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Fraud Exam 1 Study Guide

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What is Fraud?
Theft by deception. Involves all the different ways of using trickery to get another person's or organization's assets.
Types of Fraud
1. Employee embezzlement
2. Vendor fraud
3. Customer fraud
4. Management fraud
5. Investment scams and other consumer frauds
6. Other types of fraud
Employee embezzlement
Most common type of occupational fraud. Employees deceive their employers by taking company assets. Can be direct or indirect.
Example of employee embezzlement
Employees use their positions to take or divert assets belonging to their employer.
Vendor fraud
Two common forms:
1. Fraud perpetrated by vendors acting alone
2. Fraud perpetrated through collusion between buyers and vendors.
Example of vendor fraud
Vendors either overbill or provide lower quality or fewer goods than agreed.
Customer fraud
Customers either do not pay for goods purchased, they pay too little, or they get something for nothing.
Example of customer fruad
Customer convinces branch manager to give her a $525000 cashier's check even though she had only $13000 in her bank account.
Management fraud
Often called financial statement fraud, is distinguished from other types of fraud both by the nature of the perpetrators and by the method of deception. Involves deceptive manipulation of financial statements.
Example of management fraud
WorldCom, Enron, Waste Management, Sunbeam, Rite-Aid, etc.
Investment scams and other consumer frauds
Fraudulent and usually worthless investments are sold to unsuspecting investors. Includes:
1. Ponzi schemes
2. Telemarketing fraud
3. Nigerian letter or money scam
4. Identity theft
5. Advance fee scams
6. Redemption/strawman/bond fraud
7. Letter of credit fraud
8. Internet fraud
Ponzi scheme
Named after Charles Ponzi. Lure investment funds from victims and then pay those victims a premium or interest from money that is paid by subsequent investors.
Telemarketing fraud
Victims send money to people they do not know personally or give personal financial information to unknown callers. Typically these callers put pressure on potential victims to "act now because the offer won't last" or convince the victim that he won a free gift.
Nigerian letter or money scams
Potential victim receives an e-mail or other form of communication promising the victim a large financial payout in exchange for help in transporting large sums of money from one country to another.
Identity theft
Occurs when someone assumes the identity of another person to purchase goods, engage in criminal activity, or perpetrate fraud.
Advance fee scams
Occurs when a victim pays an up-front cost for a good or service that is never delivered. The victim pays up-front cost to secure a payment, loan, contract, investment, or gift.
Redemption/strawman/bond fraud
Perpetrators claim that the US government controls certain bank accounts that can be accessed by submitting paperwork with government officials. To gain access, victims must buy expensive training kits that teach individuals how to access the funds.
Letter of credit fraud
A legitimate document that is issued by banks to guarantee payment for goods that are shipped in international trade. In order to scam victims, fraud perpetrators will often create bogus letters of credit and then sell them to unsuspecting victims.
Internet fraud
Versions of other fraud but online lol.
Criminal Case
Purpose: To right a wrong
Consequences: Jail and/or fines
Burden of Proof: "Beyond a reasonable doubt"
Jury: Jury must have 12 people
Initiation: Determination by a grand jury that sufficient evidence exists to indict
Verdict: Unanimous verdict
Claims: Only one at a time
Civil Case
Purpose: To obtain a remedy
Consequences: Restitution and damage payments
Burden of Proof: "Preponderance of evidence"
Jury: May consist of fewer than 12 persons
Initiation: Filing a claim by a plaintiff
Verdict: Parties may stipulate to a less than unanimous verdict
Claims: Various claims may be joined in one action
Who commits fraud?
Anyone can commit fraud. However, 10% of people will never commit fraud under no circumstances, 10% of people will commit fraud no matter what, and 80% of people will commit fraud under the right circumstances.
Fraud Triangle
1. Perceived Pressure
2. Perceived Opportunity
3. Rationalization
The element of pressure
Financial, vice, work related, and other
Financial pressure
1. Greed
2. Living beyond one's means
3. Inability to pay bills or personal debt
4. Poor credit
5. Personal financial losses
6. Unexpected financial needs
Vice pressure
Motivations created by gambling, drugs, alcohol, and expensive extramarital relationships.
Work-related pressures
Fraud committed to get even with their employer motivated by multiple factors: little recognition, job dissatisfaction, fearing losing one's job, being overlooked for a promotion, and feeling underpaid.
Other pressures
Pressures other than the ones previously mentioned lol.
The element of opportunity
1. Lack of internal controls that prevent and/or detect fraudulent behavior
2. Inability to judge quality of performance
3. Failure to discipline fraud perpetrators
4. Lack of access to information or asymmetrical information
5. Ignorance, apathy, or incapacity
6. Lack of an audit trail
Five primary control activities
1. Segregation of duties, or dual custody
2. System of authorizations
3. Independent checks
4. Physical safeguards
5. Documents and records
Segregation of duties
Dividing a task into two parts so that one person does not have complete control of the task.
Dual custody
Requires two individuals to work together at the same task.
System of authorization
Passwords, signature cards, spending limits, etc. Requires authorization to access certain things.
Independent checks
If people know their work or activities will be monitored by others, the opportunity to commit and conceal a fraud will be reduced.
Physical Safeguards
Used to protect assets from theft by fraud or other means. Vaults, safes, fences, locks, and keys, take away opportunities to commit fraud by making it difficult for people to access assets.
Documents and records
Creates an audit trail. Documents rarely serve as preventative controls but provide excellent detective controls.
Control environment
1. Management philosophy and operating style
2. Effective hiring procedures
3. Clear organizational structure of proper modeling and labeling
4. Effective internal audit department
Management philosophy and operating style
Management's dishonest or inappropriate behavior has been learned and mimicked by employees. Proper modeling and proper labeling are some of the most important elements in the internal control environment.
Management Communication
Communication what is and is not appropriate is critical. Codes of conduct, orientation meetings, training, supervisor/employee discussions, and other types of communication that distinguish between acceptable and unacceptable behavior are critical.
Appropriate Hiring
Fraud will occur when dishonest people are hired, even if with the best internal controls.
Clear organizational structure
When everyone is an organization knows exactly who has responsibility for each business activity, fraud is less likely to be committed. It is easier to track missing assets and hard to embezzle without being caught.
Effective Internal Audit Department
Although internal auditors detect only about 20% of all employee frauds, the presence of internal auditors provides a significant deterrent effect.
The Element of Rationalization
"The organization owes 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"
Creating a Culture of Honesty and High Ethics
1. Tone at the Top
2. Hiring the Right Kind of Employees
3. Communicating Expectations of Honesty and Integrity
4. Creating a Positive Work Environment
5. Proper Handling of Fraud and Fraud Perpetrators When Fraud Occurs
Tone at the Top
Honest can be best reinforced when a proper example is set. Management of an organization cannot act one way and expect others in the organization to behave differently. Management must reinforce to its employees through its actions that dishonest, questionable, or unethical behavior will not be tolerated.
Hiring the Right Kind of Employees
An organization must have effective hiring policies that discriminate between marginal and highly ethical individuals, especially when recruiting for high-risk positions. Conducting background checks, checking references, and learning how to interpret responses
Communicating Expectations of Honesty and Integrity
Identifying and codifying appropriate values and ethics, fraud awareness training that helps employees understand potential fraud problems they may encounter and how to resolve or report them, and communicating consistent expectations about punishment of violators.

Codes of conduct must be written and communicated to employees, vendors, and customers. Requiring employees to confirm in writing that they understand the organization's ethics expectations is an effective element of communication in creating a culture of honesty.
Creating a Positive Work Environment
Fraud occurs less frequently when employees have positive feelings about an organization, and have a feeling of ownership in that organization, than when they feel abused, threatened, or ignored.
Proper Handling of Fraud and Fraud Perpetrators when Fraud Occurs
Every organization should have a fraud policy that determines whose responsibility fraud prevention, detection, and investigation are, how incidents of fraud will be handled internally and legally, and what kind of remediation and education efforts will take place when fraud does occur.
Types of Evidence
1. Testimonial evidence
2. Documentary evidence
3. Physical evidence
4. Personal observation
Testimonial evidence
Gathered from individuals. Interviewing, interrogation, and various kinds of honesty tests.
Documentary evidence
Gathered from paper, computers, and other written or printed sources. Document examination, data mining, public records searches, audits, computer searches, net worth calculations, and financial statement analysis.
Physical evidence
Fingerprints, tire marks, weapons, stolen property, identification numbers or marks on stolen objects, and other tangible evidence associated with dishonest acts. Forensic analysis.
Personal observation
Evidence that is sensed by investigators themselves. Invigilation, surveillance, and covert operations.
Fraud Investigation
1. Must be undertaken only to "establish the truth of the matter under question."

2. Person in charge must be experienced and objective. Investigators should never jump to conclusions.

3. Hypotheses should be closely guarded when discussing the progress of an investigation with others.

4. Only those who have a need to know are kept apprised of investigation activities and agree to the investigation and techniques employed.

5. All information collected during an inquiry is independently corroborated and determined to be factually correct.

6. Avoid questionable investigative techniques.

7. Must report all facts objectively and fairly.
Creating a culture of honesty, openness, and assistance
1. Hire honest people and provide fraud awareness training.
2. Create a positive work environment.
3. Provide an employee assistance program.
Preventative Controls
1. Segregation of duties
2. System of authorizations
3. Physical safeguards
Detective Controls
1. Independent checks
2. Documents and records
Accounting Anomalies
1. Irregularities in source documents
2. Faulty journal entries
3. Inaccuracies in ledgers
Irregularities in source documents
Involves checks, sales invoices, purchase orders, purchase requisitions, and receiving reports.

Missing documents, stale items on bank reconciliations, excessive voids or credits, common names or addresses of payees or customers, duplicate payments, document sequences that do not make sense, etc.
Faulty Journal Entries
Journal entries without documentary support, journal entries that do not balance, journal entries made by people who do not typically make such entries, journal entries near the end of an accounting period.

Embezzlers typically conceal fraud using expense accounts, knowing that it will be closed at the end of the year.
Inaccuracies in ledgers
1. A ledger that does not balance
2. Master (control) account balances that do not equal the sum of the individual customer or vendor balances
Analytical Fraud Symptoms
Procedures or relationships that are unusual or too unrealistic to be believable. Includes transactions or events that happen at odd times or places; that are performed by or involve people who would not normally participate; or that include odd procedures, policies, or practices.
Extravagant Lifestyles
People who commit fraud are typically under financial pressures. Once their financial needs are met, they typical continue to steal and live a lifestyle beyond their means.

Luxury cars, expensive jewelry, vacations, etc.
Unusual Behaviors
When a person commits a crime, especially for the first time, he becomes engulfed by emotions of fear and guilt. This results in stress, leading to things such as:

insomnia, increased drinking, inability to relax, drug use, defensiveness, inability to look people in the eye, etc.
Tips and Complaints
Tips and Complaints are categorized as fraud symptoms because most tips and complaints turn out to be unjustified.