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INTRODUCTION TO FRAUDINTRODUCTION TO FRAUDDoug Kalesnikoff CA-IFA, CFEDoug Kalesnikoff CA-IFA, CFE

Tel # (306) 966-1471Tel # (306) 966-1471Email: kalesnikoff@commerce.usask.caEmail: kalesnikoff@commerce.usask.ca

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DEFINITION OF FRAUDDEFINITION OF FRAUD

CICA HANDBOOK S. 5135.04CICA HANDBOOK S. 5135.04

“ “The term “fraud” refers to an The term “fraud” refers to an intentional act by one or more intentional act by one or more individuals among management, other individuals among management, other employees, those charged with employees, those charged with governance, or third parties, involving governance, or third parties, involving the use of deception to obtain an the use of deception to obtain an unjust or illegal advantage”unjust or illegal advantage”

33

DEFINITION OF FRAUDDEFINITION OF FRAUD

ACCOUNTANT’S HANDBOOK OF ACCOUNTANT’S HANDBOOK OF FRAUD AND COMMERCIAL CRIMEFRAUD AND COMMERCIAL CRIME

Fraud is criminal deception intended Fraud is criminal deception intended to financially benefit the deceiver.to financially benefit the deceiver.

44

DEFINITION OF FRAUDDEFINITION OF FRAUD

THE CRIMINAL CODE S. 380(1)THE CRIMINAL CODE S. 380(1)

Every one who, by deceit, falsehood Every one who, by deceit, falsehood or other fraudulent means, whether or other fraudulent means, whether or not it is a false pretence with the or not it is a false pretence with the meaning of this Act, defrauds the meaning of this Act, defrauds the public or any person, whether public or any person, whether ascertained or not, of any property, ascertained or not, of any property, money or valuable security or any money or valuable security or any service.service.

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DEFINITION OF FRAUDDEFINITION OF FRAUD

REGINA v. OLAN (1978)REGINA v. OLAN (1978)

“ “Dishonest Deprivation”Dishonest Deprivation”

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THE ELEMENTS OF FRAUDTHE ELEMENTS OF FRAUD

DISHONESTDISHONEST

activeactive passive passive indirect indirect

DEPRIVATIONDEPRIVATION

risk of lossrisk of loss actual lossactual loss

77

Fraud v. TheftFraud v. Theft

FraudFraud

hiddenhidden

willingly part with willingly part with property based on property based on representationrepresentation

time lagtime lag

TheftTheft

overtovert

unwillingly part unwillingly part with propertywith property

immediateimmediate

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WHO COMMITS FRAUD?WHO COMMITS FRAUD?

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Who Commits Fraud Externally?Who Commits Fraud Externally?

SuppliersSuppliers false invoicing, false invoicing, short shipmentsshort shipments

CompetitorsCompetitors espionage, price espionage, price fixingfixing

Con MenCon Men false advertisingfalse advertising

CustomersCustomers planned bankruptcy,planned bankruptcy,false credit false credit

informationinformation

1010

Who Commits Fraud Internally?Who Commits Fraud Internally?

EmployeesEmployees theft of assets, theft of assets, lapping schemeslapping schemes

ManagersManagers manipulate system, manipulate system, kickbacks, expenseskickbacks, expenses

OfficersOfficers false financial false financial reportingreporting

DirectorsDirectors manipulate share price,manipulate share price,related party related party

transactionstransactions

1111

Opportunity

Pressure Rationalization

Fraud Fraud TriangleTriangle

1212

PressurePressure

What motivates the crime in the first What motivates the crime in the first placeplace

Examples:Examples:– Inability to pay one’s billsInability to pay one’s bills– Gambling or drug addictionGambling or drug addiction– Meeting of earnings’ targets for investorsMeeting of earnings’ targets for investors– Meeting of productivity targets at workMeeting of productivity targets at work– Desire of status symbols, houses, cars etcDesire of status symbols, houses, cars etc– Family problems including marital and Family problems including marital and

sicknesssickness

1313

OpportunityOpportunity

Must see a way to abuse the position Must see a way to abuse the position of trust with low perceived risk of of trust with low perceived risk of getting caughtgetting caught

Place $500 in a coffee room with note Place $500 in a coffee room with note that says “please do not steal”. How that says “please do not steal”. How long would the money remain long would the money remain untouched?untouched?

Internal controlsInternal controls Honesty ScaleHonesty Scale

1414

Why People Commit FraudWhy People Commit Fraud

20% honest

20% dishonest

60% honestdepending

uponsituation

THE HONESTY SCALE

1515

Rationalizations for FraudRationalizations for Fraud

• I’m just borrowing the funds!I’m just borrowing the funds!• I deserve it, I’m underpaid!I deserve it, I’m underpaid!• I should have been promoted by I should have been promoted by

now!now!• It’s only the government!It’s only the government!• I’m not hurting anyone!I’m not hurting anyone!• Others are doing it!Others are doing it!

1616

Fraud Behaviour EquationsFraud Behaviour Equations

B = f (O,E)B = f (O,E)

CC = P – = P – AA

CC = P - = P - AA

1717

What is a red flag?What is a red flag?

An irregularity thatmay relate to:

Time Frequency Place Amount

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Personal Red FlagsPersonal Red Flags

Living beyond means Personal financial losses Addiction problems Change in personal

circumstances Outside business

interests Rarely takes vacations

1919

More Personal Red FlagsMore Personal Red Flags

Rationalizes poor performanceRationalizes poor performance Provides unreliable workProvides unreliable work Dissatisfied with jobDissatisfied with job Close association to suppliers or Close association to suppliers or

competitorscompetitors Likes to “beat the system”Likes to “beat the system”

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FRAUD IN THE REVENUE FRAUD IN THE REVENUE CYCLECYCLE

FRONT END FRAUDFRONT END FRAUD

FALSE SALES INVOICESFALSE SALES INVOICES

LAPPING OF ACCOUNTS RECEIVABLELAPPING OF ACCOUNTS RECEIVABLE

2121

Front End FraudsFront End Frauds

cash sales not recorded cash sales not recorded and cash divertedand cash diverted

customers directed customers directed elsewhereelsewhere

misappropriation of misappropriation of purchase rebatespurchase rebates

misappropriation of misappropriation of miscellaneous revenuemiscellaneous revenue

2222

False Sales InvoicesFalse Sales Invoices

invoices altered to invoices altered to reflect reflect lowerlower sale sale amountamount

invoices altered to invoices altered to reflect reflect higherhigher sale sale amountamount

2323

Lapping of Accounts Lapping of Accounts ReceivableReceivable

robbing Peter to pay robbing Peter to pay PaulPaul

subsequent receipts subsequent receipts used to cover earlier used to cover earlier misappropriationsmisappropriations

2424

FRAUD IN THE COST CYCLEFRAUD IN THE COST CYCLE

FALSE INFORMATIONFALSE INFORMATION

FALSE SUPPLIER INVOICESFALSE SUPPLIER INVOICES

FALSE EXPENSE REPORTSFALSE EXPENSE REPORTS

SECRET COMMISSIONS & KICKBACKSSECRET COMMISSIONS & KICKBACKS

PAYROLL PAYROLL

OTHEROTHER

2525

False InformationFalse Information

false financial statementsfalse financial statements overstated accounts and loans receivableoverstated accounts and loans receivable over or understated accounts payableover or understated accounts payable fictitious suppliersfictitious suppliers false asset valuationsfalse asset valuations false journal entries false journal entries altered internal company recordsaltered internal company records

2626

False Supplier InvoicesFalse Supplier Invoices

goods not receivedgoods not received

inferior quality goods receivedinferior quality goods received

service not renderedservice not rendered

invoice for higher value than receivedinvoice for higher value than received

invoice for higher quantity than receivedinvoice for higher quantity than received

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Example – Garry’s Example – Garry’s ConstructionConstruction

Identify the suspicious characteristics Identify the suspicious characteristics of these two invoices.of these two invoices.

2828

False Expense ReportsFalse Expense Reports

non-business itemsnon-business items

inflated itemsinflated items

fictitious itemsfictitious items

duplicate itemsduplicate items

2929

Secret Commissions & Secret Commissions & KickbacksKickbacks

giftsgifts

cashcash

traveltravel

entertainmententertainment

consulting feesconsulting fees

future benefitsfuture benefits

3030

PayrollPayroll

fictitious employeesfictitious employees

inflated hoursinflated hours

inflated ratesinflated rates

manipulated manipulated deductionsdeductions

lump sum paymentslump sum payments

3131

Other Cost Cycle FraudOther Cost Cycle Fraud

Procurement FraudProcurement Fraud

Bid-riggingBid-rigging

Employees in collusion with vendorsEmployees in collusion with vendors

Vendor fraudVendor fraud

3232

FRAUD POLICYFRAUD POLICY

increases probability of increases probability of discoverydiscovery

decreases probability of decreases probability of occurrenceoccurrence

defines acceptable defines acceptable conduct and dealingsconduct and dealings

defines responsibilities for defines responsibilities for prevention & detectionprevention & detection

states consequences states consequences

3333

CODE OF CONDUCTCODE OF CONDUCT

Relates to all aspects ofRelates to all aspects of

employee:employee:

honestyhonesty

integrityintegrity

actionsactions

3434

Deterrents to Internal FraudDeterrents to Internal Fraud

SYSTEM DETERRENTSSYSTEM DETERRENTS

hiring practiceshiring practices supervision and controlsupervision and control adequate books & recordsadequate books & records proper authorizationproper authorization segregation of dutiessegregation of duties employee programsemployee programs internal auditinternal audit red flag programred flag program

3535

Deterrents to Internal Fraud Deterrents to Internal Fraud (5)(5)

PHYSICAL PHYSICAL DETERRENTSDETERRENTS

combination lockscombination lockscard accesscard accesssecuritysecuritypassword controlspassword controls

3636

Deterrents to External Fraud Deterrents to External Fraud (1)(1)

USE HONEST USE HONEST

SUPPLIERSSUPPLIERS

background checksbackground checks due diligence due diligence

reviewsreviews feasibility studiesfeasibility studies

3737

Deterrents to External Fraud Deterrents to External Fraud (2)(2)

DEAL WITH HONESTDEAL WITH HONEST

CUSTOMERSCUSTOMERS

background checksbackground checks credit ratingscredit ratings prior lawsuitsprior lawsuits

ASSESSING YOUR ASSESSING YOUR RISKRISK

What is your organization’s What is your organization’s risk of fraud?risk of fraud?

3939

Fraud Risk MatrixFraud Risk Matrix

Likelihood of OccurrenceLikelihood of Occurrence

Impact on the OrganizationImpact on the Organization

4040

Risk AssessmentRisk Assessment

management management characteristicscharacteristics

industry conditionsindustry conditions operating characteristicsoperating characteristics susceptibility of assets to susceptibility of assets to

misappropriationmisappropriation employee relationships employee relationships

and pressuresand pressures controlscontrols

4141

Management CharacteristicsManagement Characteristics

failure to display, communicate failure to display, communicate and support and support appropriate attitudeappropriate attitude regarding internal control and regarding internal control and financial reportingfinancial reporting

high management high management turnoverturnover dominationdomination by an individual or by an individual or

small groupsmall group compensation related to the compensation related to the

achievement of unduly achievement of unduly aggressive operating targetsaggressive operating targets

4242

Susceptibility of Assets to MisappropriationSusceptibility of Assets to Misappropriation

• large amounts of large amounts of cashcash on on handhand

• small size, high demand, small size, high demand, high value high value inventoryinventory

• easily easily convertible assetsconvertible assets

• fixed assetsfixed assets marketable or marketable or lack ownership lack ownership identificationidentification

4343

Control Risk FactorsControl Risk Factors

• lack of appropriate lack of appropriate segregation of dutiessegregation of duties• lack of lack of independent checksindependent checks• lack of appropriate lack of appropriate management oversightmanagement oversight• lack of job application lack of job application screeningscreening• lack of lack of mandatory vacationsmandatory vacations• poor physical safeguardingpoor physical safeguarding of assets of assets• lack of timely and appropriate transaction lack of timely and appropriate transaction

documentationdocumentation