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Internal Auditing & Corrupt Practices

Home > PowerPoint Slides > Internal Auditing & Corrupt Practices
Published in: Accounting
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PPT on Internal Auditing & Corrupt Practices.

Muhammad A / Sharjah

10 years of teaching experience

Qualification: CPA, ACCA, UAECA

Teaches: Business Studies, Accountancy: Management, Finance: Corporate, Finance: Planning, Finance, Accounting, Cost Accounting, Financial Accounting, ACCA, CAT Exam, CPA, ICAEW

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  1. INTERNAL AUDIT CORRUPT PRACTICES Auditing
  2. FRAUD IN CONTEXT Fraud is generally defined in the law as: (USLegla.com) "An intentional misrepresentation of material existing fact made by one person to another with knowledge of its falsity and for inducing the other person to act, and upon which the other person relies with resulting injury or damage. Fraud may also be made by an omission or purposeful failure to state material facts, which nondisclosure makes other statements misleading. Wikipedia defines the Fraud as follows: "Fraud is deliberate deception to secure unfair or unlawful gain, or to deprive a victim of a legal right. Fraud itself can be a civil wrong (i.e., a fraud victim may sue the fraud perpetrator to avoid the fraud or recover monetary compensation), a criminal wrong (i.e., a fraud perpetrator may be prosecuted and imprisoned by governmental authorities) or it may cause no loss of money, property or legal right but still be an element of another civil or criminal wrong.
  3. WHY DOES FRAUD HAPPEN? Interviews with persons who committed fraud have shown that most people do not originally set out to commit fraud. Often they simply took advantage of an opportunity; many times the first fraudulent act was an accident - perhaps they mistakenly processed the same invoice twice. But when they realized that it wasn't noticed, the fraudulent acts became deliberate and more frequent. Fraud investigators talk about the 10 - 80 - 10 law which states that 10% of people will never commit fraud; 80% of people will commit fraud under the right circumstances; and 10% actively seek out opportunities for fraud. So we need to be vigilant for the 10% who are out to get us and we should try to protect the 80% from making a mistake that could ruin their lives. Generally, fraud occus because of a combination of opportunity, pressure and rationalization. An opportunity arises, the person feels that the act is not entirely wrong, and has pressure pushing them to commit the fraud. Opportunity. An opportunity is likely to occu when there are weaknesses in the internal control framework or when a person abuses a position of trust. For example: organizational expediency - 'it was a high profile rush project and we had to cut corners', downsizing meant that there were fewer people and separation of duties no longer existed; or business re-engineering brought in new application systems that changed the control framework, removing some of the key checks and balances. Pressure. The pressures are usually financial in nature, but this is not always true. For example, unrealistic corporate targets can encourage a salesperson or production manager to commit fraud. The desire for revenge - to get back at the organization for some perceived wrong; or poor self-esteem - the need to be seen as the top salesman, at any cost; are also examples of non-financial pressures that can lead to fraud.
  4. WHY DOES FRAUD HAPPEN? , (CONTINUED) Rationalization. In the criminal's mind rationalization usually includes the belief that the activity is not criminal. The often feel that everyone else is doing it; or that no one will get hurt; or it's just a temporary loan, I'll pay it back, and so on. Interestingly, studies have shown that the removal of the pressure is not sufficient to stop an ongoing fraud. Also, the first act of fraud requires more rationalization than the second act, and so on. But, as if becomes easier to justify, the acts occu more often and the amounts involved increase in value. This means that, left alone, fraud will continue and the losses will only increase. I have heard it said that 'There is no such thing as a fraud that has reached maturity'. Fraud, ultimately, is fed by greed, and greed is never satisfied.
  5. FRAUD AS A CIVIL WRONG In common law jurisdictions, as a civil wrong, fraud is a tort (A tort, in common law jurisdictions, is a civil wrong that causes someone else to suffer loss or harm resulting in legal liability for the person who commits the tortious act). While the precise definitions and requirements of proof vary among jurisdictions, the requisite elements of fraud as a tort generally are the intentional misrepresentation or concealment of an important fact upon which the victim is meant to rely, and in fact does rely, to the harm of the victim. Proving fraud in a court of law is often said to be difficult. That difficulty is found, for instance, in that each and every one of the elements of fraud must be proven, that the elements include proving the states of mind of the perpetrator and the victim, and that some jurisdictions require the victim to prove fraud by clear and convincing evidence. The remedies for fraud may include rescission (i.e., reversal) of a fraudulently obtained agreement or transaction, the recovery of a monetary award to compensate for the harm caused, punitive damages to punish or deter the misconduct, and possibly others. In cases of a fraudulently induced contract, fraud may serve as a defense in a civil action for breach of contract or specific performance of contract. Fraud may serve as a basis for a court to invoke its equitable jurisdiction.
  6. FRAUD AS A CRIMINAL OFFENCE In common law jurisdictions, as a criminal offence, fraud takes many different forms, some general (e.g., theft by false pretense) and some specific to particular categories of victims or misconduct (e.g., bank fraud, insurance fraud, forgery). The elements of fraud as a crime similarly vary. The requisite elements of perhaps most general form of criminal fraud, theft by false pretense, are the intentional deception of a victim by false representation or pretense with the intent of persuading the victim to part with property and with the victim parting with property in reliance on the representation or pretense and with the perpetrator intending to keep the property from the victim. Certain types of fraud are classified as criminal offenses, mainly if the perpetrator is involved in theft under false pretenses. Like civil wrongs, certain elements must be in place for fraud to fall under the category of a criminal offense. Intentional deception by false pretense with the intent to convince the victim to part with money or property. The belief in the deception by the victim, who actually parts with the money or property under the false pretenses. The perpetrator keeping, or intending to keep, the money or property in question.
  7. TYPES OF FRAUD Most types of fraud schemes fall into the following categories: Financial Fraud Assets Misappropriation Vendor Fraud Accounting Fraud Accounts Receivables Fraud Accounts Payable Fraud Payroll Fraud Data Theft Bribery and Corruption
  8. TYPES OF FINANCIAL FRAUD Ponzi Schemes: Investment schemes that promise to pay relatively high rates of returns for fixed term investments. They are fraudulent investment plans - money is not invested at all. Instead, every new investment is used to pay Off earlier investors. Pyramid Schemes: Schemes which promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure. Identity Fraud: Someone impersonates you and Uses your personal information to steal money. Identity fraud is common on Internet Fraudsters give instructions to banks for fraudulent money transfer. Phishing: Internet Banking clients receive e-mails which are tricky asking them to give account login, password & personal details to website which look like their legitimate bank. These details are then exploited to steal money from your account. Card Fraud: Starts with the theft of your bank card. Stolen [loss cards remain usable. Thief make unauthorized purchases with the card until you notify your bank.
  9. TYPES OF FINANCIAL FRAUD (CONTINUED) Skimming: This involves stealing information off a credit card during a legitimate transaction. Fraudsters swipe the card through an electronic device known as a "wedge" or "skimming device" which records all information contained on the magnetic strip. Fraudsters use the stolen information for online purchase or to reproduce the card. Counterfeit Cards: The fraudsters steal cards' information to make fake cards or sell the card information. The victim rarely knows as he still has the real card in his possession. Advance Fee Scams: These scams are usually perpetrated through a letter, email or phone call offering you a large sum of money if you can help someone transfer millions of rupees or other currency out of his country. To initiate the transaction, you are asked to send details of your bank account and an administration fee. Wills and Legacies: A letter or email is sent to you claiming that someone has died and had mentioned your name in his will. Usually the scammer will claim to be the deceased's legal advisor and may claim an advance fee. Fund Transfer Scams: YOU are asked through an advert or email to receive a payment into your bank account, and to send it abroad in return for receiving a commission. In so doing, you may become a party to an offence.
  10. TYPES OF FINANCIAL FRAUD (CONTINUED) Fake Prizes: A perpetrator claims that you have won a non-existent prize. YOU are asked to send a cheque to pay the taxes or your credit card details, or your account number to pay for shipping and handling charges to send you the non-existent prize. Inheritance Scams: YOU receive a mail from an 'estate locator' or 'research specialist' purporting an unclaimed inheritance or refund. YOU are lured into sending a fee to receive information about how to obtain the purported asset. International Lottery Fraud: To show good faith, the perpetrator may send you a cheque which you are instructed to deposit in your account and send the money back to the lottery committee. The perpetrator will create a ' 'sense Of urgency," corn pelling YOU to send the r-noney before the which is counterfeit, is
  11. PREVENTION FROM FINANCIAL FRAUDS Keep all personal information, identity cards and bank cards safe at all times. Keep your PIN numbers secret. Do not write your PIN numbers down or store them with bank cards. Never give bank account details or other security information to any person or website unless their identity and authenticity can be verified. Place your money only at authorized financial institutions. Never give your money to people who offer to place it with a bank on your behalf for a rate of return higher than the prevailing rate. Always watch out for newer forms of Financial Frauds. Do not allow yourself to be distracted when using your bank card. If you notice something wrong or SUSPiCiOUS with an ATM, please report it. Do not let anyone else use your card. Check monthly credit cards statements and other bank statements carefully for SUSPiCiOUS transactions. Report promptly the theft or loss of your card on the 24-hour telephone numbers that most issuers make available for free. Exercise care when using your card to make payments on the internet. Make sure that you disclose your Card Verification Value only in secure payment websites. Be careful when signing any financial contract. Read the small print carefully, and ask for clarifications and advice from independent sources if needed. Beware of calls, letters, e-mails or faxes asking for your help to place huge sums of money in an overseas bank. Be SUSPiCiOUS of any job advertised by spam or unsolicited e-mails. Legitimate companies do not send spam. If the 'job' offered involves handling money - receiving or transferring funds or payments, it COUId be 'fake check' scam. Do not reply to spam or unsolicited e-mails that promises you some benefit.
  12. ASSETS MISAPPROPRIATION Check Forgery: An employee forges a signature on a check made out to himself/herself or to someone else. Check Kiting: An employee writes checks on an account that doesn't have sufficient funds with the expectation that the funds will be in the account before the check clears. Check kiting schemes are less common nowadays, with faster check clearing times. Check Tampering: An employee alters the payee, amount or other details on a check or creates an unauthorized check. Inventory Theft: An employee steals product from a company, either by physically taking if or diverting it in some other way. Theft of Cash: Most common in retail environments where cash exchanges are common, this type of fraud covers simply: Stealing Cash: Skimming (not registering a sale and pocketing the cash). Return fraud (an employee colludes with someone else to return goods fraudulently for a refund). Any other scheme that involves the removal of hard currency Theft of Services: An employee misuses company services or company-funded services, for example, an employee at an auto shop gets the mechanics to do his oil changes for free.
  13. ASSETS MISAPPROPRIATION (CONTINUED) Expense Reimbursement Fraud: Also called expense fraud, this type of fraud includes: Forging receipts Double claiming for expenses Submitting false reimbursement claims Inflated expense claims Expense Account Fraud: An employee Uses a company expense account for personal expenses and submits them as business-related. This can also include expense reimbursement fraud, above. Procurement Fraud: This type of fraud includes schemes such as over-ordering product then returning some and pocketing the refund, purchase order fraud where the employee sets up a phantom vendor account into which are paid fraudulent invoices, or initiating the purchase of goods for personal use Payment Fraud: This can include vendor fraud schemes as well as creating false customer accounts to generate false payments. It also includes: Altering payee details on checks and payables Self-authorizing payments Colluding with others to process false claims for benefits or payments
  14. ASSETS MISAPPROPRIATION (CONTINUED) Workers' Compensation Fraud: In these types of fraud, an employee exaggerates injuries or a disability, invents injuries that did not occu or attributes injuries that occurred outside of the work environment to work to receive compensation pay. Employees also commit workers' compensation fraud when they lie about their health or work status while receiving compensation. Health Insurance Fraud: An employee conspires or colludes with health care providers to defraud an insurance company by submitting false or inflated receipts. An employee claims a reimbursement for medical or health services not received. Commission Fraud: An employee inflates sales numbers to receive higher commissions, falsifies sales that did not occu or colludes with customers to record and collect commissions on falsified sales. Personal Use of Company Vehicle: This is similar to theft of services, but involves the employee using a company vehicle (and often the company-issued credit card for fuel) for unauthorized personal activities.
  15. PREVENTION FROM ASSETS MISAPPROPRIATION To prevent and detect asset misappropriation: Conduct thorough background checks on new employees. Implement checks and balances. Separate the functions of check preparer and check signer. Rotate duties of employees in accounts. Conduct random audits of company accounts. Don pay cornrnission Until goods are services have been delivered. Keep checks in a locked cabinet and destroy voided checks. Implement an anonymous ethics hotline to encourage employees to report wrongdoing.
  16. VENDOR FRAUD Billing Schemes: In a billing scheme, an employee generates false payments to himself/herself using the company's vendor payment system either by creating a fictitious vendor (Shell Company) or by manipulating the account of an existing vendor. Bribery and Kickbacks: An employee participates in a bribery scheme when he or she accepts (or asks for) payments from a vendor in exchange for an advantage. Check Tampering: A check tampering scheme involves forging, altering or creating unauthorized checks. An employee steals checks for payment to a vendor and alters the payee or forges the vendor's signature to deposit them in his or her personal account. Overbilling: A vendor pads invoices to charge the company for more goods than it ships or to charge a higher price than agreed. This can be done in collusion with an employee, who receives a kickback or by the vendor alone to defraud the company. Price Fixing: This type of fraud occus when competing vendors collude amongst themselves to set a minimum price or price range. This makes both vendors' prices appear competitive and ensures the company pays an inflated price no matter which vendor is chosen. While employees of the company are not usually involved, they sometimes provide information to the vendors about pricing and budgets to facilitate this fraud.
  17. PREVENTION FROM VENDOR FRAUD To prevent and detect vendor fraud: Conduct thorough background checks on new employees. Implement checks and balances on payments to vendors. Separate the functions of check preparer and check signer. Rotate Of ernployees in Conduct random audits of vendor files. Conduct due diligence when setting up vendors by verifying: Vendor's business name Tax Identification Number (TIN) Phone number PO box and street address Bank account Vendor contact person Use data mining to uncover anomalies and patterns. Corn pare vendor addresses with addresses. Implement a dual review process for master vendor file management. Review the vendor master file to check that volume of billing is reasonable and consistent.
  18. 76 WAYS TO IDENTIFY FICTITIOUS VENDORS Billing schemes are among the most common types of employee fraud as they can often be easily hidden by those involved in the accounts payable function. One of the most lucrative billing schemes involves the creation of fictitious vendors from whom the dishonest employee pretends to purchase goods or services and creates payments. Here's how to identify them in your accounts payable records: Look for vendors whose mailing addresses are PO boxes. l. Identify companies that are not on a list of approved vendors. 2. Look for invoices with even dollar amounts or no taxes added. 3. Flag invoices for vague services or services that don't seem necessary. 4. Look for payments without supporting documentation. 5. Compare names, addresses, bank account numbers and telephone numbers of vendors and employees. 6. Look for vendors who are also health or life beneficiaries of an employee. 7. Look for invoices created using Microsoft Excel or Word invoice templates. 8. Identify vendors with above-average revenues for investigation. 9. 10. Look for invoices from the same vendor with consecutive invoice numbers. I I . Compare names of vendors with other similar vendor names and investigate whether payments have been diverted from one to the other.
  19. 76 WAYS TO IDENTIFY FICTITIOUS VENDORS (CONTINUED) 12. Check names of accounts payable employees against Secretary of State records to determine whether they are principals or registered agents of a company that is a vendor. 13. Look for vendors without a taxpayer identification number or with an invalid one. A valid taxpayer ID number has nine digits with the first two digits separated by a hyphen. 14. Compare employer identification numbers, taxpayer identification numbers or DUNS numbers to see if more than one vendor has the same number. 15. Look for drastic changes in prices, services or products provided by a particular vendor. 16. Look for vendor names that consist only of initials and match those against employee initials. In addition to standard fraud prevention best practices, such as segregating duties and enforced vacations, a periodic review of all vendor additions and changes to existing vendor contact information should be performed by someone not involved in the accounts payable function.
  20. ACCOUNTING FRAUD Embezzlement: Also called larceny, this is any fraud conducted by a person who controls the funds being used. Accounts Payable Fraud: Accounts payable fraud is among the most damaging for affected businesses. It's also among the easiest frauds to perpetrate, since most of the money leaving a company legitimately goes through the accounts payable function. Fake Supplier: An employee sets up a fake supplier and bills the company for good or services not provided. Personal Purchases: An employee Uses company funds to pay for personal purchases and records the payments as legitimate business expenses in the accounting system. Double-Check Fraud: An employee writes a check to pay an invoice then writes a second check to himself or herself and records the disbursement in the accounting system as a payment to the same supplier. Accounts Receivable Fraud: Accounts receivable fraud takes place through many different types of schemes: lapping, fictitious sales, skimming and more.
  21. PREVENTION FROM ACCOUNTING FRAUD To prevent and detect accounting fraud: Implement tight internal controls on accounting functions. Separate the functions of account setup and approval. Conduct random audits of account payable and accounts receivable records. Assign a trusted outside contractor to review and reconcile accounts at regular intervals. Rotate duties of employees in accounts payable and accounts receivable. Make it mandatory for employees to take vacation time. Set up an automated positive pay system to detect fraud.
  22. ACCOUNTS RECEIVABLE FRAUD Accounts receivable is a thief's paradise due to the influx of money at all times. Accounts receivable fraudsters take advantage of the trust they've built with clients, using their professional position to line their pockets. Accounts receivable fraud can ruin a company financially. The fraud itself is harmful for the company's finances, but the negative impact on its reputation and relations with customers is where the real damage lies. Plus, those involved will face civil and criminal penalties. The accounts receivable process can facilitate fraud schemes if the right checks and balances aren't in place. Fraudsters often leave a long, convoluted paper trail to mislead or intimidate auditors and investigators. An employee committing fraud will use any concealing technique they can to balance the books and hide the fraud: stealing paper statements, applying discounts, applying payments to the wrong accounts and more. Lapping Fraud: Lapping is a form of accounts receivable fraud. Lapping can easily become an elaborate and complex scheme, and is best explained by example. Example of Lapping Fraud: Jim works for a company that provides cleaning services to large organizations. He is the sole member of the accounts receivable team for this company and, recently, Jim has been going through a hard time financially. Money is tight for Jim and his family and there doesn't seem to be a clear solution. One day, Jim is at work and receives a $100 check from Customer A. With no one around, Jim pockets the check. A few days later, Customer B sends in a $100 check as well. Jim Uses the check from Customer B and credits it to Customer A's account to replace the missing $100 payment. So far in the scenario, Jim now has an extra $100 in his pocket and Customer A's account has balanced out with the payment from Customer B. Customer B's account is still in the negatives until Customer C 's money arrives. Jim will continue on with this pattern, continuously recording one customer's payment to another customer's account until the scheme is found out (likely) or the employee pays back the money they've stolen (unlikely).
  23. ACCOUNTS RECEIVABLE FRAUD (CONTINUED) Uncovering Lapping Fraud: The fraudster typically ends up buckling under the pressure of an increasingly complex lapping theft. The sheer volume of transactions will overwhelm the thief. The stress of always being one step behind leads them to eventually slip and expose the scheme on their own. Lapping is a popular method for concealing skimming fraud. Skimming Fraud: Skimming fraud usually takes place in either the sales or receivables functions of the accounts receivable process. An organization that provides goods or services sends out bills to its customers and receives payments as "accounts receivable". An employee who is skimming receivables is intercepting payments from customers and pocketing the cash. The fact that skimming fraud is done before the payment enters the company's accounting system is what separates it from cash larceny. Skimming is "off book" fraud and cash larceny is "on book" fraud, in which funds are stolen after they are recorded in the company's accounts. Even a well-constructed accounts receivable process isn 't always enough to stop skimming since this happens before the receivables process begins. There are several ways fraudsters commit skimming fraud. Check Skimming: The first way is through check skimming. In this scenario, an accounts receivable employee intercepts an incoming check from an account holder. Before the payment has been recorded, the employee steals the check and cashes it into a private bank account of their own. Since they're stealing these checks before they have been recorded, an employee disguises their actions by diverting account statements and late notices. Refund Skimming: The second way is called refund skimming fraud. If a customer of the company has accidentally overpaid, they'll receive a refund check. A company with weak controls gives the fraudster an opportunity to pocket the refund check before it's been recorded in the accounting system and endorse it to Once the fraud has been there are several the conceals their actions.
  24. ACCOUNTS RECEIVABLE FRAUD (CONTINUED) How Do They Do It? In both scenarios, the skimmer will open up a bank account with a name that's similar to the company's bank name. This makes it difficult for the victims or the company to notice the misspelling and uncover the scheme. For example, if the company's bank account name is "ABC Co. ", the employee in question might open up a bank account similarly named "ABC Inc. Or instead of "i-Sight" they might call it "I-Sight" (with a lowercase L) The skimmer is usually responsible for the majority of account-related work. This includes being the primary source of communication for the customer, and a main contact for account holders with questions about billing and payment. The circumstances of this relationship work in the schemer's favor. Fraudulent Write-Offs: Fraudulent write-offs occu when an accounts receivable employee credits a customer's account for a discount, a return, or some other form of write-off. This technique can be used to cover up a previous theft or be used as a form of fraud in itself. As a method of concealment, an employee who has been skimming checks over the past couple of weeks might apply discounts to the accounts they've stolen from. Example of Fraudulent Write-Offs For example, let's say Jim has been pocketing payment checks from Debtor A. To hide his fraud, Jim will access the books and apply discounts to hide the "missing" money. As a form of fraud in itself, a thieving employee will credit old or closed accounts with several discounts. Since these accounts aren't monitored as closely as an active account, the employee can pocket any payments or divert funds to their own, personal account. Where Are Fraudulent Write-Offs Common? This form of accounts receivable fraud is common in small businesses where only one err) ployee responsible for receivables in the receivables process. An employee who doesn't share their duties with a colleague is less likely to get caught.
  25. ACCOUNTS RECEIVABLE FRAUD (CONTINUED) Fictitious Sales and Fictitious Accounts: Fictitious sales and fictitious accounts are typically set up to disguise one another. When someone makes a fictitious invoice, accounts receivable becomes inflated and there's more "money" in the company. And at the end of the day, more money in the company benefits everyone in it. Once a sale has been booked, the corresponding journal entry is to a payment that's never collected and eventually written off. So while the payment is never received, the effects and benefits that come from a fictitious sale (booked to a fictitious account) remain. Company owners might feel compelled to create fictitious sales to make their business seem more profitable to prospective or current clients. Salespersons who are based on commission might want to create fictitious sales to meet daily, weekly, or monthly goals (especially if there is a tempting target bonus). A robust accounts receivables process with strong controls can help to expose this fraud.
  26. DETECTING ACCOUNTS RECEIVABLE FRAUD Is your employee constantly debiting the wrong accounts? Are they "accidentally" misplacing or tossing statements, or billing customers at weird intervals? There are a few things that might be at play: either your employee is really, unbelievable badly at their job, or there's fraud taking place in your company. Either way, an investigation is necessary to uncover what's truly going on. Sometimes you might get lucky and an employee unintentionally learns about the fraud, other times an audit exposes the truth, or someone reports their suspicions. In most cases though, someone will witness a warning sign, making them SUSPiCiOUS and prompting action. Keep a watchful eye for these red flags that accounts receivable fraud is happening in the workplace. Excessive Discounts: Watch for excessive discounts, write-offs, voids, returns, or other modifications to accounts. These might be concealing skimmed payments. Unauthorized Sales: Watch for unauthorized sales or SUSPiCiOUS accounts. This might be a flag that employees are creating fictitious sales and accounts. Sudden Account Activity or Other Discrepancies: Watch for sudden activity in a slow or otherwise dead account. Abrupt increases in sales, revenue, or AR balances is definitely a sign that something out of the ordinary is going on. Keep an eye out for other forms of discrepancies, too. Sometimes an audit isn't possible but a quick look-through of the books might take you down a rabbit hole filled with fraud. Listen to Your Customers: Most importantly, listen to your customers. Are they receiving wrongful non-payment notices? Did they claim to have paid in September but the payment didn't show up until November?
  27. PREVENTING ACCOUNTS RECEIVABLE FRAUD Segregate Duties: It's key to segregate business functions if you're working to prevent accounts receivable fraud. Separate accounting functions among multiple employees, if you can. Don't let one employee have access to every folder, every file, every account. Relating to AR, HHCPA recommends an adequate segregation of duties among those who: invoice customers, collect accounts receivable, authorize write-offs, independently investigate AR discrepancies, process customer service calls, open the mail, and prepare deposits. If YOU have the no ear) s, ir-nplernent a sys tern where be present during key accounting tasks at all times, such as while opening mail or while invoicing customers. Be Alert: Be alert to employee problems. Employees often commit accounts receivable fraud because they're in a hard place. As you'll see below in "behavioral red flags" some employees who are committing fraud may be openly discussing their financial issues or relationship struggles. Being supporting and accommodating with an employee who is going through a tough time can sometimes avoid an issue from happening at all. An employee will be less inclined to begin stealing if their employer is willing to give them an advance on pay or some extra days off to address personal issues. Offering a helping hand can sometimes be the solution. Implement and Enforce Controls: If employees perceive that they can get away with fraud, they might be more likely to try. Make it difficult for them. Implement an anti-theft policy, or a company code of conduct that outlines prohibited behavior. Don 't just implement policies, enforce them. Employees won't take them seriously if you don't. Make employees aware of the zero-tolerance approach to employee misconduct. Explain the consequences of actions.
  28. PREVENTING ACCOUNTS RECEIVABLE FRAUD (CONTINUED) Hiring Practices: Stick to careful hiring practices. Thorough background checks are a good way to uncover the little secrets a potential employee is trying to bury. Background checks might expose a history of committing fraud or an incentive to commit fraud now. Also, don 't overlook the importance of reaching out to references. If they've given you contact information to a former boss or colleague, this person might have information you'd want to know. Behavioral Red Flags: Watch for behavioral red flags. Employee possessing a new wheeler-dealer attitude, or are they driving a Ferrari on a Civic salary? Alternatively, have they been openly discussing financial woes or troubles at home? Refusing to take vacation, unwillingness to share job tasks, or being unusually close with a customer (or two) are also signs that they might not want anyone to find their mess. Education and Training: Embrace awareness and training. Educate personnel (and especially management) about accounts receivable fraud. Suggest comprehensive internal or online training about AR fraud. The more educated and aware that employees are about this form of fraud and it's warning signs, the more likely they'll feel comfortable reporting any suspicions. On that same note, let employees know how they can anonymously report fraud in the workplace. A whistleblower hotline is a good option for this, or the open-door policy. Have Insurance: No matter your precautions, fraudsters-to-be will find a way to make it happen. Insurance can sometimes cover employee misconduct and minimize out-of-pocket expenses needed to right their wrongs. Criminal Insurance protects company assets from loss due to employee dishonesty, theft, or fraud. This coverage minimizes risk for the company, its clients, and the honest employees.
  29. ACCOUNTS PAYABLE FRAUD Accounts payable fraud, also known as AP fraud, is among the most UbiqUitOUS and damaging of frauds that affect businesses of all sizes. It's also among the easiest frauds to perpetrate, since most of the money leaving a company legitimately goes through the accounts payable function. The ACFE's 2016 Global Fraud Study identified three types of accounts payable (AP) fraud - check tampering, billing schemes and fraudulent expense reimbursements - as accounting for the largest percentage of reported fraud cases. Check tampering alone results in a median loss of $ 158,000 per business. But there are many schemes and new ones emerging as fraudsters figure out ways to skirt fraud controls in new ways. Red Flags for Accounts Payable Fraud Most AP fraud schemes involve an employee hiding fraudulent transactions among thousands of legitimate transactions. Finding them can be like looking for a needle in a haystack, unless you know what to look for. Many of the red flags for accounts payable fraud are the same as red flags for any type of fraud. For example, if you notice employees living beyond their means, not taking vacations, engaging in reckless behavior, withholding information or staying late and coming in on weekends, it's wise to investigate further. But there are also some indicators that are specific to the accounts payable department, and every anti-fraud programs should include regular audits that screen for these "needles in a haystack" as well as the more general red flags.
  30. ACCOUNTS PAYABLE FRAUD (CONTINUED) Look for these AP fraud red flags: Vendors that seem unusual or are unapproved l. Increases in payments to particular vendors without corresponding increases in goods or services 2. 3. Very large payments to one vendor Unusually large purchases on an employee's company-issued credit card 4. Payments that consistently fall just under the amount requiring authorization 5. Invoices in sequence 6. Invoices that look unprofessional or photocopied 7. Invoices that are missing key details, such as address and phone number 8. A vendor's email address that uses a free provider, such as Gmail 9. 10. Multiple invoices paid together or on the same date Vendor addresses that are the same as an employee address ll. Vendor address that look to be residential addresses 12. Vendors with similar names 13. 14. Large entertainment and gift charges 15. Rounded dollar amounts 16. Incomplete documentation or copies instead of originals 17. Duplicate payments to the same vendor Vendor's prices that seem unusually low or high 18. Close relationships an and vendor 19. 20. Repeated purchases from a vendor with a record of poor quality goods or services 21. Tips or complaints from employees, customers or vendors
  31. ACCOUNTS PAYABLE FRAUD (CONTINUED) Types of Accounts Payable Fraud: Billing Schemes: In its most general form, a billing scheme involves employees generating false payments that are eventually (or immediately) paid to themselves. There are many ways employees can do this. Creating false invoices for products or services that were not delivered. Colluding with a third party, passing invoices through an account or company the employee controls and taking a cut of the payment in what's known as a "pass-through scheme" Initiating purchase orders and payments for goods or services for personal Use. Setting up a fake vendor account and creating false invoices which are paid to the employee. Processing duplicate payments to a vendor, and when the duplicate is returned from the vendor, the ernployee keeps it. Or processing payrnents to create a credit with the vendor then keeping the vendor's next payment. The 2017 Hiscox Embezzlement Study found that two billing schemes, vendor invoicing and false billing, accounted for just 14 per cent of the cases examined but incurred 42 per cent of the dollar losses. These cases involved employees fabricating or inflating vendor invoices or creating fictitious vendors. The study also found that check fraud was used in 22. I per cent of cases, more than half of which were committed by managers. Check Fraud: Check tampering, or check fraud, is among the most lucrative of the accounts payable fraud schemes. Done well, this fraud can be hard to catch. Done badly, the paper trial created by check fraud is easy for an investigator to follow and easy to prosecute because of the documentation it creates.
  32. ACCOUNTS PAYABLE FRAUD (CONTINUED) ACH fraud, or automated clearing house fraud, is becoming more common, especially with same- ACH Fraud: day turnaround on ACH transactions. One way to commit this fraud is for employees in the accounts payable department to set themselves up as automatic bill payees in the system. An employee might set up a new payee and send funds, or even divert funds to a new account using an existing payee account but changing the details. Expense Reimbursement Fraud: Expense reimbursement fraud can be committed by any employee has business-related expenses that are reimbursable and, according to the ACFE, this type of fraud lasts an average of two years before being detected. Expense reimbursement fraud is usually achieved through one of the mischaracterized expenses, overstated expenses, fictitious expenses and double claims. Kickback Schemes: Kickback schemes, also known as corporate bribery, take place when a vendor pays an employee of a company (buyer) to purchase - or influence the purchase of - products or services offered by the vendor. Sometimes kickbacks are in the form of cash, which is difficult to trace. But kickbacks can also be entertainment, travel, gifts, use of the vendor's goods or services, promises of employment for the employee or his/her family or friends, etc. Conflicts of Interest: A conflict of interest occus when an employee has a vested interest in a company that does business with the employee's company. This doesn't constitute fraud in itself, but it does create a situation that is ripe for fraud. An employee in the accounts payable department with an undisclosed conflict of interest is in a position to overpay, collude with or provide unfair advantages to a vendor with which he or she has a relationship.
  33. PREVENTING ACCOUNTS PAYABLE FRAUD Verify Vendors: Establish mechanisms for approval of all new vendors added to the company's vendor files. This should be done by someone separate from the person who adds new vendors. Conduct regular vendor audits to verify that all vendors are legitimate. Look for the red flags listed above and manually verify, by telephone, online or in-person, any questionable ones. Reconcile Accounts: Match accounts payable entries with the company checkbook each month. Review Transactions: Examine transactions to look for indicators of fraud. Check for the red flags listed above, such as round numbers, gaps in invoice numbers, (Jr)USUal transactions, UnlJSUal frequencies or amounts. Implement a Check Review Procedure: This procedure should be conducted by someone who isn 't involved in check issuing, and occur before checks are distributed. Implement a two-signature requirement for checks above a certain amount and scan the register for checks that fall just under this threshold. Conduct Unscheduled Audits: Perform random audits of accounts payable files to check for all red flags listed above. Rotate Employees Through the AP Function: This will require cross-training, but will reduce the likelihood of employees conducting long-term AP fraud schemes or nurturing relationships with vendors. Implement Mandatory Vacations: Implement mandatory vacations for employees in the accounts payable department to increase the likelihood of long-term schemes being uncovered.
  34. PREVENTING ACCOUNTS PAYABLE FRAUD (CONTINUED) ACH fraud, or automated clearing house fraud, is becoming more common, especially with same- ACH Fraud: day turnaround on ACH transactions. One way to commit this fraud is for employees in the accounts payable department to set themselves up as automatic bill payees in the system. An employee might set up a new payee and send funds, or even divert funds to a new account using an existing payee account but changing the details. Expense Reimbursement Fraud: Expense reimbursement fraud can be committed by any employee has business-related expenses that are reimbursable and, according to the ACFE, this type of fraud lasts an average of two years before being detected. Expense reimbursement fraud is usually achieved through one of the mischaracterized expenses, overstated expenses, fictitious expenses and double claims. Kickback Schemes: Kickback schemes, also known as corporate bribery, take place when a vendor pays an employee of a company (buyer) to purchase - or influence the purchase of - products or services offered by the vendor. Sometimes kickbacks are in the form of cash, which is difficult to trace. But kickbacks can also be entertainment, travel, gifts, use of the vendor's goods or services, promises of employment for the employee or his/her family or friends, etc. Conflicts of Interest: A conflict of interest occus when an employee has a vested interest in a company that does business with the employee's company. This doesn't constitute fraud in itself, but it does create a situation that is ripe for fraud. An employee in the accounts payable department with an undisclosed conflict of interest is in a position to overpay, collude with or provide unfair advantages to a vendor with which he or she has a relationship.
  35. UNCOVER AP FRAUD WITH BENFORD'S LAW Benford's Law is a great mathematical tool for screening accounts payable records for fraudulent payments. Benford's Law outlines a pattern of naturally occurring numbers that should be consistent across any set of 'natural" numbers, such as payment records. When numbers are manually added into a naturally occurring set of numbers, they don't match the pattern dictated by Benford's Law. Discovered by Frank Benford, an American astronomer, in 1881, Benford's Law states that the expected occurrence for I as the first digit in a natural number is 30.1 per cent. The numeral 2 is expected to be the first digit 17.6 per cent of the time and the numeral 3 should be the first digit 12.5 per cent of the time. The pattern continues through to the numeral 9, which should be the first digit in a natural number 4.6 per cent of the time. 30% 20% 10% 0% Digit
  36. UNCOVER AP FRAUD WITH BENFORD'S LAW (CONTINUED) If a company has a rule that expenditures over a certain amount, say $1 ,000, require a second signature, an accounts payable employee writing fraudulent checks might keep the amounts below that threshold. In this case, a disproportionate number of checks might be written for amounts in the 900s, with a starting numeral of 9. Since the numeral 9 should occur naturally as the first digit only 4.6 per cent of the time, a lot of payments beginning with a 9 will throw the number set off the expected pattern. This is a red flag in an audit of accounts payable records. There may, of course, be a logical explanation for numbers not falling in line with Benford's Law, but it is an indicator that something is influencing the numbers and breaking the natural pattern. The fraud examiner then can investigate the cause of the anomaly to see if there is fraud occurring.
  37. PAYROLL FRAUD Ghost Employee Schemes: A fake employee or ex-employee is kept on the payroll with pay being diverted to the fraudster. Advance Fraud: An employee requests a payroll advance and doesn 't pay it back. Timesheet Fraud: An employee falsifies timesheets to inflate hours, an employee clocks in and out for another employee in his or her absence or a payroll employee manually inflates hours on an employee's timesheet. Paycheck Theft: One employee steals another employee's check and cashes it.
  38. PREVENTION FROM PAYROLL FRAUD To prevent and detect payroll fraud: Reconcile balance sheets and payroll accounts each quarter. Require managers or supervisors to approve timesheets and overtime claims. Institute mandatory vacations for payroll employees. Restrict payroll department employees' ability to modify pay rates and hours. Perform data analytics on payroll records to look for matching addresses, names, bank accounts, etc. Check payroll records to ensure terminated employees have been removed from the payroll. Separate tasks of preparing payroll checks and reconciling payroll account.
  39. HOW TO DETECT PAYROLL FRAUD Payroll fraud is a common scheme in which an employee in the payroll department causes the employer to issue payments based on a false claim for compensation. According to the Association of Certified Fraud Examiners (ACFE), payroll fraud occurs nearly twice as often in small organizations with less than 100 employees than in large ones and the average instance of payroll fraud lasts about 36 months. Common payroll fraud schemes include: Ghost employees - a person not employed by the company is on the payroll Overpayment - a company pays an employee based on falsified hours or rates Commission - the amount of sales made or the rate of commission is fraudulently inflated 28 Red Flags of Payroll Fraud While payroll fraud is hard to prevent, quarterly audits and payroll data analysis can be used to find red flags for payroll fraud. When examining payroll files and Human Resources Department data, look for the following red flags: 2. 3. 4. 5. 6. 7. 8. 9. Unrelated with the s arne address Two or more employees with the same cell phone number or home phone number Multiple employees using the same bank account number One employee using multiple bank accounts for direct deposit An employee who is on the payroll but not on the company's employee list An employee with an address that is a PO box or mail drop Missing information in employee files An employee who shares an address, telephone number or bank account number with an accounts payable vendor Payments to employees for holidays, weekends or off-days
  40. HOW TO DETECT PAYROLL FRAUD (CONTINUED) 10. Gaps in check number sequence I l. A terminated employee who is still on the payroll list 12. Unusually high overtime pay 13. An employee who has been paid for working more than 24 hours in one day 14. Employees with more than one address change within a year 15. Duplicate pay checks. 16. Blank social security numbers 17. Unusual number of checks issued for an employee in a year 18. Invalid social security numbers (match with employee records) 19. Multiple employees with the same social security number 20. Employees on the payroll register before their start date or after their termination date 21 . Deceased employees who are still on the payroll list 22. Manual payroll checks 23. Multiple paychecks issued to an employee within a single pay period 24. Employees with no deductions for taxes or benefits 25. Unusual ratio of gross to net pay 26. Bonuses paid during times when bonuses are not typically paid or to employees who are not eligible 27. Employees with no pay increases, or more than two pay increases, in a year 28. Employees who have had no paid time off, vacation or sick leave
  41. DATA THEFT Data or theft or theft of trade secrets in one type of employee fraud that can be devastating to a company that relies on its intellectual property for its product or service. This type of theft can also compromise marketing and sales efforts and/or put the company in a precarious position with authorities when personally identifiable information is stolen. Trade Secret Theft: Theft of proprietary information to sell to a competitor. Theft of Customer or Contact Lists: A departing employee copies or downloads lists of the company's contacts to either sell or Us e. Theft of Personally Identifiable Information (PID): An employee steals or shares credit card numbers, client lists or other valuable PID to sell to other parties.
  42. PREVENTION FROM DATA THEFT To prevent and detect data theft: Restrict access to company proprietary information to only those who need it in the COUrse of their jobs. Set UP IT controls to alert management of large data downloads or transfers or downloads and transfers that OCCUr at odd times. Purchase software that alerts management of SUSPiCiOUS activity on a company network, such as an employee trying to access sensitive information. Dispose of confidential information properly, by shredding documents and completely removing data from electronic devices before redeploying or disposing of them. Use strong passwords for all computers and devices that can access sensitive information. Implement a clean-desk policy that prohibits employees from keeping sensitive information on their desks they are not present.
  43. DATA THEFT PREVENTION CHECKLIST Storage and Access Shred the following: Mail with a name and address. Luggage tags Trip itineraries and boarding passes Credit offers Price lists Vendor payment stubs and invoices Cancelled checks Receipts Have your IT Department set up access roles to restrict access to your sensitive data to only those who require it. Find out what you need to protect through an audit or assessment of your data. Hold third parties and contractors your company engages to the same strict data privacy controls you implement in your own organization. Technology Protect all computers and devices with passwords and enable remote wipe capabilities. Install or enable a firewall to keep outsiders from accessing your company network. Protect your wireless network with a password and use encryption and security to hide your wireless network from outsiders. Encrypt all sensitive information being transferred. Install encryption on all • company laptops, mobile devices and removable media. Use a proxy to access the internet in public places where WIFI may be shared by other users. Activate two-factor authentication. Prohibit the transfer of personal • information, such as social security numbers or medical information, via portable devices. Purchase and use up-to-date anti-virus software and anti-spyware. People Require strong passwords at least eight characters long with uppercase and lowercase letters, numbers and special characters. Enforce a "clean desk" policy prohibiting employees from keeping working papers and sensitive documents in view. Train employees to recognize and report "phishing", "smishing" and other forms of social engineering. Set up a separate wireless "guest" network for personal devices to keep your company network safe. Implement social media policies to prevent employees from oversharing on social media or falling for social media scams and frauds. Be nice to your employees. A disgruntled employee can be the most dangerous vulnerability in your data protection program.
  44. BRIBERY AND CORRUPTION High profile employee frauds, such as bribery and kickbacks, can damage much more than a company's finances. The reputational hit from a corruption accusation can deter business, affect employee morale and affect an organization 's stock price. These frauds can include: Bribes: An employee pays or provides a benefit to an official to secure an advantage for the company or for the Kickbacks: An employee receives payments or benefits from third parties in return for business advantages or for unauthorized discounts. Shell Company Fraud Schemes: An employee or company officer may use a shell company to launder money, pay bribes, divert assets or evade taxes. Product Substitution: A contractor, acting on its own or in collusion with an employee in the purchasing company, substitutes inferior or counterfeit materials for the materials specified in the contract.
  45. PREVENTION FROM BRIBERY AND CORRUPTION To prevent and detect bribery and corruption: Have a strong code of ethics and ensure everyone in the company, from the top down, knows what it says and puts it into practice. Ensure those at the top levels of the company set an example that makes it clear that bribery and corruption are not tolerated. Discipline employees who breach the company's code of ethics. Conduct due diligence on all third parties your company does business with. Look for product substitution red flags such as: High numbers of tests or failures Unusually high numbers of repairs or replacements Lack of warranty information in packaging Unbranded packaging Products that don't look like the product ordered Conduct a risk assessment to look for areas to watch more closely Train all employees on bribery and corruption prevention Reward employees for ethical behavior
  46. RESPONSIBLITY FOR PREVENTION & DETECTION OF FRAUD There are two main views: one states that management has the responsibility for the prevention and for the detection of fraud. Management: is responsible for the day to day business operations; is responsible for developing and implementing controls; has authority over the people, systems, and records; and has the knowledge, and authority to make changes therefore, fraud prevention and detection is their problem. Audit: on the other hand: has expertise in the evaluation and design of controls; reviews and evaluates operations and controls; and has a requirernent to exercise DU e Diligence' therefore, fraud prevention and detection is audit's problem.
  47. RESPONSIBLITY FOR PREVENTION & DETECTION OF FRAUD The reality is that both management and audit have roles to play in the prevention and detection of fraud. The best scenario is one where management, employees, and internal and external auditors work together to combat fraud. Furthermore, internal controls alone are not sufficient, corporate CUItUre, the attitudes of senior management and all employees, must be such that the company is fraud resistant. Unfortunately, many auditors feel that corporate culture is beyond their sphere of influence. However, audit can take steps to ensure that senior management is aware of the risk and materiality of fraud and that all instances of fraud are made known to all employees. Also audit can encourage management to develop Fraud Awareness Training and a Fraud Policy to help combat fraud. Finally, audit can review and comment on organizational goals and objectives to redUCe the existence Of unrealistic So, there are a number of things auditors can do to help create a fraud resistant corporate culture. Fraud Awareness Training is a critical step in deterring fraud. It emphasizes the role that all employees have in preventing and detecting fraud - not just auditors. Often it is tied to a corporate ethics program, laying the foundation for all aspects of employee behavior. A Corporate Fraud Policy sets out what employees are to do when fraud is suspected. It defines a consistent course of action and sets the tone for how the company will deal with fraud. In particular, it must clearly convey the message that no one has the authority to commit illegal acts - even to the benefit of the company.

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