Auditing for Fraud .

Auditing for Fraud. • 2nd International Symposiumon 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 Fraud designed to benefit the organization • 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

Examples of Fraud Fraud perpetrated to the detriment of 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

"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 aremany employees who are as honest as theyare required to be under the system in whichthey 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

Opportunity Rationalisation Motive General ideas on fraudIndirect trigger: the fraud triangle • 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” • Financial problems • Unrealistic goals set by organisation • Lifestyle pressures • Debt

Managing the Triangle • The 10/80/10 Rule • Employees will be no more ethical thanthose 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

Financial statement fraudFive classifications • Fictitious revenues • Timing differences • Improper asset valuation • Concealed liabilities/expenses • Improper disclosures

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 are expected. Communicating a process of detection and the consequences of prosecution 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 Operations Know Your Vendors Know Your Employees Know Your Customers

Know Your Employees, Know Your Customers • Your front-line staff is your front lineof 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 .