Chapter 10 Identifying and
preventing fraud
Qiang Jiang
School of Business
Sichuan University, China
[email protected]
Topic list
1 What is fraud
2 Potential for fraud
3 Implications of fraud for the organisation
4 Systems for detecting and preventing fraud
5 Responsibility for detecting and preventing
fraud
6 Money laudering
1 What is fraud
• Fraud may be generally defined as deprivation
by deceit . In a court case, fraud was defined
as a false representation of fact made with the
knowledge of its falsity .or without belief in its
truth, or recklessly careless, whether it be true
or false.
1 What is fraud
• Two main categories of fraud
– Removal of funds or assets from a business
– Intentional misrepresentation of the financial
position of the business
1 What is fraud
• Removal of funds or assets from a business
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Theft of cash
Theft of inventory
Payroll fraud
Teeming and lading
Fictitious customers
Collusion with customers
Bogus supply of goods or services
Paying for goods not received
Meeting budgets /target performance measures
Manipulation of band reconciliations and cash books
Misuse of pension funds or other assets
Disposal of assets to employees
1 What is fraud
• Intentional misrepresentation of the financial
position of the business
– Over-valuation of inventory
– Irrecoverable debt policy may not be enforced
– Fictitious sales
– Manipulation of year end events
– Understating expenses
– Manipulation of depreciation figures
2 Potential for fraud
• Prerequisites for fraud
– Dishonesty
– Motivation
– Opportunity
2 Potential for fraud
• Assessing the risk of fraud
– External factors
– Business risks
– Personnel risks
2 Potential for fraud
• Potential for computer fraud
– Computer hackers
– Lack of training within the management team
– Identifying the risks
– Need for ease of access and flexible systems
3 Implications of fraud for the
organisation
• Removal of funds or assets from a business
– Immediate financial implications
• Profits are lower than they should be
• Less cash or fewer assets
• Returns to shareholders are likely to fall
– Long term effects on company performance
• The reduction in working capital makes it difficult to
operate effectively
• Ultimately result in the collapse of successful business
3 Implications of fraud for the
organisation
• Intentional misrepresentation of the financial
position of the business
– If results are overstated
• Retained profits will be lower than believed
• Incorrect decisions will be made
– If results are understated
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Returns to investors may be reduced
Share price fall and market strength may be eroded
Assess to loan finance may be restricted
Negative publicity can damage the business
Legal consequences
4 Systems for detecting and preventing
fraud
• Reasons for fraud
– Factors specific to the industry
– Factors specific to the business
– Changes in circumstances
– Certain areas
4 Systems for detecting and preventing
fraud
• Reason for poor controls
– Lack of emphasis on compliance or lack of
understanding of why ,how and who the controls
are required
– Staff problems: understaffing, poor quality or
poorly motivated staff
– Changes in senior personnel lead to lack of
supervision
– Emphasis on the autonomy of operational
management lead to control be bypassed
4 Systems for detecting and preventing
fraud
• General prevention policies
– Emphasising ethics
– Personnel controls
– Training and raising awareness
4 Systems for detecting and preventing
fraud
• Prevention of fraud in specific business areas
– Segregation of duties
– Appropriate documentation be required
– Limitation controls
– Certain actions be prohibited
– Internal audit work concentrate on these areas
4 Systems for detecting and preventing
fraud
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Detection and prevention
Internal controls
Physical controls
Segregation of duties
authorisation policies
Customer signatures
Using words rather than numbers
4 Systems for detecting and preventing
fraud
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Documentation
Sequential numbering
Dates
Standard procedures
Holidays
Recruitment policies
Computer security
4 Systems for detecting and preventing
fraud
• Manager and staff responsibilities
– Operational managers be alert for sings of petty fraud
– finance staff be alert for signs of unusual items or trends
– Personnel staff be alert for signs of discontent or low morale, also
aware of close personal relationships between staff
– Internal audit staff ensuring systems and controls reviewed
– External audit staff assess the risk of fraud
– Non-executive directors act on signs of dishonesty by senior executive
management
– Audit committee review the organisation performance in fraud
prevention and report any suspicious matters.
4 Systems for detecting and preventing
fraud
• Availability of information to fraud
– Cost and management accounting systems
provide promptly information with sufficient
detail
– Personnel procedures
– Lines of reporting should be clear
• Whistleblowing
4 Systems for detecting and preventing
fraud
• Investigation of fraud
– Establishing the extent of the loss
– Establishing how the fraud occurred
– Considering who else be implicated in the fraud
– Assessing why the fraud was not detected
• Evloving control systems
5 Responsibility for detecting and
preventing fraud
• The responsibility of directors
• The role of the auditor
6 Money laudering
• Money laundering constitutes any financial
transactions whose purpose is to conceal the
origins of the proceeds of criminal activity.
6 Money laudering
• Risks associated with a company’s products
and services
• The effects of regulation
• UK legislation
• Categories of criminal offence
• Penalties
• Money laundering process
• The role of the Financial conduct autority
• The costs of compliance
6 Money laudering
• Financial Action Task Force
• International Monetary Fund (IMF)