In fraudulent financial statement cases, the fraud examiner must competently interview the CEO and CFO for one reason - they probably committed the crime. 

This article is excerpted from the Fraud Examiners Manual, Third Edition Updated 2000-2001. © 2000 Association of Certified Fraud Examiners. 

Financial statement fraud doesn't occur in an isolated environment. People in organizations who have both motive and opportunity are the prime candidates to commit fraudulent misstatement. In the overwhelming majority of situations, two key managers most often participate actively in the fraud: the Big Dogs, the chief executive and the chief financial officer. From there, the smaller pups - the staff members - become involved largely out of necessity. Those who aren't directly involved often aren't aware that anything is wrong.
The competent and experienced fraud examiner must have the ability to solicit honest answers from the CEO and CFO to tough - but vital - questions about whether anyone has tampered with the books. 

Interviewing Techniques

Situations in which accountants are tempted to misstate financial statements most often involve pressure connected with financial performance. The following is a fictitious conversation between upper managers of a corporation.

CFO (to CEO): "Boss, it looks like we won't have a good year financially. We told the shareholders (or bank) that our earnings would be $4 a share, and it looks like we'll be very lucky to make $3." 

CEO: "Well, what are we going to do about it? If we miss the earnings projections (or don't get the loan) our geese will be cooked; we'll both lose our jobs. We have to boost those earnings up to where they should be." 

CFO: "What do you mean?" 

CEO: "What I mean is that it's your job to bring in the numbers. You're going to have to find a way to get them up. I'm sure we can probably make up the difference next year, but for now, you get raise up our earnings (or assets or equity) however you have to. All financial statements are essentially estimates anyhow. So you figure out how to 'estimate' the numbers more in our favor. I don't know how to do it, and I don't want you to tell me. But get it done." 

The CFO faces a dilemma: cook the books or lose his job. If the CFO steps over the edge, chances are she will need to enlist the aid of accounting and clerical personnel to carry out the details, even if these employees don't know what they're actually doing. In order to detect financial statement frauds through interviews, management as well as key support staff must be interviewed. The following issues should be considered by fraud examiners when conducting interviews:

1. A fraud examiner has the legal right to be fearless in asking questions, as long as the questions are asked privately and under reasonable circumstances. That doesn't extend to accusations - only questions. Example: "Are you still cooking the books?" is an accusation. It's important to know the difference, and frame questions accordingly.

2. All interviews should be conducted one person at a time. Groups of people shouldn't be interviewed because members tend to influence each other. Interviews should always be conducted under private conditions, which permit the respondent to answer candidly.

3. A good interviewer will be non-threatening in approach. The interviewer shouldn't show surprise, disgust, or be judgmental; those actions will inhibit the flow of information.

4. An interviewer should warm up the respondent thoroughly before asking sensitive questions. This means that fraud should usually be the last thing discussed in an interview; get all the procedural information and internal control questions out of the way first.

5. An interviewer can almost always ask tough questions without offending if it's done right. One way to make the process easier is to explain the nature of interest before asking the question. Example: "As you know, we as auditors are required to actively look for fraud. That means we must ask you some direct questions about the subject. Do you understand?" After obtaining a positive response, the fraud examiner should proceed with questions, from the easiest to the hardest.

6. An interviewer also can make tough questions more palatable by phrasing them hypothetically. For example, don't start with the most direct question, "Have you committed fraud?" The common response of course would be "no," whether that person actually has or not. It would also be common for the respondent to either laugh at the question or be offended by it.
A better approach with a CFO is to first ask, "Suppose someone in the position of chief financial officer decided to pump up the financials. How would she do it?" The first question, although legal and direct, isn't as likely to elicit specific information as would the latter.

7. Before ending an interview with a highly placed executive, the interviewer should ask the executive specifically if he or she has committed fraud. The question may be phrased something like, "Ms. Smith. My professional responsibilities require me to ask you one particularly sensitive direct question. Have you committed fraud or illegal acts against the company?" Again, the vast majority of respondents will answer "no" without hesitation, whether they have or not. However, simply asking this question will give the fraud examiner a much more favorable posture if attacked professionally for not detecting the fraud. The fraud examiner will be able to tell the court or any other authority that he or she didn't shirk professional responsibilities, asking all persons interviewed in connection with the audit or examination if they were involved in the fraud, and that they lied.

The Interview

With the above as a predicate, there's a series of questions you can ask which are designed to elicit the most specific information in a professional manner. These questions will also help the fraud examiner to not only uncover potential problems, but also to comply with requirements under the AICPA's Statement on Auditing Standards No. 82, the Institute of Internal Auditor's Statement on Internal Audit Standards No. 3, and the Association of Certified Fraud Examiners' Code of Professional Ethics, Article 1.

THE CHIEF EXECUTIVE OFFICER

Generally, the CEO should be interviewed first in any proactive or reactive fraud situation. There are several good reasons for this approach. First of all, the fraud examiner must have a thorough understanding with top management of his responsibilities in this area. Second, it's unwise to conduct sensitive inquiries within any organization without first advising the CEO. If he learns from some other source that the fraud examiner is making discreet fraud-related inquiries without telling him, he's more likely to misunderstand your objectives and take the inquiry as a personal affront. Third, as stated, if there's any significant diddling with the books, the chief executive officer is always involved. The fraud-related questions the fraud examiner should ask in connection with a regular audit should include, as a minimum, the following:

1. "Mr. CEO, as you know we're required to assess the risk that material fraud exists in every company, not just yours. This is sort of a sensitive area for everyone, but our professional responsibilities dictate that we address this area. Do you understand?" (Wait for an affirmative response before proceeding.)

2. "Do you have any reason to believe that material fraud is being committed at any level within the organization?"

3. "Mr. CEO, one trend in fraud is that small frauds are committed by employees with little authority, which means the largest ones are usually committed with the knowledge of upper management. Do you understand that?" (Wait for an affirmative response before proceeding.)

4. "Because of that, we're required to at least look at the possibility that all CEOs, including you, might commit significant fraud against customers, investors, or shareholders. Do you understand our situation?" (Wait for an affirmative response.)

5. "So during this audit (examination) I need to ask direct questions about this subject with you and your staff. As a matter of fact, we'll at least discuss the possibility of fraud with every employee we talk with in connection with this audit/examination. Do you have any trouble with that?" (Wait for a negative response. If the CEO protests, satisfy his objections. If he cannot be satisfied, assess the risk of whether the CEO is attempting to obstruct the audit or examination.)

6. "First, let's look at your CFO position. Can you think of a reason she might have to get back at you or the company by committing fraud?"

7. "Has the CFO ever asked you to approve any financial transaction you thought might be improper or illegal?"

8. "Do you know whether the CFO has any outside business interest that might conflict with her duties here?"

9. "Does the CFO employ any friends or relatives in the company?" (Look for possible conflicts or sweetheart deals.)

10. "What information do you have about the CFO's lifestyle?" (Look for expensive homes, cars, toys, and habits.)

11. "What is you general impression of how the CFO gets along with her staff?" (Look for abuses of authority, etc., that would motivate employees directly below the CFO to participate in fraud.)

12. "How do you think fraud in your company compares with others in the same industry?"

13. "Of course, Mr. CEO, I must ask you many of the same questions about yourself. Is there any reason that anyone below you might claim you're committing fraud against the company?"

14. "I must also ask you some personal financial questions. Does that give you any problem?" (Wait for negative response.)

15. "Please give me a current estimate of your personal assets, liabilities, income, and expenses. What percentage of your net worth is tied directly to this company? (Look for highly leveraged individuals whose company holdings are the significant portion of their net worth.)

16. "Are you currently experiencing any personal financial problems?" (Look for lawsuits, liens, judgments, or other indicators.)

17. "Do you have friends or relatives working for major suppliers or vendors to your company?" (Look for conflicts of interest.)

18. "Do you have friends or relatives working for major suppliers or vendors to your company?" (Look for conflicts.)

19. "Do you own any portion of a company that does business with this organization?" (Look for conflicts.)

20. "Hypothetically, if you wanted to pump up your company's profits, what would be the easiest way to do it?"

21. "As I said, we'll be required to ask many questions of your staff. Is there any reason why someone who works for you would say you are at risk to commit significant fraud against the company or its shareholders?"

22. "Mr. CEO, this is the last question, and it should be obvious why I have to ask it. Have you committed fraud or other illegal acts against the company?" (Do not apologize for asking the question; it's you job.)

THE CEO'S TOP STAFF

Chief executive officers of corporations, large and small, are busy individuals. Because they tend to be "big picture" people by nature, they rely heavily on their staffs - principally their personal assistants - to take care of the details. But personal assistants don't usually get closely tied with the boss without a demonstrated history of loyalty and discretion. In short, if you make the boss's assistant mad, your fraud-related questions are going to be interpreted in the worst possible light, thereby making your job much more difficult.
So the key to interviewing the CEO's top staff is to approach it correctly from the outset. That means laying a great deal of groundwork before you ask sensitive questions. Start with procedural matters or some other non-sensitive topic, and ask the fraud-related questions toward the end of your conversation.

1. "Mr. Assistant, part of my job as a fraud examiner is to assess the risk that the company's books aren't materially correct as a result of fraud by employees or management. I already have talked about these issues to your boss, and he understands the importance of this, and that in the audit I will be talking to everyone about the subject to some extent. Do you have any problem with that?" (Wait for negative response.)

2. "Do you think fraud is a problem for business in general?" (icebreaker)

3. "How do you think this company stacks up with others in terms of honesty of its employees and managers?"

4. "Do you ever hear rumors in the company that someone is committing fraud, especially someone high up in the organization?"

5. "Is the company in any kind of financial trouble that would motivate management to misstate the company's profits?"

6. "Do you think your co-workers are essentially honest?"

7. "Has anyone you work with ever asked you to do something you felt wasn't legal or ethical?"

8. "How would you handle that situation if someone asked you?" (Solicit information on fraud reporting program.)

9. "If someone in a position of authority in the company wanted to commit fraud, what would be the easiest way to do it?"

10. "May I ask you to report any instances in the future if someone asks you to do something to the books and records that you feel isn't right?" (Solicit future cooperation.)

THE CHIEF FINANCIAL OFFICER

In the vast majority of cases, the CFO is an integral part of any financial statement fraud As a result, the interview with the CFO should concentrate not only on possible motivations to commit fraud, but the opportunity to do so. Since most CFOs are accountants, they should more readily understand your fraud-related mission. This can be good and bad; good if the CFO is honest, and bad if she isn't. Among all financial personnel, the CFO is in the best position to know how to cook the books and keep it from being uncovered. If that weren't enough, many CFOs are hired directly from the firms who audit the company. Is there any other person more likely to be at the center of the fraud?

1. "Ms. CFO, you now know that new audit standards require us to actively assess the risk that material fraud could be affecting the financial statements. We have talked to the CEO, and he is fully aware that we will be inquiring of most everyone we speak with about the possibility of fraud or irregularities. You understand that, don't you?" (Wait for affirmative response.)

2. "Of the accounts on the company's books, which do you suspect might be the most vulnerable to manipulation, and why?"

3. "What kind of history does the company have with fraud in general, including defalcations and employee thefts?" (Look for signs of a weak corporate culture.)

4. "We know that fraud usually exists to some extent - even if it's small - in most companies. How does your company compare to others, do you think?"

5. "What is your overall impression of the company's ethics and corporate culture?"

6. "During our assessment of risk of fraud in your company, are there any specific areas you'd like to discuss with us?"

7. "Is there any reason that someone in the company might say that management had a motive to misstate the financials?"

8. "Has anyone you work with ever asked you to do something with the books that you thought was questionable, unethical, or illegal?"

9. "Are you involved in the personal finances of the CEO? If so, is there anything about them that might make you think he is under personal financial pressure?"

10. "Does the CEO's lifestyle or habits give you any reason to think he may be living above his means?"

11. "Has anyone in a position of authority ever asked that you withhold information from the auditors, alter documents, or make fictitious entries in the books and records?"

12. "Is there anything about your own background or finances that would cause someone to suspect that you had the motive for committing fraud?"

13. "Because of your importance as CFO, I must ask you one final question: Have you yourself committed fraud or illegal acts against this company?" (Remember - don't apologize.)

THE ACCOUNTING STAFF

If a financial statement fraud had been ordered by the CFO, either she will do the actual dirty work herself, or she will get her staff to do it. In some cases, the staff will understand the big picture, but in most situations, the employee is told only what he or she needs to know. It's uncommon for a CFO to disclose to a lower staff person that she is cooking the books.

As a result, the fraud examiner generally must complete his audit work before beginning the interviews of the accounting staff. This will allow specific transactions to be discussed with the people who actually entered them in the company's records. For example, all thorough audits will examine the major journal entries. Frequently, these journal entries will be ordered by the CFO but actually entered by a staff member. There generally would be no record of the CFO requesting the entry, so this fact must be established through interviews.

Interviews of the accounting staff will allow sufficient examination of procedures and controls over assets. After these questions are answered, the fraud examiner can generally pursue the line of inquiry suggested above for the CEO's assistant.

There are similarities and differences in the questions asked of the CEO, the CFO, and their staffs. In the case of CEO and the CFO, both were specifically asked if they had committed fraud against the company, albeit in nice ways. The staffers weren't asked that specific question. Again, the reason is that financial statement fraud generally originates with one or both of these executives. Staffers have less motivation to engage in this type of fraud, and are therefore at less risk to do so. They are also less likely to have the financial authority to enter transactions in the books without higher approval.

Asking the CFO and the CEO the direct question will add measurably to the prevention of fraud. There are few defenses to not asking the question, other than the specter of embarrassing the executives being audited.

In a possible financial statement fraud case, the smaller pups - the staff members - may hold a few pieces of the puzzle but the fraud examiner must competently and carefully interview the Big Dogs for one reason: they probably did it.