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UNIT OBJECTIVES
 Define fraud
 classify fraud into the three factors
 Categorise fraudulent activities.
 distinguish between fraudulent financial reporting and
misappropriation of assets
 Assess the impact of fraud on businesses (fraud facts
and figures)
 evaluate the internal auditor responsibility in the
detection of fraud
 Recommend solutions to management

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INTERNAL AUDITING & FRAUD
1. Need Internal Auditing due to increase defalcation in
business
2. Systems of control use to safeguard the companies
assets
3. Using (COSO) Control Activities, Risk Assessment,
Information & Communication, Monitoring and
Control Environment to combat CRIME of Fraud.

4.Control Activities – transaction authorisation,

accounting records, custody of assets, segreation of
duties, independent verification and supervision
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FRAUD – IIA Definition
The Institute of Internal Auditors (IIA) defines fraud
as “any illegal acts characterized by deceit,
concealment or violation of trust. These acts are
not dependent upon:
 the application of threat of violence
 or of physical force.

Frauds are perpetrated by parties and organizations to

 obtain money,
 property or services;
 to avoid payment or loss of services;
 or to secure personal or business advantage.”

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FRAUD – IIA Definition
Frauds are perpetrated by parties and organizations to
 obtain money,
 property or services;
 to avoid payment or loss of services;
 or to secure personal or business advantage.”

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FRAUD Legal Definition
 Hall (2004) states that fraud is a false representation
of material facts made by one party to another with
the intent to deceive and induce the other party to
justifiably rely on the facts to his or her detriment.

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Legal Definition of Fraud
 False representation - false statement or
disclosure
 Material fact - a fact must be substantial in
inducing someone to act
 Intent to deceive must exist
 The misrepresentation must have resulted in
justifiable reliance upon information, which
caused someone to act
 The misrepresentation must have caused injury or
loss

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Fraud Factors/Conditions

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 Figure 3-1 Fraud Triangle
Pressure Opportunit
y No Fraud

Pressure Opportunit
y

Ethics

Fraud
Ethics
Source: Accounting Information Systems, James Hall, 2005
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Fraud risks factors/indicators
 Excessive pressure to meet debt covenant
 Management bonus tied to performance
 Unregularised vacation system
 The existence of high-value, small, liquid assets, and
 Ineffective board of directors or audit committee oversight
 High turnover of accounting, internal audit and IT staff
 Inappropriate communications and support of the entitiy’s
values
 Known history of violation of security laws

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Employee Fraud
 Committed by non-management personnel
 Usually consists of: an employee taking cash or other
assets for personal gain by circumventing a company’s
system of internal controls

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 Management Fraud
 Perpetrated at levels of management above the one to
which internal control structure relates
 Frequently involves using financial statements to create
an illusion that an entity is more healthy and prosperous
than it actually is
 Involves misappropriation of assets, it frequently is
shrouded in a maze of complex business transactions

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Fraud Schemes
Three categories of fraud schemes according to the
Association of Certified Fraud Examiners:
A. fraudulent statements
B. asset misappropriation
C. corruption

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Fraudulent Statements
 Misstating the financial statements to make the copy
appear better than it is
 Usually occurs as management fraud
 May be tied to focus on short-term financial measures
for success
 May also be related to management bonus packages
being tied to financial statements

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Asset Misappropriation
 Most common type of fraud and often occurs as
employee fraud
 Examples:
 making charges to expense accounts to cover theft of
asset (especially cash)
 lapping: using customer’s check from one account to
cover theft from a different account
 transaction fraud: deleting, altering, or adding false
transactions to steal assets

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Corruption
 Corruption includes the following:
 Bribery – the influence officials in the performance of
duties by offering , giving or soliciting valuable items
Examples (paying monies (other than normal fees)
for driver’s licence and clearance of goods at the
customs, paying to avoid a traffic or evade taxes
etc).

 conflicts of interest – acts on behalf of a third party

when conducting duties or has self interest in activities

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Corruption
 economic extortion – use of force to obtain something of
value (also referred to as protection money in Jamaica)

 Illegal gratuity – similar to bribery except that reward

comes after the activity.

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2008 ACFE Study of Fraud
 Loss due to fraud equal to 7% of revenues—
approximately $994 billion
 Loss by position within the company:
Position % of Frauds Loss $
Owner/Executive 23% $834,000
Manager 37% 150,000
Employee 40% 70,000
 Other results: higher losses due to men, employees
acting in collusion, and employees with advance
degrees
Fraud Figures in Jamaica
 Losses under the category of fraudulent conversion were
assessed at US$1 million plus J$215 million,
 and from employee theft or 'larceny as a servant' at $54.2
million.
 Another pervasive problem, credit card and cheque fraud -
obtaining money and goods by means of forged documents
- were reported at US$61,967 and J$63 million.

Fraud hits historic high at $3b

Gleaner Article Published: Friday | July 31, 2009
http://jamaica-gleaner.com/gleaner/20090731/business/business3.html

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AUDITOR ROLE
 The IIA issued a pronouncement about fraud entitled
Deterrence, Detection, Investigation and Reporting of
Fraud. The main points of this pronouncement are:

 The deterrence of fraud is the responsibility of

management.
 Internal auditors must have sufficient knowledge to be able
to identify the indicators that fraud may have occurred.
 If control weaknesses are detected, additional tests should
be performed to identify other factors of fraud that may be
present.

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AUDITOR ROLE
 Audit procedures alone will not guarantee that fraud
will be detected.
 A fraud that is detected needs to be reported.
 In the course of planning the engagement, the internal
auditor should consider the potential areas of fraud
that might be present during the engagement.
Therefore, auditors should have knowledge of the risk
factors and red flags of fraud.

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Risks factors stemming from
inadequate/ poor controls
 No segregation of duties,
 Not limiting access to assets,
 Failing to compare existing assets with recorded assets,

 Executing transactions without proper authorization,

 Lack of personnel or qualified personnel that leads to
improper controls,
 Collusion among employees,
 The existence of high-value, small, liquid assets, and
 The ability of management to override the controls in
place.

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Auditor Role
 The internal auditor is responsible for examining the
controls that are in place to determine if they are
adequate to prevent or detect fraud.

 The internal auditor is also responsible for examining

for fraud.

 However, the internal auditor is not responsible for

preventing fraud (due to collusion).

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AUDITOR ROLE
 When an internal auditor suspect’s fraud, he or she
should:
 1. determine the possible effects
 2. discuss the matter with the appropriate level of
management who should then initiate an
investigation.
Note: It is generally not the auditor’s duty to report
this to individuals outside of the organization

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Recommendations
 Mandatory vacation scheduling
 Implementing a compliance department
 Implementing a fraud investigations unit
 Setting attainable objectives
 Well design organisation structure
 Code of ethics
 Procedures manual
 Job description
 Access cards and vaults
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Question 1
 Which of the following policies is most likely to result in an
environment conducive to the occurrence of fraud?
a. The division's hiring process frequently results in the
rejection of trained applicants.
b. Budget preparation input by the employees who are
responsible for meeting the budget.
c. The application of some accounting controls on a sample
basis.
d. Unreasonable sales and production goals.
 (CIA Adapted)

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Answer
 d – Some of the requirements that top management
sets forth for middle management can make the
organization susceptible to fraud. For example,
unreasonable goals that managers are required to meet
in order to keep their jobs may create an environment
in which fraudulent reporting will take place. In
addition, a member of top management may be
tempted to commit fraud if he or she would stand to
benefit financially as a result, for example by receiving
a substantial bonus.

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Question 2:
When comparing perpetrators who have embezzled
company funds to perpetrators of financial statement
fraud (falsified financial statements), those who have
falsified financial statements would be less likely to:

a. Be living beyond their obvious means of support.

b. Rationalize the fraudulent behavior.
c. Use company expectations as justification for the act.
d. Have experienced an autocratic management style.
(CIA Adapted)

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answer
 a – Someone who is embezzling from his employer will
have access to funds that payroll records do not
indicate he should legitimately have. Although a
perpetrator of financial fraud may be living a luxurious
lifestyle due to having received compensation (e.g.,
bonuses) above and beyond what he legitimately
earned, the compensation will be a matter of record.

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conclusion
 http://www.youtube.com/watc
h?v=oNoSWZZk1IQ

 What is fraud
 The categories
 The conditions
 Fraud facts and figures
 The internal auditor’s role

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