Question

Background:

Crispy Bagel Corporation is a fast-growing bagel chain in the Northeast. Crispy has made a name for

itself in the baking and creation of specialty bagels, muffins, and pastries. The company currently has

150 stores and 750 employees, and expects to triple that number in the next five years. Due to its fast

growth, the accounting information system at Crispy has required several upgrades.

This year, Crispy Bagel’s payroll software needed to be upgraded. The IT Department is organized

into two groups, Development and Operations. The Development Group is responsible for the coding

and testing of the payroll software; the Operations Group is responsible for the operation and

maintenance of the new payroll software. As the supervisor of both IT groups, the IT manager had

global access to all aspects of the payroll software, including employee additions, pay rate changes, and

employee benefits changes.

The payroll supervisor was responsible for updating the new payroll system, inputting employee data

(names, Social Security numbers, tax and benefit information) and pay rates. Because of Crispy

Bagel’s accelerated growth rate, there was no time to perform detailed tests of the payroll data.

Instead, the payroll supervisor assumed that the company’s employees would notify the payroll

department of any discrepancies in their rate of pay or deductions.

The Fraud:

The IT manager has been with Crispy for just over one year. He has been struggling with a gambling

addiction for the past five years and has run up considerable debts. Crispy Bagel’s fast growth has put

a strain on the IT Department staff. The IT manager has been required to work overtime nearly every

weekend for the last six months, and because he is a salaried employee, his pay does not reflect this

extra work. In addition, the IT manager was passed over for a raise during his annual review, but was

promised a significant increase in salary in another six months.

Subsequent to turning control of the new payroll software over to the Payroll Department, and before

the first payroll was run using the new system, the IT manager used his supervisory access to increase his

annual pay by $5,000, the raise that he expected to receive in connection with his annual review.

Since this was only an increase of $208 each paycheck, it’s unlikely that the adjustment would be

noticed.

Required

1. The fraud triangle lists three conditions that are usually present when fraud occurs. Discuss the

three conditions and if they are present for the IT manager? For each condition, provide examples

from the case.

2. What are the red flags present that suggest the possibility of fraud?

3. How would the fraud impact the financial statements? (list the financial statement, the account impacted by the fraud and the impact i.e. overstated or understated)

4. Discuss the procedures you would use to detect this fraud. (be very specific)

5. Discuss the procedures that should be implemented to prevent this fraud. (be very specific)

Answer 1

1)The three conditions present when fraud occurs are:-

• Perceived pressure- A person may resort to fraud when he/she has to Bear the cost of family member's sickness , huge loan amounts and other liability which he can't afford.
• Opportunity- The person grabs all the possible chances to commit fraud whenever it is available.Eg:- An accountant may change the accounts if nobody cross checks them.
• Rationalization- In this situation , the person shows his/her immoral act as being acceptable although it is not. Eg:-Person stealing from company's retained earnings with no motive to return that money but showing it as borrowing.

Conditions Present for IT Manager to commit fraud

Perceived pressure- He is in a gambling addiction for the past 5 years and has gone in debts.

Opportunity - He uses his supervisory access to increase his annual pay by $5000 for his annual review.

Rationalization - Since it's an increase of just $208 per paycheck , he knows it would not be noticed.

2)Red flags present for the possibility of fraud are:

• Negligenceon supervisor's part as he doesn't have time to perform detailed test of payroll data.
• Assumption that employees would report discrepancies.
• Lack of deep study of employee's past work experience and habits as It manager was in gambling since last 5 years.
• Company has not recognised extra benefits for extra work done by employees as it has only promised to pay but has not yet paid any money.

3) Financial statements include Profit and Loss Account , Balance sheet and cash flow Statement.Due to fraud , the financial statement of the company will be understated since in Profit and Loss Account , debit side will increase due to increase in expenses of $5000 thus reducing the Net profit of Crispy Bagel.

4)Procedures that can be used to detect this fraud:-

• Crispy Bagel should appoint an Internal Auditor to detect frauds as he/she checks all the frauds and not only frauds related to financial statements.
• Employees should be trained to report any doubtful activity in the organisation for which proper training cell must be developed.
• 100% of the data must be verified by experts and impose in employees' mind that every transaction is being strictly monitored.