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Welcome to . ACG6686 Fraud Examination. Introduction to Fraud Examination. Why Study Fraud Examination?. AICPA called fraud examination (Forensic Accounting) one of the seven hot new “sizzling” career areas in accounting. The size and the number of frauds is increasing.

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welcome to

Welcome to


Fraud Examination

why study fraud examination
Why Study Fraud Examination?
  • AICPA called fraud examination (Forensic Accounting) one of the seven hot new “sizzling” career areas in accounting.
  • The size and the number of frauds is increasing.
  • Great Job Opportunities: there will be a shortage of between 25,000 and 50,000 security professionals in the next few years in the United States.
fraud examination 3e

Fraud Examination, 3E

Why People Commit Fraud

learning objectives
Learning Objectives

Know the types of people that commit fraud

Explain why people commit fraud

Describe the Fraud Triangle

Understand how pressure contributes to fraud

Tell why people rationalize

Understand how people are recruited to participate in fraud


type of people that commit fraud
Type of People That Commit Fraud

What type of people commit fraud?

  • Anyone!
  • Not demographically or psychologically differentiated
  • Have the profile of other honest people


reasons to commit fraud
Reasons to Commit Fraud
  • A combination of the following (Fraud Triangle):
    • Pressure
    • Rationalization
    • Opportunity
  • Immediate financial need
  • The fraud gets larger and larger as confidence in the fraud gets higher and higher


the fraud triangle
The Fraud Triangle


Fraud Triangle




the fraud triangle9
The Fraud Triangle


Fire Triangle




the fraud triangle10
The Fraud Triangle










Small Chance

High Chance

The Fraud Scale



Divided into four main groups:

  • Financial pressures
  • Vices
  • Work-related pressures
  • Other pressures



Financial Pressures

Common Financial Pressures:

  • Greed
  • Living beyond one’s means
  • High bills or personal debt
  • Poor credit
  • Personal financial losses
  • Unexpected financial needs



Vice Pressures

Worse kind of pressures to commit fraud

Examples include:




Expensive extramarital relationships



Vice Pressures

Real-life examples:

  • Dad that embezzled his six-year-old son’s allowance
  • Women who stole money to fund her children's drug addiction
  • Man that used company money to fund his drug addiction
  • The parents who took their new-born baby from the hospital with heroine under its tongue



Work-related Pressures

“Get even with the employer”

Motivated by these factors:

  • Getting little recognition
  • Feeling job dissatisfaction
  • Fear of losing one’s job
  • Being overlooked for a promotion
  • Feeling underpaid



Work-related Pressures

Real-life examples:

  • The worker that worked 12-14 hour days, received a promotion, and accepted kickbacks to compensate for his “over working.”



Other Pressures

Spouse Pressures

  • Spouse’s lifestyle demands

Life Pressures

  • Family Crisis

Social Pressures

  • “Being successful”



Six major factors that increase opportunity:

  • Lack of controls
  • Inability to judge performance quality
  • Fail to discipline fraudsters
  • Lack of access to information
  • Ignorance, apathy and incapacity
  • Lack of audit trail


recruitment of fraudsters
Recruitment of Fraudsters

Many frauds are committed by more than one person



recruitment of fraudsters21
Recruitment of Fraudsters

A Business Week forum for CFOs:

At the forum, participants were queried about whether or not they had ever been asked to “misrepresent corporate results.” Of the attendees, 67 percent of all CFO respondents said they had fought off other executives’ requests to misrepresent corporate results. Of those who had been asked, 12 percent admitted they had “yielded to the requests,” while 55 percent said they had “fought off the requests.”


recruitment of fraudsters22
Recruitment of Fraudsters

Reward Power

Legitimate Power


Coercive Power

Expert Power

Referent Power


recruitment of fraudsters23
Recruitment of Fraudsters

Types of Power

  • Reward Power
    • A’s ability to provide benefits to B
  • Coercive Power
    • A’s ability to punish B if B does not comply with A
  • Expert Power
    • A’s possession of special knowledge or expertise
  • Legitimate Power
    • A’s legitimate right to prescribe behavior for B
  • Referent Power
    • The extent to which B identifies with A


recruitment of fraudsters24
Recruitment of Fraudsters


Conspirator (A)


Co-Conspirator (B)

Perceived Reward Power

Desire for Reward or Benefit

Perceived Coercive Power

Fear of Punishment

Successful Collusion


Perceived Expert Power

Lack of Knowledge

Perceived Legitimate Power

Level of Obedience

Perceived Referent Power

Relationship Needs


controls to prevent detect fraud
Controls to Prevent/Detect Fraud

Internal Control Framework (from COSO)

Control Environment

Risk Assessment

Control Activities

Information and Communication



controls to prevent detect fraud26
Controls to Prevent/Detect Fraud

The Internal Control Structure

Control Environment

  • Management’s Role and Example
  • Management Communication
  • Appropriate Hiring
  • Clear Organizational Structure
  • Effective Internal Audit Department


controls to prevent detect fraud27
Controls to Prevent/Detect Fraud

The Internal Control Structure

Accounting System

Transactions are…

  • Valid
  • Properly authorized
  • Complete
  • Properly classified
  • Reported in the proper period
  • Properly valued
  • Summarized correctly


controls to prevent detect fraud28
Controls to Prevent/Detect Fraud

The Internal Control Structure

Control Activities or Procedures:

  • Segregation of duties, or dual custody
  • System of authorizations
  • Independent checks
  • Physical safeguards
  • Documents and records


what if i don t want to be a fraud expert
What If I Don’t Want to Be a Fraud Expert?
  • Even if you decide not to become a fraud expert, the topics covered in this course will help you be a better professional in whatever career path you choose. The technology, interviewing, document examination, public records, and other tools you will learn will make you a better consultant, auditor, tax professional, or manager, as well as a better and more astute investor.
an important source
An Important Source
  • http://www.cfenet.com
  • The website for the Association of Certified Fraud Examiners (ACFE)
seriousness of the fraud problem
Seriousness of the Fraud Problem
  • It is difficult to give you a definite answer.
  • ACFE conducted a fraud study in the mid-1990s. Based on voluntary reports of over 2,600 frauds, the ACFE estimated that fraud costs U.S. organizations more than $400 billion annually. It is estimated that the average organization’s fraud losses are more than $9 per day per employee, and that about 6% of a company’s total annual revenue is lost to fraud.
seriousness of the fraud problem32
Seriousness of the Fraud Problem
  • The FBI has labeled fraud the fastest growing crime.
  • Not only the number of fraud cases seems increasing, the size of discovered fraud is increasing too.
  • Fraud is very costly to organizations.
Given that the frauds are very costly, the best way to maximize profits for companies is to eliminate fraud.
  • The best way to minimize fraud is to prevent it from occurring.
  • Therefore, we will cover fraud prevention, as well as fraud detection and investigation.
what is fraud
What Is Fraud?
  • Black’s Law Dictionary defines fraud as:

“… all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the truth. It includes all surprise, trick, cunning or dissembling, and any unfair way by which another is cheated.”

what is fraud35
What Is Fraud?
  • A victim
  • Details of the deceptive act thought to be fraudulent
  • The victim’s loss
  • A perpetrator
  • Evidence that the perpetrator acted with intent
  • Evidence that the perpetrator profited by the act(s)
can we sue the contractor for fraud
Can we sue the contractor for fraud?
  • Assume that an entity contracted to have the roof of a warehouse redone, specifying that an expensive rubberized sheeting be used. The job is advertised and contractor A submits the lowest bid. After the job is completed, the entity discovers that the roof leaks. Further investigation discloses that a much cheaper roofing material was installed, inferior to the quality of product that was specified in the contract. The cost difference between the two grades of roof sheeting was $10,000 and it will cost $5,000 to repair the leak.
types of fraud
Types of Fraud
  • Misrepresentation of material facts
  • Concealment of material facts
  • Bribery
  • Conflicts of interest
  • Theft of money or property
  • Theft of trade secrets or intellectual property
  • Breach of fiduciary duty
  • Statutory offenses
misrepresentation of material facts
Misrepresentation of Material Facts
  • Deliberate making of false statements to induce the intended victim to part with money or property
  • The elements normally include
    • A material false statement
    • Knowledge of its falsity
    • Reliance on the false statement by the victim
    • Damages suffered.
  • Opinions, speculative statements about future events, even if made with intent to mislead, may not be the basis for a fraud case.
an accountant may be prosecuted for fraud who
An Accountant May Be Prosecuted for Fraud who:
  • Certifies that a financial statement fairly presents the financial condition of the audited company when the accountant knows it does not.
  • Falsely states that the audit was conducted in accordance with GAAS.
  • Deliberately distorts the audit results
concealment of material facts
Concealment of Material Facts
  • The essential elements of fraud based on failure to disclose material facts are
    • That the defendant had knowledge
    • Of a material fact
    • That the defendant had a duty to disclose
    • And failed to do so
    • With the intent to mislead or deceive the other party
  • Bribery includes official bribery, which refers to the corruption of a public official and commercial bribery, which refers to the corruption of a private individual to gain a commercial or business advantage.
  • Elements:
    • Giving or receiving
    • A thing of value
    • To influence
    • An official act
  • Obtaining of property from another with the other party’s “consent” having been induced by wrongful use of actual or threatened force or fear.
  • A demand for a bribe or kickback might constitute an extortion.
  • In most states and federal system, extortion is not a defense to bribery.
conflict of interest
Conflict of Interest
  • An agent taking an interest in a transaction
  • That is actually or potentially adverse to the principal
  • Without full and timely disclosure to an approval by the principal
    • An agent includes any person who, under the law, owes a duty of loyalty to another, including employees of a corporation, brokers, accountants.
  • The wrongful appropriation of money or property by a person to whom it has been lawfully entrusted. Embezzlement implicitly involves a breach of trust.
    • The defendant took or converted
    • Without the knowledge or consent of the owner
    • Money or property of another
    • That was properly entrusted to the defendant
  • Taking or carrying away
  • Money or property of another
  • With the intent to permanently deprive the owner of its use of possession
  • Without the consent of the owner
theft of trade secrets
Theft of Trade Secrets
  • That a party possessed information of value to the business
  • That was treated confidentially
  • That the defendant took or used by breach of an agreement, confidential relationship, or other improper means.
breach of fiduciary duty
Breach of Fiduciary Duty
  • People in a position of trust or fiduciary relationship, such as officers, directors, owe certain duties imposed by law to their principals or employers.The principal fiduciary duties are loyalty and care.
duty of loyalty
Duty of Loyalty
  • Requires that employee/agent act solely in the best interest of the employer/principal, free of any self-dealing, conflicts of interest, or other abuse of the principal for personal advantage.
  • Embezzlements, thefts, acceptance of kickbacks, and conflicts of interest also violate the duty of loyalty and may be prosecuted as such in addition to or instead of the underlying offense.
duty of care
Duty of Care
  • People in a fiduciary relationship must conduct business affairs prudently with the skill and attention normally exercised by people in similar positions.
  • People in a fiduciary relationship are not guarantors against all business reverses or errors in judgment.
  • The Business Judgment Rule protects corporate officers and directors from liability for judgment that were made in good faith and appeared to be prudent
federal legislation related to fraud
Federal Legislation Related to Fraud
  • Most white-collar crimes are prosecuted under the state systems. Prosecution under the criminal fraud statutes in the U.S. Code requires a federal jurisdictional basis, such as an effect on interstate commerce or mail uses.
  • Example: mail fraud, wire fraud, Racketeer Influenced and Corrupt Organizations (RICO)
types of fraud51
Types of Fraud
  • Another easier way to classify fraud: fraud committed against an organization and fraud committed on behalf of an organization.
fraud against an organization
Fraud Against an Organization
  • “The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organizations’ resources or assets.” –ACFE
  • Also call it occupational fraud
  • Can range from lunch break abuses to high-tech schemes
fraud on behalf of an organization
Fraud on Behalf of an Organization
  • The most common fraud in this category is fraudulent financial reporting.
  • Trying to make reported earning look better or to increase a company’s stock price.
  • Often occurs in companies that are experiencing net losses or have profits much less than expectation.
another classification scheme
Another Classification Scheme
  • Employee embezzlement
  • Management fraud
  • Investment scams
  • Vendor fraud
  • Customer fraud
  • Miscellaneous fraud
employee embezzlement
Employee Embezzlement
  • Another name for occupational fraud
  • Direct employee fraud: occurs when company’s assets go directly into the perpetrator’s pockets without the involvement of third parties.
  • Indirect employee fraud: occurs when employees take bribes or kickbacks from vendors, customers, or others outside the company to allow for lower sales prices, higher purchase prices. Payment to employees is usually made by organizations that deal with the perpetrator’s employer, not by the employer itself.
management fraud
Management Fraud
  • Top management’s deceptive manipulation of financial statements.
  • Example: Crazy Eddie, Inc. overstated inventories on financial statements; ZZZZ Best overstated revenues and receivables.
investment scams
Investment Scams
  • Fraudulent and usually worthless investments are sold to unsuspecting investors.
  • It includes telemarketing fraud, selling of worthless partnership interests, and other investment opportunities.
  • Charles Ponzi is regarded as the father of investment scams.
vendor fraud
Vendor Fraud
  • Fraud perpetrated by vendors acting alone
  • Fraud perpetrated through collusion between buyers and vendors
  • Overcharge for purchased goods, the shipment of inferior goods, or the nonshipment of goods even though payment was made.
customer fraud
Customer Fraud
  • Customers either do not pay for goods purchased, or they get something for nothing, or they deceive organizations into giving them something they should not have .
  • Constitution is the supreme law of the land.
  • Constitutional rights that are of particular importance to CFE include those found in the Fourth, Fifth and Sixth Amendments.
  • The Fourth Amendment guarantees the right of all citizens to be free from unreasonable searches and seizures.This means that the government may not seize any records in a criminal case unless there exist reasonable grounds—”probable cause”—to believe that the records would constitute evidence of a crime, and that a suspect may not be arrested unless there is probable cause.
  • The Fifth Amendment guarantees subjects of a criminal investigation the right to refuse to answer questions or to provide certain personal information that might be incriminating.
  • The Sixth Amendment affords subjects in a criminal investigation the right to counsel, the right to confront (cross-examine) the witnesses against them and the right to a speedy trial.
  • The two sources of substantive law are statutes passed by Congress and state legislatures (including regulations enacted by administrative and regulatory agencies) and the common law (judge-made law).
  • Criminal law prosecutions are always based on statutes, but civil actions can be based on both.
  • Substantive law is comprised of the basic laws of rights and duties as opposed to procedural law which involves rules governing pleadings, evidence, jurisdiction, etc.
  • Substantive law sets the terms of any dispute; procedural law dictates how a legal dispute is handled.
  • Fraud can be prosecuted civilly and criminally.
  • Criminal and civil actions for fraud may proceed simultaneously.