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Fraud Essentials: WHO - HOW – WHY - WHAT Mark Dauberman, CPA EMBA
Fraud Essentials:
WHO - HOW – WHY - WHAT
Mark Dauberman, CPA EMBA
* WHO COMMITS FRAUD?
* HOW IS IT DONE?
* WHY DO THEY DO IT?
* WHAT CAN WE DO TO PREVENT OR DETECT IT?
OVERVIEW
WHO?
“Fraud is committed by desperate individuals”
Joseph T Wells, CPA, CFE
Founder of the Association of Certified Fraud Examiners (ACFE)
Fraud Perpetrators
-Officers -Managers
-Directors -Employees
-Customers -Suppliers
-Strangers -Aliens
Profile
Fraudster
Opportunist
Honest crook
Psychopath
Fraudster
Commits fraud as a vocation◦Intelligent & skilled
◦Abilities applied to committing fraud instead of legitimate endeavor
◦Potential victim’s CONfidence sought
◦Victim & victim’s systems studied
◦Weaknesses identified & exploited
Opportunist
Commits fraud to enhance lifestyle◦Risk averse
◦Fraud only attempted if detection is not expected
◦Actions believed to be universal & accepted
◦No feelings of remorse
Honest Crook
Commits fraud due to
perceived necessity◦No intention to steal or damage victim
◦Resources considered loan or advance
◦Feels misunderstood & victimized
◦Guidance or assistance perceived as unavailable
PsychopathCommits fraud under the belief that it is okay
unless caught◦Grandiose sense of self worth
◦Believes rules are for others who do not know how to get away with breaking them
◦Manipulative
◦Pathological liar
Polling Question #1
What aspect of the accounting profession are you involved in?◦ 1 – I am a CPA working in public accounting.
◦ 2 – I am a CPA working in private industry, government, or for a not-for-profit.
◦ 3 – I am a CPA working outside of the profession of accounting, for example as an investment advisor.
◦ 4 – Accounting? I must be in the wrong room, Do you know where the Committee for Protecting Everything is meeting?
HOW?
Common Schemes Used to Commit
Fraud
The Nature of Fraud
Misappropriation of assets
Fraudulent statements
Corruption schemes
Misappropriation of Assets
Cash
-Theft of cash on hand
-Theft of cash receipts
-Fraudulent disbursements
Inventory and other assets
-Larceny
-Misuse
Asset Misappropriation
- Cash
Embezzlement Skimming
Inappropriate invoice
False expense reports
Fraudulent Statements
NET WORTH & NET INCOME OVERSTATEMENTS
NET WORTH & NET INCOME UNDERSTATEMENTS
FRAUDULENT NONFINANCIAL STATEMENTS
Examples of Fraudulent Statements
Stealing from the company – Reporting fictional sales to
obtain commission
Stealing by the company – Fictional invoice sent to
customer to collect illegitimate funds
Fraudulent financial reporting – Falsified accounts
receivable schedule to avoid bad debt recognition
SYMBOL TECHNOLOGIES
Director of corporate accounting inflated performance measures to appear to meet analysts’ forecasts
Used topside adjustments to make actual results appear to match forecasts
Created “cookie jar” reserve by overstating obsolete inventory
Fraudulently deferred payment of FICA on bonuses
Recorded revenues for purchase orders not shipped
Participated in channel stuffing
Reclassified trade receivables to notes receivable to improve aging
SEC initiated investigation
Corruption SchemesConflict of interest
Bribery
Illegal gratuities
Economic extortion
Corruption Schemes
Kickbacks from vendors for favorable pricing
Writing off or reducing accounts for kickbacks
Diverting customer orders to competing business
Kickback from competitor
Interest in competitor
Polling Question #2
What is your opinion of the profession‘s peer review
program?◦ 1 – I think it’s a great program and makes the profession better.
◦ 2 – I think it is unnecessary and wastes a firm’s resources and time.
◦ 3 – I think it has become more punitive than informative and is hurting, rather than helping the profession.
◦ 4 – I think the idea is great, but the program falls a little short.
WHY?
Conditions Leading to the Commission of Fraud
The Fraud Triangle
Characteristics of Fraud
Reason
Opportunity
Rationalization
Reason
Greed
Pressure
Perceived unfairness
Perceived unfairness
https://Youtube.com/watch?v=meiU6TxysCg
Opportunity
Lack of Internal Controls
Lack of enforcement
Ability to override or circumvent
controls
Rationalization
Not wrong
Not my fault
Entitlement
Everybody does it
No choiceI had no choice!
Polling Question #3
At what level do you function within your firm or company?◦ 1 – I am a decision-maker in relation to the overall operations of
my organization.
◦ 2 – I make decisions related to my department or division, subject to override by officers or executives.
◦ 3 – I supervise other employees, but do not have decision-making authority
◦ 4 – I have responsibilities in relation to my role but do not supervise others and do not have decision-making authority.
How the Characteristics Apply to Fraud Perpetrators
Different strokes for different folks!
Fraudster
Characteristics◦Reason – basis of support
◦Opportunity – ability to overcome or avoid controls
◦Rationalization – not doing anything wrong
Strategy◦Avoid association
◦Practices for establishing relationships
Opportunist
Characteristics◦Reason – personal gain
◦Opportunity – lack of controls
◦Rationalization – everybody does it
Strategy◦Appearance of controls
◦Enforcement with ramifications
Honest CrookCharacteristics◦Reason – pressure
◦Opportunity – ability to circumvent or override controls
◦Rationalization – no choice
Strategy◦Familiarity
◦Conscious observation
PsychopathCharacteristics◦Reason –perceived as normal behavior
◦Opportunity – creates feeling of confidence to establish trust
◦Rationalization – not wrong
Strategy◦Awareness of characteristics
◦Design interview to reveal characteristics
Characteristics of “White Collar” Criminals
-Older & more mature
-More religious
-Higher IQ
-Better education
-Clean lifestyle
-Lack of criminal record
-Positive outlook & outgoing personality
-Highly motivated
-Passive follower of leadership
Behavioral Warning Signs
Insomnia
Increased drinking or substance abuse
Changes in temperament or disposition
Nervousness
Lack of eye contact
Increased belligerence
Sweating
Possible Red Flags
Living beyond means
Financial difficulties
Control issues with unwillingness to share duties
Unusually close association with a customer or vendor
Divorce or family problems
“Wheeler-dealer” attitude
Irritability, suspiciousness, & defensiveness
Red Flags -continued
Addiction problems
Complaints of inadequate compensation
Past employment-related problems
Refusal to take vacations
Social isolation
Excessive family or peer pressure for success
Instability in life circumstances
Past legal problems
Complaints about lack of authority
Fraud Committed at Entity Level
“Groupthink” – Contributing factors
◦ Supermen & women – Illusion of
invulnerability
◦ Denial – Illusion of anonymity
◦ Invisibleness – Suppression of personal
doubts
◦ Delusional – Self-appointed mind guards
◦ Apathy – Atmosphere of docility
◦ Peer pressure – Taboo against
antagonizing certain individuals
Polling Question #4
What is your favorite way of obtaining CPE?◦ 1 – I like short (2-4 hour) live seminars that also give me an opportunity to
network.
◦ 2 – I like live seminars for the networking opportunity, but I’d prefer to get it done in large chunks of 1 or more full days so I am not as likely to be distracted by unrelated issues.
◦ 3 – I like webinars of varying lengths where the instructor can respond to questions, either conducting the class from a remote location or monitoring one that has been pre-recorded.
◦ 4 – I like pre-recorded programs of varying lengths approved for self-study, allowing me to study at my own pace and convenience.
WHAT?
OBJECTIVEFraud PreventionFraud Detection
SOLUTIONInternal ControlsInternal Reporting & Analytical Procedures
Prevention & Detection Measures
Identify potential frauds through risk assessment
System of checks & balances
Regulation of employee authority & access
Internal controls appropriate forGoods or services provided
Business practices
Fraud Prevention Techniques
Improve Opportunities to Prevent Fraud By Applying A 4-Step Process
1) Identify Fraud Schemes That May Be Applicable
2) Understand Existing Internal Controls
3) Identify Vulnerabilities
4) Create or Enhance Controls
ACFE – Report to the Nations on Occupational Fraud and Abuse
Using the Fraud Tree – Ask…
Could this type of fraud occur here?
Who is in position to perpetrate this type of fraud?
What conditions would have to exist in order for this fraud to occur?
What signs might indicate that this type of fraud occurred?
Management’s Responsibilities
• Awareness of vulnerable assets
• Processes & relationships conducive to fraud
Could this type of fraud occur here?
• Due diligence upon hiring
• Background checks
• Bonding
• Identify favorable characteristics
Who is in position to perpetrate this type of fraud?
What conditions would have to exist in order for this fraud to occur?
Policies & procedures to prevent conditions
Close supervision when conditions not avoidable
What
signs
might
indicate
that this
type of
fraud
occurred?
Management reports
providing indicators
“Management by walking
around”
Polling Question #5
If it is learned that audited financial statements are materially misstated due to
fraud, is the auditor likely to be held liable?
◦ 1 –Yes, even if all requirements of standards were complied with, because the
public expects auditors to detect fraud.
◦ 2 – No, because professional standards indicate that it is not the purpose of
the audit to detect fraud and the engagement letter, signed by the client, says
that they are responsible for fraud and that the auditor is not.
◦ 3 – No, if the requirements of standards were complied with in all material
respects, and the CPA applied due diligence performing in the same manner
as any other qualified auditor would under the circumstances.
Framework for Developing & Enhancing Controls
Understand existing systems◦ Initiation of transactions
◦Authorization to commit resources
◦Execution
◦Recording
◦Verifications throughout the
process
MAKE SURE YOU HAVE AN ACCURATE UNDERSTANDING
Designing Effective Internal Controls
The COSO model
◦Control
environment
◦Risk assessment
◦Control activities
◦ Information &
communication
◦Monitoring
Control Environment
Standards, processes, and structures providing basis for carrying out internal control
Established by board of directors and management
Importance of internal controls
Expected standards of conduct
Integrity and ethical values of organization
Organizational structure and assignment of authority and responsibility
Process for attracting, developing, and retaining competent individuals
Accountability for performance
Risk Assessment
Dynamic and iterative process to identify and assess risks from external and internal sources
Risks to achievement of objectives considered in relation to entity’s risk tolerances
Tied to establishment of objectives related to operations, reporting, and compliance
Considers changes to external and internal environment affecting internal control
Control Activities
Policies and procedures designed to ensure that management’s directives are followed
Performed at all levels of entity
May be preventive or detective
May involve manual and authorizations and approvals, verifications, reconciliations, and performance reviews
Should incorporate segregation of duties, where possible, or alternatives when not achievable
Documentation Alternatives
Narrative
Flowchart
Decision Tree
Questionnaire
Identify & Evaluate Weaknesses
•Operations
•Compliance
•Reporting
Establish internal control objectives
•Obtain understanding of how system operates
• Identify control activities
•Evaluate deficiencies
Determine applicable systems
Events & Transactions
Occurrence
Completeness
Accuracy
Cutoff
Classification
Account Balances
Existence
Rights & obligations
Completeness
Valuation & allocation
Presentation & Disclosure
Occurrence & rights & obligations
Completeness
Classification & understandability
Accuracy & valuation
Adequate Segregation of Duties
Authorization
Custody
Recording
Reconciliation
Risk Assessment Process
For each system
•Identify control activities
•Determine which assertions are supported
Effect of control activities
•Prevent fraud
•Detect fraud
•Prevent errors
•Detect errors
WCGW ANALYSIS
Ask the Tough Question
WHAT COULD GO WRONG?
Polling Question #6
Which of the following best describes the control environment in your
workplace?
◦1 – There is openness and transparency, executives exhibit ethical behavior, and all individuals are treated with respect.
◦2 – Executives make certain employees know of their special benefits to inspire employees to want to move up.
◦3 – There is tension and competition among employees at all levels because there are fewer opportunities at higher levels.
◦4 – I really don’t pay attention to that type of thing.
Objective of Control Activities
Break down the fraud
triangle
◦Reason
◦ What would motivate someone to commit this type of
fraud?
◦ Are there procedures that would prevent or deter
them from wanting to do so?
◦Opportunity
◦ What mechanical process will be used to commit this
type of fraud?
◦ Are there procedures that would prevent or deter
someone from performing those procedures?
Environment Surrounding Effective Controls
Transparency & effective communication
Policies & procedures to protect assets
Effective hiring practices
Updating risk assessment & internal controls
Conventional Control Activities
Physical controls
Information processing controls
Performance indicators
Segregation of duties
Control Activities Potentially Effective for Fraud
Accept Reality
Involve Others
Give Carrots
SEND AN EMAIL TO [email protected] IF YOU HAVE COMMENTS OR QUESTIONS OR IF I MAY OTHERWISE BE OF ASSISTANCE
- IN-HOUSE TRAINING
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BY MARK DAUBERMAN, CPA CGMA EMBA
PH (310) 905-4433WWW.MARKDAUBERMAN.COM
Thank You
COPYRIGHT © 2020 – MARK DAUBERMAN, CPA
