Frauds and other irregularity

ERRORS AND FRAUD

ZU Presented by: H. B. Hamad

Frauds-Hamadbakar68@hotmail.com

2 Frauds-Hamadbakar68@hotmail.com

Introduction

Errors and frauds are regarded as taking-off grounds of all financial evils.

Both errors and frauds have a significant impact to the financial statements of the organization and more importantly the going concern of the business

Introduction…

Who are responsible for errors and frauds in an organisation?

The management, audit committee, board of directors, auditors (internal and external) and employees.

So why the auditors are always find themselves on the news’s front pages whenever the financial crimes events get the media attentions?

Introduction….

Errors are unintentional mistakes done into our financial statements.

Frauds are rather intentional errors.

When some wrong postings or calculations are made in the books of accounts, are known as errors

Introduction…

Mostly, errors are not intentionally, however, we should all know that, some clever guys for some reason are creating errors for their own benefit.

Apparently when errors are done intentional automatically became frauds and is virtually a financial crime that can send someone behind the bars!!

Definitions

Fraud: obtaining a material advantage by unfair or wrongful means.

Fraud is the use of dishonesty means to obtain an advantage or avoid an obligation.

Fraud can be divided into two:

1. Management fraud

2. Employee fraud Frauds-

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Definitions

Corruption is practice of offering, soliciting( ask for), or accepting of an inducement or reward to influence an action by an officer of an entity.

Corruption is the misuse of public power for private profit." This clearly includes all kinds of bribery of national or local officials or politicians.

Management fraud

Management fraud or some time known as white color crimes

Done by senior managers by utilizing their posts and power vested on them.

Normally it’s difficult to scrutinize the managers hence creating a good chance to commit frauds

Frauds-

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Employee frauds

Are those types of frauds undertaken by ordinary staff

Normally management are not involved in this type of fraud

Corruption

Corruption can be seen into two:

1. Grand corruption

2. Petty corruption

corruptions

Grand corruption: is the one which involves senior officials, ministers, and heads of state

Grand corruption involves influencing decision-makers

grand corruption can destroy nations:

where it is rampant( uncontrolled), there is no hope of controlling petty corruption

Grand corruption

Three criteria for grand corruption:

1. Size: a big transaction or project (big bosses do not bother about small fishes)

2. Immediacy of reward: bribe matured in long time, big bosses do not like.

3. Mystification: complicated and technological transactions,

corruption

Petty corruption is the one which entails immigration officials, customs clerks, policemen, and the like.

Petty corruption is usually about getting routine procedures followed more quickly—or not followed at all.

Petty corruption can seriously damage the quality of life of the ordinary citizen—particularly that of the most vulnerable members of society

Economic Impact of corruption

Wide spread poverty, hunger, and underdevelopment.

Corruption hinders direct foreign investment.

Developing countries are quite keen to attract investment.

For this purpose they also offer tax concessions to investors.

But research reveals that a more effective method to attract investment is to curtail corruption than to reduce taxes.

Source: Anti-Corruption Policy of ADB, pp.13

Economic Impact of corruption.. “Although the economic costs of corruption are difficult

to measure, some studies suggest they include:

• A 3 to 10 per cent increase in the price of a given transaction to speed up the delivery of government service

• Inflated prices for goods – as much as 15 to 20 per cent higher - as result of government-imposed monopolies

• A loss of as much as 50 per cent of government tax revenues because of graft and corruption

• Excessive charges to governments for goods and services because of over billing on procurement contracts or the purchase of expensive and unnecessary items, with governments paying 20 to 100 per cent more than necessary.”

Source: Stapenhurst and Kpundeh, pp.4.

Auditor’s dilemma Corruption is a highly complex phenomenon.

The parties involved leave very little tell-tale in the form of certain hard evidence.

Most of the corruption takes place in an informal manner and under the dark cover of isolated contacts.

At times it does not even require a spoken word. Mere eye contact can establish a relationship of corruption.

The auditors find themselves at cross-purposes with the society.

Role of auditor in fighting corruption

In case of corruption, they can hardly detect or investigate into the actual event of corruption, since the criminals, generally, do not leave any evidence.

It is, therefore, important to know that the auditors cannot quantify corruption nor can they report the actual event of corruption.

They can only indicate the existences of opportunities for corruption.

Such a report can become basis for corrective action by the government to forestall corruption or minimize the opportunities

Larceny

Is the legal language indicating a charge to theft or stealing.

It is on other hand, a wrongfully taking and carrying away of the personal property of another person with intent to convert it or deprive the owners of its use and possession.

the thief does not have legal possession or custody of the property

Embezzlement

is fraudulent appropriation of property by a person entrusted with its custody, thus breaching the trust or fiduciary responsibility

in embezzlement the person is legally authorized by its owner to take or receive possession of the property at least for the time being

How can we determine if frauds is bad or not?

Materiality of error

Materiality of error is what determine if error is so bad or what

Materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it to be useful

Materiality flash-back

Materiality is the relativity of the size and magnitude of an item as compared to other items, alternatively an error is said to be material if:-

The amount involved is substantial in relative to the company’s financial position

It has a reversing trend i.e if it can change a profit into a loss and vice-versa

It varies substantially from the estimates that are usually considered normal and acceptable.

Importance of materiality of an error in auditing

It influences the auditor’s time budget on specific items.

It dictated the auditor’s plan.

It influences the auditor’s plan.

It determines the amount of audit evidence to be gathered.

Audit procedures of frauds vs. materiality

If errors are innocent and immaterial – ignore the same

If errors are innocent and material – mention it in the management letter and request correction of the accounts.

If errors are intentional and immaterial – mention it in the management letter with caution to the party committing the error

If errors are intentional and material – qualify the report and also mention this in the management letter.

Motives for fraud to take place

3 motives

1. Opportunity

2. Pressure

3. Rationalization

Motive for fraud

fraud triangle

pressure

Opportunity

Need/Rationalization

Motive for fraud

Opportunity: it is occurred when the controls placed are weak and or where and individual is in a position of trust to override the controls.

Someone at a position of trust may, because of seniority, be able to bypass controls or exploit known weakness.

Motive for fraud

Pressure- influence financial fraud. For example unrealistic corporate targets can influence employees to commit fraud to meet the targets.

Motive for fraud

Rationalization- for fraud often includes such beliefs as :

Activity is not criminal

Their actions are justified

They are simply borrowing the money.

They are ensuring that corporate goals are met

Every one else is doing it.

Way does frauds occurs

1. Manipulation of accounts-

is the willful misrepresentation of facts in the accounts either for the purpose of concealing defalcations or misrepresenting figures to convey a better picture of performance or financial position of the business than it is otherwise.

E.g. to inflating profits or reducing losses or showing a better position that it is actually exists

How does fraud occurs

2. Misappropriation of assets-

this crime involves misappropriation of cash, goods or negotiable instruments. With or without the manipulation of accounts.

Omission to record cash receipts

Recording fictitious assets

Receipt counterfoils showing lower amounts

Intentional errors in balancing the cashbook

How does fraud occurs

3. Suppression or omissions-this is achieved by total omission to record cash received from a debtor or a cash sale transaction totally not recorded.

how does fraud occurs

4. Transaction without substance- claims by fictitious debtors may be honored after the successful creation of fictitious records along with other credit records, or payment of salaries to ghost workers.

how does fraud occurs

5. Misapplication of account- deliberate use of wrong accounting policies so as t benefit from the use of an inappropriate alternative policy for example use of wrong rates and formulas.

Employee fraud (transaction fraud)

It is done by an ordinary staff (employees) mgt is not involved at all.

It comprises among others,

1. outright theft

2. embezzlement

3. defalcation

4. misappropriation of account

5. manipulation of account

Employee fraud

Techniques use are like:

1. falsifying expenses reports and staff claims

2. embezzling fund

3. using corporate property for private uses

4. accepting gratuity from vendors, contractors and suppliers

Frauds-

Employee fraud

Motives for conducting transaction fraud.

1. Weak internal control

2. Employment of dishonest staff

3. corrupt mgt models

4. inefficient internal controls

5. personal financial problems

Employee fraud

Symptoms of transaction fraud.

1. adjusting journal entry, escaping authorization and destroying documents

2. Expenditure not supported by adequate documentation.

3. False and improper entries in the records

4. unauthorized payments

5. Unauthorized uses of corporate assets.

6. misapplication of funds

Employee fraud

Fraud fighting activities:

It is seen into three steps:

1. Prevention

2. Investigation

3. Detection

Early fraud detection is critical because the sizes of most frauds increase geometrically over time as perpetuators gain confidence that their schemes are not being detected

Fraud fighting

Fraud fighting activities

Prevention:

Fraud prevention includes such activities as designing

corporate fraud policies,

creating internal audit departments,

implementing internal controls,

whistle-blower systems,

publicizing fraud occurrences

employee’s screening system Frauds-Hamadbakar68@hotmail.com

Investigation.

Investigation involves steps taken to answer the questions of

when, and

once fraud is suspected or “fraud predication” is present Frauds-

Detection- Fraud detection includes both proactive and reactive activities targeted at finding the first indication that fraud might be occurring or undertaken to develop a “predication of fraud

Reactive method for fraud detection:

Most traditional fraud detection methods are reactive in nature that is, they are initiated by tips or complaints, control overrides, or other indicators that someone observes or hears

Proactive fraud detection

It involves aggressively targeting specific types of fraud and searching for their indicators, symptoms, or red flags

Controlling employee fraud (3 methods)

1. Managerial controls:

Installing strong managerial controls that the responsibility of internal controls, proper reporting, and the adoption of sound accounting policies rests solely with management, not the auditors.

E.g. separation of duties

Frauds-

Controlling employee fraud

2. Screening: Adequate employee screening is powerful

tool. Hiring honest employees is best way; It can best done by out-sourcing screening tests include -lie detector and

drug tests and fingerprinting of employees. background checks of information on resumes and applications, an employer can elicit significantly more information and determine if the original information is accurate

Screening;

It should have BOD approval

It must comply with the law and existing organizational policy eg

• The extent, who have responsibility

• Levels of checking used

• Whether existing staff should be included or internal promotions and transfers

Question used in screening questionnaire forms:

1. Are legal, fair and unambiguous?

2. Assess honesty, reliability, suitability, experience and qualification?

3. Can answer be checked?

4. How will errors, omissions or discrepancies affect employments?

Screening will also include:

1. Bankruptcy checks

2. Research and verification of the CV looking for gaps and inconsistencies.

3. Confirmation of education

4. Confirmation of professional qualification for prof. bodies (NBAA)

5. Directorship and media searching

Screening will also include:

6. Verification of employment history with direct line managers and HR, for last five years

7. Supreme court record searches.

3. Business environment: A third component to deterring fraud

reduces the perceived need of a pressured employee to commit fraud.

creating open and consistent communications for hiring,

evaluating employee performance, and assessing employees for promotion.

counseling programs and employee enrichment efforts,

4. Other methods:

hotline whereby fellow employees can report improper conduct,

having a high level employee review unopened bank statements monthly,

establishing a written code of ethics,

making sure management level employees are role models.

Forensic accounting

Forensic accounting is the integration of accounting, auditing, and special investigative skills

The goal of forensic accounting is to uncover the paper trail left by a fraud and prepare the investigation prior to presenting it to a court of law

forensic accounting

Examples of situations where forensic accountants might be involved are:

1. analyze and investigate financial evidence

2. develop computerized applications to perform analysis

3. present findings through reports and exhibits

4. Testify in court as an expert witness

Forensic accounting

Management fraud

Its done by most senior officer in an organization.

It involves deceitful practices adopted by managers to benefit themselves economically and socially or to sustain jobs to the costs of the organization they are working for.

Managers mostly vested/given wide and absolute powers, faith and trust such that their crimes are usually very difficulty to be uncovered under normal circumstances.

Management fraud

Managers are not subject to ordinary checks as opposed to subordinates.

It is always very difficulty to detect fraud made by management through naked eyes but it is usually start from customers complains.

Examples of management frauds:

1. misrepresentation of facts which result in

2. over-statement of assets, sales, and profits

3. understatement of liabilities, expenses, and losses

4. Some times they inflate profits so as to earn higher salaries and bonuses.

Management fraud

Example of fraudulent case: Several years ago, a senior vice president of a bank embezzled nearly $14 million over a 16-year period. When the fraud was discovered through a customer complaint, the bank sued its external auditors for negligence in not detecting the fraud. The fraud had been committed by manipulating, looting and abusing customer accounts and maintaining several slush accounts with sufficient funds to handle problems when customers complained

Management fraud

Motives for mgt fraud:

1. opportunity: managers have high privilege in relation to ordinary staff in organization as they have responsible positions of trust and necessary belief and respect from authorities that appointed them. Since managers are judged by results, their crimes can be over weighted by attainment of those results.

2. Need- need for committing management fraud may arise to improve status or lifestyle, to satisfy their ambitious of having good living standard.

3. Pressure- excessive pressures influence management fraud. It can be internal or external pressure

Internal pressure;

Self imposed discipline, inner desires etc 1. Excel in performance in comparison with prior

period

2. Show superior performance in comparison with competitors

3. Earn promotion, larger bones or incentives

4. Win favor of bosses for various reasons.

5. Retain the position by any means, fair or foul

External pressure:

from higher authorities e.g goals set by bosses, owners, or BoD may be unrealistic and highly demanding

Manager cannot refuse

Use deceitful tactics to accomplish them

Or just make them appear accomplished

Frauds-

External pressure

1. Public image

2. Self-preservation

3. Concealment of incompetence

4. Out put linked incentive plans

5. Ambition for self-advancement

6. Vested interest

7. Manipulation of accounts

Frauds-

Symptoms of mgt fraud

1. Protected delays in submission of reports

2. Incompatible functions done by same person

3. Flouting corporate directives, rules and regulations

4. Personal interest

5. Duplicate entries

6. Uncorrelated entries

7. High fly-management decisions

How frauds are detected

The end

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