Test 1 Flashcards
Fraud Triangle (3 aspects):
-Motive/Pressure
-Opportunity
-Rationalization
Legal elements of Fraud
-Material false statement
-Knowledge that the statement was false (scienter)
-Reliance of the victim on the false statement
-Damages resulting from the victim’s reliance on the false statement
Fraud is deception that includes the following elements:
- A representation
- About a material point
- Which is false
- And intentionally or recklessly so
- Which is believed
- And acted upon by the victim
- To the victim’s damage
True or False: Fraud is different from unintentional errors.
True
True or False: Negligence is different from fraud because it lacks “intent
True
-Negligence is when they should have known better, but were negligent and did not do something correctly.
Criminal Law
- Branch of law that deals with offenses of a public nature
- Criminal laws :
-Generally deal with offenses against society as a whole
-Prosecuted either federally or by a state for violating a statute that prohibits some type of activity
Civil Law
- Body of law that provides remedies for violations of private rights
- Deals with rights of individuals
- Civil claims:
-Begin when one party files a complaint against another, usually for the purpose of gaining financial restitution
Fraud-Related Careers
- Accounting professionals
- Corporate security officers
- Expert witness
- Government inspectors
- Independent consultant
- Internal auditors
- Investigators
- Law enforcement
- Lawyers
Who commits Fraud?
- Anyone can commit fraud.
- Fraud perpetrators usually can’t be distinguished from other people on the basis of demographic or psychological characteristics.
- Most employees, customers, vendors, and business associates and partners fit the profile of fraud perpetrators and are capable of committing fraud.
- It is impossible to predict in advance which employees, vendors, clients, customers, and others will become dishonest.
Fraud Triangle: Pressure/Motive
- Financial Pressures
- Vice Pressures
- Work-Related Pressures
- Other Pressures
Fraud Triangle: Opportunity
- A perceived opportunity to commit fraud, conceal it, or avoid being punished is the second element of the fraud triangle.
- At least six major factors increase perceived or real opportunities for individuals to commit fraud within an organization.
At least Six major factors:
* Lack of internal controls that prevent and/or detect fraudulent behavior
* Inability to judge quality of performance
* Failure to discipline fraud perpetrators
* Lack of access to information or asymmetrical information
* Ignorance, apathy, or incapacity
* Lack of an audit trail
* Lack of segregation of duties
Fraud Triangle: Rationalization
- Most fraud perpetrators are first-time offenders who would not commit other crimes.
- In some way, they must rationalize away the dishonesty of their acts:
-How the perpetrator justifies their actions…. So they do not feel bad about what they are doing.
Common rationalizations used by fraud perpetrators include the following:
- 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.
- We’ll fix the books as soon as we get over this financial difficulty.
- Something has to be sacrificed—my integrity or my reputation.
Internal controls that prevent or detect fraudulent behavior
- The control environment
- Management’s role and example
- Management communication
- Clear organizational structure
- Effective internal audit department
- Information and communication
- Control activities (procedures, processes) (includes segregation of duties)
Segregation of duties
- Generally, the primary incompatible duties that need to be segregated are:
- Authorization or approval.
- Custody of assets.
- Recording transactions.
- Reconciliation.
- System of authorizations
- Independent checks
- Physical safeguards
- Documents and records
Five type of control activities
- Separation of duties
- Authorizations
- Physical controls
- Independent checks
- Documents and records.
-First three activities (S A P) are the control activities that prevent fraud from occurring but are often the most expensive to implement.
-Last two activities (I D) don’t prevent fraud but are instead detective controls that help catch or detect fraud before it gets too large.
Fraud Prevention
-Preventing fraud is generally the most cost-effective way to reduce losses from fraud.
-Assessing the risks for fraud and developing concrete responses to mitigate the risks and eliminate the opportunities for fraud
-Organizations can proactively eliminate most fraud opportunities.
Effective Fraud Prevention involves:
-Taking steps to create and maintain a culture of honesty and high ethics
* Tone at the top (proper modeling)
* Hiring the right kind of employees
* Communicating expectations of honesty and integrity
* Creating a positive work environment
* Proper handling of fraud and fraud perpetrators when fraud occurs
Fraud Prevention: Ways to assess and mitigate the risk of fraud
o Accurately identifying sources and measuring risks
o Implementing appropriate preventive and detective controls to mitigate those risks
o Creating widespread monitoring by employees
o Having internal and external auditors who provide independent checks on performance
Fraud Detection
o Detection of fraud usually begins by identifying symptoms, indicators, or red flags that tend to be associated with fraud.
3 primary ways to detect fraud:
-By chance
-By providing ways for people to report suspicions of fraud
-By proactively examining transaction records and documents to determine if there are anomalies that could represent fraud
Prediction
-Predication refers to the circumstances, taken as a whole, that would lead a reasonable, prudent professional to believe a fraud has occurred, is occurring, or will occur.
-Fraud investigations should not be conducted without predication.
-A specific allegation of fraud against another party is not necessary, but there must be some reasonable basis for concern that fraud may be occurring.
Fraud Investigation:
Once predication is present, an investigation is usually undertaken to determine whether or not fraud is actually occurring
~The purpose of an investigation is to find the truth.
~Do the symptoms observed actually represent fraud or do they represent unintentional errors or other factors?
Fraud Investigation:
If investigations are not properly conducted, any or all of the following might occur
-Reputations of innocent individuals can be irreparably injured.
-Guilty parties can go undetected and be free to repeat the act.
-Offended entity may not have information to use in preventing and detecting similar incidents or in recovering damages.
Fraud Investigation: Conducting a Fraud investigation
-Investigations must be undertaken only to “establish the truth of the matter under question.”
-Investigators must be experienced and objective.
-Hypothesis about whether or not someone committed fraud should be closely guarded when discussing an investigation with others.
-Investigators must ensure that only those who have a need to know are kept apprised of investigation activities.
-Investigators must ensure that all information collected during an inquiry is independently corroborated.
-Investigators must exercise care to avoid questionable investigative techniques.
-Investigators must report all facts fairly and objectively.
Legal Action when Fraud is discovered:
-Pursue no legal action,
-Pursue civil remedies, and/or
-Pursue criminal action against the perpetrators.
Civil Action
-Purpose is to recover money or other assets from the fraud perpetrators and others associated with the fraud
Criminal Action
-Law enforcement or statutory agencies
-Fines, prison terms, or both
-Restitution agreements
Prevention of Fraud Tips:
Create a culture of honesty, openness, and assistance
-Hire honest people and providing fraud awareness training
-Create a positive work environment, which means having a well-defined code of conduct, having an open-door policy, not operating on a crisis basis, and having a low-fraud atmosphere
Prevention of Fraud Tips:
Hire honest people and providing fraud awareness training
-Verify all information on the applicant’s résumé:
* Require all applicants to certify that all information on their application and/or résumé is accurate
* Train those involved in the hiring process to conduct thorough and skillful interviews
* Use industry-specific or other approaches as deemed necessary (credit checks, fingerprinting, drug tests, public record searches, honesty tests, etc.)
Prevention of Fraud Tips:
Creating a positive work environment..
-Creating expectations about honesty through having a good corporate code of conduct and conveying those expectations throughout the organization
-Having open-door or easy access policies
-Having positive personnel and operating procedures
Five methods of eliminating fraud opportunities:
-Having good internal controls
-Discouraging collusion between employees and customers or vendors and clearly informing vendors and other outside contacts of the company’s policies against fraud
-Monitoring employees and providing a hotline (whistle-blowing system) for anonymous tips
-Creating an expectation of punishment
-Conducting proactive auditing
-Each method reduces either the actual or the perceived opportunity to commit fraud.
Control Activities: Segregation of Duties
-Having two people do a task together or splitting the task into parts so that no one person handles the complete assignment
Control Activities: Authorizations
Having a system of proper authorizations so that only authorized or designated individuals have permissions to complete certain tasks
Control Activities: Physical Controls
Implementing physical safeguards such as locks, keys, safes, fences, and so on, to prohibit access to assets and records
Control Activities: Independent Checks
Implementing a system of independent checks such as job rotations, mandatory vacations, audits, and so on
Control Activities: Documentation
Having a system of documents and records that provide an audit trail that can be followed to check on suspicious activity and to document transactions
True or False:
Collusion is where two or more people are working together to commit and cover up fraud
True
Monitor employees and have a whistle-blowing system:
-Close monitoring
-A good whistle-blowing program is one of the most effective fraud prevention tools.
-Create an expectation of punishment
Monitor employees and have a whistle-blowing system:
Close monitoring
-Facilitates early detection
-Deters frauds because potential perpetrators realize that “others are watching”
Monitor employees and have a whistle-blowing system:
A good whistle-blowing program is one of the most effective fraud prevention tools.
-Approximately 33 percent of all frauds are detected through tips.
-Section 806 of the Sarbanes-Oxley Act of 2002 requires all public companies to have a whistle-blower system.
-Government agencies and some foreign companies have whistle-blower systems.
-Elements of an effective whistleblowing system
Elements of an effective whistleblowing system:
- Anonymity
- Independence
- Accessibility
- Follow-up
True or False: You must Develop a comprehensive approach to handle fraud incidents
True
