Question

4-3 (Learning objectives 4-8 and 4-14) List and explain at least four proactive audit tests that could be performed to help detect a shell company scheme.

Answer 1

A shell corporation is a company or corporation that exists only on paper and has no office and no employees, but may have a bank account or may hold passive investments or be the registered owner of assets, such as intellectual property, or ships. Shell companies may be registered to the address of a company that provides a service setting up shell companies, and which may act as the agent for receipt of legal correspondence (such as an accountant or lawyer). The company may serve as a vehicle for business transactions without itself having any significant assets or operations. Sometimes, shell companies are used for tax evasion, tax avoidance, and money laundering, or to achieve a specific goal such as anonymity. Anonymity may be sought to shield personal assets from others, such as a spouse when a marriage is breaking down, from creditors, from government authorities, besides others.

Shell companies are fictitious entities created for the sole purpose of committing a fraud. Because shell company schemes are among the most costly of all forms of occupational fraud, it is imperative that organizations have controls in place to prevent these frauds. The most important is the strict segregation of duties, then maintaining and approving of vendor list.

1.One way to search out red flags is to sort payments by vendor, amount, and invoice number.

2.If company’s expenses exceed budget projections or if expenses increased from the previous year, it is a sign of fraudulent billing activity

3.Because billing schemes generally involve the purchase of fictitious goodsor services, a review of purchase levels can help detect this form of fraud.

4.When a red flag arises, the purchases in question should be reviewed, and both performance of the service and the legitimacy of the provider should be confirmed. By tracking approval authority for all purchases, organizations can also run comparison reports looking for employees or managers who approve an unusually high level of services based on their job function.

5.Companies should monitor trends in average unit price of goods purchased, because significant increases can be a sign of not only pass-through schemes, but also kickback schemes.

6.Companies should also pay attention to the types of goods purchased. In many shell company schemes, the nature of the purchases is patently unreasonable, but invoice is still approved. Auditors, accountants, and managers should have a basic understanding of how companies function.