INTERNAL AUDITING RED FLAG DETECTIONS AND FRAUD DIAMOND

Created By : Febiyanti Dwi Annisa (120110100006) Ratna Saridewi (120110100103)

Faculty of Eco o!"c# a d Bu#" e## $ad%ad%ara U "&er#"ty '()*

Fraud Red Fla+#

This tool provides opportunity red la!s" personal #hara#teristi# red la!s" and situational pressure red la!s o possible raudulent a#tivity$ %t also provides indi#ators o possible raudulent a#tivity or various business pro#esses in#ludin! a##ounts payable pro#ess" pur#hasin! pro#ess" payroll pro#ess" #ash re#eipts pro#ess" a##ounts re#eivable pro#ess" inventory&produ#tion pro#ess" and inan#e pro#ess$ ), O--ortu "ty Red Fla+# a$ Fraud 'ondu#ted (y )*ployees A!ainst The 'o*pany Fa*iliarity with operations (in#ludin! #over+up #apabilities and in a position o trust) 'lose asso#iation with suppliers and other ,ey people A ir* that does not in or* e*ployees about the rules or the a#tion ta,en to #o*bat raud Rapid turnover o ,ey e*ployees either by -uittin! or irin! .o *andatory va#ations" periodi# rotations" or trans ers o ,ey e*ployees %nade-uate personnel+s#reenin! poli#ies when hirin! new e*ployees to ill positions o trust An absen#e o e/pli#it and uni or* personnel poli#ies .o *aintenan#e o a##urate personnel re#ords o dishonest a#ts or dis#iplinary a#tions )/e#utive dis#losures and e/a*inations not re-uired A dishonest or overly do*inant *ana!e*ent 0peratin! on a #risis basis .o attention paid to details 1nrealisti# produ#tivity *easure*ents 2oor #o*pensation pra#ti#es A la#, o internal se#urity %nade-uate trainin! pro!ra*s b$ Fraud 'ondu#ted (y %ndividuals 0n (ehal 0 The 'o*pany Related party transa#tions A #o*ple/ business stru#ture

.o e e#tive internal auditin! sta A hi!hly #o*puteri3ed ir* A ir* in atypi#al or 4hot4 industries A ir* that uses several di erent auditin! ir*s or #han!es auditors o ten A ir* that is relu#tant to !ive auditors needed data A ir* that uses several di erent le!al ir*s or #han!es le!al #ounsels o ten A ir* that uses an unusually lar!e nu*ber o di erent ban,s" none o whi#h #an see the entire pi#ture 'ontinuous proble*s with various re!ulatory a!en#ies 5ar!e year+end and&or unusual transa#tions An inade-uate internal #ontrol syste* or no en or#e*ent o the e/istin! internal #ontrols 1nduly liberal a##ountin! pra#ti#es 2oor a##ountin! re#ords and inade-uate sta in! in the a##ountin! depart*ent A ir* that inade-uately dis#loses -uestionable or unusual a##ountin! pra#ti#es

#$ So*e #ir#u*stan#es that *i!ht #ontribute to raud in#lude6 7ea, internal #ontrol environ*ent 8ana!e*ent does not e*phasi3e the role o stron! internal #ontrols 8ana!e*ent does not prose#ute or punish identi ied e*be33lers 8ana!e*ent does not have a #lear position about #on li#ts o interest 9i!hly pla#ed e/e#utives are less than prudent or restrained on e/penditures or travel and entertain*ent" urnishin!s o o i#es" !i ts to visitors and dire#tors" et#$ %nternal auditin! does not have authority to investi!ate #ertain e/e#utive a#tivities involvin! heavy personal e/penditures A##ountin! poli#ies and pro#edures are on the la/ or loose side ', $er#o al C.aracter"#t"c Red Fla+# 7arnin! Si!nals Should :o 0 'hara#teristi#s Su#h As6

7hen )*ployees )viden#e

Rationali3ation o #ontradi#tory behavior 5a#, o a stron! #ode o personal ethi#s A wheeler+dealer personality 5a#, o stability A stron! desire to beat the syste* A #ri*inal or -uestionable ba#,!round A poor #redit ratin! and inan#ial status

*, S"tuat"o al $re##ure Red Fla+# Fraud 'o**itted (y )*ployees A!ainst The 'o*pany Si!ni i#ant observed #han!es ro* past behavior patterns 9i!h personal debts or inan#ial losses %nade-uate in#o*e or li estyle )/tensive sto#, *ar,et or other spe#ulation behavior )/#essive !a*blin! 1ndue a*ily" #o*pany" or #o**unity e/pe#tations )/#essive use o al#ohol or dru!s 2er#eived ine-uities in the or!ani3ation Resent*ent o superiors and rustration with ;ob 2eer !roup pressures 1ndue desire or sel +enri#h*ent and personal !ain )*otional trau*a in ho*e li e or wor, li e Fraud 'o**itted (y 8ana!e*ent 0n (ehal 0 The 'o*pany 1n avorable e#ono*i# #onditions within the industry %nsu i#ient wor,in! #apital Dependen#e on one or two produ#ts #usto*ers or transa#tions Severe obsoles#en#e 9i!h debt )/tre*ely rapid e/pansion throu!h new business or produ#t lines Redu#ed ability to a#-uire #redit or restri#tive loan a!ree*ents 2ro it s-uee3e< #osts and e/penses risin! hi!her and aster than sales and revenues Di i#ulty in #olle#tin! re#eivables 2ro!ressive deterioration in -uality o earnin!s

Si!ni i#ant ta/ ad;ust*ents 8ana!ers who re!ularly assu*e subordinates duties .on#o*plian#e with #orporate dire#tives and pro#edures 8ana!ers dealin! in *atters outside their pro it #enter=s s#ope 2ay*ents to trade #reditors supported by #opies instead o ori!inals .e!ative debit *e*os 'o**issions not in line with in#reased sales Telltale Si!ns o 8ana!e*ent and 'orporate Fraud %n every #ase o *ana!e*ent and #orporate raud telltale si!ns o the raud e/ist or so*e period o ti*e be ore a third party dete#ts or dis#loses it$ These si!ns *ay be 1) Si!ni i#ant observed #han!es ro* the de rauder=s past behavior patterns 2) >nowled!e that the de rauder was under!oin! e*otional trau*a in his ho*e li e or wor, li e 3) >nowled!e that the de rauder was bettin! heavily" drin,in! heavily" had a very e/pensive so#ial li e" or was se/ually pro*is#uous ?) >nowled!e that the de rauder was heavily in debt @) Audit indin!s dee*ed to be errors and irre!ularities that were #onsidered i**aterial at the ti*e 6) >nowled!e that the #o*pany was havin! inan#ial di i#ulties su#h as re-uent #ash low shorta!es" de#linin! sales and&or pro its" and loss o *ar,et share A) >nowled!e that *ana!e*ent was showin! in#reasin! si!ns o in#o*peten#e" i$e$" poor plannin!" or!ani3ation #o**uni#ations #ontrols" *otivation" and dele!ation" *ana!e*ent inde#ision and #on usion about #orporate *ission" !oals" and strate!ies" and *ana!e*ent i!noran#e o #onditions in the industry and in the !eneral e#ono*y B) Substantial !rowth beyond the industry nor* versus re!ulated industries /, C.aracter"#t"c# of To- Ma a+e!e t Fraud Top 8ana!e*ent De rauders Tend to have hi!hly *aterial personal values$

 Su##ess to the* *eans inan#ial su##ess" not pro essional re#o!nition$ Tend to treat people as ob;e#ts" not individuals and o ten as ob;e#ts or e/ploitation$ Are hi!hly sel +#entered$ Are o ten e##entri# in the way they display their wealth or spend their *oney$ They tend to be #onspi#uous #onsu*ers and o ten boast o the thin!s they have a#-uired" the riends they have in hi!h o i#e" and all the ine pla#es they have visited$ Spea, about their #unnin! a#hieve*ents and winnin!s *ore than their losses$ Appear to be re#,less or #areless with a#ts and o ten enlar!e on the*$ Appear to be hard wor,in!" al*ost #o*pulsive" but *ost o their ti*e at wor, is spent s#he*in! and desi!nin! short #uts to !et ahead or beat the #o*petition$ 8ana!e by #risis *ore o ten than by ob;e#tives$ Tend to dri t with the ti*es and have no lon!+ran!e plans" tend to override internal #ontrols with i*punity and ar!ue or#e ully or less or*ality in #ontrols$ De*and absolute loyalty ro* subordinates" but they the*selves are loyal only to their own sel +interests$ 9ave ew real riends within their own industry or #o*pany$ Their #o*petitors and #ollea!ues o ten disli,e the*$ 0, I d"cator# of $o##"1le Fraudule t Act"&"t"e# 1) Transa#tions that are odd as to6 Ti*e (o day" wee," *onth" year" or season)" Fre-uen#y (too *any" too ew)" 2la#es (too ar C" too near" and too 4Far out4)" A*ount (too hi!h" too low" too #onsistent" too ali,e" too di erent)" 2arties or personalities (related parties" oddball personalities" stran!e and estran!ed relationships between parties" *ana!e*ent per or*in! #leri#al un#tions)$ %nternal #ontrols that are unen or#ed or too o ten #o*pro*ised by hi!her authorities 2) )*ployee *otivation" *orale and ;ob satis a#tion levels that are #hroni#ally low

3) A #orporate #ulture and reward syste* that supports unethi#al behavior toward e*ployees" #usto*ers" #o*petitors" lenders" and shareholders )/a*ples o raud ris, indi#ators that *i!ht be noted durin! ieldwor, are6 Dis#repan#ies in A##ountin! Re#ords A##ount balan#es that are si!ni i#antly over or understated Transa#tions not re#orded in a #o*plete or ti*ely *anner or i*properly re#orded as to a*ount" a##ountin! period" #lassi i#ation" or #o*pany poli#y 1nsupported or unauthori3ed re#ords" balan#es" or transa#tions 5ast *inute #lient ad;ust*ents that si!ni i#antly a e#t inan#ial results (parti#ularly those in#reasin! in#o*e presented a ter sub*ission o the proposed audit ad;ust*ents) 2, U der#ta d" + Sy!-to!#3Red Fla+# of Fraud 1nderstandin! sy*pto*s o raud is the ,ey to dete#tin! raud$ A sy*pto* o raud *ay be de ined as a #ondition whi#h is dire#tly attributable to dishonest or raudulent a#tivity$ %t *ay result ro* the raud itsel or ro* the atte*pt to #on#eal the raud$ The ollowin! are representative e/a*ples o sy*pto*s or red la!s o raud6 1) A##ounts 2ayable 2ro#ess Re#urrin! identi#al a*ounts ro* the sa*e vendor$ 1nusual even dollar or hi!h #ash disburse*ent a*ounts or routine odd dollar or low value pur#hase$ 8ultiple re*ittan#e addresses or the sa*e vendor$ Dendor addresses do not a!ree with vendor approval appli#ation$ Se-uential invoi#e nu*bers ro* the sa*e vendor or invoi#e nu*bers with an alpha su i/$ 2ay*ents to vendor have in#reased dra*ati#ally or no apparent reason$ slow or no pay*ents not ;usti ied by disburse*ent s#hedule$ 2) 2ur#hasin! 2ro#ess Turnover a*on! buyers within the pur#hasin! depart*ent si!ni i#antly e/#eeds attrition rates throu!hout the or!ani3ation$

 2ur#hase order pro i#ien#y rates lu#tuate si!ni i#antly a*on! buyers within #o*parable wor,load levels$ Dra*ati# in#rease in pur#hase volu*e per #ertain vendor(s) not ;usti ied by #o*petitive biddin! or #han!es in produ#tion spe#i i#ations$ 1na##ounted pur#hase order nu*bers or physi#al loss o pur#hase orders$ Rise in the #ost o routine pur#hases beyond the in lation rate$ 1nusual pur#hases not #onsistent with the #ate!ories identi ied by prior trends or operatin! bud!et$ 3) 2ayroll 2ro#ess Dra*ati# in#rease in labor or#e or overti*e not ;usti ied by produ#tion or sales volu*e$ Turnover within the payroll depart*ent si!ni i#antly e/#eeds attrition rates throu!hout the or!ani3ation$ 8issin! or easy a##ess to blan, #he#,s" a#si*ile" and *anual #he#, preparation *a#hine$ Ta/ deposits are substantially less than those re-uired by #urrent payroll e/penses$ 9i!h volu*e o *anually prepared payroll #he#,s$ ?) 'ash Re#eipts 2ro#ess %*proper sa e!uardin! o #ash under lo#, and ,ey$ .o se!re!ation o duties between the ollowin!6 Re#eivin! #ash and postin! to #usto*er a##ounts %ssuin! re#eipts and deposit preparation %n re-uent ban, deposits" allowin! #ash to a##u*ulate$ 'onsistent shorta!es in #ash on hand$ 'onsistent lu#tuations in ban, a##ount balan#es$ 'losin! out #ash drawer be ore end o shi t$ )/#essive nu*ber o voided transa#tions on a re!ular basis without proper e/planation$ 8issin! #opies o pre+nu*bered re#eipts$ .ot balan#in! #ash to a##ounts re#eivable subled!er$ %nsu i#ient supervisory review o #ashier=s daily a#tivity$ @) A##ounts Re#eivable 2ro#ess

 5a#, o a##ountability or invoi#e nu*bers issued$ 5a#, o se!re!ation o duties between the ollowin!6 2ro#essin! o a##ounts re#eivable invoi#es and postin! to subled!er 5a#, o poli#ies and pro#edures re!ardin! write+o s to satis y industry standards$ Fre-uent undo#u*ented and&or unapproved ad;ust*ents" #redits" and write+ o s to a##ounts re#eivable subled!er$ 5ow turnover or slow #olle#tion #y#le or a##ounts re#eivable$ Dra*ati# in#rease in allowan#e or doubt ul a##ounts in view o positive e#ono*i# events and strin!ent #redit poli#ies$ .o re#on#iliation o a##ounts re#eivable subled!er to !eneral led!er #ontrol a##ount$ %nsu i#ient supervisory review o a##ounts re#eivable a#tivity as well as #usto*er a##ount a!in! s#hedule$ 1nrestri#ted a##ess to subled!ers and !eneral led!er$ 6) A) %nventory&2rodu#tion 2ro#ess 'redit balan#es in inventory a##ounts$ 'onsistent lu#tuations in inventory a##ounts between *onths (e$!$ debit balan#e one *onth" #redit balan#e the ne/t)$ )/#essive inventory write+o s without do#u*entation or approvals$ 1nusual volu*e o ad;ust*ents" write+o s" and disposal o *aterial" inventory" or i/ed assets$ 1nrestri#ted a##ess to inventory stora!e areas by non+ responsible e*ployees and&or vendors$ Si!ni i#ant wea,nesses in inventory #ut+o pro#edures$ .o poli#y re!ardin! identi i#ation" sale" and disposal o obsolete and surplus *aterials$ Finished !oods inventory turnover rate does not #orrelate with operatin! #y#le$ Finan#e 2ro#ess Si!ni i#ant ad;ust*ents to a##rued liabilities" a##ounts re#eivable" #ontin!en#ies" and other a##ounts prior to a#-uisition o new inan#in!$ Dra*ati# #han!e in ,ey levera!e" operatin!" and pro itability ratios prior to obtainin! inan#in!$

 Adoptin! a #han!e in a##ountin! prin#iple or revisin! an a##ountin! esti*ate prior to obtainin! inan#in!$ A delay in issuan#e o *onthly" -uarterly" or annual inan#ial reports prior to see,in! new inan#in!$

T.e Fraud D"a!o d: Co #"der" + t.e Four Ele!e t# of Fraud

Despite intense e orts to sta*p out #orruption" *issappropriation o assets" and raudulent inan#ial reportin!" it appears that raud in its various or*s is a proble* that is in#reasin! in re-uen#y and severity$ >28:Es Fraud Survey 2003 do#u*ented a *ar,ed in#rease in overall raud levels sin#e its 1FFB survey" with e*ployee raud by ar the *ost #o**on type o raud$ The 2003 survey also noted that raudulent inan#ial reportin! had *ore than doubled ro* 1FFB$ This trend is #onsistent with the unpre#edented re#ent spate o lar!e a##ountin! rauds ()nron" 7orld'o*)" as well as the in#reased nu*ber o a##ountin! restate*ents and S)' en or#e*ent a#tions in re#ent years$ (See 2003 Annual Review of Financial Reporting Matters by the 9uron 'onsultin! :roup and the S)'Es Report Pursuant to Section 704 of the Sar anes!"#ley Act of 2002$) %n response to the raud proble*" 'on!ress and re!ulatory authorities have ena#ted tou!her laws and in#reased en or#e*ent a#tions$ 0r!ani3ations are i*ple*entin! ti!hter #ontrols and broader oversi!ht$ The auditin! pro ession has adopted *ore ri!orous auditin! standards and pro#edures" and so tware developers are addin! #ontinuous *onitorin! eatures to ba#,+o i#e syste*s$ %t re*ains un#lear whether these e orts are su i#ient to *iti!ate the raud proble*$ 8any studies su!!est raud is *ore li,ely to o##ur when so*eone has an incentive (pressure) to #o**it raud" wea, #ontrols or oversi!ht provide an opportunity or the person to #o**it raud" and the person #an rationali$e the raudulent behavior (attitude)$ This three+pron!ed ra*ewor," #o**only ,nown as the G raud trian!le"H has lon! been a use ul tool or '2As see,in! to understand and *ana!e raud ris,s$ The ra*ewor, has been or*ally adopted by the auditin! pro ession as part o SAS FF$ A D"ffere t 4ay to T." 5 A1out Fraud R"#5#

The raud trian!le #ould be enhan#ed to i*prove both raud prevention and dete#tion by #onsiderin! a ourth ele*ent$ %n addition to addressin! in#entive" opportunity" and rationali3ation" the authorsE our+sided G raud dia*ondH also #onsiders an individualEs capa ility6 personal traits and abilities that play a *a;or role in whether raud *ay a#tually o##ur even with the presen#e o the other three ele*ents$ 8any rauds" espe#ially so*e o the *ultibillion+dollar ones" would not have o##urred without the ri!ht person with the ri!ht #apabilities in pla#e$ 0pportunity opens the doorway to raud" and in#entive and rationali3ation #an draw the person toward it$ (ut the person *ust have the #apability to re#o!ni3e the open doorway as an opportunity and to ta,e advanta!e o it by wal,in! throu!h" not ;ust on#e" but ti*e and ti*e a!ain$ A##ordin!ly" the #riti#al -uestion is" G7ho #ould turn an opportunity or raud into realityIH 1sin! the our+ele*ent raud dia*ond" a pro#ess *i!ht pro#eed as ollow 6 raudsterEs thou!ht

%n#entive6 % want to" or have a need to" #o**it raud$ 0pportunity6 There is a wea,ness in the syste* that the ri!ht person #ould e/ploit$ Fraud is possible$ Rationali3ation6 % have #onvin#ed *ysel that this raudulent behavior is worth the ris,s$ 'apability6 % have the ne#essary traits and abilities to be the ri!ht person to pull it o $ % have re#o!ni3ed this parti#ular raud opportunity and #an turn it into reality$

7hile these our ele*ents #ertainly overlap" the pri*ary #ontribution o the raud dia*ond is that the #apabilities to #o**it raud are e/pli#itly and separately #onsidered in the assess*ent o raud ris,$ (y doin! so" the raud dia*ond *oves beyond viewin! raud opportunity lar!ely in ter*s o environ*ental or situational a#tors" as has been the pra#ti#e under #urrent and previous auditin! standards$ For e/a*ple" #onsider a #o*pany where the internal #ontrols allow the possibility that revenues #ould be re#orded pre*aturely by alterin! sales #ontra#t dates in the sales syste*$ An opportunity or raud e/ists" i the ri!ht person is in pla#e to understand and e/ploit it$ This opportunity or raud be#o*es a *u#h *ore serious proble* i the #o*panyEs ')0" who is under intense pressure to in#rease sales" has the te#hni#al s,ills to understand that the #ontrol wea,ness e/ists" #an #oer#e the 'F0 and sales *ana!er to *anipulate the sales #ontra#t dates" and #an #onsistently lie to analysts and board *e*bers about the #o*panyEs !rowth$ %n the absen#e o su#h a ')0" the raud possibility would never be#o*e reality" despite the presen#e o the ele*ents o the raud trian!le$ Thus" the ')0Es #apabilities are a *a;or a#tor in deter*inin! whether this #ontrol wea,ness will ulti*ately lead to raud$ T.e $er#o 6"t. Ca-a1"l"ty (ased on one authorEs e/perien#es in investi!atin! rauds or the past 1@ years" there are several essential traits or #o**ittin! raud" espe#ially or lar!e su*s or or a lon! period o ti*e$ First" the personEs position or un#tion within the or!ani3ation *ay urnish the ability to #reate or e/ploit an opportunity or raud not available to others$ For e/a*ple" a ')0 or divisional president has the positional authority to in luen#e when #ontra#ts or deals ta,e e e#t" thus a e#tin! the ti*in! o revenue or e/pense re#o!nition$ Fraudulent Financial Reporting% &'(7)&''7* An Analysis of +,S, Pu lic -o.panies ((easley et al$" 1FFF) ound that #orporate ')0s were i*pli#ated in over A0J o publi#+ #o*pany a##ountin! rauds" indi#atin! that *any or!ani3ations do not i*ple*ent su i#ient #he#,s and balan#es to *iti!ate the ')0Es #apabilities to in luen#e and perpetuate raud$ Additionally" when people per or* a #ertain un#tion repeatedly" su#h as ban, re#on#iliations or settin! up new vendor a##ounts" their #apability to #o**it raud in#reases as their ,nowled!e o the un#tionEs pro#esses and #ontrols e/pands over ti*e$

Se#ond" the ri!ht person or a raud is s*art enou!h to understand and e/ploit internal #ontrol wea,nesses and to use position" un#tion" or authori3ed a##ess to the !reatest advanta!e$ 8any o todayEs lar!est rauds are #o**itted by intelli!ent" e/perien#ed" #reative people" with a solid !rasp o #o*pany #ontrols and vulnerabilities$ This ,nowled!e is used to levera!e the personEs responsibility over or authori3ed a##ess to syste*s or assets$ A##ordin! to the Asso#iation o 'erti ied Fraud )/a*iners" @1J o the perpetrators o o##upational raud had at least a ba#helorEs de!ree" and ?FJ o the raudsters were over ?0 years old$ %n addition" ?6J o the rauds the Asso#iation re#ently studied were #o**itted by *ana!ers or e/e#utives$ Third" the ri!ht person has a stron! e!o and !reat #on iden#e that he will not be dete#ted" or the person believes that he #ould easily tal, hi*sel out o trouble i #au!ht$ Su#h #on iden#e or arro!an#e #an a e#t oneEs #ost+bene it analysis o en!a!in! in raud< the *ore #on ident the person" the lower the esti*ated #ost o raud will be$ %n GThe 9u*an Fa#e o FraudH (-A Maga$ine" 8ay 2003)" R$ Allan notes that one o the #o**on personality types a*on! raudsters is the Ge!otistHKso*eone who is Gdriven to su##eed at all #osts" sel + absorbed" sel +#on ident and nar#issisti#$H Si*ilarly" Du ield and :rabos,y (GThe 2sy#holo!y o Fraud"H /rends 0 1ssues in -ri.e and -ri.inal 2ustice" 8ar#h 2001) note that" in addition to inan#ial strain" GAnother aspe#t o *otivation that *ay apply to so*e or all types o raud is e!o&power$H The authors !o on to -uote Stotland (G7hite 'ollar 'ri*inals"H 2ournal of Social 1ssues" 1FAA) re!ardin! e!o6 GAs L raudstersM ound the*selves su##ess ul at this #ri*e" they be!an to !ain so*e se#ondary deli!ht in the ,nowled!e that they are oolin! the world" that they are showin! their superiority to others$H Fourth" a su##ess ul raudster #an #oer#e others to #o**it or #on#eal raud$ A person with a very persuasive personality *ay be able to #onvin#e others to !o alon! with a raud or to si*ply loo, the other way$ %n addition" Allan notes that a #o**on personality type a*on! raudsters is the Gbully"H who G*a,es unusual and si!ni i#ant de*ands o those who wor, or hi* or her" #ultivates ear rather than respe#t N and #onse-uently avoids bein! sub;e#t to the sa*e rules and pro#edures as others$H 8any inan#ial reportin! rauds are #o**itted by subordinates rea#tin! to an edi#t ro* above to G*a,e your nu*bers at all #osts" or else$H

Fi th" a su##ess ul raudster lies e e#tively and #onsistently$ To avoid dete#tion" she *ust loo, auditors" investors" and others ri!ht in the eye and lie #onvin#in!ly$ She also possesses the s,ill to ,eep tra#, o the lies" so that the overall story re*ains #onsistent$ %n the 2har+8or raud" the auditors #lai*ed that 2har+8or had or*ed a G raud tea*H o e/e#utives and or*er auditors who G#ontinually wor,ed to hide eviden#eH about the raud ro* the*$ The auditors #lai*ed that the raud tea* Glied" or!ed do#u*ents and Os#rubbedE everythin! the auditors saw to hide any indi#ations o *al easan#e$H (See GFindin! Auditors 5iable or Fraud6 7hat the Pury 9eard in the 2har+8or 'ase"H 'ottrell and :lover" /he -PA 2ournal" Puly 1FFA$) Finally" a su##ess ul raudster deals very well with stress$ 'o**ittin! a raud and *ana!in! the raud over a lon! period o ti*e #an be e/tre*ely stress ul$ There is the ris, o dete#tion" with its personal ra*i i#ations" as well as the #onstant need to #on#eal the raud on a daily basis$ For*er 9ealthSouth ')0 Ri#hard S#rushy now a#es nu*erous #ri*inal #har!es or alle!edly *aster*indin! a lon!+ runnin! s#he*e to in late the #o*panyEs earnin!s durin! the ter*s o several di erent 'F0s$ Despite the enor*ous pressure on hi*" S#rushy has re*ained resolute durin! the #ourse o the investi!ation" even appearin! on 30 Minutes to pro#lai* his inno#en#e$ %n #ontrast" durin! his senten#in!" or*er 9ealthSouth Assistant 'ontroller )*ery 9arris" who alle!edly was #oer#ed to parti#ipate in the raud" told the ;ud!e how relieved he was a ter the #o*pany was raided by ederal a!ents" thin,in! it provided hi* the opportunity to inally G!et out o this *ess$H Deal" + 6"t. Ca-a1"l"ty Appre#iatin! the i*portan#e o #apability as a ourth ele*ent o raud is only part o the #hallen!e$ The ne/t tas, is to address #apability when assessin! raud ris," and to use ,nowled!e about raud #apability to prevent or dete#t raud$ (eyond #onsiderin! in#entive" opportunity" and rationali3ation" the ollowin! steps #ould shed li!ht on #apability$ Explicitly assess the capabilities of top executives and key personnel. Fo#usin! on #apability re-uires or!ani3ations and their auditors to better understand e*ployeesE individual traits and abilities$ The audit #o**ittee *e*ber" #orporate a##ountant" or auditor should o#us on the personality traits and s,ills o top e/e#utives and others responsible or hi!h+ris, areas when assessin!

raud ris, or see,in! to prevent or dete#t raud$ Routine ba#,!round #he#,s on new e*ployees #an identi y past #ri*inal #onvi#tions$ %n assessin! individualsE traits and abilities" several *ethods o !atherin! in or*ation *ay be help ul$ First" there is no substitute or spendin! ti*e with a person$ Fre-uent intera#tion under a variety o #ir#u*stan#es" both business and so#ial" #an provide a *eanin! ul pi#ture o the personEs #apabilities$ Se#ond" loo, or si!nals in the Glittle thin!s$H % the person #uts #orners on s*all issues or #onsistently displays an absolute re usal to lose or ail" no *atter what the issue or the #ost" this *ay su!!est si*ilar behavior on lar!er issues$ For e/a*ple" *any have said that an e/e#utive who #heats in !ol will #heat in business$ Finally" pay attention to what others say about a person$ % there are #onsistent state*ents about #ertain traits or tenden#ies" this in or*ation #an supple*ent *ore dire#t observations$ For e/a*ple" i people in the or!ani3ation are #onsistently in awe o so*eoneEs te#hni#al or #reative ability" this provides additional insi!ht into the personEs #apabilities$ If there are concerns about capability, respond accordingly. % so*eoneEs #apabilities present a si!ni i#ant ris, a#tor" respond with stron!er #ontrols or enhan#ed audit testin!$ For e/a*ple" i the sales vi#e president is overly a!!ressive" #o*petitive" and obsessed with hittin! *onthly sales -uotas" there *ay be a need or e/tra+ti!ht #ontrols over revenue re#o!nition or e/panded testin! o sales durin! the annual audit$ %n addition" i*ple*entin! a periodi# rotation o routine" but ,ey" un#tions a*on! sta #an *ini*i3e the opportunities or raud !ained ro* lon!+ter* ,nowled!e o the un#tion and its #ontrols$ %n this response phase" a ,ey to *iti!atin! raud is to o#us parti#ular attention on situations o erin!" in addition to in#entive and rationali3ation" the #o*bination o opportunity and #apability$ %n other words" GDo we have any doorways to raud that #an be opened by people with the ri!ht set o ,eysIH % so" these areas are espe#ially hi!h ris," be#ause all the ele*ents are in pla#e or a raud opportunity to be#o*e reality$ For e/a*ple" when desi!nin! dete#tion syste*s" it is i*portant to #onsider who within the or!ani3ation has the #apability to -uash a red la!" or to #ause a potential in-uiry by internal auditors to be redire#ted$ 'ynthia 'ooper" the internal auditor at 7orld'o* #redited with dis#overin! the *assive raud" has des#ribed in /i.e *a!a3ine how 'F0 S#ott Sullivan had e/er#ised his position and seniority to dissuade her tea* ro* loo,in! into #ertain areas that later proved to

have been in ested with *assive raud$ (ut believin! they were on to so*ethin!" her tea*s wor,ed behind SullivanEs ba#," on *any o##asions at ni!ht or ro* ho*e" to avoid dete#tion and retribution$ Althou!h it appears he tried" a##ordin! to 'ooper" in this instan#e Sullivan was not #apable o #o*pletely thwartin! the persistent e orts o the auditors to un#over the apparent raud$ Reassess the capabilities of top executives and key personnel. Assessin! #apability and respondin! to #on#erns should not be viewed as one+ti*e e/er#ises$ 'ontinuous updatin! o the #apability assess*ent and response is warranted or two reasons$ First" people #an develop new #apabilities over ti*e" espe#ially i they are #li*bin! the #orporate ladder and !rowin! pro essionally$ Pust be#ause so*eone did not have enou!h power or ,nowled!e o an area to #o**it raud in the past" there is no !uarantee that the person will not develop su#h power or ,nowled!e in the uture$ Their #apability to #o**it raud *ay in#rease" and additional #ontrols or s#rutiny *ay be warranted$ Se#ond" or!ani3ational pro#esses" #ontrols" and #ir#u*stan#es #han!e over ti*e$ As a result" so*e people *ay be better suited to #o**it raud in the new environ*ent" even thou!h they were not #apable under previous #onditions$ For e/a*ple" #onsider a #o*pany that has re#ently i*ple*ented a #o*ple/ new %T syste*$ The new syste* *ay render those less di!itally sophisti#ated e*ployees in#apable o e/ploitin! its #ontrols$ 0n the other hand" or those with stron! %T s,ills" the #han!e *i!ht in#rease their #apability o #o**ittin! raud$ This new #apability should be #onsidered" and appropriate responses i*ple*ented$ Beyo d Sta dard# %n the inal analysis" re#ent le!islation" in#reased en or#e*ent" re!ulatory oversi!ht" broader #ontrols" i*proved auditin! standards" and sophisti#ated *onitorin! te#hnolo!y are all steps in the ri!ht dire#tion and will #ontribute to preventin! and dete#tin! raud$ 5i*itin! this e ort to #urrent standards and pra#ti#es *ay not be enou!h" however" espe#ially or auditors$ 'onsistent with this view" the 2004 Miller 4AAS 4uide des#ribes the raud trian!le ele*ents presented in SAS FF and notes that Git is obvious that the Auditin! Standards (oard is stru!!lin! with the broad topi# o how to dete#t raud" auditors should be #are ul about ollowin! relevant pro essional

standards and then havin! a sense o se#urity about the li,elihood that raud does not e/ist in a parti#ular en!a!e*ent$H A##ordin!ly" i #apability #ould play a role in in luen#in! or *a!ni yin! the other raud ele*ents" other #he#,s and balan#es or dete#tion syste*s should be i*ple*ented" or an auditor should e/pand audit s#ope" pro#edures" and testin! or potential raud$