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Presentation shows the various redflags to prevent and detect internal fraud in a company
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Preventing a Koss Meltdown at your Company:
How to Prevent and Detect Fraud: Implementing Internal Controls
Presenters David Buslee
– MBA UC Irvine– Certified Managerial Accountant– Certified Financial Manager– Partner – B2BCFO
Paul Rodrigues– Certified Public Account– Masters in Tax– Certified Fraud Examiner– Certified in Financial Forensics– Principal at Chortek and Gottschalk
3
Goal
To Educate You on What is Happening To Scare You to Death To Make You Paranoid To Provide Best Practices
4
What is Fraud
The elements of fraud are:– A representation about a material fact– Which is false– And made intentionally, knowingly, or recklessly– Which is believed– And acted upon by the victim– To the victim’s damage
5
Common Myths About Fraud
It can’t happen on MY watch No one would do that here... We have an excellent accounting system My accounting clerk is my best employee We don’t handle cash - What’s to steal Problem Employees are likely suspects I wouldn’t know where to start looking
The Fraud Triangle
Opportunity - Generally provided through weaknesses in the internal controls.
Pressure - Can be imposed due to problems or vices
Rationalization - Occurs when the individual develops a justification for their fraudulent activities.
7
Fraud Schemes
Three categories of fraud schemes according to the Association of Certified Fraud Examiners:
A. fraudulent statementsB. corruptionC. asset misappropriation
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A. 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
9
B. Corruption Examples:
– bribery– illegal gratuities– conflicts of interest– economic extortion– Kickbacks
Foreign Corrupt Practice Act of 1977: – indicative of extent of corruption in business world– impacted accounting by requiring accurate records
and internal controls
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C. 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 checks 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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How Management Encourages Fraud
Management Attitude - Do Nothing Little or poor Applicant screening No written policies or procedures Inadequate training - classroom or OJT Responsibility, accountability, and authority not established or
documented Goals and objectives neither established nor monitored for
success Weak Enforcement Policy Break accounting and policy rules - “Too Much Bureaucracy” Inconsistent application of policies or procedures - may result in
unfair treatment of employees - favoritism - low morale Not listening to employees - treatment of whistleblowers We’ll get them to resign - the problem will go away
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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
It is perpetrated at levels of management above the one to which internal control structure relates.
It frequently involves using the financial statements to create an illusion that an entity is more healthy and prosperous than it actually is.
If it involves misappropriation of assets, it frequently is shrouded in a maze of complex business transactions.
14
Who Commits Fraud ?
Almost anyone, rationalize they are just in borrowing, believe they deserve what they take, plan to repay - never do. Will continue to commit fraud until caught.
– Has an addictive need - alcohol, drugs, gambling, sex, shopping– Is intelligent– Has a position of trust and responsibility– Understands and skillfully uses technology– Is well respected in the community– Is married, 2 children, owns home
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Perpetrator’s History
87%
6%7%
Perpetrator's Criminal His-tory
Never charged or convicted
Charged but not con-victed
Prior Convic-tions
83%
5%
12%
Perpetrator's Employment History
Never Pun-ished or Terminated
Previously Punished
Previously Terminated
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Victim Organizations
Private Companies
Public Companies
Government
Not-for-Profit
$0 $50,000 $100,000 $150,000 $200,000 $250,000 $300,000
Organization Type of Victim - Median Loss
20082006
Median Loss
Type
of V
ictim
Org
aniz
atio
n
18
Victim Organizations
10,000+
1,000 - 9,999
100 - 999
<100
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0%
Size of Victim Organization - Frequency
20062008
Percent of Cases
Num
ber o
f Em
ploy
ees
19
Victim Organizations
Lack of Internal Controls
Lack of Management Review
Override of Existing Controls
Poor Tone from the Top
Lack of Competent Oversight
Lack o f Independent Audits
Lack of Clear Lines of Authority
Lack of Employee Fraud Education
Lack of Reporting Mechanism
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%
Primary Internal Control Weakness Observed by CFE
Percent of Cases
Mos
t Im
porta
nt C
ontri
butin
g Fa
ctor
20
What is a RED FLAG of Fraud?
A red flag is a set of circumstances that are unusual in nature or vary from normal activity. It is a signal that something is out of the ordinary and may need to be investigated further. These are warning signs.
Some Red Flags are easily discerned, while others may be more subdued and/or concealed.
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Detection of Fraud Schemes
©2008 by the Association of Certified Fraud Examiners, Inc.
Initial Detection Method by Organization Type8
8The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.
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How Costly is Fraud The direct amount that is misappropriated is
oftentimes only a small portion of the cost to an organization.
Intangible Costs– Distraction of organization– Employee morale– Embarrassment– Loss of customer confidence
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Red Flags Knowing how to spot and investigate Red Flags is
imperative in a proactive fraud deterrence program. Learn to spot the behavioral and data red flags. When red flags are present, investigate and
document. Data mining is an effective tool for identifying red
flags in the company data files
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Behavioral Red Flags
Fraudsters oftentimes demonstrate behaviors that may serve as warning signs
Some perpetrators may act irritable, may spend lavishly or become secretive.
The presence of these signs do not, in and of itself, indicate fraud is occurring
Management and anti fraud professionals should be trained to identify potential warning signs so that they may be investigated.
25 ©2008 by the Association of Certified Fraud Examiners, Inc.
26 ©2008 by the Association of Certified Fraud Examiners, Inc.
Behavioral Red Flags Present During Fraud Scheme24
24The sum of percentages for each scheme type exceeds 100 percent because in several cases the perpetrator exhibited more than one behavioral red flag.
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Cash FraudRed Flags
Discrepancies between cash count and account balance
Mutilated/destroyed cash register receipts Employee working from open cash drawer Unexplained inventory adjustments Unexplained increase in the use of petty cash Personal checks included in cash funds Unusual journal entries affecting cash accounts Differences between daily receipts and bank deposits “Less Cash” line on deposit tickets indicates cash
taken
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Accounts Receivable FraudRed Flags
Customer complaints regarding amounts owed Discrepancies between deposit tickets and customer
records Different dates between deposits and customer
payments Unusual discounts or credits Increase in delinquent accounts Increase in the amount of write-offs Receivables with unusual characteristics Customers with unusual name, address or phone
number
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Inventory FraudRed Flags
Unexplained inventory shrinkage Excessive inventory adjustments Decrease in gross margins Unusual journal entries to inventory Unusual trash removal practices Increase in credit memos Temporary workers with access to
inventory
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Fixed Asset FraudRed Flags
Unusual or unexpected asset purchases Missing assets Unusual increases in repairs and
maintenance on assets that could be subject to personal use
Unusual fluctuations in depreciation accounts
31
Accounts Payable/Vendor Fraud
Red Flags Higher-than-usual costs or expenses Vendor complaints Altered or modified vendor invoices Unexplained fluctuations in payables Unusual vendor names and addresses Unusual payees on checks Discrepancy between payees on checks and check
register Unusual increase in purchases from vendor(s) Copies of vendor invoices instead of originals Missing cancelled checks
32
Payroll FraudRed Flags
Unusual fluctuations in payroll expense or hours Checks to employees with minimal personnel records Missing payroll checks Number of paychecks do not match the number of
employees Employee complaints regarding W-2 amounts Employees who pick up paychecks for other
employees Highly compensated employees who elect no
withholdings Dual endorsements on cancelled payroll checks
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Expense Reporting Fraud
Red Flags Improper or inadequate receipts underlying expenses Information on expense report differs from receipts Photocopies of expense receipts submitted instead of
originals Repeated entertainment expenses with customer with
no associated business Failure to utilize company credit cards when available Expenses submitted not in line with other employees
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The Perpetrators
Corruption
Billing
Skimming
Non-Cash
Check Tampering
Expense Reimbursement
Cash on Hand
Fraudulent Statements
Cash Larceny
Payroll
Register Disbursements
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0
Fraud Schemes By Accounting Personnel
All Cases
Accounting
Percent of Cases
Type
of S
chem
e
Reduce Risk of Fraud:Tools of Protection
Segregation of Duties
Environment
Internal Control Procedures
Segregation of Duties
• No employee should be in a position to commit fraud and then conceal it
• Example: Person collecting/receipting cash should not:• Post cash receipts to the general ledger system• Process cash disbursements• Prepare billings• Make bank deposits, wire transfers
Environment
The same rules apply to all Don’t belittle internal control procedures Don’t allow management to override
procedures Be alert to employee’s outside interests
Internal Controls – Who?
As the owner, you are pulled in a variety of directions
Need to focus on the overall businessNo experience in creating controlsAs the “Finder” you can’t be constantly
involved in “Minder” activities
Controls - Part-time CFO
Experienced partner to CEOKnowledgeable in creating controls and
enforcing controlsEnables the “Finder” to concentrate on
building the businessCost effective alternative – can help build
sales and gross margins
40
Controls - Part Time CFO Physical security Segregation of duties Employee monitoring Surprise audits Job rotation Examination of Documentation
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Your Bank – Account Control
Specify what, if any, ACH debits can hit your accounts
Require 2 signatures for any outbound wire Make sure they don’t give cash back on business
deposits Make sure they only deposit to business accounts Use a “token” for all account inquiries Only signors should access accounts Positive Pay and Reverse Positive Pay
Suspected Fraud ?
•Seek out a Fraud Practitioner…– Type of fraud:– Employee fraud - dismissal or prosecution of employees?– Vendor fraud?– Any misconduct involving a high-level officers, executives or
managers– Financial reporting fraud?– Complaints involving the Foreign Corrupt Practices Act (FCPA)– Certain industry practices
•Who should be in the know before any action is taken?•How was the (potential) fraud detected?•Involvement of authorities?
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Legal Considerations of Fraud
Intentionally false representation– Not an error– Lying or concealing actions– Pattern of unethical behavior
Personal material benefit Organizational or victim loss
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Summary Anyone can be a Fraudster – they tend to be
the most trusted employee Fraud Prevention Checkup Most Frauds are discovered by accident or tips Be vigilant for Red Flags Part Time CFO will create and enforce internal
and external controls Your Bank has many tools to prevent fraud Have a game plan for when fraud is suspected
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Contact InformationDavid Buslee
PartnerB2BCFO LLC(262) [email protected]
Paul RodriguesPrincipalChortek and Gottschalk(262) [email protected]