WHY - my-cpe.com · Polling Question #2 What is your opinion of the profession‘s peer review...

Fraud Essentials:

WHO - HOW – WHY - WHAT

Mark Dauberman, CPA EMBA

* WHO COMMITS FRAUD?

* HOW IS IT DONE?

* WHY DO THEY DO IT?

* WHAT CAN WE DO TO PREVENT OR DETECT IT?

OVERVIEW

WHO?

“Fraud is committed by desperate individuals”

Joseph T Wells, CPA, CFE

Founder of the Association of Certified Fraud Examiners (ACFE)

Fraud Perpetrators

-Officers -Managers

-Directors -Employees

-Customers -Suppliers

-Strangers -Aliens

Profile

Fraudster

Opportunist

Honest crook

Psychopath

Fraudster

Commits fraud as a vocation◦Intelligent & skilled

◦Abilities applied to committing fraud instead of legitimate endeavor

◦Potential victim’s CONfidence sought

◦Victim & victim’s systems studied

◦Weaknesses identified & exploited

Opportunist

Commits fraud to enhance lifestyle◦Risk averse

◦Fraud only attempted if detection is not expected

◦Actions believed to be universal & accepted

◦No feelings of remorse

Honest Crook

Commits fraud due to

perceived necessity◦No intention to steal or damage victim

◦Resources considered loan or advance

◦Feels misunderstood & victimized

◦Guidance or assistance perceived as unavailable

PsychopathCommits fraud under the belief that it is okay

unless caught◦Grandiose sense of self worth

◦Believes rules are for others who do not know how to get away with breaking them

◦Manipulative

◦Pathological liar

https://m.youtube.com/watch?v=mh8owwaEcgM

Polling Question #1

What aspect of the accounting profession are you involved in?◦ 1 – I am a CPA working in public accounting.

◦ 2 – I am a CPA working in private industry, government, or for a not-for-profit.

◦ 3 – I am a CPA working outside of the profession of accounting, for example as an investment advisor.

◦ 4 – Accounting? I must be in the wrong room, Do you know where the Committee for Protecting Everything is meeting?

HOW?

Common Schemes Used to Commit

Fraud

The Nature of Fraud

Misappropriation of assets

Fraudulent statements

Corruption schemes

Misappropriation of Assets

Cash

-Theft of cash on hand

-Theft of cash receipts

-Fraudulent disbursements

Inventory and other assets

-Larceny

-Misuse

Asset Misappropriation

- Cash

Embezzlement Skimming

Inappropriate invoice

False expense reports

Fraudulent Statements

NET WORTH & NET INCOME OVERSTATEMENTS

NET WORTH & NET INCOME UNDERSTATEMENTS

FRAUDULENT NONFINANCIAL STATEMENTS

Examples of Fraudulent Statements

Stealing from the company – Reporting fictional sales to

obtain commission

Stealing by the company – Fictional invoice sent to

customer to collect illegitimate funds

Fraudulent financial reporting – Falsified accounts

receivable schedule to avoid bad debt recognition

SYMBOL TECHNOLOGIES

Director of corporate accounting inflated performance measures to appear to meet analysts’ forecasts

Used topside adjustments to make actual results appear to match forecasts

Created “cookie jar” reserve by overstating obsolete inventory

Fraudulently deferred payment of FICA on bonuses

Recorded revenues for purchase orders not shipped

Participated in channel stuffing

Reclassified trade receivables to notes receivable to improve aging

SEC initiated investigation

Corruption SchemesConflict of interest

Bribery

Illegal gratuities

Economic extortion

Corruption Schemes

Kickbacks from vendors for favorable pricing

Writing off or reducing accounts for kickbacks

Diverting customer orders to competing business

Kickback from competitor

Interest in competitor

Polling Question #2

What is your opinion of the profession‘s peer review

program?◦ 1 – I think it’s a great program and makes the profession better.

◦ 2 – I think it is unnecessary and wastes a firm’s resources and time.

◦ 3 – I think it has become more punitive than informative and is hurting, rather than helping the profession.

◦ 4 – I think the idea is great, but the program falls a little short.

WHY?

Conditions Leading to the Commission of Fraud

The Fraud Triangle

Characteristics of Fraud

Reason

Opportunity

Rationalization

Reason

Greed

Pressure

Perceived unfairness

Perceived unfairness

https://Youtube.com/watch?v=meiU6TxysCg

Opportunity

Lack of Internal Controls

Lack of enforcement

Ability to override or circumvent

controls

Rationalization

Not wrong

Not my fault

Entitlement

Everybody does it

No choiceI had no choice!

Polling Question #3

At what level do you function within your firm or company?◦ 1 – I am a decision-maker in relation to the overall operations of

my organization.

◦ 2 – I make decisions related to my department or division, subject to override by officers or executives.

◦ 3 – I supervise other employees, but do not have decision-making authority

◦ 4 – I have responsibilities in relation to my role but do not supervise others and do not have decision-making authority.

How the Characteristics Apply to Fraud Perpetrators

Different strokes for different folks!

Fraudster

Characteristics◦Reason – basis of support

◦Opportunity – ability to overcome or avoid controls

◦Rationalization – not doing anything wrong

Strategy◦Avoid association

◦Practices for establishing relationships

Opportunist

Characteristics◦Reason – personal gain

◦Opportunity – lack of controls

◦Rationalization – everybody does it

Strategy◦Appearance of controls

◦Enforcement with ramifications

Honest CrookCharacteristics◦Reason – pressure

◦Opportunity – ability to circumvent or override controls

◦Rationalization – no choice

Strategy◦Familiarity

◦Conscious observation

PsychopathCharacteristics◦Reason –perceived as normal behavior

◦Opportunity – creates feeling of confidence to establish trust

◦Rationalization – not wrong

Strategy◦Awareness of characteristics

◦Design interview to reveal characteristics

Characteristics of “White Collar” Criminals

-Older & more mature

-More religious

-Higher IQ

-Better education

-Clean lifestyle

-Lack of criminal record

-Positive outlook & outgoing personality

-Highly motivated

-Passive follower of leadership

Behavioral Warning Signs

Insomnia

Increased drinking or substance abuse

Changes in temperament or disposition

Nervousness

Lack of eye contact

Increased belligerence

Sweating

Possible Red Flags

Living beyond means

Financial difficulties

Control issues with unwillingness to share duties

Unusually close association with a customer or vendor

Divorce or family problems

“Wheeler-dealer” attitude

Irritability, suspiciousness, & defensiveness

Red Flags -continued

Addiction problems

Complaints of inadequate compensation

Past employment-related problems

Refusal to take vacations

Social isolation

Excessive family or peer pressure for success

Instability in life circumstances

Past legal problems

Complaints about lack of authority

Fraud Committed at Entity Level

“Groupthink” – Contributing factors

◦ Supermen & women – Illusion of

invulnerability

◦ Denial – Illusion of anonymity

◦ Invisibleness – Suppression of personal

doubts

◦ Delusional – Self-appointed mind guards

◦ Apathy – Atmosphere of docility

◦ Peer pressure – Taboo against

antagonizing certain individuals

Polling Question #4

What is your favorite way of obtaining CPE?◦ 1 – I like short (2-4 hour) live seminars that also give me an opportunity to

network.

◦ 2 – I like live seminars for the networking opportunity, but I’d prefer to get it done in large chunks of 1 or more full days so I am not as likely to be distracted by unrelated issues.

◦ 3 – I like webinars of varying lengths where the instructor can respond to questions, either conducting the class from a remote location or monitoring one that has been pre-recorded.

◦ 4 – I like pre-recorded programs of varying lengths approved for self-study, allowing me to study at my own pace and convenience.

WHAT?

OBJECTIVEFraud PreventionFraud Detection

SOLUTIONInternal ControlsInternal Reporting & Analytical Procedures

Prevention & Detection Measures

Identify potential frauds through risk assessment

System of checks & balances

Regulation of employee authority & access

Internal controls appropriate forGoods or services provided

Business practices

Fraud Prevention Techniques

Improve Opportunities to Prevent Fraud By Applying A 4-Step Process

1) Identify Fraud Schemes That May Be Applicable

2) Understand Existing Internal Controls

3) Identify Vulnerabilities

4) Create or Enhance Controls

ACFE – Report to the Nations on Occupational Fraud and Abuse

Using the Fraud Tree – Ask…

Could this type of fraud occur here?

Who is in position to perpetrate this type of fraud?

What conditions would have to exist in order for this fraud to occur?

What signs might indicate that this type of fraud occurred?

Management’s Responsibilities

• Awareness of vulnerable assets

• Processes & relationships conducive to fraud

Could this type of fraud occur here?

• Due diligence upon hiring

• Background checks

• Bonding

• Identify favorable characteristics

Who is in position to perpetrate this type of fraud?

What conditions would have to exist in order for this fraud to occur?

Policies & procedures to prevent conditions

Close supervision when conditions not avoidable

What

signs

might

indicate

that this

type of

fraud

occurred?

Management reports

providing indicators

“Management by walking

around”

Polling Question #5

If it is learned that audited financial statements are materially misstated due to

fraud, is the auditor likely to be held liable?

◦ 1 –Yes, even if all requirements of standards were complied with, because the

public expects auditors to detect fraud.

◦ 2 – No, because professional standards indicate that it is not the purpose of

the audit to detect fraud and the engagement letter, signed by the client, says

that they are responsible for fraud and that the auditor is not.

◦ 3 – No, if the requirements of standards were complied with in all material

respects, and the CPA applied due diligence performing in the same manner

as any other qualified auditor would under the circumstances.

Framework for Developing & Enhancing Controls

Understand existing systems◦ Initiation of transactions

◦Authorization to commit resources

◦Execution

◦Recording

◦Verifications throughout the

process

MAKE SURE YOU HAVE AN ACCURATE UNDERSTANDING

Designing Effective Internal Controls

The COSO model

◦Control

environment

◦Risk assessment

◦Control activities

◦ Information &

communication

◦Monitoring

Control Environment

Standards, processes, and structures providing basis for carrying out internal control

Established by board of directors and management

Importance of internal controls

Expected standards of conduct

Integrity and ethical values of organization

Organizational structure and assignment of authority and responsibility

Process for attracting, developing, and retaining competent individuals

Accountability for performance

Risk Assessment

Dynamic and iterative process to identify and assess risks from external and internal sources

Risks to achievement of objectives considered in relation to entity’s risk tolerances

Tied to establishment of objectives related to operations, reporting, and compliance

Considers changes to external and internal environment affecting internal control

Control Activities

Policies and procedures designed to ensure that management’s directives are followed

Performed at all levels of entity

May be preventive or detective

May involve manual and authorizations and approvals, verifications, reconciliations, and performance reviews

Should incorporate segregation of duties, where possible, or alternatives when not achievable

Documentation Alternatives

Narrative

Flowchart

Decision Tree

Questionnaire

Identify & Evaluate Weaknesses

•Operations

•Compliance

•Reporting

Establish internal control objectives

•Obtain understanding of how system operates

• Identify control activities

•Evaluate deficiencies

Determine applicable systems

Events & Transactions

Occurrence

Completeness

Accuracy

Cutoff

Classification

Account Balances

Existence

Rights & obligations

Completeness

Valuation & allocation

Presentation & Disclosure

Occurrence & rights & obligations

Completeness

Classification & understandability

Accuracy & valuation

Adequate Segregation of Duties

Authorization

Custody

Recording

Reconciliation

Risk Assessment Process

For each system

•Identify control activities

•Determine which assertions are supported

Effect of control activities

•Prevent fraud

•Detect fraud

•Prevent errors

•Detect errors

WCGW ANALYSIS

Ask the Tough Question

WHAT COULD GO WRONG?

Polling Question #6

Which of the following best describes the control environment in your

workplace?

◦1 – There is openness and transparency, executives exhibit ethical behavior, and all individuals are treated with respect.

◦2 – Executives make certain employees know of their special benefits to inspire employees to want to move up.

◦3 – There is tension and competition among employees at all levels because there are fewer opportunities at higher levels.

◦4 – I really don’t pay attention to that type of thing.

Objective of Control Activities

Break down the fraud

triangle

◦Reason

◦ What would motivate someone to commit this type of

fraud?

◦ Are there procedures that would prevent or deter

them from wanting to do so?

◦Opportunity

◦ What mechanical process will be used to commit this

type of fraud?

◦ Are there procedures that would prevent or deter

someone from performing those procedures?

Environment Surrounding Effective Controls

Transparency & effective communication

Policies & procedures to protect assets

Effective hiring practices

Updating risk assessment & internal controls

Conventional Control Activities

Physical controls

Information processing controls

Performance indicators

Segregation of duties

Control Activities Potentially Effective for Fraud

Accept Reality

Involve Others

Give Carrots

SEND AN EMAIL TO MARK@DAUBERMAN.COM IF YOU HAVE COMMENTS OR QUESTIONS OR IF I MAY OTHERWISE BE OF ASSISTANCE

- IN-HOUSE TRAINING

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BY MARK DAUBERMAN, CPA CGMA EMBA

PH (310) 905-4433WWW.MARKDAUBERMAN.COM

Thank You

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