Auditing for Fraud

Auditing for Fraud.

2nd International Symposium on Auditing in Turkey

Jean-Pierre Garitte, CIA, CSSA, CISA, CFE

April 26, 2007

Understanding Fraud

Definition for Fraud (IIA)

Fraud encompasses an array of irregularities and illegal acts characterized by intentional deception. It can be perpetrated for the benefit of or to the detriment of the organization and by persons outside as well as inside the organization.

Examples of Fraud

• Sale or assignment of fictitious or misrepresented assets• Improper payments (e.g. bribes, kickbacks, payoffs to government

officials)• Intentional, improper representation or valuation of transactions,

assets, liabilities or income• Intentional, improper transfer pricing• Intentional, improper related-party transactions• Intentional failure to record or disclose significant information to

improve the financial picture of the organization to outside parties• Prohibited business activities (e.g. those that violate government

regulations)• Tax fraud

Fraud designed to benefit the organization

• Acceptance of bribes or kickbacks• Diversion to an employee or outsider of a potentially profitable

transactions that would normally generate profits for the organization

• Embezzlement as typified by the misappropriation of money or property and falsification of financial record to cover up the act

• Intentional concealment or misrepresentation of events or data• Claims submitted for services or goods not actually provided to the

organization

Fraud perpetrated to the detriment of the organization

Examples of Fraud

Auditing for fraud / Jean-Pierre Garitte

7©2007 Deloitte Belgium

"It was recently estimated that 99% of all dishonesty within a given company was perpetrated by people who regarded themselves as honest when hired.

It is therefore apparent, that there are many employees who are as honest as

they are required to be under the system in which they work."

The Wall Street Journal



Typical Fraudster

• On the Surface– Long-time employee– In a position of trust– Doesn’t take vacations– Appears to be extremely dedicated– Has unexplained cash or other wealth



Typical Fraudster

• Beneath the Surface– Living beyond means– Gambler– Drug or alcohol problem– Behavioral changes– Extramarital affairs– Hostility toward management– General disenchantment with compensation



General ideas on fraudIndirect trigger: the fraud triangle

Oppor

tuni

ty

Rationalisation

Motive• Financial problems

• Unrealistic goals set by organisation

• Lifestyle pressures

• Debt

• Opportunity through the organisation:• no clear rules boundaries

• weak/deficient internal control

• Individual opportunity:• good operational knowledge

• “key to the organisation”

• “Everybody does it”

• “I’ve been doing overtime unpaid”

• “I was doing it as a favor to show the internal control weaknesses”

• “I was passed for promotion”



Managing the Triangle

• The 10/80/10 Rule• Employees will be no more ethical than those who run the company• Challenge is to manage the 80%• Justify their activity as non-criminal• Even when convicted, don’t see themselves as criminals



A Statistical Certainty...

…and the basis of our practice

“At any given moment, there is a certain percentage of the population that’s up to no good.”

J. Edgar Hoover



Why all the Fraud?

• What’s the motivation?– Corporate Culture

• Downsizing• Diminished loyalty• Bottom-line pressures

– Changing Technology– Globalization– Organized Crime Influence



A Vulnerable Organization

• Corrupt management• Internal controls weak or unmonitored• Company or department dominated by one or two managers• Management compensation linked to short-term results• Employees poorly managed, trained or paid• Top management incompetent or focused solely on short-term profits • Lack of internal audit function



Common Management Fraud Schemes

• Pre-billing clients for shipments not yet made• Booking sales before final• Altering invoices • Altering credit card receipts• Charging personal expenses• Overstating revenues and assets• Understating expenses and liabilities• Inadequate provisions for allowance for doubtful accounts…



Why?

• Shares of management and administrators• Weak financial results• High expectations of the market• Bonus of management



How?

• Manipulation of revenues• Manipulation of costs• Manipulations in the balance sheet



• Fictitious revenues• Timing differences • Improper asset valuation• Concealed liabilities/expenses• Improper disclosures

Financial statement fraudFive classifications

Detective and investigative techniques

…it’s everyone’s responsibility



Financial Statement Fraud Analytical Procedures

Examples of consistency and inter-relationship tests:• Net income to cash flow• Relative movements in inventory, A/P, sales, cost of sales• Comparison to industry trends, such as bad debt write-offs• Production, inventory, sales relationships• Comparing results of an entity to those of competitors provides valuable

information as to whether (and how) the entity is outperforming or underperforming other entities in the industry



Proactive Anomaly

• Address Verification• Duplicate Payments• Unexpected Relationships• Overpayments• Identification Number Testing• Shared Elements Testing

Corporate Awareness: How to defend against fraud?

…it’s everyone’s responsibility



Creating a Control Environment

Fraud Deterrence – Create a control environment where honesty and integrity areexpected. Communicating a process of detection and the consequences ofprosecution to dissuade the attempt at fraud

• Tone at the Top • Code of Business Conduct• Whistleblower Hotline • Communications• “Walk” the walk, and “talk” the talk



Code of ethics



Corporate Awareness

…every employee has responsibility

Know Your Customers

Know Your Vendors

Know Your Employees

Know Your Operations



Know Your Employees, Know Your Customers

• Your front-line staff is your front line of defense. They are key to identifying fraud.

• If they are fraudsters themselves, you begin to see the “circle of co-conspirators.”



Know Your Employee

Employee($60,000 median loss)

Managers/Executives($250,000 median loss)

Managers & Employees conspiring in a fraud scheme

($500,000 median loss)



Know Your Employees, Know Your Customers

• Ignorance is NOT an excuse• Thoroughly verify identities• What you don’t know CAN hurt you• Assertiveness is key to knowing the truth

Corporate Awareness is Everyone’s Responsibility!

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Auditing for Fraud