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Presented by: H. B. Hamad

Errors and frauds are regarded as taking-off grounds of all financial evils. Both errors and frauds have a significant impact to the financial statements of the organization and more importantly the going concern of the business 3

Who are responsible for errors and frauds in an organisation? The management, audit committee, board of directors, auditors (internal and external) and employees. So why the auditors are always find themselves on the newss front pages whenever the financial crimes events get the media attentions? 4

Errors are unintentional mistakes done into our financial statements. Frauds are rather intentional errors. When some wrong postings or calculations are made in the books of accounts, are known as errors

Mostly, errors are not intentionally, however, we should all know that, some clever guys for some reason are creating errors for their own benefit. Apparently when errors are done intentional automatically became frauds and is virtually a financial crime that can send someone behind the bars!! 6

Fraud: obtaining a material advantage by unfair or wrongful means. Fraud is the use of dishonesty means to obtain an advantage or avoid an obligation. Fraud can be divided into two: 1. Management fraud 2. Employee fraud 7

Corruption is practice of offering, soliciting( ask for), or accepting of an inducement or reward to influence an action by an officer of an entity. Corruption is the misuse of public power for private profit." This clearly includes all kinds of bribery of national or local officials or politicians.

Management fraud
Management fraud or some time known as white color crimes Done by senior managers by utilizing their posts and power vested on them. Normally its difficult to scrutinize the managers hence creating a good chance to commit frauds 9

Employee frauds
Are those types of frauds undertaken by ordinary staff Normally management are not involved in this type of fraud



Corruption can be seen into two: 1. Grand corruption 2. Petty corruption


Grand corruption: is the one which involves senior officials, ministers, and heads of state Grand corruption involves influencing decision-makers grand corruption can destroy nations: where it is rampant( uncontrolled), there is no hope of controlling petty corruption 12

Grand corruption
Three criteria for grand corruption: 1. Size: a big transaction or project (big bosses do not bother about small fishes) 2. Immediacy of reward: bribe matured in long time, big bosses do not like. 3. Mystification: complicated and technological transactions, 13

Petty corruption is the one which entails immigration officials, customs clerks, policemen, and the like. Petty corruption is usually about getting routine procedures followed more quickly or not followed at all. Petty corruption can seriously damage the quality of life of the ordinary citizen particularly that of the most vulnerable members of society 14

Economic Impact of corruption

Wide spread poverty, hunger, and underdevelopment. Corruption hinders direct foreign investment. Developing countries are quite keen to attract investment. For this purpose they also offer tax concessions to investors. But research reveals that a more effective method to attract investment is to curtail corruption than to reduce taxes.
Source: Anti-Corruption Policy of ADB, pp.13 15

Economic Impact of corruption..

Although the economic costs of corruption are difficult
to measure, some studies suggest they include: A 3 to 10 per cent increase in the price of a given transaction to speed up the delivery of government service Inflated prices for goods as much as 15 to 20 per cent higher - as result of government-imposed monopolies A loss of as much as 50 per cent of government tax revenues because of graft and corruption Excessive charges to governments for goods and services because of over billing on procurement contracts or the purchase of expensive and unnecessary items, with governments paying 20 to 100 per cent more than necessary. Source: Stapenhurst and Kpundeh, pp.4. 16

Auditors dilemma
Corruption is a highly complex phenomenon. The parties involved leave very little tell-tale in the form of certain hard evidence. Most of the corruption takes place in an informal manner and under the dark cover of isolated contacts. At times it does not even require a spoken word. Mere eye contact can establish a relationship of corruption. The auditors find themselves at cross-purposes with the society.


Role of auditor in fighting corruption

In case of corruption, they can hardly detect or investigate into the actual event of corruption, since the criminals, generally, do not leave any evidence. It is, therefore, important to know that the auditors cannot quantify corruption nor can they report the actual event of corruption. They can only indicate the existences of opportunities for corruption. Such a report can become basis for corrective action by the government to forestall corruption or minimize the opportunities 18

Is the legal language indicating a charge to theft or stealing. It is on other hand, a wrongfully taking and carrying away of the personal property of another person with intent to convert it or deprive the owners of its use and possession. the thief does not have legal possession or custody of the property 19

is fraudulent appropriation of property by a person entrusted with its custody, thus breaching the trust or fiduciary responsibility in embezzlement the person is legally authorized by its owner to take or receive possession of the property at least for the time being 20

How can we determine if frauds is bad or not?


Materiality of error
Materiality of error is what determine if error is so bad or what Materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it to be useful


Materiality flash-back
Materiality is the relativity of the size and magnitude of an item as compared to other items, alternatively an error is said to be material if: The amount involved is substantial in relative to the companys financial position It has a reversing trend i.e if it can change a profit into a loss and vice-versa It varies substantially from the estimates that are usually considered normal and acceptable. 23

Importance of materiality of an error in auditing

It influences the auditors time budget on specific items. It dictated the auditors plan. It influences the auditors plan. It determines the amount of audit evidence to be gathered.


Audit procedures of frauds vs. materiality

If errors are innocent and immaterial ignore the same If errors are innocent and material mention it in the management letter and request correction of the accounts. If errors are intentional and immaterial mention it in the management letter with caution to the party committing the error If errors are intentional and material qualify the report and also mention this in the management letter. 25

Motives for fraud to take place

1. 2. 3. 3 motives Opportunity Pressure Rationalization


Motive for fraud

fraud triangle
Opportunity pressure

Need/Rationalization 27

Motive for fraud

Opportunity: it is occurred when the controls placed are weak and or where and individual is in a position of trust to override the controls. Someone at a position of trust may, because of seniority, be able to bypass controls or exploit known weakness. 28

Motive for fraud

Pressure- influence financial fraud. For example unrealistic corporate targets can influence employees to commit fraud to meet the targets.


Motive for fraud

Rationalization- for fraud often includes such beliefs as :
Activity is not criminal Their actions are justified They are simply borrowing the money. They are ensuring that corporate goals are met Every one else is doing it. 30

Way does frauds occurs

1. Manipulation of accountsis the willful misrepresentation of facts in the accounts either for the purpose of concealing defalcations or misrepresenting figures to convey a better picture of performance or financial position of the business than it is otherwise. E.g. to inflating profits or reducing losses or showing a better position that it is actually exists 31

How does fraud occurs

2. Misappropriation of assetsthis crime involves misappropriation of cash, goods or negotiable instruments. With or without the manipulation of accounts.
Omission to record cash receipts Recording fictitious assets Receipt counterfoils showing lower amounts Intentional errors in balancing the cashbook


How does fraud occurs

3. Suppression or omissions-this is achieved by total omission to record cash received from a debtor or a cash sale transaction totally not recorded.


how does fraud occurs

4. Transaction without substanceclaims by fictitious debtors may be honored after the successful creation of fictitious records along with other credit records, or payment of salaries to ghost workers.


how does fraud occurs

5. Misapplication of accountdeliberate use of wrong accounting policies so as t benefit from the use of an inappropriate alternative policy for example use of wrong rates and formulas.


Employee fraud

(transaction fraud)

It is done by an ordinary staff (employees) mgt is not involved at all. It comprises among others, 1. outright theft 2. embezzlement 3. defalcation 4. misappropriation of account 5. manipulation of account


Employee fraud
Techniques use are like: 1. falsifying expenses reports and staff claims 2. embezzling fund 3. using corporate property for private uses 4. accepting gratuity from vendors, contractors and suppliers 37

Employee fraud
Motives for conducting transaction fraud.

1. 2. 3. 4. 5.

Weak internal control Employment of dishonest staff corrupt mgt models inefficient internal controls personal financial problems


Employee fraud
Symptoms of transaction fraud. 1. adjusting journal entry, escaping authorization and destroying documents 2. Expenditure not supported by adequate documentation. 3. False and improper entries in the records 4. unauthorized payments 5. Unauthorized uses of corporate assets. 6. misapplication of funds 39

Employee fraud
Fraud fighting activities: It is seen into three steps: 1. Prevention 2. Investigation 3. Detection Early fraud detection is critical because the sizes of most frauds increase geometrically over time as perpetuators gain confidence that their schemes are not being detected 40

Fraud fighting


Fraud fighting activities

Prevention: Fraud prevention includes such activities as designing corporate fraud policies, creating internal audit departments, implementing internal controls, whistle-blower systems, publicizing fraud occurrences Frauds42 employees screening system

Fraud fighting activities

Investigation. Investigation involves steps taken to answer the questions of whom, how, when, and why once fraud is suspected or fraud predication is present


Fraud fighting activities

Detection- Fraud detection includes both proactive and reactive activities targeted at finding the first indication that fraud might be occurring or undertaken to develop a predication of fraud


Fraud fighting activities

Reactive method for fraud detection: Most traditional fraud detection methods are reactive in nature that is, they are initiated by tips or complaints, control overrides, or other indicators that someone observes or hears


Fraud fighting activities

Proactive fraud detection It involves aggressively targeting specific types of fraud and searching for their indicators, symptoms, or red flags 46

Controlling employee fraud (3 methods)

1. Managerial controls: Installing strong managerial controls that the responsibility of internal controls, proper reporting, and the adoption of sound accounting policies rests solely with management, not the auditors. E.g. separation of duties 47

Controlling employee fraud

2. Screening: Adequate employee screening is powerful tool. Hiring honest employees is best way; It can best done by out-sourcing screening tests include -lie detector and drug tests and fingerprinting of employees. background checks of information on resumes and applications, an employer can elicit significantly more information and determine if the original information is accurate 48

Controlling employee fraud

Screening; It should have BOD approval It must comply with the law and existing organizational policy eg The extent, who have responsibility Levels of checking used Whether existing staff should be included or internal promotions and transfers 49

Controlling employee fraud

Question used in screening questionnaire forms: 1. Are legal, fair and unambiguous? 2. Assess honesty, reliability, suitability, experience and qualification? 3. Can answer be checked? 4. How will errors, omissions or discrepancies affect employments? 50

Controlling employee fraud

Screening will also include: 1. Bankruptcy checks 2. Research and verification of the CV looking for gaps and inconsistencies. 3. Confirmation of education 4. Confirmation of professional qualification for prof. bodies (NBAA) 5. Directorship and media searching 51

Controlling employee fraud

Screening will also include: 6. Verification of employment history with direct line managers and HR, for last five years 7. Supreme court record searches.


Controlling employee fraud

3. Business environment: A third component to deterring fraud reduces the perceived need of a pressured employee to commit fraud. creating open and consistent communications for hiring, evaluating employee performance, and assessing employees for promotion. counseling programs and employee enrichment efforts, 53

Controlling employee fraud

4. Other methods: hotline whereby fellow employees can report improper conduct, having a high level employee review unopened bank statements monthly, establishing a written code of ethics, making sure management level employees are role models. 54

Controlling employee fraud

Forensic accounting Forensic accounting is the integration of accounting, auditing, and special investigative skills The goal of forensic accounting is to uncover the paper trail left by a fraud and prepare the investigation prior to presenting it to a court of law 55

forensic accounting
Examples of situations where forensic accountants might be involved are: 1. analyze and investigate financial evidence 2. develop computerized applications to perform analysis 3. present findings through reports and exhibits 4. Testify in court as an expert witness


Forensic accounting


Management fraud
Its done by most senior officer in an organization. It involves deceitful practices adopted by managers to benefit themselves economically and socially or to sustain jobs to the costs of the organization they are working for. Managers mostly vested/given wide and absolute powers, faith and trust such that their crimes are usually very difficulty to be uncovered under normal circumstances. 58

Management fraud
Managers are not subject to ordinary checks as opposed to subordinates. It is always very difficulty to detect fraud made by management through naked eyes but it is usually start from customers complains. Examples of management frauds: 1. misrepresentation of facts which result in 2. over-statement of assets, sales, and profits 3. understatement of liabilities, expenses, and losses 4. Some times they inflate profits so as to earn higher salaries and bonuses.


Management fraud


Management fraud
Example of fraudulent case: Several years ago, a senior vice president of a bank embezzled nearly $14 million over a 16-year period. When the fraud was discovered through a customer complaint, the bank sued its external auditors for negligence in not detecting the fraud. The fraud had been committed by manipulating, looting and abusing customer accounts and maintaining several slush accounts with sufficient funds to handle problems when customers complained 61

Management fraud
Motives for mgt fraud: 1. opportunity: managers have high privilege in relation to ordinary staff in organization as they have responsible positions of trust and necessary belief and respect from authorities that appointed them. Since managers are judged by results, their crimes can be over weighted by attainment of those results.


Motives for mgt fraud:

2. Needneed for committing management fraud may arise to improve status or lifestyle, to satisfy their ambitious of having good living standard. 3. Pressure- excessive pressures influence management fraud. It can be internal or external pressure


Motives for mgt fraud:

Internal pressure; Self imposed discipline, inner desires etc
1. Excel in performance in comparison with prior period 2. Show superior performance in comparison with competitors 3. Earn promotion, larger bones or incentives 4. Win favor of bosses for various reasons. 5. Retain the position by any means, fair or foul


Motives for mgt fraud:

External pressure: from higher authorities e.g goals set by bosses, owners, or BoD may be unrealistic and highly demanding Manager cannot refuse Use deceitful tactics to accomplish them Or just make them appear accomplished 65

External pressure
1. 2. 3. 4. 5. 6. 7. Public image Self-preservation Concealment of incompetence Out put linked incentive plans Ambition for self-advancement Vested interest Manipulation of accounts 66

Symptoms of mgt fraud

1. Protected delays in submission of reports 2. Incompatible functions done by same person 3. Flouting corporate directives, rules and regulations 4. Personal interest 5. Duplicate entries 6. Uncorrelated entries 7. High fly-management decisions 67

How frauds are detected


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