Certified Forensic Accountant

Module 2: Topic 4
Identifying the Opportunities for Fraud
 Who Commits Fraud?
• Fraud perpetrators usually can’t be distinguished from
other people on the basis of demographics or
psychological characteristics. Most fraud perpetrators
have profiles that look like those of other honest
people.
• Fraud perpetrators were considerably older. Although
only 2 percent of property offenders were female, 30
percent of fraud perpetrators were women.
• Fraud perpetrators were better educated, more
religious, less likely to have criminal records, less likely
to have abused alcohol, and considerably less likely to
have used drugs.
FRAUD STATISTICS: Perpetrator’s
Position (1/2)

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FRAUD STATISTICS: Perpetrator’s Position (2/2)

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FRAUD STATISTICS: PERPETRATOR’S AGE

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FRAUD STATISTICS: PERPETRATOR’S
GENDER

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 Why People Commit Fraud

• Perceived pressure, perceived opportunity and

rationalization are common to every fraud.
• These three elements make up what we call the fraud
triangle.
• Whether the fraud is one that benefits the perpetrators
directly, such as employee fraud, or one that benefits
the perpetrator’s organization, such as management
fraud, the three elements are always present.
 Overview of FRAUD: Fraud
Triangle
Motivation for Fraud
Opportunity
-- A perceived or actual opportunity to commit fraud
-- A belief that no one will notice

Pressure
Rationalization
-- Personal debt
-- I’ll pay it back
-- Costly addictions such as
-- Other people are doing it
-- They don’t pay me enough 9
gambling
-- Unforeseen expenses
Source: Association of CFEs (ACFE)
 Overview of Fraud: Definition
• A knowing misrepresentation of the truth or
concealment of a material fact to induce
another to act to his or her detriment.1

• TYPES OF FRAUD
1. Internal Fraud (also referred as occupational
fraud)
2. External Fraud
1
Bryan Garner, ed., Black’s Law Dictionary. 8th Ed. (2004), s.v., “fraud.”  

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 The Fraud Triangle
The First Element of the Fraud Triangle: Pressure

• Fraud can be perpetrated to benefit oneself or to benefit an

organization.
• Employee fraud, in which an individual embezzles from his or her
employer, usually benefits the perpetrator.
• Management fraud, in which an organization’s officers deceive
investors and creditors usually by manipulating financial statements, is
most often perpetrated to benefit an organization, and indirectly, its
officers.

Pressure is divided into four types:

1. financial pressures,
2. vices,
3. work-related pressures, and
4. other pressures.
 Financial Pressures

• Common financial pressures associated with fraud that

benefits perpetrators directly include the following:
Greed
Living beyond one’s means
High bills or personal debt
Poor credit
Personal financial losses
Unexpected financial needs
• Financial pressure is the most common type of
pressure to commit fraud.
 Vice Pressures
• Closely related to financial pressures are motivations
created by vices such as gambling, drugs, alcohol and
expensive extramarital relationships.
• Vices are the worst kind of pressures to commit fraud.
 Work Related Pressures

• Financial pressures and vices may motivate most

frauds, but some people commit fraud to get even with
their employer or others.

• Factors such as getting little recognition for job

performance, having a feeling of job satisfaction,
fearing losing one’s job, being overlook for a
promotion, and feeling underpaid have motivated
many frauds.
 Other Pressures
 
• Once in a while, fraud is motivated by other pressures,
such as a spouse who insists on an improved lifestyle or a
challenge to beat the system.

• Most of us face pressures in our lives; we sometimes have

a difficult time distinguishing between wants and needs.
 Fraud Statistics: Pressures

Source: ACFE 2012 Report to the Nation

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Source: Association of CFEs (ACFE)
The Second Element of the Fraud Triangle: Opportunity (1/5)
A perceived opportunity to commit fraud, to conceal it, or to
avoid being punished is the second element of the fraud
triangle. At least six major factors increase opportunities for
individuals to commit fraud within an organization:
1. Lack of circumvention of controls that prevent or detect
fraudulent behavior
2. Inability to judge quality of performance
3. Failure to discipline fraud perpetrators
4. Lack of access to information
5. Ignorance, apathy and incapacity
6. Lack of audit trail
The Second Element of the Fraud Triangle: Opportunity (2/5)
• The second critical element in the control environment is
management’s communication.
– Communicating what is and is not appropriate is critical.
– To be an effective deterrent to fraud, communication
must be consistent.
– Messages that change based on circumstances and
situations serve not only to confuse employees but also
to encourage rationalization.
– One of the reasons so many frauds occur in crash or
rush projects is that typical control procedures are not
followed. Inconsistent messages relating to procedures
and controls are often conveyed.
 The Second Element of the Fraud Triangle: Opportunity (3/5)

• The third critical element in creating the proper control

structure is appropriate hiring.
– When dishonest individuals are hired, even the best
controls will not prevent fraud.
– For example, a bank has tellers, managers, loan officers,
and others who have daily access to cash and can steal.
– Because it is impossible to deter all bank fraud, banks
hope that personal integrity, together with preventive
and detective controls and the fear of punishment will
deter theft
The Second Element of the Fraud Triangle: Opportunity (4/5)

• The fourth fraud deterring element of the control

environment is a clear organizational structure.
– When everyone in an organization knows exactly
who has responsibility for each business activity,
fraud is less likely to be committed.
– In such situations, it is easier to track missing assets
and harder to embezzle without being caught.
– Strict accountability for job performance is critical
for a good control environment.
The Second Element of the Fraud Triangle: Opportunity (5/5)

• The fifth element of the control environment is an

effective internal audit department, combined with
security or loss prevention program.
– Internal auditors provide independent checks and
cause perpetrators to question whether they can act
and not be caught.
– A visible and effective security function, in conjunction
with an appropriate loss prevention program, can help
ensure that fraud is properly investigated and that
control weaknesses and violations are appropriately
punished.
 Polling Questions
Gavin fills out a life insurance application form. In the
section on medical conditions, he ticks a box which
states that he does not have any heart conditions. In
fact, Gavin has a serious heart condition. Which type
of fraud might Gavin be charged with?
 
a.Fraud by false representation and fraud by abuse of position
b.Fraud by false representation and fraud by failing to disclose
information
c.Fraud by failing to disclose information and fraud by abuse of
position
d.All three types of fraud
 The Accounting System (1/2)

• The second component of the control structure is a good

accounting system.
• Every fraud is comprised of three elements:

1. the theft act, in which assets are taken

2. concealment, which is the attempt to hide the fraud from
others
3. conversion, in which the perpetrator spends the money or
converts the stolen asses to cash and then spends the
money.
 The Accounting System (2/2)
• An effective accounting system provides an audit trail that
allows frauds to be discovered and make concealment difficult.
• Frauds are often concealed in the accounting records.
Accounting records are based on transactions documents,
either paper or electronic.
• A good accounting system should ensure that recorded
transactions are:
1. valid
2. properly authorized
3. complete
4. properly classified
5. reporting in the proper period
6. properly valued
7. summarized correctly
 Control Activities
• The third component of the control structure is good control
activities or procedures.
• An individual who owns his or her own business and is the
sole employee probably does not need many control
procedures.
• Organizations that involve many employees must have
control procedures so that the actions of employees will be
congruent with the goals of management or the owners. In
addition, with control procedures, opportunities to commit
or conceal frauds are eliminated or minimized.
• The five primary control procedures:

1. Segregation of duties, or dual custody

2. System of authorizations
3. Independent checks
4. Physical safeguards
5. Documents and records
 Segregation of Duties and Dual Custody
• Activities can usually be better controlled by invoking
either segregation of duties or dual custody control.
• Dual custody requires two individuals to work together at
the same task.
• Either way, it takes two people to do one job.
• This form of control, like most preventive controls, is
most often used when cash is involved.
• The accounting for and the handling of cash are
separated so that one person does not have access to
both.
 System of Authorizations
• The second internal control procedure is a proper system of
authorizations.
• Authorization control procedures take many forms. Passwords
authorize individuals to use computers and to access certain
databases.
• Signature cards authorize individuals to enter safe deposit
boxes, to cash checks, and to perform other functions at
financial institutions.
• Spending limits authorize individuals to spend only what is in
their budget or approved level.
• When individuals are not authorized to approve purchases, they
cannot order items for personal use and have their companies
pay for the goods
 Independent Checks
• The theory behind independent checks is that if people
know their work or activities will be monitored by others,
the opportunity to commit and conceal a fraud will be
reduced.
• Periodic job rotations, cash counts or certifications,
supervisor reviews, employee hot lines, and the use of
auditors are other forms of independent checks.
 Physical Safeguards
•  Physical safeguards are often used to protect assets from
theft by fraud or other means.
• Physical safeguard such as vaults, safes, fences, locks and
keys, take away opportunities to commit fraud by making it
difficult for people to access assets.
• Physical controls are often used to protect inventory by
storing it in locked cages or warehouses, small assets such as
tools or supplies by locking them in cabinets, and cash by
locking it in vaults or safes.
 Documents and Records
• The fifth control procedure involves using documents or
records to create a record of transactions and an audit trail.
• Documents rarely serve as preventive controls but provide
excellent detective controls.
• Most companies require a customer order to initiate a sales
transaction. In a sense, the entire accounting system serves
as a documentary control.
• Without documents, no accountability exists.
• Without accountability, it is much easier to perpetrate fraud
and not get caught.
 Summary of the Controls That Prevent or
Detect Fraud
• The control environment, the accounting system, and the many
variations of the five control activities or procedures work
together to eliminate or reduce the opportunity for employees
and others to commit fraud.
• A good control environment establishes an atmosphere in which
proper behavior is modeled and labeled, honest employees are
hired, and all employees understand their job responsibilities.
• The accounting system provides records that make it difficult for
perpetrators to gain access to assets, to conceal frauds, and to
convert stolen assets without being discovered.
• Together, these three components make up the control
structure of an organization.
 Internal Control Structure
summarizes these components and their elements:

.
Non Control Factor: Inability to Judge the
Quality of Performance

Apparently, face with the pressure to cheat or fail, and

believing that customers would not know for them
whether the parts and services were actually needed,
many service center employees decided to commit
fraud.
 Non Control Factor: Failure to Discipline
Fraud Perpetrators
• Fraud perpetrators are usually individuals who command respect
in their jobs, communities, churches, and families.
• If they are marginally sanctioned or terminated, they rarely
inform their families and others of the real reason for their
termination or punishment.
• On the other hand, if they are prosecuted, they usually suffer
significant embarrassment from having family, friends, and
business associates know about their offenses.
• Indeed, it is usually suffering humiliation, more than any other
factor that deters future fraud activity by fraud perpetrators.
John Doe’s Employment and Fraud History
 FRAUD STATISTICS:
The Cost of Occupational Fraud

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FRAUD STATISTICS: HOW OCCUPATIONAL
FRAUD IS COMMITTED

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FRAUD STATISTICS: Duration of Fraud
Schemes

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FRAUD STATISTICS: Initial Detection of
Occupational Frauds

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FRAUD STATISTICS: Control Weaknesses That
Contributed to Fraud

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Non Control Factor: Lack of Access to Information

• Many frauds are allowed to be perpetrated because

victims don’t have access to information possessed by the
perpetrators.
• This factor is especially prevalent in many of the large
management frauds that have been perpetrated against
stockholders, investors, and debt holders. In the famous
ESM fraud case, for example, the same securities had been
sold to investors several times.
• Yet, because those investment records were only in the
possession of the ESM, victims didn’t know of the
fraudulent sales.
 Non Control Factor: Lack of an Audit Trail
• Smart employee fraud perpetrators understand that their
frauds must be concealed. They also know that such
concealment must usually involve manipulation of financial
records.

• When faced with a decision about which financial record to

manipulate, perpetrators almost always manipulate the
income statement, because they understand that the audit
trail will quickly be erased.
Nigerian Scam Letter
 The Third Element of the Fraud Triangle:
Rationalization
• The third element is rationalization. An example of
how rationalization contributes to fraud is the case of
Jim Bakker and Richard Dortch. These men were
convicted on 23 counts of wire and mail fraud and one
count of conspiracy to commit wire and mail fraud.
Common rationalizations used by fraud
perpetrators include the following:

• The organization owes it to me.

• I am only borrowing the money and 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 his financial
difficulty.
• Something has to be sacrificed- my integrity, or my
reputation. (If I don’t embezzle to cover my inability to
pay, people will know I can’t meet my obligations and
that will be embarrassing because I’m a professional.)
 The following example of rationalization allows
one to be dishonest by breaking the law:

• You get in your car and start down on the freeway. You see a
sign that says, “65 miles per hour.” What do you do? Most
likely you will go faster than 65, justifying your speeding by
using one or more of the following rationalizations. 
– Nobody drives 65. Everyone else speeds.
– My car was made to go faster.
– Sixty-five miles per hour is a stupid law. Going faster is
still safe.
– I must keep up with the traffic or I’ll cause an accident.
– It’s all right to get one or two speeding tickets.
– I’m late.
– The speed limit is really 72 or 73.
Many people rationalize underpaying taxes by using the
following rationalizations:

• I pay more than my fair share of taxes.

• The rich don’t pay enough taxes.
• The government wastes money.
• I “work” for my money