Chapter 4 Preventing Fraud Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LEARNING OBJECTIVES After studying this chapter, you should be able to: • Understand how to create a culture of honesty, openness, and assistance. • Know how to eliminate opportunities for fraud. • Understand how to create an effective organization to minimize fraud. • Understand the importance of proactive fraud auditing. • Understand the importance of creating a comprehensive approach to fighting fraud. Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Just About Everyone Can Be Dishonest • It would be nice to believe that most individuals and employees are so honest that they would never commit fraud. • Unfortunately, most people are capable of committing fraud, and most people adapt to their environments. • When placed in an environment of low integrity, poor controls, loose accountability, or high pressure, people tend to become increasingly dishonest. Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Creating a Culture of Honesty, Openness, and Assistance • Three major factors in fraud prevention relate to creating a culture of honesty, openness, and assistance. • These three factors include: • Hiring honest people and providing fraud awareness training • Creating a positive work environment, which means having a well-defined code of conduct, having an open-door policy, not operating on a crisis basis, and having a low-fraud atmosphere • Providing an employee assistance program (EAP) that helps employees deal with personal pressures Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Creating a Culture of Honesty, Openness, and Assistance—Illustration Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Verify Applicant’s Résumé and Application • Verify all information on the applicant’s résumé and/or application using the following suggestions: • Require all applicants to certify that all information on their application and/or résumé is accurate • Train those involved in the hiring process to conduct thorough and skillful interviews • Use industry-specific or other approaches as deemed necessary (credit checks, fingerprinting, drug tests, public record searches, honesty tests, etc.) Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Hiring Policies and Practices Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Creating a Positive Work Environment • Create a positive work environment, making the organization less vulnerable to fraud, by • Creating expectations about honesty through having a good corporate code of conduct and conveying those expectations throughout the organization • Having open-door or easy access policies • Having positive personnel and operating procedures Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Preventing Fraud—A Summary • Fraud is reduced and prevented by • Creating a culture of honesty, openness, and assistance • Eliminating fraud opportunities Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 4.1: Hormel Foods Code of Conduct • Figure 4.1 shows an example of a good code of ethics for all employees. • Refer to Figure 4.1 in textbook to see all the text. Topics Addressed • Conflict of Interest • Harassment • Gifts • Safety • Corporate Opportunities • Government Reporting • Illegal Payments • Environmental Responsibility • Illegal Political Contributions • Product Integrity • Protection and Proper Use of Company Assets • Diversity • Proper Accounting • Foreign Trade • Insider Trading • Responsible Delegation • Confidential Information • Disciplinary Action • Inventions, Developments, Improvements • Antitrust Compliance • Reporting Illegal, Unethical Behavior, or Violations of the Code • Fair Dealing • Waivers of the Code • Fair Employment Practices Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Implementing Employee Assistance Programs (EAPs) • Help employees deal with: • • • • Substance abuse Gambling Money management Health, family, and personal problems • Provide support systems with programs like: • • • • • • • • Wellness Team building Coaching Conflict resolution Critical incident response Assessment Counseling Referral Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table 4.1: Creating a Culture of Honesty, Openness, and Assistance WAYS TO CREATE A CULTURE OF HONESTY, OPENNESS, AND ASSISTANCE 1. Hire honest people and provide fraud awareness training. HOW THIS STEP IS ACCOMPLISHED 1. Verify all information on the applicant’s résumé and application. 2. Require all applicants to affirm the truth of the matters set forth in their application and résumé. 3. Train management to conduct thorough and skillful interviews. 2. Create a positive work environment. 1. Create expectations about honesty by having a good corporate code of conduct and conveying those expectations throughout the organization. 2. Have open-door or easy access policies. 3. Have positive personnel and operating procedures. 3. Provide an employee assistance program (EAP). 1. Implement an EAP that helps employees deal with personal and nonsharable pressures in their lives. Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Eliminating Opportunities for Fraud to Occur • Five methods of eliminating fraud opportunities: • Having good internal controls • Discouraging collusion between employees and customers or vendors and clearly informing vendors and other outside contacts of the company’s policies against fraud • Monitoring employees and providing a hotline (whistle-blowing system) for anonymous tips • Creating an expectation of punishment • Conducting proactive auditing • Each method reduces either the actual or the perceived opportunity to commit fraud. Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Having a Good System of Internal Controls • Committee of Sponsoring Organizations’ (COSO) definition of an internal control framework includes the following elements: • Good control environment • Risk assessment process • Set of control activities • Information and communication system (including the accounting system) • Process of monitoring compliance with the controls Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 4.2: Assessing Risk and Implementing Appropriate Controls Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Control Activities • Segregation of Duties • Having two people do a task together or splitting the task into parts so that no one person handles the complete assignment • Authorizations • Having a system of proper authorizations so that only authorized or designated individuals have permissions to complete certain tasks • Physical Controls • Implementing physical safeguards such as locks, keys, safes, fences, and so on, to prohibit access to assets and records • Independent Checks • Implementing a system of independent checks such as job rotations, mandatory vacations, audits, and so on • Documentation • Having a system of documents and records that provide an audit trail that can be followed to check on suspicious activity and to document transactions Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table 4.2: Types of Control Activities TYPE OF CONTROL CONTROL ACTIVITIES Preventive controls 1. Segregation of duties 2. System of authorizations 3. Physical safeguards Detective controls 4. Independent checks 5. Documents and records Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Discouraging Collusion between Employees and Others • Approximately 29 percent of frauds involve collusion • Ways to discourage fraud involving collusion • Use periodic letters to explain policies to vendors • Include a “right-to-audit” clause on all purchase invoices Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Monitoring Employees and Having a Whistle-Blowing System • Close monitoring • Facilitates early detection • Deters frauds because potential perpetrators realize that “others are watching” • A good whistle-blowing program is one of the most effective fraud prevention tools. • Approximately 33 percent of all frauds are detected through tips. • Section 806 of the Sarbanes-Oxley Act of 2002 requires all public companies to have a whistle-blower system. • Government agencies and some foreign companies have whistle-blower systems. Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Elements of an Effective Whistle-Blowing System • Anonymity • Independence • Accessibility • Follow-up Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Creating an Expectation of Punishment • Fear of punishment • Examples of punishment • Termination—not always a real punishment • Having to disclose dishonest behavior to family and friends • Prosecution • Expectation of punishment can be conveyed by • Having a policy that states employees who engage in fraud will be prosecuted to the fullest extent of the law • Applying the policy Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Conducting Proactive Fraud Auditing • Good fraud auditing involves four steps: • Identify fraud risk exposures • Identify the fraud symptoms of each exposure • Build audit programs to proactively look for symptoms and exposures • Investigate fraud symptoms identified Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 4.3: Fraud Prevention Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. A Comprehensive Approach to Fighting Fraud • Many companies do NOT have a comprehensive approach to fighting fraud. • Responsibility for fraud in an organization is often seen as belonging to “someone else.” • A “non-ownership” attitude regarding fraud is common. Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Organizations and Fraud—The Current Model • The current model that many organizations use for dealing with fraud is characterized by four stages: • Fraud incident • Investigation • Action • Resolution • Once these four stages are completed, no further action is taken—until another fraud occurs. • Fraud will never decrease with this model. • Fraud will become a recurring problem. Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 4.4: Dealing with Fraud: The Current (Default) Model Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Elements of Fraud-Fighting Model Element 1: Positive tone at the top Element 2: Education and training for employees and others about the seriousness of fraud and informing them what to do if fraud is suspected Element 3: Integrity risk assessment and having a good internal control system Element 4: Reporting and monitoring system Element 5: Proactive fraud detection methods in place Element 6: Effective investigation and follow-up when fraud occurs Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure 4.5: Sound Organizations—Minimal Fraud Albrecht/Albrecht/Albrecht/Zimbelman, Fraud Examination, 6th Edition. © 2019 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
