Chapter 12 - Business Ethics, Fraud, and Fraud Detection

Question 1

_____________ pertains to the principles of conduct that individuals use in making choices and guiding their behavior in situations that involve the concepts of right and wrong.

Answer 1

Ethics

Question 2

Business ethics involves finding the answers to two questions:

Answer 2

(1) How do managers decide what is right in conducting their business? and (2) Once managers have recognized what is right, how do they achieve it?

Question 3

Ethical issues in business can be divided into four areas: ___________________________.

Answer 3

equity, rights, honesty, and the exercise of corporate power.

Question 4

Implementing a new computer information system within an organization may cause some employees to lose their jobs, while those who remain enjoy the benefit of improved working conditions.
Seeking a balance between these consequences is the managers’ _____________________________.

Answer 4

ethical responsibility

Question 4

Implementing a new computer information system within an organization may cause some employees to lose their jobs, while those who remain enjoy the benefit of improved working conditions.
Seeking a balance between these consequences is the managers’ _____________________________.

Answer 4

ethical responsibility

Question 5

Ethical Issues in Business: Equity

Answer 5

Executive Salaries
Comparable Worth
Product Pricing

Question 6

Ethical Issues in Business: Rights

Answer 6

Corporate Due Process
Employee Health Screening
Employee Privacy
Sexual Harassment
Diversity
Equal Employment Opportunity
Whistleblowing

Question 7

Ethical Issues in Business: Honesty

Answer 7

Employee and Management Conflicts of Interest
Security of Organization Data and Records
Misleading Advertising
Questionable Business Practices in Foreign Countries
Accurate Reporting of Shareholder Interests

Question 8

Ethical Issues in Business: Exercise of
Corporate Power

Answer 8

Political Action Committees
Workplace Safety
Product Safety
Environmental Issues
Divestment of Interests
Corporate Political Contributions
Downsizing and Plant Closures

Question 9

This is the principle that says that the benefit from a decision must outweigh the risks. Furthermore, there must be no alternative decision that provides the same or greater benefit with less risk.

Answer 9

Proportionality

Question 10

This is the principle that says the benefits of the decision should be distributed fairly to those who share
the risks. Those who do not benefit should not carry the burden of risk.

Answer 10

Justice

Question 11

This is the principle that says that even if judged acceptable by the principles, the decision should be implemented so as to minimize all of the risks and avoid any unnecessary risks.

Answer 11

Minimize risk

Question 12

__________________ is “the analysis of the nature and social impact of computer technology and the corresponding formulation and justification of policies for the ethical use of such technology…. [This includes] concerns about software as well as hardware and concerns about networks connecting computers as well as computers themselves.”

Answer 12

Computer ethics

Question 13

three levels of computer ethics:

Answer 13

pop, para, and theoretical

Question 14

_______________ is simply the exposure to stories and reports found in the popular media regarding the good or bad ramifications of computer technology.

Answer 14

Pop computer ethics

Question 15

_____________ involves taking a real interest in computer ethics cases and acquiring some level of skill and knowledge in the field

Answer 15

Para computer ethics

Question 16

____________________ is of interest to multidisciplinary researchers who apply the theories of philosophy, sociology, and psychology to computer science with the goal of bringing some new understanding to the field.

Answer 16

Theoretical computer ethics

Question 16

____________________ is of interest to multidisciplinary researchers who apply the theories of philosophy, sociology, and psychology to computer science with the goal of bringing some new understanding to the field.

Answer 16

Theoretical computer ethics

Question 17

People desire to be in full control of what and how much information about themselves is available to others, and to whom it is available. This is the issue of ___________.

Answer 17

privacy

Question 18

The creation and maintenance of huge, shared databases make it necessary to protect people from the potential misuse of data. This raises the issue of _____________ in the personal information industry.

Answer 18

ownership

Question 19

____________ is an attempt to avoid such undesirable events as a loss of confidentiality or data integrity

Answer 19

Computer security

Question 20

________________ attempt to prevent fraud and other misuse of computer systems; they act to protect and further the legitimate interests of the system’s constituencies

Answer 20

Security systems

Question 21

______________ denotes a false representation of a material fact made by one party to another party with the intent to deceive and induce the other party to justifiably rely on the fact to his or her detriment

Answer 21

Fraud

Question 22

According to common law, a fraudulent act must meet the following five conditions:

Answer 22

1. False representation. There must be a false statement or a nondisclosure.
2. Material fact. A fact must be a substantial factor in inducing someone to act.
3. Intent. There must be the intent to deceive or the knowledge that one’s statement is
   false.
4. Justifiable reliance. The misrepresentation must have been a substantial factor on
   which the injured party relied.
5. Injury or loss. The deception must have caused injury or loss to the victim of the
   fraud.

Question 23

In accounting literature, fraud is also commonly known ___________________________________.

Answer 23

as white-collar crime, defalcation, embezzlement, and irregularities.

Question 24

Auditors encounter fraud at two levels:

Answer 24

employee fraud and management fraud.

Question 25

_____________________ is generally designed to directly convert cash or other assets to the employee’s personal benefit. Typically, the employee circumvents the company’s internal control system for personal gain.

Answer 25

Employee fraud, or fraud by non-management employees

Question 26

Employee fraud usually involves three steps:

Answer 26

(1) stealing something of value (an asset)
(2) converting the asset to a usable form (cash)
(3) concealing the crime to avoid detection

Question 27

__________________ is more insidious than employee fraud because it often escapes detection until the organization has suffered irreparable damage or loss.

Answer 27

Management fraud

Question 28

Management fraud typically contains three special characteristics:

Answer 28

1. The fraud is perpetrated at levels of management above the one to which internal
   control structures generally relate.
2. The fraud frequently involves using the financial statements to create an illusion that
   an entity is healthier and more prosperous than, in fact, it is.
3. If the fraud involves misappropriation of assets, it frequently is shrouded in a maze
   of complex business transactions, often involving related third parties.

Question 29

The ___________ consists of three factors that contribute to or are associated with management and employee fraud.

Answer 29

fraud triangle

Question 30

The fraud triangle consists of three factors:

Answer 30

(1) situational pressure, which includes personal or job-related stresses that could coerce an individual to act dishonestly;
(2) opportunity, which involves direct access to assets and/or access to information that controls assets, and;
(3) ethics, which pertains to one’s character and degree of moral opposition to acts of dishonesty.

Question 31

The actual cost of fraud is, however, difficult to quantify for a number of reasons:

Answer 31

(1) not all fraud is detected;
(2) of that detected, not all is reported; (3) in many fraud cases, incomplete information is gathered; (4) information is not properly distributed to management or law enforcement authorities; and
(5) too often, business organizations decide to take no civil or
criminal action against the perpetrator(s) of fraud.

Question 32

Three broad categories of fraud schemes are defined:

Answer 32

fraudulent statements, corruption, and asset misappropriation.

Question 33

________________ are fraud schemes associated with management fraud. For example, misstating the cash account balance to cover the theft of cash is not financial statement fraud. On the other hand, understating liabilities to present a more favorable financial picture of the organization to drive up stock prices does fall under this classification.

Answer 33

Fraudulent statements

Question 34

The Underlying Problems involving Fraud:

Answer 34

1. Lack of auditor independence
2. Lack of director independence
3. Questionable executive compensation schemes
4. Inappropriate accounting practices.

Question 35

____________ involves giving, offering, soliciting, or receiving things of value to influence an official in the performance of his or her lawful duties

Answer 35

Bribery

Question 36

An ___________ involves giving, receiving, offering, or soliciting something of value because of an official act that has been taken.

Answer 36

illegal gratuity

Question 37

A _________ occurs when an employee acts on behalf of a third party during the discharge of his or her duties or has self-interest in the activity being performed.

Answer 37

conflict of interest

Question 38

___________________ is the use (or threat) of force (including economic sanctions) by an individual or organization to obtain something of value.

Answer 38

Economic extortion

Question 39

_______________ involves stealing cash from an organization before it is recorded on the organization’s books and records. One example of this is an employee who accepts payment from a customer but does not record the sale.

Answer 39

Skimming

Question 40

_________________ is where an employee opening the mail steals a customer’s check and destroys the associated remittance advice

Answer 40

Mailroom fraud

Question 41

_________________ involves schemes where cash receipts are stolen from an organization after they have been recorded in the organization’s books and records.

Answer 41

Cash larceny

Question 42

_______________, also known as _______________, are perpetrated by employees who cause their employer to issue a payment to a false supplier or vendor by submitting invoices for fictitious goods or services, inflated invoices, or invoices for personal purchases.

Answer 42

Billing schemes, vendor fraud

Question 43

Three examples of billing scheme:

Answer 43

1. shell company fraud
2. pass-through fraud
3. pay-and-return scheme

Question 44

A ______________ first requires that the perpetrator establish a false supplier on the books of the victim company. The fraudster then manufactures false purchase orders, receiving reports, and invoices in the name of the vendor and submits them to the accounting system, which creates the allusion of a legitimate transaction. Based on these documents, the system will set up an account payable and ultimately issue a check to the false supplier (the fraudster).

Answer 44

shell company fraud

Question 45

A _____________ is similar to the shell company fraud with the exception that a transaction actually takes place. Again, the perpetrator creates a false vendor and issues purchase orders to it for inventory or supplies. The false vendor then purchases the needed inventory from a legitimate vendor. The false vendor charges the victim company.

Answer 45

pass-through fraud

Question 46

A _______________ is a third form of vendor fraud. This typically involves a clerk with check writing authority who pays a vendor twice for the same products (inventory or supplies) received. The vendor, recognizing that its customer made a double payment, issues a reimbursement to the victim company, which the clerk intercepts and cashes.

Answer 46

pay-and-return scheme

Question 47

____________ involves forging or changing in some material way a check that the organization has written to a legitimate payee.

Answer 47

Check tampering

Question 48

_______________ is the distribution of fraudulent paychecks to existent
and/or nonexistent employees

Answer 48

Payroll fraud

Question 49

_________________ are schemes in which an employee makes a claim for reimbursement of fictitious or inflated business expenses.

Answer 49

Expense reimbursement frauds

Question 50

________________ are schemes that involve the direct theft of cash on
hand in the organization.

Answer 50

Thefts of cash

Question 51

__________________ involve the theft or misuse of the victim organization’s non cash assets.

Answer 51

Non cash fraud schemes

Question 52

___________________ is the first operational stage in the information system. The objective is to ensure that transaction data entering the system are valid, complete, and free from material errors. In many respects, this is the most important stage in
the system.

Answer 52

Data collection

Question 53

Two rules govern the design of data collection procedures:

Answer 53

relevance and efficiency

Question 54

Networked systems expose organizations to transaction frauds from remote locations. __________________________ are examples of such fraud techniques

Answer 54

Masquerading, piggybacking, and hacking

Question 55

_______________ involves a perpetrator gaining access to the system from a remote site by pretending to be an authorized user. This usually requires first gaining authorized access to a password.

Answer 55

Masquerading

Question 56

________________ is a technique in which the perpetrator at a remote site taps into the telecommunications lines and latches onto an authorized user who is logging into the system.

Answer 56

Piggybacking

Question 56

________________ is a technique in which the perpetrator at a remote site taps into the telecommunications lines and latches onto an authorized user who is logging into the system.

Answer 56

Piggybacking

Question 57

_______________ are distinguished from other computer criminals because their motives are not usually to defraud for financial gain. They are motivated primarily by the challenge of breaking into the system rather than the theft of assets

Answer 57

Hackers

Question 58

Program fraud includes the following techniques:

Answer 58

(1) creating illegal programs that can access data files to alter, delete, or insert values into accounting records; (2) destroying or corrupting a program’s logic using a computer virus; or (3) altering program logic to cause the application to process data incorrectly.

Question 59

__________________ is the misuse or theft of the firm’s computer resources. This often involves using the computer to conduct personal business.

Answer 59

Operations fraud

Question 60

___________________ includes altering, deleting, corrupting, destroying, or stealing an organization’s data. Because access to database files is an essential element of this fraud, it is often associated with transaction or program
fraud

Answer 60

Database management fraud

Question 61

__________________ is the process of compiling, arranging, formatting, and presenting information to users. Information may be an operational document such as a sales order, a structured report, or a message on a computer screen.

Answer 61

Information generation

Question 62

Regardless of physical form, useful information has the following characteristics:

Answer 62

relevance, timeliness, accuracy, completeness, and summarization

Question 63

A common form of fraud at the information generation stage is to steal, misdirect, or misuse computer output. One simple but effective technique called ___________ involves searching through the trash cans of the computer center for discarded output

Answer 63

scavenging

Question 64

_______________ involves listening to output transmissions over telecommunications lines

Answer 64

eavesdropping

Question 65

Risk factors that relate to fraudulent financial reporting are grouped according to the following classifications:

Answer 65

• Management’s characteristics and influence over the control environment.
• Industry conditions.
• Operating characteristics and financial stability.

Question 66

In the case of financial fraud (management fraud), external auditors should look for the following kinds of common schemes:

Answer 66

• Improper revenue recognition
• Improper treatment of sales
• Improper asset valuation
• Improper deferral of costs and expenses
• Improper recording of liabilities
• Inadequate disclosures

Question 67

Two risk factors are related to misappropriation of assets:

Answer 67

1. Susceptibility of assets to misappropriation.
2. Controls.

Question 68

The __________________ is used extensively for consumer accounts. Total sales to customers for the period are itemized and billed at the period end. Customers are required to
pay only a minimum amount off the balance. The rest of the balance, plus interest, is carried forward to the next period.

Answer 68

balance forward method

Question 69

The ____________ is often used to manage trade accounts receivable (sales to other business organizations).

Answer 69

open invoice method

Question 70

The auditor’s judgments about the risk of material misstatements due to fraud may affect the audit in the following ways:

Answer 70

• Engagement staffing and extent of supervision. The knowledge, skill, and ability of personnel assigned to the engagement should be commensurate with the assessment of the level of risk of the engagement.
• Professional skepticism. Exercising professional skepticism involves maintaining an attitude that includes a questioning mind and critical assessment of audit evidence.
• Nature, timing, and extent of procedures performed. Fraud risk factors that have control implications may limit the auditor’s ability to assess control risk below the maximum and thus reduce substantive testing.