Chapter 3 Part 1 (Ethics, Fraud and Internal Control) Flashcards
pertains to the principles of conduct that individuals use in making choices and guiding their behavior in situations that involve the concept of right and wrong
ethics
the most significant securities law since the SEC act of 1933 and 1934, comprised of many sections
Sarbanes -Oxley
section 406 in the Sarbanes Oxley sates that Codes of Ethics should address what items?
- conflict of interest
- full and fair disclosure
- legal compliance
- internal reporting of code violations
- accountability
outlines procedures for dealing with the actual or apparent conflict between personal and professional relationships. Does not prohibit; but rather talks about how to handle them if they do arise.
conflict of interest
organization must provide full, fair, accurate, timely and understandable disclosures in the documents, reports and financial statements.
overly complex or misleading information is not right; must be open, trustful, void of deception
full & fair disclosure
must follow all governmental laws, rules and regulations
cannot confuse ethics with legal issues
legal compliance
provide a way for people to report violations
internal reporting of code violations
action for violations of the code
accountability
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 hoer detriment
fraud
What are the 5 conditions of fraud according to the common law?
- false representation: must be a false statement or a non-disclosure
- material fact: must be a substantial factor in inducing someone to act
- intent: must be the intent to deceive or the knowledge that one’s statement is false
- justifiable reliance: misrepresentation must have been a substantial factor on which the injured party relied
- injury or loss: the deception must have caused injury or loss to the victim of fraud
intentional deception or misappropriation of a company’s assets, or manipulation of a company’s financial data to the advantage of the perpetrator
fraud and business
- done by non-management employee
- most often to convert cash or other company assets into employee’s benefit
- employee has circumvented the internal control system for personal gain
- stealing something
- converting that to cash
- concealing the act
employee fraud
- does not usually involve a direct theft of assets
- drive market price up to help meet a stock target that then drives compensations
management fraud
- at a level of management where internal controls do not relate
- involves using the financial statements to create an illusion that an entity is healthier than is
- involves misappropriation of assets and hidden in a maze of complex transactions
an individual with high moral ethics who is confronted wit lower-level of opportunity and pressure will be more honest than someone with weaker ethics who are confronted with greater pressure and opportunity
the fraud triangle
- if pressure and opportunity is larger then ethics is going to be weaker and vise versa
stresses, motivation, or incentive to commit fruad
pressure
ability to carry out misappropriation of cash or organizational assets
opportunity
one’s character and moral opposition to act dishonest or one’s ability to rationalize the event
ethics
ACFE deals with what type of fraud?
occupational fraud
three categories:
- asset misappropriation scheme
- corruption schemes
- financial statements fraud schemes
an employee steals or misuses the organization’s resources (e.g., theft of company cash, false billing scheme or inflate expense reports)
- stealing small supplies as in highlighters, keying in extra time, and creating fictitious vendors
asset misappropriation scheme
an employee misuses his or her influences in a business transaction in a way that violates his or her duty to the employer in order to gain a direct or indirect benefit (e.g., schemes involving bribery or conflicts of interest)
corruption scheme
an employee intentionally causes a misstatement or omission of material information in organization’s financial reports (e.g., recording fictitious revenues, understating reported expenses or artificially inflating reported assets)
financial statement fraud scheme
auditing firms also engaged by tier clients to perform non-accounting activities
lack of auditor independence
directors who also serve on the boards of other companies, have a business trading relationship, have a financial relationship as stockholders or have received personal loans, or have an operational relationship as employees
lack of director independence
short-term stock options as compensation result in short-term strategies aimed at driving up stock prices at the expense of the firm’s long-term health
questionable executive compensation scheme
a characteristic common to many financial statement fraud schemes
inappropriate accounting practices
sets auditing, quality control and ethics standards for auditing public companies is a way to review auditors of public companies which investigates and takes disciplinary action on auditor
public company accounting oversight board (PCAOB) created by SOX
audit committee members must be independent and the audit committee must oversee the external auditors
corporate governance and responsibility
A process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting and compliance.
internal control - COSO definition
cannot provide 100% absolute assurance
reasonable assurance
- Possibility of honest errors
- Circumvention via collusion
- Management override
- Changing conditions–especially - in companies with high growth
limitations of internal controls
CEO and CFO must certify quarterly/annually the internal controls of the organization
section 302 of the SOX
management must “assess” and issue an opinion on the internal controls of a company:
- management’s responsibility for establishing and maintaining adequate controls over financial reporting
- assessment of the controls
- the external auditors must review
- must disclose the framework used
section 404 of the SOX
