Chapter 8
Risk of Fraud and Illegal Acts
Learning Objectives
Understand the prevalence of fraud and illegal acts in today’s world.
Compare and contrast various illegal acts/fraud definitions.
Describe the fraud triangle and why all three elements must exist for fraud to
occur.
Define the types of fraud and fraud risk factors.
Define governance, risk management, and control in the context of fraud.
Describe fraud prevention, deterrence, and detection techniques.
Understand the behavioral aspects of fraudsters.
Understand evolving responsibilities of the internal audit function, including the
involvement of forensic accountants and fraud examination specialists.
Learning Objective 1
Understand the prevalence of fraud and
illegal acts in today’s world.
Overview of Fraud in Today’s Business World
Fraud is not limited to only certain countries or industries
Examples of large accounting scandals:
USA: Enron and WorldCom
Other countries: see Exhibit 8-2
Indonesia: ?????
Impact?
A loss of confidence in the capital markets
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Exhibit 8-2
Survey Result by ACFE - 2012
Organizations lose 5% of their annual revenues to fraud
Occupational fraud schemes tend to be extremely costly
Occupational frauds schemes frequently for years before they
are detected
Occupational frauds are much likely to be detected by a tip
than by audits, controls, or other means
The most common fraud schemes were asset misappropriation
Corruption and billing schemes pose the greatest risks to
organizations throughout the world
The longer a perpetrator has worked for an organization, the
higher the fraud losses tend to be
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Survey Result by ACFE - 2012
Industries most commonly victimized were banking and
financial services, government and public administration and
manufacturing
Occupational fraud were most often committed by individuals
working in one of six departments: accounting, operations, sales,
executives/upper management, customer service, and purchasing
Occupational fraudsters are generally first-time
offenders.
Common fraud perpetrator red flags:
Living beyond their means
Experiencing financial difficulties
Excessive organizational pressure
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Learning Objective 2
Compare and contrast various illegal
acts/fraud definitions.
Apakah Yang
Dimaksud Dengan
Fraud?
What Is Fraud?
Restaurant Fraud
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Illegal Acts
Are activities that violate laws and regulations of
particular jurisdictions where a company is operating
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Fraudulent financial reporting
Fraudulent financial reporting involves intentional
misstatements or omissions of amounts or disclosures in
financial statements designed to deceive financial
statement users.
Accomplished by:
Manipulating, falsifying, or altering accounting records or
supporting documents from which the financial statements
are prepared.
Misrepresenting, or intentionally omitting from, the financial
statements events, transactions, or other significant
information.
Intentionally misapplying accounting principles relating to
amounts, classification, manner of presentation, or
disclosure.
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Misappropriation of assets
Pilferage = pencurian
Embezzlement = penggelapan, pencurian, korupsi
Defalcation
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Exhibit 8-6
Occupational Fraud:
• Falsification of
financial statements
• Asset misappropriation
• corruption
Learning Objective 3
Describe the fraud triangle and why all three
elements must exist for fraud to occur.
Conceptual framework
Donald Cressey Fraud Triangle
Perceive need/pressure
Perceived opportunity
Rationalization of fraudulent behavior
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Quotes
“Biasakanlah yang benar dan
janganlah membenarkan yang
biasa”
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Learning Objective 4
Define key principles for managing fraud risk.
Key principles for managing fraud risks
The Fraud Guide outlines five core
principles that organizations would be
well-advised to follow:
1. Fraud Risk Governance
2. Fraud Risk Assessment
3. Fraud Prevention and Detection
4. Fraud Reporting, Investigation, and Resolution
Key principles for managing fraud risks
The Fraud Guide outlines five core
principles that organizations would be
well-advised to follow:
1. Fraud Risk Governance
2. Fraud Risk Assessment
3. Fraud Prevention and Detection
4. Fraud Reporting, Investigation, and Resolution
Fraud Risk Governance
There must be a structure in place to
oversee the identification and
management of fraud risks
Governing board:
Helps set the tone for fraud risk management
Encourage management to establish policies
Responsible for monitoring the effectiveness of the
organization’s fraud risk management program
Key principles for managing fraud risks
The Fraud Guide outlines five core
principles that organizations would be
well-advised to follow:
1. Fraud Risk Governance
2. Fraud Risk Assessment
3. Fraud Prevention and Detection
4. Fraud Reporting, Investigation, and Resolution
Fraud Risk Assessment
Management should understand the
inherent fraud risks the organization faces
Steps:
Identify the potential fraud events or scenarios
Assess the impact and likelihood of each risk
Decide what fraud risk responses are appropriate
Key principles for managing fraud risks
The Fraud Guide outlines five core
principles that organizations would be
well-advised to follow:
1. Fraud Risk Governance
2. Fraud Risk Assessment
3. Fraud Prevention and Detection
4. Fraud Reporting, Investigation, and Resolution
Fraud Prevention and Detection
Prevention controls may include policies,
procedures, training and communication.
Detection controls may include manual or
automated activities that will recognize
timely that a fraud has or is occurring.
Key principles for managing fraud risks
The Fraud Guide outlines five core
principles that organizations would be
well-advised to follow:
1. Fraud Risk Governance
2. Fraud Risk Assessment
3. Fraud Prevention and Detection
4. Fraud Reporting, Investigation, and Resolution
Fraud Reporting, Investigation and Resolution
Establishing a reporting system to facilitate and
encourage reporting of potential fraud incidents
Whistleblower system
Establishing a sound investigation process
Internal or external legal counsel.
Other function in the organization
Timely resolution will help ensure prosecution or
disciplinary actions can be taken
Learning Objective 5
Define governance, risk management, and
control in the context of fraud.
Governance Over the Fraud Risk
Management Program
Developing corporate cultures
Board ownership of agendas and information flow
Access to multiple layers of management and effective
control of a whistleblower hotline
Independent nomination processes
Effective senior management team
A code of conduct
Board evaluation
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Governance Over the Fraud Risk
Management Program
Roles and responsibilities
Board of directors
Management
Employees
The internal audit function
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Governance Over the Fraud Risk
Management Program
Components of a fraud risk management program
Commitment
Fraud awareness
An affirmation
A conflict disclosure
Fraud risk assessment
Reporting procedures and whistleblower protection
An investigation process
Disciplinary and/or corrective actions
Process evaluation and improvement
Continuous improving
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Fraud Risk Assessment
Involving individuals with varying knowledge
Accounting and finance personnel
Legal and compliance personnel
Risk management personnel
Internal auditors
Other internal or external parties
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Fraud Risk Assessment
Three key steps
1. Identify inherent fraud risks;
2. Assess impact and likelihood of the identified risk; and
3. Develop responses to those risks
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Learning Objective 6
Describe fraud prevention and detection
techniques.
Fraud Prevention
Common elements in preventing fraud:
Performing background investigations
Providing anti-fraud training.
Evaluating performance and compensation programs.
Conducting exit interview.
Authority limits.
Transaction-level procedures.
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Fraud Detection
Common detection methods:
Whistleblower hotlines
Process control.
Proactive fraud detection procedures.
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Fraud Investigation and Corrective Action
Steps in this stage
Receiving the allegation
Evaluating the allegation
Establishing investigation protocols
Determining appropriate actions
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Key principles for managing fraud risks
Steps in this stage
Receiving the allegation
Evaluating the allegation
Establishing investigation protocols
Determining appropriate actions
Receiving the Allegation
Received from various sources
Should include a process for:
Categorizing issues
Confirming the validity of the allegation
Escalating the severity of the allegation
Referring issues outside the scope of the program
Conducting the investigation and fact-finding
Resolving or closing the investigation
Listing types of information that should be kept confidential
Defining how the investigation will be documented
Managing and retaining documents and information
Key principles for managing fraud risks
Steps in this stage
Receiving the allegation
Evaluating the allegation
Establishing investigation protocols
Determining appropriate actions
Evaluating the Allegation
Not all allegation of fraud prove to be acts
of fraud.
Steps:
Does the allegation require a formal investigation or is there
enough information now to draw a conclusion?
Who should lead the investigation?
Are there special skills or tools needed to conduct the
investigation?
Who needs to be notified and when?
Establishing formal protocols
Key principles for managing fraud risks
Steps in this stage
Receiving the allegation
Evaluating the allegation
Establishing investigation protocols
Determining appropriate actions
Establishing Investigation Protocols
• To ensure an investigation achieves its
objectives.
• Factors to be considered:
• Time sensitivity.
• Notification
• Confidentiality
• Legal privileges
• Compliance
• Securing evidence
• Objectivity
• Goals
Key principles for managing fraud risks
Steps in this stage
Receiving the allegation
Evaluating the allegation
Establishing investigation protocols
Determining appropriate actions
Determining Appropriate Actions
Possible actions include:
Legal actions, whether criminal or civil
Disciplinary actions, such as warning, demotions,
censure, suspension, or termination
Insurance claims if losses from the act are covered by
insurance policies
Redesign or reinforcement of processes and controls
that may have been inadequate designed or that
operated ineffectively, allowing the incident to occur.
Learning Objective 7
Understand the behavioral aspects of
fraudsters.
Potential red flags
Exhibit a lifestyle that appears to be well beyond their
current means
Are experiencing extreme financial problem and/or have
overwhelming personal debts.
Are suffering from depression or other emotional
problems.
Appear to have a gambling obsession.
Have a need or craving for status, and believe money
can buy that status
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Learning Objective 8
Understand evolving responsibilities of the
internal audit function, including the
involvement of forensic accountants and
fraud examination specialists.
Fraud Proficiency and Due Professional Care
Standard 1210.A2 - Internal auditors must have sufficient
knowledge to evaluate risk of fraud and the manner in which it
is managed by the organization, but are not expected to have
the expertise of a person whose primary responsibility is
detecting and investigating fraud.
Standard 1220.A1 – Internal auditors must exercise due
professional care by considering the … probability of significant
errors fraud, or noncompliance.
Standard 2060 – the chief audit executive must report
periodically to senior management and the board on … fraud
risks…
Standard 2120.A2 – the internal audit [function] must evaluate
the potential for the occurrence of fraud and how the
organization manages fraud risk.
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Opportunities For Insight
Assist the organization in the development of
comprehensive fraud risk assessment.
Develop processes for early detection fraud.
Develop data analysis tools that can be used to detect
fraud in the early stages.
Assist with the development of hotline call procedures.
Provide fraud awareness training throughout the
organization.
Act decisively on significant fraud events.
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Opportunities For Insight
Assist in postmortem analysis when fraud occurs.
Inform management of potential legal acts that are risks
to the organization.
Assist management in developing a culture of ethical
behavior and low tolerance of fraud.
Stay abreast and inform management of emerging issues
and developing issues related to compliance and
regulations.
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End of Chapter 8
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