How Benford’s Law Could Have Been Used to Find a $2M Fraud As it Happened
When CPAs Christopher McDonald and Nancy Rickett were retained by a lawyer to investigate a two-million dollar fraud, they weren’t sure what they would find.
The task was simple: the accounting duo, who together make up McDonald Rickett Chartered Professional Accountants, had to investigate an already-exposed fraud involving one individual who managed to pocket millions from their organization over four years to determine if the original accounting firm involved could have caught it.
The Burnaby-based firm was familiar with IDEA, having implemented it in 2018 to audit multiple not-for-profit organizations in Canada’s Far North. So, when tasked with the fraud case, McDonald knew the software’s data analytics capabilities would be a good place to start.
They watched IDEA video courses with Mark Nigrini and became familiar with Benford’s Law, which he says he hadn’t known about before IDEA.
“We looked at what the fraudster had taken and it fit perfectly into Benford’s Law,” he says. “All the numbers were under 10,000 dollars.”
The fraudster involved with the original case had been copying invoices and having her bank transfer funds to her personal account. She had started small, initially around $1,000, then increasing gradually over time to over $9,000, but always staying under $10,000.
“She must’ve felt that going above $10,000 would trip something,” McDonald explains.
Benford’s Law, which observes frequency distribution of the leading digits of naturally occurring number sets, can be used to find ‘anomalous’ numbers within these sets—numbers that may have been fabricated by a human, for example.
When McDonald and Rickett applied IDEA’s Benford tests to the case at hand, the results suggested fraudulent activity. They deemed that the original accounting firm would have been better equipped to detect the fraud as it occurred by running Benford tests.
“IDEA wouldn’t have been the solution on its own, but it would have pushed us in the right direction, even though using Benford’s Law isn’t a current auditing standard requirement,” McDonald says. “If (the original accounting firm) had it, they would have at least been able to say, ‘Hey, maybe something’s up here.’”
Without it, the firm had been left in the dark, with no indicators suggesting fraud since the fraudster had such a clean system running. Her invoices were spot on. And it wasn’t enough to confirm accounts payable from the suppliers, because they were all paid on time. Eventually, the bank noticed regular supplier cheques deposited into her account and flagged it. The police were notified and the fraudster, who is now serving jail time, promptly confessed.
But examining past fraud is but a fraction of the uses McDonald and Rickett find for IDEA, which they regularly use to audit NFPO’s receiving government dollars.
“They ship their accounting files to us, we convert them to be suitable for IDEA import, then we run the tests on it,” Rickett explains, highlighting IDEA’s General Ledger and Exceptional Exceptions tests as the first pit stop for any project files.
“That’s the first thing we do, before the audit,” McDonald adds. “Just to see what the profile of transactions looks like.”
They’ve noticed a trend among existing assurance clients who might not be keeping a close eye on the details of business activity.
“As the shareholders get older, they’re not as involved in the business anymore and they’re not looking at all the cheques going out anymore,” McDonald says. “As a service to them, we use IDEA to scan for patterns of risky behaviour.”
The firm has also used CaseWare Working Papers since 2005, when they adopted it to replace paper-based accounting processes. And McDonald knew what a paper-based environment looked like; he started his firm in 1981 when, “everything was on paper. You were lucky if you had a PC in your office that was an XT. So, we had a word processor in our office on an XT and that was it.”
Rickett joined his firm in 1988 as a staff member. Over the years she studied, took courses and became a designated CPA, all while raising a young family, and became a partner at McDonald Rickett in 2006.
“We saw all these areas where we could electrify all these processes with CaseWare,” she says. “Same thing happened with IDEA. Went to it a couple years ago and got ourselves going a bit, and ran some basic stuff. Then we took courses and now we feel like we’re just getting started with it. It’s powerful. We need IDEA.”
Paul Leavoy is a writer who has covered enterprise management technology for over a decade. Currently, he researches and writes on data analytics and internal audit technology.
See Benford’s Law in action by watching our on-demand webinar, How to Recognize Fraud Like a Pro Detective.