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

2. IT Auditing & Assurance, 2e, Hall & Singleton
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
Source: ACFE
Corruption fraud
Bribery, etc.
IT Auditing & Assurance, 2e, Hall & Singleton

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

4. IT Auditing & Assurance, 2e, Hall & Singleton
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
FRAUD SCHEMES
 ACFE 2002 Report to the Nation
Fraudulent Financial Statements {5%}
Corruption {10%}
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
Employee fraud – done by non-management employees are generally designed to directly convert cash or other assets to the employee’s personal benefit.
Employee fraud usually involves 3 steps: stealing something of value, converting the asset to a usable form, and concealing the crime to avoid detection.
Management fraud – often escapes detection until irreparable damage has been done.
Does not involve the direct theft of assets.
Management may engage in fraudulent activities to obtain a higher price from a stock or debt offering or just to meet the expectations of investors.
May typically involve materially misstating financial data and reports to gain additional compensation, to garner a promotion, or to escape the penalty for poor performance.
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
IT Auditing & Assurance, 2e, Hall & Singleton

9. MISAPPROPRIATION OF ASSETS
Risk factors:
Susceptibility of assets to misappropriation
Controls
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
IT Auditing & Assurance, 2e, Hall & Singleton

17. FRAUD DETECTION TECHNIQUES USING ACL
Lapping A.R.
Balance forward method
Open invoice method
Three special characteristics:
·        Perpetrated at levels of management above the one where internal controls relate
·        Frequently involves using the financial statements to create illusions about corporate financial health
·        If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties
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