Fraud
CHAPTER 1
Fraud - involves deception, confidence, and trickery
Fraud is deception that includes the following elements:
1. A representation
2. About a material point
3. That is false,
4. Intentionally or recklessly so,
5. Which is believed
6. And acted upon by the victim
7. To the victim’s damage.
Profit margin
Net income divide revenue
To recover the loss
Loss divide profit margin
Careers for fraud examiners
**Many believe that fraud examination and forensic
accounting will be among the fastest growing and most
rewarding careers in the future**
Government fraud-fighters, consultant fraud-fighters,
corporate employee fraud-fighters, and defense and
plaintiff lawyers are just a few of the possible careers
related to fraud prevention and detection.
Civil law deals with rights and duties between
individuals.
Criminal laws generally deal with offenses against
society as a whole.
By proceeding in a civil suit, the company can try to
recover some of the money lost from the fraud.
By pursuing a criminal suit, the company can ensure
that when other companies hire the perpetrator, those
companies will know that the employee has committed
fraud in the past and will be able to prevent the
prospective employee from being in a position that
provides the opportunity to commit fraud again.
Auditing vs. fraud examination
Auditing - uses sampling to test the account balances to
make sure the accounts are not overstated or
understated
Fraud examination - cannot be done effectively through
sampling, each transaction should be reviewed and
evaluated.
**As fraud detection methods get more sophisticated,
so do fraud perpetration techniques. Fraud examination
is one of the fastest-growing and most financially
rewarding careers. It is not part of a financial statement
audit but a distinct profession. **
CFE
- Certified fraud examiner
- considered to be leaders in the antifraud
community
ACFE
- Association of Certified Fraud Examiners
- world’s largest antifraud organization and the
premier provider of antifraud training and
education
**Financial statement fraud can be very difficult to
detect because of the sophistication of the perpetrators
and their positions of trust and authority in the
company. **
CASES:
As fraud detection methods get more sophisticated, so
do fraud perpetration techniques. Fraud examination is
one of the fastest-growing and most financially
rewarding careers. It is not part of a financial statement
audit but a distinct profession.
Trading after hours
- Civil law - By performing trades after approved
trading hours, the perpetrators have allowed
certain traders to trade with perfect
information and have prevented other traders
and brokers from trading equities at a price at
which they normally would. If proven guilty, the
perpetrators will be forced to compensate
monetarily for the damages they caused to
others.
- Criminal law - by breaking the law that
regulates approved trading hours. If proven
guilty, the perpetrators could be sent to jail.
- other stock and mutual fund traders were hurt.
They had an apparent disadvantage to those
traders and brokers who practiced late trading.
Eventually, however, the perpetrators will incur
the most damage as they are forced to fulfill
their civil obligations and endure tarnished
reputations.
CHAPTER 2
Fraud triangle:
- Perceived pressure
- Perceived opportunity
- Rationalization
Fraud scale:
the greater the perceived opportunity or the more
intense the perceived pressure, the less rationalization
it takes to motivate someone to commit fraud. Likewise,
the more dishonest a perpetrator is, the less
opportunity and/or pressure it takes to motivate fraud.
Types of pressures:
- Financial pressure (greed)
- Vices (addictions)
- Work-related pressure (feeling overworked)
- Other types of pressures
**Having an effective control structure is probably the
single most important step that organizations can take
to prevent and even to detect fraud**
Components in a company’s control structure:
- control environment,
- risk assessment,
- information and communication,
- control procedures or activities,
- monitoring.
Internal control activities
Preventive controls
1. Segregation of duties (having two people do a task
together or splitting the task into parts so that no one
person handles the complete assignment)
2. System of authorizations (so that only authorized or
designated individuals have permissions to complete
certain tasks)
3. Physical safeguards (locks, keys, safes, fences)
Detective controls
1. Independent checks (job rotations, mandatory
vacations, audits, and so on)
2. Documents and records (provide an audit trail that
can be followed to check on suspicious activity and to
document transactions)
Non-control factors that provide opportunities for
fraud
- failure to discipline fraud perpetrators;
- -lack of access to information;
- ignorance, apathy, and incapacity;
- lack of an audit trail.
Rationalizing helps minimize the perceived dishonesty
of their acts
- The organization owes me.
- I am only borrowing the money—I will pay it
back.
- Nobody will get hurt.
- I deserve more.
- It’s for a good purpose.
- We’ll fix the books as soon as we get over this
financial difficulty.
- Something has to be sacrificed
**they judge themselves by their intentions and not by
their actions, they do not see themselves as criminals.**
Power - the ability to influence someone else.
When a fraud takes place, the conspirator has the
desire to carry out his or her own will—influence
another person to act and do as the perpetrator
wishes—regardless of resistance.
Fraud perpetrators use power to influence and
persuade individuals
- reward power (promising a reward or benefit)
- legitimate power (following the orders of a
person who is in a position of authority)
- coercive power (making the potential recruit
feel fear for not joining the fraud scheme)
- expert power (through deceiving someone
because the potential recruit has a lack of
knowledge)
- referent power (influence of a relationship)
It is the overriding and ignoring of existing controls, not
the lack of controls, that allows most frauds to be
perpetrated.
CASES
How could this fraud have been detected? (Helen case)
- The fraud would have been detected if the
company had possessed a good internal audit
department, combined with security or loss
prevention programs. A good accounting
system would have helped in the discovery of
the fraud and would have made it difficult for
Helen to conceal.
How do vices such as gambling motivate people to
commit fraud? (Ruth case)
- With so much pressure, it takes only a little
rationalization and a small opportunity for
someone to perpetrate a fraud.
What factors provided the optometrist with an
opportunity to commit fraud? (optometrist)
- The major fraud opportunity in this case was
the inability to judge the quality of performance
of the optometrist. Although the insurance
companies clearly could have said that the
services rendered by the optometrist were not
consistent with what they were paying for, they
never had reason to believe they needed to
assess the optometrist’s services. Another
factor was the lack of access to information.
The insurance companies had no way of
knowing that many of the services being billed
for were not actually being performed, or that
many of the patients did not even exist.
List four reasons why Len should have the employee
prosecuted.
- Prosecution sets precedence within the
company that fraud will not be tolerated.
- Prosecution brings about justice.
- Prosecution may result in recovery of stolen
funds because of ordered restitution payments.
- Prosecution will help prevent dishonest
employees from defrauding other
organizations.
List three reasons why Len might not want to seek
prosecution of his employee.
- Fear that negative publicity will hurt the image
of the CPA firm.
- He might feel badly for the employee or his
family.
- He doesn’t want to accept responsibility for
the lax internal controls that existed in his firm.
If you were Len, what would you do?
- Prosecution
How will you approach your employee interaction and
relationships in the future? (local dept store case)
- This fraud might have been detected earlier by
implementing basic cash accounting and
reconciliation techniques—separate employee
ID numbers to log into registers, independent
checks on register totals, two employees always
being present to count cash, periodic employee
rotations and vacations, and basic analytic
reviews.
GREEN GRASS
What symptoms of fraud exist, and what symptoms
should the owner look for if he believes fraud may be
occurring?
- Fraud symptoms that should be looked for or
that are evident in this case include: less time
with office manager, more chemicals being
used than necessary, employee homes receiving
unpaid services, and increased revenues with
declining profits. Employees may have taken on
new customer jobs and pocketed the money
because the customers are not entered on the
computer system.
WATKINS
Controls or actions that could have detected James’s
behavior
- independent checks by the insurance company,
investigations of complaints by customers being
charged too much, and investigations of the
apparently rapid growth of his company.
JOHNSON
What factors in Johnson’s control environment have
led to and facilitated the manager’s manipulation of
inventory?
- does not have a very active board of directors,
and there is little monitoring of employees.
ARMSTRONG
- Because investors trusted him, they put
substantial amounts of money into his funds. If
the investors had trusted Mr. Armstrong less,
they would not have given him unlimited
control of their money.
- If investors had known of Mr. Armstrong’s
background, they would have been less likely to
trust him and probably wouldn’t have allowed
him complete control over so much money.