As the economy struggles, businesses and individuals are hanging on to their money more tightly than ever. With fewer resources available and reserves dwindling, becoming a victim of fraud during a recession could prove financially disastrous. However, a little awareness can go a long way in protecting hard-earned assets from would-be fraudsters.
Use this quiz to see how your knowledge of fraud prevention, detection and investigation measures up.
1. Under the concept of ____________, corporations can be held criminally responsible for the acts of their employees if those acts were done in the course and scope of their employment and for the apparent benefit of the corporation.
a. Connected accountability
b. Civil responsibility
c. Imputed liability
2. Larry Holt is the lead auditor for Modus Industries, a company that manufactures technological components. With the economic downturn, company management has been under increased pressure to meet earnings expectations, and the company is in danger of violating its loan covenants. Because of these factors, Larry is concerned that management may be fraudulently concealing liabilities and expenses to improve the company’s financial statements. He performs his preliminary analytical procedures with these factors in mind. Which of the following is a red flag that might reaffirm Larry’s suspicions?
a. The company’s gross margin is significantly lower than industry average.
b. The company has experienced an unusual increase in the number of days’ purchases in accounts payable.
c. The financial statements reflect an unusual change in the relationship between fixed assets and depreciation.
d. The company shows a significant reduction in accounts payable, even though its competitors are stretching out payments to vendors.
3. Which of the following is considered a fraud preventive internal control?
a. Employee support programs
b. Segregation of duties
c. Employee background checks
d. All of the above
4. The concept of the fraud triangle states that, for a fraud to occur, three factors generally are present. Which of the following is NOT one of the three sides of the fraud triangle?
a. Criminal predisposition
b. Incentive or pressure
c. Perceived opportunity
5. In general, the best way to prevent fraud is to:
a. Implement harsh penalties for perpetrators
b. Outsource all possible functions
c. Increase the perception of detection
d. Conduct covert audits
6. ___________ is defined as “the 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."
7. Which of the following is NOT an element generally included as part of a fraud risk assessment?
a. Risk identification
b. Formal fraud policy development
c. Assessment of likelihood and significance of risks
d. Risk response
8. The three primary categories of occupational fraud are:
a. Corruption, financial statement fraud and asset misappropriation
b. Skimming, money laundering and bid rigging
c. Asset misappropriation, identity theft and fictitious revenues
d. Financial statement fraud, inventory theft and cash larceny
9. Sarah Ludner is conducting an investigation into a possible accounts receivable lapping scheme at Horace Paper Supply Co. If Ludner plans to interview all of the following parties, whom should she interview first?
a. Chuck Pensky, the primary suspect
b. Julia Rodriguez, an accounts payable clerk who filled in for Pensky when he was on vacation
c. Stephen Milton, a regular customer of the company whose complaint about his account balance prompted the investigation
d. Kathryn Beatty, Pensky’s supervisor, who is suspected of helping Pensky cover the fraud in exchange for a portion of the proceeds
10. Most employees who commit fraud have a history of fraudulent misconduct.
1. (c) The concept of imputed liability holds that corporations can be legally held responsible for the criminal acts of their employees in certain circumstances. For example, the controller of a company fraudulently increases the amount of sales revenue recorded on the company’s books to bolster the corporation’s financial statements. Even if his supervisors and those charged with governance are unaware of his actions, the company may be held criminally liable for the fraud.
2. (d) Concealing operating expenses and the associated trade payables would result in a reduction in accounts payable. Such a reduction, especially during a period when other companies in the industry were experiencing an increase in accounts payable, would be a red flag that Larry should investigate further. If the company were hiding product costs, it would likely see an increase in gross margin, not a decrease. Likewise, concealing payables would result in a decrease in the number of days’ purchases in accounts payable rather than an increase. The relationship between fixed assets and depreciation would generally not be affected by such a scheme.
3. (d) All of these choices, if properly implemented, can help prevent fraud. Employee support programs—including financial, drug, and family counseling services—assist employees in finding ways to deal with pressures that may otherwise lead them to pilfer company funds. Segregating incompatible duties—for example, signing checks and reconciling the bank account—eliminates the opportunity for a single individual to perpetrate and conceal fraud. And conducting background checks on prospective employees as a pre-condition for hiring can prevent companies from letting a thief in through the front door. When combined with other preventive controls, such as a formal antifraud policy and ongoing employee fraud education, these controls reduce the risk that organizations will be defrauded by their trusted employees.
4. (a) The concept of the fraud triangle provides three conditions that generally must be present for a fraud to occur: (1) incentive or pressure, (2) perceived opportunity and (3) rationalization. Each leg of the triangle represents one of these three elements.
The incentive element typically stems from circumstances that cause the perpetrator to feel an immense amount of pressure to engage in dishonest actions. Examples of pressures that may lead to fraud include personal financial problems, potential job loss, and fear of failing to meet earnings expectations.
Opportunities to commit fraud generally arise when circumstances allow an individual to carry out a misappropriation of assets, a financial statement manipulation, or some other type of fraud scheme. Within an organization, such opportunities usually appear in the form of weak internal controls. This element is the one most often addressed by management and auditors in their fraud prevention efforts.
Rationalization involves the ability to justify the commission of fraud. To overcome the hurdle of knowingly committing a crime, the fraudster may adopt an attitude that the fraudulent act is harmless to others, that the fraud is warranted as revenge, or, in the case of embezzlement, that he or she is “borrowing” the money rather than stealing.
5. (c) Most fraud perpetrators engage in illegal conduct only when they perceive there is an opportunity to reduce whatever pressures they are facing without getting caught. Therefore, if an organization can increase in its employees’ minds the perception that the illegal acts will be detected, it can significantly deter occupational fraud.
Generally, occupational fraudsters are not deterred by the threat of sanctions because they do not plan to get caught. Additionally, clandestine internal controls, such as covert audits, will do little good in forestalling theft and fraud because employees do not know of their presence and, consequently, of their potential detective ability.
6. (d) Predication is the 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. In other words, predication is the basis upon which a fraud examination is launched. Fraud examinations should not be conducted without proper predication.
For example, while conducting a routine internal audit, an auditor overheard one of the company’s purchasing agents bragging about receiving a substantial discount on a new luxury SUV from the company’s supplier of fleet cars. Because the auditor has sufficient reason to believe the purchasing agent is engaging in illicit activity—perhaps directing business to the supplier in exchange for the personal discount— she has predication to initiate a fraud examination.
If, however, she had not overheard the conversation and had merely witnessed the purchasing agent arriving at work in the new SUV, she may have suspicion about how the agent afforded the vehicle, but would not have proper predication to begin a formal investigation.
7. (b) A fraud risk assessment generally involves three key elements: (1) identifying fraud risks inherent to the organization, (2) assessing the likelihood and significance of the fraud risks identified and (3) deciding on the appropriate responses to the identified risks. Although the development of a formal fraud policy is an important part of a proactive fraud prevention stance, it is not one of the steps involved in performing a fraud risk assessment.
8. (a) Occupational fraud, also called internal fraud, is fraud committed by an employee against his or her employer. The three primary categories of occupational fraud are:
Corruption, in which an employee uses his or her influence in a business transaction in a way that benefits the fraudster or someone else. Examples of this violation of fiduciary duty are accepting or offering bribes and engaging in conflicts of interest.
Financial statement fraud, which is the intentional misstatement or omission of material information from the company’s financial statements. These cases often entail reporting fictitious revenues, omitting liabilities and expenses, or overstating asset values.
Asset misappropriation, which involves the theft or misuse of an organization’s resources. Common asset misappropriation schemes include skimming cash receipts, falsifying expense reimbursement requests and stealing office supplies.
9. (c) The collection of evidence in a fraud examination should progress from the general to the specific. Likewise, when interviewing witnesses as part of a fraud examination, the investigator should proceed in order from those witnesses least likely to be involved in the misconduct to those most culpable. This generally means first interviewing neutral third-party witnesses, then moving on to corroborative witnesses, co-conspirators, and, finally, to the suspect.
In the situation in question, the complaint from Stephen Milton prompted the investigation. Consequently, an interview with Milton to learn more about his complaint is the most logical and appropriate place to begin the interview process. Ludner should then speak with Julia Rodriguez to see if she noticed anything unusual when she filled in for Chuck Pensky, followed by Kathryn Beatty to determine her role in the alleged misconduct. Chuck Pensky, the primary suspect, should be interviewed last.
10. (b) According to the Association of Certified Fraud Examiners’ 2008 Report to the Nation on Occupational Fraud and Abuse, 87% of occupational fraudsters are firsttime fraud offenders. Additionally, 83% of the perpetrators in the ACFE’s study had never been punished or terminated by their employers for fraudulent behavior.
If you answered nine or 10 questions correctly, congratulations. Your arsenal of antifraud knowledge is well-armed and ready to aid in the fight against fraudulent conduct. Keep up the good work.
If you answered seven or eight questions correctly, you’re on the right track. Use the resources on the previous page to continue to build on your knowledge of fraud prevention and detection.
If you answered fewer than seven questions correctly, you may want to brush up on your antifraud knowledge. The resources are a good place to start. Enhancing your understanding of fraud prevention, detection and investigation concepts will help ensure that you have what it takes to keep your assets protected during this turbulent economic time.
Andi McNeal, CPA, CFE, is the research program manager for the Association of Certified Fraud Examiners (ACFE). Her e-mail address is email@example.com.
“What Is Your Fraud IQ?” Dec. 07, page 56
“What Is Your Fraud IQ?” May 07, page 64
“What’s Your Fraud IQ?” July 06, page 86
Antifraud/Forensic Accounting resource section
“Ponzi Schemes, Bernard Madoff and Beyond,” an archived webcast (#780157)
Fraud and the CPA, a CPE self-study course (#738600HS)
For more information or to place an order, go to www.cpa2biz.com or call the Institute at 888-777-7077.
FVS Section and CFF credential
Membership in the Forensic and Valuation Services (FVS) Section provides you with access to numerous specialized resources in the forensic and valuation services discipline areas, including practice guides and exclusive member discounts for products and events. Go to www.aicpa.org/FVS to learn more about the FVS Section or to join go to tinyurl.com/d93r6w. In addition to the FVS section, members with a specialization in financial forensics may be interested in applying for the Certified in Financial Forensics (CFF) credential. For more information, go to www.aicpa.org/CFF.
Advanced Forensic Techniques for Accountants (Acronym #AFTA)
Auditing for Internal Fraud (Acronym #FE-AIF)
Detecting Misappropriation Schemes (Acronym #FE-MS)
Forensics and Financial Fraud: Real-World Issues & Answers (Acronym #FFF)
Fraud and the Financial Statement Audit: Auditor Responsibilities (Acronym #FFSA)
Identifying Fraudulent Financial Transactions (Acronym #FE-FFT)
To access On-Site Training courses, go to www.aicpalearning.org, click on “On-Site Training” and search by “Acronym Index.” If you need assistance, please contact a training representative at 800-634-6780 (option 1).
Association of Certified Fraud Examiners Fraud Resources
2008 Report to the Nation on Occupational Fraud & Abuse