????????????????? 231
Notes 231
Chapter 4: Who Works in Government and What Is Their Motivation? 235
Understanding People?????????????????????????????????????????????????????? 236
Government Workers?????????????????????????????????????????????????? 237
Elected Officials???????????????????????????????????????????????? 237
Delegate Model Versus the Trustee Model of Representation???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 239
Political Appointees?????????????????????????????????????????????????????? 241
Bureaucrats???????????????????????????????????? 242
Nurturing Homegrown Gorillas?????????????????????????????????????????????????????????????????????? 244
The Care and Feeding of a Gorilla???????????????????????????????????????????????????????????????????????????????? 244
Gorilla Hunting, Capture, Control, and Banishment???????????????????????????????????????????????????????????????????????????????????????????????????????????????? 245
The Carrot and the Stick?????????????????????????????????????????????????????????????? 247
A Case Study in Too Much Carrot Eating?????????????????????????????????????????????????????????????????????????????????????????? 248
Union Workers???????????????????????????????????????? 249
Unions as Gorillas?????????????????????????????????????????????????? 254
Virtuous Public Servants?????????????????????????????????????????????????????????????? 255
PFDA?????????????????????? 255
Political Operatives?????????????????????????????????????????????????????? 256
Human Resources: The First Line of Defense?????????????????????????????????????????????????????????????????????????????????????????????????? 258
Hiring Process?????????????????????????????????????????? 259
Personnel Data?????????????????????????????????????????? 264
Policies and Job Descriptions???????????????????????????????????????????????????????????????????????? 266
Job Descriptions?????????????????????????????????????????????? 268
Lead by Example???????????????????????????????????????????? 269
Employee Relations?????????????????????????????????????????????????? 270
Compensation and Benefits???????????????????????????????????????????????????????????????? 272
Training and Development?????????????????????????????????????????????????????????????? 278
Performance Management?????????????????????????????????????????????????????????? 280
Payroll???????????????????????????? 282
Typical Types of Frauds???????????????????????????????????????????????????????????? 285
Segregation of Duties among HR, Payroll (Hiring and Paying), and Accounting???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 285
Time Entry?????????????????????????????????? 286
Management/Supervisory Review and Approval?????????????????????????????????????????????????????????????????????????????????????????????????? 286
Security and Access Controls?????????????????????????????????????????????????????????????????????? 287
Human Resources???????????????????????????????????????????? 288
Conclusion?????????????????????????????????? 288
Notes 289
Chapter 5: Fraud in Public Agencies: Horse Trading or Stealing? 291
Understanding Government Fraud and Mismanagement?????????????????????????????????????????????????????????????????????????????????????????????????????????????? 292
Just How Pervasive Are Fraud and Corruption??????????????????????????????????????????????????????????????????????????????????????????????????????? 296
Why Do Agencies Do What They Do??????????????????????????????????????????????????????????????????????????????? 298
Who Motivates Policy????????????????????????????????????????????????????????? 302
Government and Public Agency Frauds and Mismanagement-Why??????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 303
Types of Government and Public Agency Fraud???????????????????????????????????????????????????????????????????????????????????????????????????? 307
Criminality and Intent versus Ineptitude?????????????????????????????????????????????????????????????????????????????????????????????? 310
Auditor versus Accountant Understanding???????????????????????????????????????????????????????????????????????????????????????????? 314
Quantifiable Evidence???????????????????????????????????????????????????????? 314
"More Likely Than Not" Standard???????????????????????????????????????????????????????????????????????????? 316
"Reasonable Person" Standard?????????????????????????????????????????????????????????????????????? 316
Identify, Record, and Communicate???????????????????????????????????????????????????????????????????????????????? 317
Categories of Waste???????????????????????????????????????????????????? 324
Centralization?????????????????????????????????????????? 325
Centralization vs Decentralization of Government/Public Agency Internal Accounting Control?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 330
Money and Power???????????????????????????????????????????? 334
How Wealth Distribution Leads to Fraud?????????????????????????????????????????????????????????????????????????????????????????? 334
How Donations Can Lead to Fraud???????????????????????????????????????????????????????????????????????????? 339
Political Principles to Prevent Fraud???????????????????????????????????????????????????????????????????????????????????????? 343
Health Care Diversion???????????????????????????????????????????????????????? 345
Typical Health Care Frauds?????????????????????????????????????????????????????????????????? 346
Improper Payments???????????????????????????????????????????????? 351
Meals and Entertainment: Directly Connected to a Public Entity's Operations???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 351
Applicable Limitations?????????????????????????????????????????????????????????? 352
Record-Keeping Requirements???????????????????????????????????????????????????????????????????? 353
Churches and Political Campaign Activity?????????????????????????????????????????????????????????????????????????????????????????????? 354
Common Travel and Expense Reimbursement Fraud Schemes???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 357
Systems and Structures That Can Potentially Prevent Expense Reimbursement Schemes and Abuse???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 359
Bribery, Kickbacks, and Gratuities Frauds???????????????????????????????????????????????????????????????????????????????????????????????? 360
Making or Using False Statements Frauds???????????????????????????????????????????????????????????????????????????????????????????? 360
Companies Conducting Business under Several Names???????????????????????????????????????????????????????????????????????????????????????????????????????????????? 361
Collusive Bidding???????????????????????????????????????????????? 361
Conspiracy to Defraud???????????????????????????????????????????????????????? 361
Disclosure of Proprietary Source Selection Sensitive Information?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 362
Insufficient Delivery of Contracted Items???????????????????????????????????????????????????????????????????????????????????????????????? 362
Failure to Meet Specifications?????????????????????????????????????????????????????????????????????????? 362
Common Schemes?????????????????????????????????????????? 362
Rigging Specification???????????????????????????????????????????????????????? 362
Small Purchases Pattern???????????????????????????????????????????????????????????? 363
Breaking Large Requirements into Smaller Ones???????????????????????????????????????????????????????????????????????????????????????????????????????? 363
Duplicate Payment???????????????????????????????????????????????? 363
Overstatement of Weights and Numbers Ordered?????????????????????????????????????????????????????????????????????????????????????????????????????? 363
Patterns in Expense Frauds?????????????????????????????????????????????????????????????????? 363
Conclusion?????????????????????????????????? 365
Notes 366
Chapter 6: Corrupt Policies and Actions 369
Corruption: Agency Thinking and Inbreeding?????????????????????????????????????????????????????????????????????????????????????????????????? 370
Systematic Risk???????????????????????????????????????????? 373
Why Does Wrongdoing Continue to Happen????????????????????????????????????????????????????????????????????????????????????????????? 375
Types of Corruption Found in Government???????????????????????????????????????????????????????????????????????????????????????????? 377
Examining Demographic Factors for Corruption Potential?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 382
Size of a Municipality?????????????????????????????????????????????????????????? 382
Condition of the Local Economy?????????????????????????????????????????????????????????????????????????? 384
Education???????????????????????????????? 385
Political Culture of the Municipality???????????????????????????????????????????????????????????????????????????????????????? 386
Corrupt Acts?????????????????????????????????????? 387
Corrupt Act 1: Money Makes the Government/Public Agency World Go Round?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 388
Corrupt Act 2: Entitlement versus Earned (Rights)???????????????????????????????????????????????????????????????????????????????????????????????????????????????? 389
Social Security???????????????????????????????????????????? 391
How the U.S. Government Spends?????????????????????????????????????????????????????????????????????????? 395
How People Spend?????????????????????????????????????????????? 396
Political Risks???????????????????????????????????????????? 400
Public Corruption???????????????????????????????????????????????? 404
Deregulation?????????????????????????????????????? 405
Banking Deregulation?????????????????????????????????????????????????????? 406
Energy Deregulation???????????????????????????????????????????????????? 409
Airline Deregulation?????????????????????????????????????????????????????? 409
Conclusion?????????????????????????????????? 411
Notes 411
Chapter 7: Policing of Public Corruption and Fraud 415
Background on Internal Control?????????????????????????????????????????????????????????????????????????? 417
Distinguishing among Deterrence, Prevention, and Detection?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 423
Back to Analyzing the Risk Beyond Numbers???????????????????????????????????????????????????????????????????????????????????????????????? 425
Financial Reporting Risk?????????????????????????????????????????????????????????????? 425
Operational Risk?????????????????????????????????????????????? 426
Compliance Risk???????????????????????????????????????????? 427
Worms???????????????????????? 428
Warnings Operations Revolve Management System (WORMS)???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 428
Policing and Understanding the Enforcement Gaps???????????????????????????????????????????????????????????????????????????????????????????????????????????? 431
How to Preserve the Evidence of Fraud and Corruption in the Public Entities???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 439
How to Present the Evidence in a Public Entity Fraud or Corruption Case???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 440
Conclusion?????????????????????????????????? 442
Notes 442
Chapter 8: Final Thoughts 445
Six Symbolic Shapes of Government: Organizational Symphony?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 447
Fraud Can Happen at Any Time or Place???????????????????????????????????????????????????????????????????????????????????????? 450
First Story: Embezzling from Churches???????????????????????????????????????????????????????????????????????????????????????? 451
Second Story: Dixon, Illinois???????????????????????????????????????????????????????????????????????? 454
Third Story: Nick's Roast Beef?????????????????????????????????????????????????????????????????????????? 455
The Warning System?????????????????????????????????????????????????? 456
Five Categories of Fraud?????????????????????????????????????????????????????????????? 457
Misstatement of Revenues?????????????????????????????????????????????????????????????? 458
Misstatement of Expenditures?????????????????????????????????????????????????????????????????????? 460
Misstatement of Assets?????????????????????????????????????????????????????????? 462
Inadequate Disclosures?????????????????????????????????????????????????????????? 466
Misappropriation of Assets?????????????????????????????????????????????????????????????????? 467
Why Public Entities' Auditors/Accountants Fail to Detect Fraud?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 467
A Simple Fraud Risk Plan for the Public Entity?????????????????????????????????????????????????????????????????????????????????????????????????????????? 470
Fraud and Mismanagement Types, Signs, and Suggested Actions???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 472
Approval?????????????????????????????? 472
Billing???????????????????????????? 473
Cash?????????????????????? 475
Complaints?????????????????????????????????? 478
Conflicts-of-Interest Risk?????????????????????????????????????????????????????????????????? 478
Contract Bid Award Process: Request for Proposal (RFP)?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 480
Procurement/Purchasing-Bribery and Kickbacks?????????????????????????????????????????????????????????????????????????????????????????????????????? 485
Favoritism (Nepotism)???????????????????????????????????????????????????????? 489
Information (Disclosure)?????????????????????????????????????????????????????????????? 489
Middleman Fraud and Mismanagement???????????????????????????????????????????????????????????????????????????????? 491
Reputation (Rumors)???????????????????????????????????????????????????? 492
Segregation (Overlap, Levels of Trust, Approval)?????????????????????????????????????????????????????????????????????????????????????????????????????????????? 493
Change Orders, Unusual Volume, Late Delivery, Subpar Goods and Services???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????? 493
Risk Overview and Plan?????????????????????????????????????????????????????????? 494
Compliance Checklist?????????????????????????????????????????????????????? 496
Conclusion?????????????????????????????????? 497
Final Word?????????????????????????????????? 498
Notes 500
Appendix: Tables?????????????????????????????????????????????? 501
Index???????????????????????? 541
EULA 562