Chapter 1
Introduction to Fraud Examination
Learning Objectives
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Define fraud examination and differentiate it from auditing.
Understand the fraud theory approach.
Define occupational fraud.
Define fraud.
Define abuse.
Know the difference between fraud and abuse.
Describe the criminological contributions of Edwin H. Sutherland.
Understand Donald Cressey’s hypothesis.
Give examples of non-shareable problems that contribute to fraud.
Understand how perceived opportunity and rationalization contribute to fraud.
Explain W. Steve Albrecht’s “fraud scale.”
Summarize the conclusions of the Hollinger-Clark study.
Summarize the results of the 2012 Report to the Nations on Occupational
Fraud and Abuse.
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Discipline of Fraud Examination
• Resolving allegations of fraud from tips,
complaints, or accounting clues
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Documentary evidence
Interviewing witnesses
Writing investigative reports
Testifying
Assisting in the detection and prevention of fraud
• Forensic accounting vs. fraud examination
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Auditing vs. Fraud Examination
Issue
Auditing
Fraud Examination
Timing
Recurring
Nonrecurring
Scope
Objective
Relationship
General
Opinion
Nonadversarial
Specific
Affix blame
Adversarial
Methodology
Audit techniques
Presumption
Professional
skepticism
Fraud examination
techniques
Proof
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Fraud Examination Methodology
• Predication
– Totality of circumstances that would lead a
reasonable, professionally trained, and prudent
individual to believe a fraud has occurred, is
occurring, and/or will occur
– Fraud examinations must be based on
predication.
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Fraud Theory Approach
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Analyze available data
Create a hypothesis
Test the hypothesis
Refine and amend the hypothesis
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Tools Used in Fraud Examination
T
Observation
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Defining Occupational
Fraud and Abuse
The use of one’s occupation for personal
enrichment through the deliberate misuse or
misapplication of the employing
organization’s resources or assets
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Elements of Fraud
• A material false statement
• Knowledge that the statement was false
when it was uttered
• Reliance on the false statement by the
victim
• Damages resulting from the victim’s
reliance on the false statement
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Occupational Fraud and Abuse
Research
• Edward Sutherland
• Donald Cressey
– Cressey’s Hypothesis
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Opportunity
Fraud
Triangle
Pressure
Rationalization
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2012 Report to the Nations on
Occupational Fraud & Abuse
• Global survey
• Measuring the costs of occupational fraud
– 5 percent lost to fraud
– $3.5 trillion worldwide
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Position of Perpetrator
Position of Perpetrator
Employee
41.6%
Manager
37.5%
Owner/Executive
17.6%
Other
3.2%
0%
10%
20%
30%
Percent of Cases
40%
50%
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Position of Perpetrator
Median Loss by Position
Employee
$60,000
Manager
$182,000
Owner/Executive
$573,000
Other
$100,000
$0
$200,000
$400,000
Median Loss
$600,000
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Gender of Perpetrator
Female
35.0%
Male
65.0%
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Median Loss by Gender
$250,000
$200,000
Median Loss
$200,000
$150,000
$100,000
$91,000
$50,000
$0
Female
Male
Gender of Perpetrator
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Department of Perpetrator
Department of Perpetrator
Accounting
Operations
Sales
Executive/upper mgmt
Customer service
Other*
Purchasing
Warehousing, inventory
Finance
Information technology
Manufacturing & production
Board of Directors
Human resources
Marketing/PR
Research and development
Legal
Internal audit
0.0%
22.0%
17.4%
12.8%
11.9%
6.9%
5.9%
5.7%
4.2%
3.7%
2.0%
1.9%
1.4%
1.2%
1.1%
0.7%
0.6%
0.6%
5.0%
10.0%
15.0%
Percent of Cases
20.0%
25.0%
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Department of Perpetrator
Median Loss by Department
Executive/upper mgmt
Finance
Board of Directors
Purchasing
Accounting
Legal
Marketing/PR
Manufacturing & production
Human resources
Operations
Other*
Information technology
Research and development
Sales
Warehousing, inventory
Internal audit
Customer service
$500,000
$250,000
$220,000
$200,000
$183,000
$180,000
$165,000
$160,000
$121,000
$100,000
$100,000
$100,000
$100,000
$90,000
$67,000
$32,000
$30,000
$0
$100,000 $200,000 $300,000 $400,000 $500,000 $600,000
Median Loss
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Perpetrator’s Criminal History
Criminal History of Perpetrator
Never charged or convicted
87.3%
Charged but not convicted
5.9%
Had prior convictions
5.6%
Other
1.2%
0.0%
20.0%
40.0%
60.0%
Percent of Cases
80.0%
100.0%
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Median Loss per Number of
Employees
Number of Employees
<100
$147,000
100-999
$150,000
1,000-9,999
$100,000
10,000+
$140,000
$0
$50,000
$100,000
Median Loss
$150,000
$200,000
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Initial Detection of Frauds
Tip
43.3%
Management Review
14.6%
Internal Audit
14.4%
Detection Method
By Accident
7.0%
Account Reconciliation
4.8%
Document Examination
4.1%
External Audit
3.3%
Notified by Police
3.0%
Surveillance/Monitoring
1.9%
Confession
1.5%
IT Controls
1.1%
Other
1.1%
0%
10%
20%
30%
40%
50%
Percent of Cases
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Occupational Fraud and Abuse
Corruption
Conflicts
of Interest
Bribery
Asset
Misappropriations
Fraudulent
Statements
Cash
Financial
Inventory &
All Other Assets
Nonfinancial
Illegal
Gratuities
Economic
Extortion
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Frequency of Types of
Occupational Fraud and Abuse
Percent of Casesa
Asset Misappropriation
86.7%
Corruption
33.4%
Financial Statement
7.6%
Fraud
Median Loss
$120,000
$250,000
$1,000,000
aThe
sum of percentages listed in this column exceeds 100 percent because some cases involved
fraud schemes that fell into more than one category. The same is true for every scheme
classification chart in this book that is based on the 2011 Global Fraud Survey.
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