86 terms

Fraud - All PPT notes


Terms in this set (...)

T or F. Many organizations will not report fraud.
T or F. Many organizations do not catch fraud within their organization, thus fraud statistics are underestimated
The theft of incoming cash and cash equivalents BEFORE its entry into the accounting system
The theft of incoming cash and cash equivalents AFTER its entry into the accounting system
Legal definition of fraud (7 parts)
1. A representation
2. about a material point
3. Which is false
4. And intentionally or recklessly so
5. Which is believed
6. And acted upon by the victim
7. To the victim's damage
3 things Fraud is NOT
1. taken by physical force
2. a mistake or error
3. victimless
Consequences of Fraud when committed by employed individual (3)
1. For every $1 of fraud committed, net income is reduced by $1
2. Negative impact on reputation (vendors, customers, investors)
3. Reduced employee morale
Consequences of Fraud when committed by an organization (3)
1. Shareholders, creditors, others lose money
2. Employee lay-offs often common
3. General consequences to: the industry? the capital markets? society?
Classification System of Fraud [Fraud Tree]
Corruption, Asset Misappropriation, Financial Statement Fraud
______(3 top) is the most common type of fraud but _______(3 top) is the costliest type of fraud.
Asset Misappropriation
Financial Statement Fraud
an act done with an intent to give some advantage inconsistent with official duty and the rights of others
4 categories of Corruption
1. Bribery
2. Illegal Gratuities
3. Economic extortion
4. Conflict of Interest
Conflict of Interest
Someone has an undisclosed economic/personal interest in a transaction that adversely affects the company.
The offering/giving/receiving/soliciting any thing of value to influence an official act or business decision
Illegal gratuities
Similar to bribery except that something of value is given to an employee to reward a decision rather than influence it (Wells 2006)
Economic extortion
A demand for something of value; "pay up or else"
Fraudulent disbursement examples. (Subcategory of Cash) [5]
1. Billing Schemes
Employee in accounts payable sets up a false vendor and creates invoices that are paid by the organization for services not rendered

2. Payroll schemes
Employee in payroll sets up a false employee and pays this "person"

3. Expense reimbursements schemes
Employees who submit false or overstated travel or entertainment claims for reimbursement

4. Cheque tampering

5. Register disbursements
Fraud perpetrated by more than one individual working together
Compared to the regular Fraud definition, occupational fraud does not talk about
The ethical or legal consequences
Organizational Fraud as defined (in class)
1. Misrepresentation (in writing or verbally) or misuse
2. Intentional or grossly negligent
3. Within the course of one's employment
4. Again for the perpetrator(s)
5. Illegal and/or highly unethical
6. Loss may be in the past, present, or future
7. Victim (who has burden of proof) can be anyone
Fraud triangle.
Motive: A reason to commit fraud

Opportunity: The perceived opportunity that one can perpetrate fraud and get away with it

Attitude/rationalization: A predisposition or ease of rationalizing
Theory of differential association. (Sutherland)
A theory that criminal and deviant behavior is learned through intimate personal groups with criminal or deviant behavior patterns, norms, and values.
What are the two areas of learning that the theory of differential association mentions?
1. Techniques to commit the crime (skill)
2. Attitudes/rationalizations and motives (2 parts of the fraud triangle)
Fraud scale. [3] -Albrecht
Situational pressure.
Opportunities to commit fraud.
Personal integrity.
"Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property" -Cressy

What is the motive, opportunity, rationalization in this case?
Motive: Financial problem

Opportunity: position of financial trust

Rationalization: verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property

This led to the fraud triangle.
Are there a certain group more inclined to commit fraud?
No. Not demographically differentiated.
What do people see when they see an opportunity?
Perceived weak controls or enforcement
3 types of motives
1. Financial incentives and pressures (need, greed)
2. Social incentives and pressure (couple team)
3. Malevolent work environment (truck guy)
Attitude/Rationalization. Who are the people are "predisposed" to commit fraud when opportunity and motive are present?
Identifying Psychopath
Callous, insensitive, cynical
Lack of remorse
Lack of concern regarding morality
Identifying Machiavellians
Coldly rational and self-interested
Belief that the ends justifies the means
Manipulative, deceitful, exploitative
Identifying Narcissists
Overly concerned about oneself
Craves: admiration, attention, prestige, status
Expects special favours
What else (other than predisposed attitude) leads someone to commit fraud given the opportunity and motive?
Rationalization. Which helps to justify our actions.
Why do people/fraudsters rationalize?
To reduce negative feelings caused by committing fraud.
Allows us to continue believing we're ethical.
5 Key Rationalization categories
1. Shifting the blame. "XX company made me."
2. Pleading ignorance. "I don't know what your talking about."
3. Moral justification. "I was the hero."
4. Temporary. "I was going to pay it back."
5. Entitlement. "I deserve this."
New category to the fraud tree, _____. Define.

See as intentional "under the radar" activities. Pollution. Anti-trust Laws.
Pronzi scheme
Investment operation where the operator, an individual or organization, pays returns to its investors from new capital paid to the operators by new investors, rather than from profit earned by the operator.
Pyramid scheme
Unsustainable business model that involves promising participants payment or services, primarily for enrolling other people into the scheme, rather than supplying any real investment.
How to prevent opportunity? [2]
1. Strong internal controls

2. Provide a whistle-blowing system
Strong Internal Controls (Prevent Opportunity) [5]
.Control environment ("tone at the top") (5)

2.Risk assessment (4)

3.Control activities (5)

4.Information and communication [Mgt needs reports on effectiveness of controls: system error reports, breaches of security, transaction trends]

5.Monitoring [Who is responsible for such activity and should report it]
Information and communication
Mgt must know controls are working and processes are being followed, for example:
Backlog reports
Transaction frequency (trends, etc.)
System error reports
Reports of breaches of security
Control Environment ('Tone at the top') [5]
1. Starts with integrity at the top ("walk the talk")
2. Hire good people (thorough background checks)
3. Provide fraud awareness training
4. Create positive environment (expectations, consequences)
5. Follow up regularly with employees
Organization must clearly delineate who is responsible for monitoring which processes

And reporting up the chain of command if there is a problem

Internal audit function is helpful here
Examples of Control activities (Internal Controls which prevent Opportunity) [5]
1. Segregation of duties
2. Proper authorizations (large or unusual)
3. Documentation to form audit trail
4. Passwords/Lock controls for assets and records
5. Independent audits of data and performance
How to prevent motive? [4]
1. Employee assistance program
2. ESP: treated fairly
3. paid equitably
4. prevent highly competitive environments
Behavioral cues - When employee has motive.
-Living beyond their means
-Suddenly extravagant lifestyle
-Unusually close relationship with vendor/customer
-Too competitive toward peers
-Appearing excessively stressed
-Appearing excessively angry toward the organization or bosses
How to prevent attitude/rationalization
1. Do not hire people predisposed (background checks)
2. Be aware through listening and training
Behavioral cues - When employee has attitude/rationalization
-Bullying of co-workers or bosses
-"Wheeler dealer" attitude (a person who makes deals in business or politics in a skillful and sometimes dishonest way)
-Refusing to take vacations
-Refusing to allow anyone else to perform their work
-Evasive answers to questions
-Withholding information or documents
Successful whistle-blowing systems needs to provide (4)
1. Anonymity
2. Independence (person your reporting to isn't apart of it)
3. Accessibility
4. Follow-up
Does detecting fraud act as a prevention for potential future fraud?
Does increased punishment for fraudsters act as a prevention for potential future fraud?
Some say yes, I say not after a certain point

Sarbanes Oxley Act of 2002 (in US) designed to reduce FS fraud, yet FS fraud stats don't bear this out
Effective prevention methods [15]
Job rotation / mandatory vacation (most effective method in the past)
Employee support programs
Proactive data monitoring and analysis

Dedicated fraud department
Anti-fraud policy - Training for everyone
Code of conduct
Formal fraud assessments
Hotline (whistleblower system)
Rewards for whistle-blowers

Management review
Management certification of FSs

External audit of FSs
Independent audit committee
Internal audit (most effective method currently)
External audit of internal controls

Most effective recent: Surprise audits, employee support programs, Internal audit, External audit of internal controls
3 sources for Fraud Detection
1. Tips (complaints)
2. Accounting/Data anomalies
3. Behavioral red flags
Fraud Detection (Accounting/Data anomalies). Examples? (4)
1. DOCUMENTS. Irregular documents (missing, excessive, alternations, handwriting, photocopied, page order messed up)

2. FS ITEMS. Strange relationships in Financial statements (increasing Revenue with decreasing Assets, more volume but more cost per unit, less scrap)

3. JOURNAL ENTRIES Faulty journal entries (lack of documents, unexplained expenses, not balancing, entries near end of period)

4. LEDGER: Inaccuracies in ledgers (not balancing, sums not equal)
Fraud Detection - Behavioral red flags
How do behavior changes come about? Some examples of behavioral changes?
Guilt --> Fear --> Stress --> Behavior Changes

Examples: Not sleeping, drugs, lack of interest, sweating, defensiveness, work standing up
The MOST effective fraud detection method?
Data driven fraud detection needs to be used with _______ for it to be effective
Red Flags
6 steps towards data driven fraud detection
1. Understand the business
2. Identify possible frauds that could exist
3. Narrow that list by using red flags
4. Use technology to gather data
5. Analyze results
6. Investigate symptoms
Benford's Law is. And why is it useful for detecting fraud?
"The first digit of random data sets will begin with a 1 more often than with a 2, a 2 more often than with a 3, and so on"

Since people assume that the digits 1-9 have an equal chance of appearing in the first position.
Forensic investigator/accountant should be called when
Fraud is strongly suspected
4 Steps in Financial statement analysis
1. Compare account balances from one period to the next

2. Calculate key ratios and compare them from period to period

3. Perform vertical analysis

4.Perform horizontal analysis
3 Different types of bonds between co-offenders
1. Individual-serving functional bonds
2. Organization-serving functional bonds
3. Affective bonds
What is Individual-serving bonds? Is this a dangerous bond? What motive is usually behind this bond?
Co-offending offers a structure that provides, or enhances, opportunities to commit fraud. In their own self-interest to cooperate, results in individualistic benefits.

Most predatory

Motive/Pressure strongest: Financial
What are Organizational-serving functional bonds? What kind of rationalization do they use? Why does this kind of bond have the most members?
Goal is to enhance the financial position of their organization

Workplace is the site for recruiting and socialization into the fraud

Most members

Rationalization: Moral justification
What are Affective bonds?
Strong emotional ties between the members (family, friends, attraction)

Least members

Justification used: Moral justification
An interviewer should be:
-no interrupt
-display interest
-present questions in non-accusatory manner
-lack of bias
-faciliate effective communication (fulfilling expectations, recognition, altruistic appeals, sympathetic understanding, catharsis)
Cues for when someone's being deceptive?
1. Increased tension
2. Less positive and pleasant interactions
3. Less forthcoming responses
4. Less compelling tales
5. Story "too good to be true" unlike normally flawed stories
6. Changes in body language
Why is organizational climate important when preventing fraud?
Since climate can promote or allow unethical decisions or fraudulent behavior. A good climate can supports ethical decision making and deters fraud.
What are the 6 factors increase opportunity?
1. Lack of controls
2. Inability to judge performance quality
3. Failure to discipline fraudsters
4. Lack of access to information
5. Ignorance, apathy and incapacity
6. Lack of an audit trail
7. An instrumental climate**
Larceny is especially a problem when inventory is ___, ___, ___
Small, Expensive and Portable
The consequences of fraud to an organization are far greater than the actual loss from the fraud itself. Which of the following is the biggest reason given by organizational leaders for refusing to report a fraud?

a. Avoiding the legal expenses for hiring attorneys to prosecute the fraudster
f. Avoiding reputational damage to the organization for being a victim of fraud
b. Avoiding decreased employee morale
c. Avoiding the extended time period for seeking and recapturing losses
d. Avoiding the hassle of answering questions about what happened
Avoiding reputational damage to the organization for being a victim of fraud
Which of the following elements are important for setting the appropriate 'tone at the top'?
a. Create a positive environment
b. Ensure that expectations are flexible so they can be changed frequently
c. Regularly following up with employees
g. Only a and c
d. Only a and b
Only a and c
. Which side(s) of the fraud triangle are most fraud prevention methods focused on?
h. Opportunity
a. Detection
b. Motive
c. Attitude / rationalization
d. All of the above
h. Opportunity
Proactive data driven fraud detection includes the following steps:
a. Understanding the business
b. Close examination of the chart of accounts used for the financial statements
c. Using red flags to help narrow the list of possible frauds that could exist
d. All the above
k. Only a and c
k. Only a and c (Understanding the business, using red flags)
Which functional area(s) within most organizations is/are most vulnerable to fraud?
a. Accounting
b. Human Resources
c. Executive management
d. Only a and c
e. Only b and c
d. Only a and c [Accounting & Executive Mgt]
For which aspect of internal controls is the internal audit function most helpful?
a. Control environment
b. Risk assessment
c. Control activities
d. Information and c
e. Monitoring
e. Monitoring
3. Professor Murphy's research identified three types of group bonds when collusion occurs within an organization:organization-serving functional bonds, and affective bonds. Which
rationalization is commonly used by individuals in both groups 2 and 3?

a. Shifting the blame
b. Pleading ignorance
c. Moral justification
d. Temporary
e. Entitlement
c. Moral justification
What prevention method is most effective and least costly for preventing collusion?
a. Surprise audits
b. Mandatory vacation without role replacement
c. Employee support programs
d. Fraud training
e. Job rotation
e. Job rotation
5. Which of the following theories or frameworks help describe fraud within organizations?
a. Fraud triangle
b. Theory of differential association
c. Theory of bad behavior
d. Only a and b
e. All of the above
d. Only a and b [Fraud Triangle, Theory of Differential association]
6. What is the best way to detect an instrumental climate?
a. Examination of the internal audit function
b. Interviews with executives
c. Anonymous surveys of employees
d. Interviews with employees
e. All of the above
c. Anonymous surveys of employees
___ of organizations worldwide were a victim of fraud in a one-year period

Fraud costs organizations an estimated ____ of annual revenues

What ___ of frauds cost over 1mil


Asset Misappropriation's two categories includes:
1. Cash
2. Inventory/other assets
Inventory/other assets sub categories include
1. Misuse
2. Larceny
White collar fraud. Sutherland.
"acts of corporations and individuals acting in their capacity"
An instrumental climate is significantly associated with _______. Negatively associated with
asset misappropriation
What is an instrumental climate/culture?