Fraud

 Intentional act by one or more individuals among management, those charged

with governance, employees, or third parties, involving the use of deception to
obtain an unjust or illegal advantage
 If act is unintentional – Error
o Error – unintentional misstatements in the financial statements, including
omission of an amount or disclosure

5 Conditions of Fraud
1. False representation
a. Non-disclosure of fact
b. Statement is altered (e.g. company is in “stable” condition when it is
actually going bankrupt)
2. Material fact
3. Intent
4. Justifiable reliance
5. Injury or loss

Fraud Triangle
 Situational pressure – includes personal/job-related stresses that could coerce
an individual to act dishonestly
 Opportunity – involves direct access to assets and/or access to information that
controls assets
 Ethics/Rationalization – pertains to one’s character and degree of moral
opposition to acts of dishonesty

Fraudulent Financial Reporting (Management Fraud)

 Involves intentional misstatements or omissions of amounts or disclosures in the
financial statements to deceive financial statement users
 Risk factors:
o Management’s characteristics and influence over control environment
o Industry conditions
o Operating characteristics and financial stability
Misappropriation of Assets (Employee Fraud)
 Involves theft of an entity’s assets committed by entity’s employees
 Risk factors:
o Susceptibility of assets to misappropriation (e.g. misappropriation/theft of
liquid assets)
o Controls (e.g. weak internal control)

Fraud Schemes
 Fraudulent Statements
o Financial statement misrepresentation must itself bring direct/indirect
financial benefit to perpetrator
o E.g. Window dressing, Kiting
o Underlying problems:
 Lack of Auditor Independence
 Auditing firms that are engaged by clients to do non-
accounting services
 Lack of Director Independence
 Director one of the suppliers of the company
 Questionable Executive Compensation Scheme
 Inappropriate Accounting Practices
 Corruption
o Involves an executive, manager, or employee of the organization in
collusion with an outsider
o Four types:
 Bribery
 Pay before acting
 Conflicts of interest
 Employee of company has self interest/acts under authority
of a 3rd party
 Employee of XYZ company is part owner of the supplier
company where XYZ company purchases from
 Illegal gratuities
 Act before pay (Opposite of Bribery)
 Economic extortion
 Asset Misappropriation
o Skimming (steal before recording)
o Cash larceny (record before stealing) – e.g. lapping
o Billing schemes
o Check tampering
o Payroll fraud
o Expense reimbursements

2
 o Thefts of cash
o Non-cash misappropriations
 Computer Fraud
o Theft, misuse, or misappropriation of assets by altering computer-readable
records and files
o Theft or illegal use of computer-readable information
 By altering the logic of computer software
 Of computer hardware
o Theft, corruption, illegal copying, or internal destruction of computer
software