CHAPTER 2 :

Why do people
commit fraud?
Most pressures involve a financial need, although
nonfinancial pressures, such as the need to report
financial results better than actual performance,
frustration with work, or even a challenge to beat the
system, can also motivate fraud

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+ Whether the fraud is one + In the case of management
that benefits the fraud, the pressure could be
perpetrator directly, such the need to make earnings
as employee fraud, or one look better, opportunity could
that benefits the be a weak audit committee,
perpetrator’s organization, rationalization could be “we’ll
such as management only ‘cook the books’ until we
fraud, the three elements can get over this temporary
are always present. hump.”

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Firefighters know that a fire can be extinguished by
eliminating any one of the three elements.
Oxygen is often eliminated by smothering, by using
chemicals, or by causing explosions, as is the case in oil
well fires.
Heat is most commonly eliminated by pouring water on
fires.
Fuel is removed by building fire lines or fire breaks or by
shutting off the source of the fuel.
The Element of Pressure
Employee fraud, in which an individual embezzles from
his or her employer, usually benefits the perpetrator.
Management fraud, in which an organization’s officers
deceive investors and creditors by manipulating financial
statements, is most often perpetrated to benefit an
organization and its officers.

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+ When one perpetrator was caught embezzling over
$1.3 million from his employer, for example, it was
discovered that he had spent the money on
monogrammed shirts and gold cuff links, two
Mercedes-Benz cars, an expensive suburban home,
a beachfront condominium, furs, rings and other
jewelry for his wife, a new car for his father-in-law,
and a country club membership.

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+ Financial pressures can occur suddenly or be long term.
Unfortunately, very few fraud perpetrators inform others when they
are having financial problems. Susan Jones, she had worked at the
same company for over 32 years. Her integrity had never been
questioned. At age 63, she became a grandmother. Immediately, she
became a “spendaholic.” She bought everything she could get her
hands on for her two grandchildren. She even became addicted to
the Home Shopping Network.

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+ During the three years prior to her retirement, Susan stole over
$650,000 from her employer. When caught, she was sentenced
and served one year in prison. She also deeded everything she
and her husband owned to her former employer in an attempt to
repay the employer. By giving her employer her home, her
retirement account, and her cars, she repaid approximately
$400,000 of the $650,000 she stole. The fact that someone has
been an “honest” employee for a long time (32 years in this
example) seems to make no difference when severe financial
pressures occur or an individual perceives that such pressures
exist.

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+ Approximately 30 percent of employee frauds are perpetrated by
employees during their first three years of employment, 70
percent are committed by employees with four to 35 years of
experience, and the age group with the highest evidence of fraud
involves individuals between the ages of 35 and 44 years old.

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confession from reformed gambler
+ “Gambling was the ultimate experience for me,
better than any drug. I had withdrawal tortures just
like a heroin junkie.”
confession from former addicted drug
+ “I was the branch manager of a large bank. But
user
secretly I was shooting up in my office all day and
stealing money from my employer to finance it.”

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+ Approximately 30 percent of employee frauds are
perpetrated by employees during their first three years
of employment, 70 percent are committed by
employees with four to 35 years of experience, and the
age group with the highest evidence of fraud involves
individuals between the ages of 35 and 44 years old.

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The control environment
+ The control + The control
environment is the environment includes
work atmosphere that management’s role
an organization and example
establishes for its
employees.

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 Management’s Role and Example
+ The most important element in establishing an appropriate
environment is management’s role and example. In numerous
instances, management’s dishonest or inappropriate behavior has
been learned and modeled by employees.
Management’s communication
+ Communicating what is and is not appropriate is critical. Just
as parents who are trying to teach their children to be honest
must communicate often and openly with them, organizations
that want employees to behave in a certain way must clearly
label what is and is not acceptable.

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Appropriate Hiring
+ When dishonest individuals are hired, even the best controls will
not prevent fraud. For example, a bank has tellers, managers, loan
officers, and others who have daily access to cash and can steal.
Because it is impossible to deter all bank fraud, banks hope that
personal integrity, together with preventive and detective controls
and the fear of punishment, will deter theft

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Clear Organizational Structure
+ When everyone in an organization knows exactly who has
responsibility for each business activity, fraud is less likely to
be committed. In such situations, it is easier to track missing
assets and harder to embezzle without being caught. Strict
accountability for job performance is critical for a good control
environment

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Effective Internal Audit Department
+ A visible and effective security function, in conjunction with an
appropriate loss prevention program, can help ensure that fraud
is properly investigated and that control weaknesses and
violations are appropriately handled and punished.

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The Accounting System
+ Every fraud is comprised of three elements: (1) the theft act, in
which assets are taken, (2) concealment, which is the attempt to
hide the fraud from others, and (3) conversion, in which the
perpetrator spends the money or converts the stolen assets to
cash and then spends the money.

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Segregation of Duties and Dual Custody
+ Segregation of Duties - involves dividing a task into two parts
so that one person does not have complete control of the task.
+ Dual custody requires two individuals to work together at the
same task
+ The accounting for and the handling of cash receipts are
separated so that one person does not have access to both

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System of Authorizations
+ Authorization control procedures take many forms. Passwords
authorize individuals to use computers and to access certain
databases. Signature cards authorize individuals to enter safe
deposit boxes, to cash checks, and to perform other functions at
financial institutions. Spending limits authorize individuals to
spend only what is in their budget or approved level.

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Independent
+
Checks
The theory behind independent checks is that if people know that their work or
activities will be monitored by others, the opportunity to commit and conceal a
fraud will be reduced.
+ Periodic job rotations, cash counts or certifications, supervisor reviews,
employee hot lines, and the use of auditors are other forms of independent
checks. One large department store in Europe has a complete extra staff of
employees for its chain of department stores. This staff goes to a store and
works while everyone who is employed there goes on vacation for a month.
While they are gone, the transient staff operates the store. One of the purposes
of this program is to provide complete, independent checks on the activities of
store employees. If someone who is committing fraud is forced to leave for a
month, the illegal activity is often discovered.

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Physical Safeguards
+ Physical safeguards are often used to protect assets from theft by
fraud or other means. Physical safeguards, such as vaults, safes,
fences, locks, and keys, take away opportunities to commit fraud
by making it difficult for people to access assets

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Documents and Records
+ The fifth control procedure involves using documents and
records to create a record of transactions and an audit trail.

+ Documents rarely serve as preventive controls but provide

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Thank
you!