Question

 

1. List some controls that reduce fraud risks.

2. Explain how you can detect fraud.

Answer 1

Answer No 1

There are five basic elements that lead to a good system of internal control which helps in prevention and detention of errors & Fraud. These elements are control environment, risk assessment, control activities, monitoring, and information and communications. Let’s break these elements down to look at how they can be implemented.

Control Environment. Any good system of internal controls must begin with the control environment, particularly the “tone at the top.” You must make it clear to employees, investors, vendors, customers and competitors that the company will be run honestly and ethically and deviations from this policy will not be tolerated.

Risk Assessment. Once a proper tone is established, you should then perform a risk assessment. What areas of financial reporting are most vulnerable to fraud or error? Which assets are most likely to be stolen, misappropriated or wasted? In what areas are failure to comply with laws and regulations most likely to occur? In other words, you want to assess the areas where there is the greatest risk that your organization will not be successful. These are essential questions to ask as you look to protect your company from various types of fraud.

Control Activities. Once risk has been assessed, institute policies and procedures that mitigate those risks. A system of internal controls must be designed specifically to address the greatest areas of risk, whether the risk is the occurrence of fraud or error. Control activities that mitigate risk include segregation of duties, safeguarding of assets and policies related to information processing.

Unfortunately, leaders and management often accomplish the first three steps and then fail to follow through on the two elements listed below. Once the control environment has been established, risk has been assessed and control activities have been designed and implemented, there must be follow up in the form of monitoring and information and communications.

Monitoring:-Monitoring of the internal control system may include internal audits, testing of procedures, follow up on errors and reaction to perceived deficiencies. If it is clear that there are shortcomings in the system, the system will need to be altered. Both design and implementation are critical. It is not enough to assess risk and design a system of controls to mitigate those risks – the system must also be properly implemented. A system that is well designed but improperly implemented is probably as ineffective as a fully implemented system that was not properly designed.

Communication:-Finally, there must be clear communication of information. Provide all levels of employees with the information that they need to properly carry out the activities of the organization and adhere to the developed controls.

Answer No 2

1. Unusual Behavior

The perpetrator will often display unusual behavior, that when taken as a whole is a strong indicator of fraud. The fraudster may not ever take a vacation or call in sick in fear of being caught. He or she may not assign out work even when overloaded. Other symptoms may be changes in behavior such as increased drinking, smoking, defensiveness, and unusual irritability and suspiciousness.

2. Complaints

Frequently tips or complaints will be received which indicate that a fraudulent action is going on. Complaints have been known to be some of the best sources of fraud and should be taken seriously. Although all too often, the motives of the complainant may be suspect, the allegations usually have merit that warrant further investigation.

3. Stale Items in Reconciliations

In bank reconciliations, deposits or checks not included in the reconciliation could be indicative of theft. Missing deposits could mean the perpetrator absconded with the funds; missing checks could indicate one made out to a bogus payee.

4. Excessive Voids

Voided sales slips could mean that the sale was rung up, the payment diverted to the use of the perpetrator, and the sales slip subsequently voided to cover the theft.

5. Missing Documents

Documents which are unable to be located can be a red flag for fraud. Although it is expected that some documents will be misplaced, the auditor should look for explanations as to why the documents are missing, and what steps were taken to locate the requested items. All too often, the auditors will select an alternate item or allow the auditee to select an alternate without determining whether or not a problem exists.

6. Excessive Credit Memos

Similar to excessive voids, this technique can be used to cover the theft of cash. A credit memo to a phony customer is written out, and the cash is taken to make total cash balance.

7. Common Names and Addresses for Refunds

Sales employees frequently make bogus refunds to customers for merchandise. The address shown for the refund is then made to the employee's address, or to the address of a friend or co-worker.

8. Increasing Reconciling Items

Stolen deposits, or bogus checks written, are frequently not removed, or covered, from the reconciliation. Hence, over a period of time, the reconciling items tend to increase.

9. General Ledger Out-of-Balance

When funds, merchandise, or assets are stolen and not covered by a fictitious entry, the general ledger will be out of balance. An inventory of the merchandise or cash is needed to confirm the existence of the missing assets.

10. Adjustments to Receivables or Payables

In cases where customer payments are misappropriated, adjustments to receivables can be made to cover the shortage. Where payables are adjusted, the perpetrator can use a phony billing scheme to convert cash to his or her own use.

11. Excess Purchases

Excess purchases can be used to cover fraud in two ways:

Fictitious payees are used to convert funds.

Excessive purchases may indicate a possible payoff of purchasing agent.

12. Duplicate Payments

Duplicate payments are sometimes converted to the use of an employee. The employee may notice the duplicate payment, then he or she may prepare a phony endorsement of the check.

13. Ghost Employees

Ghost employee schemes are frequently uncovered when an auditor, fraud examiner, or other individual distributes paychecks to employees. Missing or otherwise unaccounted for employees could indicate the existence of a ghost employee scheme.

14. Employee Expense Accounts

Employees frequently conceal fraud in their individual expense account reimbursements. These reimbursements should be scrutinized for reasonableness and trends, especially in the area of cash transactions on the expense account.

15. Inventory Shortages

Normal shrinkage over a period of time can be computed through historical analysis. Excessive shrinkage could explain a host of fraudulent activity, from embezzlement to theft of inventory.

16. Increased Scrap

In the manufacturing process, an increased amount of scrap could indicate a scheme to steal and resell this material. Scrap is a favorite target of embezzlers because it is usually subject to less scrutiny than regular inventory.

17. Large Payments to Individuals

Excessively large payments to individuals may indicate instances of fraudulent disbursements.

18. Employee Overtime

Employees being paid for overtime hours not worked by altering time sheets before or after management approval.

19. Write-off of Accounts Receivable

Comparing the write-off of receivables by customers may lead to information indicating that the employee has absconded with customer payments.

20. Post Office Boxes as Shipping Addresses

In instances where merchandise is shipped to a post office box, this may indicate that an employee is shipping to a bogus purchaser.