Auditing

and
Fraud Prevention

What is fraud
and how can you protect
your organization?

Presented by: OCPS Internal Audit Department

 What is FRAUD?

Fraud covers a range of irregularities and

illegal acts characterized by intentional
deception. It can be perpetrated for the
benefit of or to the detriment of the or-
ganization and by persons outside as well
as inside the organization. It can also be
described as diverse means used by re-
sourceful people to get an advantage over
another by suppressing the truth, trickery
misinformation, false suggestions,
cunning, deceit, and other methods by
which to cheat.
 Identification of Fraud

Fraud designed to benefit the organization generally produces benefit by

exploiting an unfair or dishonest advantage that also may deceive an outside party.
Perpetrators of such frauds usually accrue indirect personal benefit. Examples of
this type of fraud include:

♦ Improper payments such as illegal political contributions, bribes, kickbacks

and payoffs to government officials, intermediaries, customers or suppliers.
♦ Intentional, improper representation or valuation of transactions, assets,
liabilities or income.
♦ Sale or assignment of fictitious or misrepresented assets.
♦ Intentional, improper related party transactions in which one party receives
some benefit not obtainable in an arm’s length transaction.
♦ Intentional failure to record or disclose significant information to improve the
financial picture of the organization to outside parties.
♦ Prohibited business activities such as those that violate government statutes,
rules, regulations or contracts.
♦ Tax fraud.

Fraud perpetrated to the detriment of the organization generally is for the direct or
indirect benefit of an employee, outside individual, or another organization. Some
examples are:

♦ Acceptance of bribes or kickbacks.

♦ Diversion to an employee or outsider of a potentially profitable transaction that
would normally generate profits for the organization.
♦ Embezzlement, as typified by the misappropriation of money or property, and
falsification of financial records to cover an act, thus making detection difficult.
♦ Intentional concealment or misrepresentation of events or data.
♦ Claims submitted for services or goods not actually provided to the organization.
 Deterrence of Fraud
Deterrence of fraud consists of those actions taken to discourage the perpetration of
fraud and limit the exposure if fraud does occur. The principal mechanism for deterring
fraud is control. The primary responsibility for establishing and maintaining control
rests with management. Internal control is a process effected by an organization’s
management that is designed to provide reasonable assurance regarding the
achievement of objectives in the following categories:

1. Reliability of financial reporting,

2. Compliance with applicable laws and regulations and
3. Effectiveness and efficiency of operations.

The Role of the Internal Auditor

The Internal Auditors are responsible for assisting in the deterrence of fraud by
examining and evaluating the adequacy and the effectiveness of the system of internal
control, proportionate with the extent of the potential exposure/risk in the various
segments of the organization’s operations. Internal auditors should determine
whether:

• The organizational environment promotes control consciousness.

• Realistic organizational goals and objectives are set.
• Written policies exist that describe prohibited activities and the action required
when violations are discovered.
• Appropriate authorization policies for transaction are established and maintained.
• Policies, practices, procedures, report and other mechanisms are developed to
monitor activities and safeguard assets, particularly in high-risk areas.
• Communication channels provide management with adequate and reliable
information.
• Recommendations need to be made for the establishment or enhancement of cost-
effective controls to help deter fraud.
 Materiality and Government Fraud

♦ Subject to more public scrutiny

♦ Negative publicity may arise if not pursued

♦ Fiduciary responsibilities for public funds

♦ Fraud undermines the public trust

♦ Any fraud is material to the taxpayers

♦ Criminal action is more likely with public funds

Common Forms of Fraud
♦ Kiting
♦ Lapping

♦ Bid Rigging

♦ Pilfering

♦ Travel Claim Fraud

♦ Disposal Fraud

♦ Double Payments

♦ False Claims

♦ Payroll Fraud

♦ Charge-off Fraud

♦ Petty Cash Fraud

♦ Healthcare Beneficiary Fraud

♦ Workers Compensation Fraud
 KEY ENVIRONMENTAL FACTORS THAT
PERMIT FRAUD

♦ Absence of Internal Controls

♦ No segregation of duties

♦ Weak Control Environment

♦ Unlimited access to assets

♦ Failure to record assets

♦ Not comparing existing assets with recorded

assets
♦ Not implementing prescribed controls

♦ Lack of computer expertise by supervisors

♦ Ability to bypass controls

♦ Collusion among employees over whom

limited control is exercised

♦ Existence of liquid assets, such as cash

♦ Management Philosophy

♦ Lack of an Audit Presence

♦ Program Overload

♦ Unrestricted access to computer disks

 FRAUD IN GOVERNMENTAL ENTITIES
IS OFTEN PROMPTED BY THESE
FACTORS

♦ Frequent cash collections with difficulty in

predicting timing and collection

♦ Pressure from taxpayers to limit administrative

personnel and cost

♦ Lack of a profit motive

♦ Smaller entities may have low-wage workers

with frequent access to cash

♦ Perception that money is unlimited

 FRAUD SYMPTOMS
AND INDICATORS
♦ High level approval
♦ High volume of adjustment entries
♦ Manual or computer detail not equal to the control totals
♦ Special handled transactions
♦ Missing documents
♦ Excessive voids or credits; unexplained adjustments
♦ Bank reconciliations not completed promptly
♦ Altered or re-written documents
♦ Photocopies of documents
♦ Questionable handwriting on documents or handwritten instruments
(checks)
♦ Duplicate payments
♦ Second endorsements on checks
♦ Increased reconciling items
♦ Entries without supporting documentation
♦ Entries that do not balance
♦ Unexplained shortages or overages
♦ Significant increases or decreases in account balances
♦ Too many debit or credit memos
♦ Accounts recorded that do not reconcile to counts
♦ Excessive late charges
♦ Unusual checks
♦ Unreasonable expenses and reimbursements
♦ Vendor addresses are the same as employee addresses
♦ Unusual financial statement relationships
♦ Regular borrowing
♦ Excessive complaints on accounts
♦ Goods purchased in excess of needs
♦ Deposits in transit are increasing
♦ Signature stamp used on checks and contracts
♦ Overstated travel expenses
♦ Multiple reimbursements
♦ Fictitious expenses
♦ Inclination toward covering up inefficiencies by ‘plugging’ figures
♦ Failure to make daily bank deposits
♦ Refusing to take vacations or shunning promotions for fear of detection
♦ Carrying an unusually large bank balance
♦ Extended illness of self or family
♦ High personnel turnover; low employee morale
 MISUSE OF ENTITY ASSETS
♦ Credit cards

♦ Vehicles

♦ Gas

♦ Supplies

♦ Cell Phones

♦ Office Telephones

♦ Computers

♦ Internet
 Procurement Fraud
♦ Procurement fraud occurs when governmental units
either over-pay for goods and services or pay for
goods or services it has not received.

♦ Payments to fictitious vendors

♦ Payment of kickbacks

♦ Use of sole-source procurement contracts

 REFERENCES

Susan D. Battini, CPA, Annette K. Campbell, CPA and

David A Vaudt, CPA, 2005, Auditing and Fraud Prevention
for Cities

Sawyer, Dittenhofer, and Scheiner, Sawyer’s Internal Audit-

ing, 5th ed.

Professional Practices Framework, The Institute of Internal

Auditors