Chapter 12: Fraud Schemes & Fraud Detection

1. Chapter 12:Fraud Schemes & Fraud Detection IT Auditing & Assurance, 2e, Hall & Singleton IT Auditing & Assurance, 2e, Hall & Singleton

2. FRAUD TREE • Asset misappropriation fraud • Stealing something of value – usually cash or inventory (i.e., asset theft) • Converting asset to usable form • Concealing the crime to avoid detection • Usually, perpetrator is an employee • Financial fraud • Does not involve direct theft of assets • Often objective is to obtain higher stock price (i.e., financial fraud) • Typically involves misstating financial data to gain additional compensation, promotion, or escape penalty for poor performance • Often escapes detection until irreparable harm has been done • Usually, perpetrator is executive management • Corruption fraud • Bribery, etc. IT Auditing & Assurance, 2e, Hall & Singleton

3. ACFE 2004 REPORT TO THE NATION IT Auditing & Assurance, 2e, Hall & Singleton

4. FRAUD SCHEMES • Fraudulent financial statements {5%} • Corruption {13%} • Bribery • Illegal gratuities • Conflicts of interest • Economic extortion • Asset misappropriation {85%} • Charges to expense accounts • Lapping • Kiting • Transaction fraud Percentages per ACFE 2002 Report to the Nation – see Table 12-1 IT Auditing & Assurance, 2e, Hall & Singleton

5. COMPUTER FRAUD SCHEMES • Data Collection • Data Processing • Database Management • Information Generation IT Auditing & Assurance, 2e, Hall & Singleton

6. AUDITOR’S RESPONSIBILITY FOR DETECTING FRAUD—SAS NO. 99 • Sarbanes-Oxley Act 2002 • SAS No. 99 – “Consideration of Fraud in a Financial Statement Audit” • Description and characteristics of fraud • Professional skepticism • Engagement personnel discussion • Obtaining audit evidence and information • Identifying risks • Assessing the identified risks • Responding to the assessment • Evaluating audit evidence and information • Communicating possible fraud • Documenting consideration of fraud IT Auditing & Assurance, 2e, Hall & Singleton

7. FRAUDULANT FINANCIAL REPORTING • Risk factors: • Management’s characteristics and influence over the control environment • Industry conditions • Operating characteristics and financial stability IT Auditing & Assurance, 2e, Hall & Singleton

8. FRAUDULANT FINANCIAL REPORTING • Common schemes: • Improper revenue recognition • Improper treatment of sales • Improper asset valuation • Improper deferral of costs and expenses • Improper recording of liabilities • Inadequate disclosures IT Auditing & Assurance, 2e, Hall & Singleton

9. MISAPPROPRIATION OF ASSETS • Risk factors: • Susceptibility of assets to misappropriation • Controls IT Auditing & Assurance, 2e, Hall & Singleton

10. MISAPPROPRIATION OF ASSETS • Common schemes: • Personal purchases • Ghost employees • Fictitious expenses • Altered payee • Pass-through vendors • Theft of cash (or inventory) • Lapping IT Auditing & Assurance, 2e, Hall & Singleton

11. ACFE 2004 REPORT TO THE NATION IT Auditing & Assurance, 2e, Hall & Singleton

12. AUDITOR’S RESPONSE TO RISK ASSESSMENT • Engagement staffing and extent of supervision • Professional skepticism • Nature, timing, extent of procedures performed IT Auditing & Assurance, 2e, Hall & Singleton

13. AUDITOR’S RESPONSE TO DETECTED MISSTATEMENTS DUE TO FRAUD • If no material effect: • Refer matter to appropriate level of management • Ensure implications to other aspects of the audit have been adequately addressed • If effect is material or undeterminable: • Consider implications for other aspects of the audit • Discuss the matter with senior management and audit committee • Attempt to determine if material effect • Suggest client consult with legal counsel IT Auditing & Assurance, 2e, Hall & Singleton

14. AUDITOR’S DOCUMENTATION • Document in the working papers criteria used for assessing fraud risk factors: • Those risk factors identified • Auditor’s response to them IT Auditing & Assurance, 2e, Hall & Singleton

15. FRAUD DETECTION TECHNIQUES USING ACL • Payments to fictitious vendors • Sequential invoice numbers • Vendors with P.O. boxes • Vendors with employee address • Multiple company with same address • Invoice amounts slightly below review threshold IT Auditing & Assurance, 2e, Hall & Singleton

16. FRAUD DETECTION TECHNIQUES USING ACL • Payroll fraud • Test for excessive hours worked • Test for duplicate payments • Tests for non-existent employee IT Auditing & Assurance, 2e, Hall & Singleton

17. FRAUD DETECTION TECHNIQUES USING ACL • Lapping A.R. • Balance forward method • Open invoice method IT Auditing & Assurance, 2e, Hall & Singleton

18. Chapter 12:Fraud Schemes & Fraud Detection IT Auditing & Assurance, 2e, Hall & Singleton IT Auditing & Assurance, 2e, Hall & Singleton