The Fraud Triangle

By-

Vinay Kr Saini

vinay.kr.saini@gmail.com

9811703596

Fraud Definition

Standard on Internal Audit (SIA) 11,

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"Consideration of Fraud in an Internal Audit'

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• as an intentional act by one or more individuals among management, those charged with governance, or third parties, involving the use of deception to obtain unjust or illegal advantage.
• A fraud could take form of misstatement of an information (financial or otherwise) or misappropriation of the assets of the entity.

Components of Fradulent Activity

The following are, essentially, the components in a fraudulent activity:

• A dishonest intention

• Use of deception

• Personal advantage or loss to a third person

• Generally results in financial/asset loss to an organization and may involve financial misstatements.

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A common example of a fraudulent activity is availing of multiple loan transactions with several financial institutions by gross misrepresentations against the same asset. The value of the asset financed or income of the applicant is misstated to increase the eligibility norms, or make up for no down payment resulting in generation of cash proceeds for the perpetrator of fraud, profiting him at the cost of the company (entity).

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Types of Fraud�

Fraud tree

Cash

larceny

Theft of other assets – inventory/

AR/

fixed assets

Revenue

recognition

Non-

financial

(Disclosures)

Conflicts

of

interest

Bribery and

corruption/

FCPA

Illegal

gratuities

Bid-rigging/

procurement

Corruption

Fraudulent Statements

Asset Misappropriation

Fake

vendor

Payroll

fraud

T&E

fraud

Theft of

data

GAAP

Reserves

What causes People to commit Fraud?

Motive

• Motive (or pressure) — It is the need for committing fraud (need for money, etc.).
• This is a key ingredient to any illegal activity more relevant to criminal law.
• Usually, in case of frauds, the motive is quick and easy financial gain. The motive could emanate from economical, social or personal prejudices.

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• Addiction
• Extraordinary need
• Expensive tastes
• Anger or jealousy

Rationalization

• Rationalization — It is the mindset of the fraudster that justifies him to commit fraud. When a wrongful act is justified, the fraudster is emboldened to carry out such acts.

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• Justifying theft
• Underpaid/mistreated
• Feeling they deserve more

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Opportunity

• Situation that enables fraud to occur (often when internal controls are weak or non-existent).
• A person with fraudulent tendencies looks for opportunities when there is a least likelihood of detection.
• For the purpose, such a person may indulge in trial runs and test the vulnerability on a sample basis. As the confidence level increases, there is a tendency to increase the frequency of such acts and cause further damages.
• The fraudster is, generally, aware of the consequences and takes a calculated risk.

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• For the greater good
• Chance they can get away with it
• Lax internal control

Why people commit fraud: The Fraud Triangle

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Internal

Controls

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Internal and External

Pressure

Layoffs and salary cuts creates personal financial hardship

Tight credit environment

Opportunity to

Commit Fraud

More regulatory focus increased

Budgets are decreasing. Companies and organizations are doing more with less

Companies are decentralized with inconsistent internal controls

Stressed and disgruntled employees may have greater ability to rationalize improper actions

Pressure

Opportunity

Rationalization

Large projects and acquisitions increases risks of costs not being noticed

Lack of infrastructure and controls in locations

Stock prices are unstable

Companies are downsizing, impacting internal controls.

Dissatisfaction with compensation compared to peers and supervisors

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Fraud Auditing Philosphy

1. Fraud auditing is unlike financial auditing. It is more a mind-set than a methodology.

2. Fraud auditors are unlike financial auditors, they focus on exceptions, accounting irregularities, & patterns of conduct, not on errors & omissions.

3. Fraud auditing is learned primarily from experience: “learning to think like a thief— “Where are the weakest links in this chain of internal controls?”

4. From fraud-audit perspective, fraud is an intentional misrepresentation of finance facts.

5. Frauds are committed for economic, egocentric, ideological, and psychotic reasons. Of the four, the economic motive is the most.

6. Fraud tend to encompass the theory structure around the motive, opportunity, and benefit.

7. Fraud is a computerized accounting environment can be committed at any state of processing---input, Processing, or output.

8. The most common fraudulent schemes low level employees involve disbursement (payable, payroll, and benefit and expense claims).

9. The most common fraudulent schemes by higher-level managers involve “profit smoothing” (booking sales too early, overstating inventory).

10. Accounting-type frauds are caused more often by absence of controls than by loose controls.

11. Fraud incidents are not growing exponentially, but looses are.

12. Accounting frauds are discovered more often by accident than by financial audit purposes or design.

13. Fraud prevention is a matter of adequate controls and work environment that places a high value on personal honesty and fair dealing.

Fraud Auditor’s Competency

1. Conduct a review of internal controls and Assess the strengths and weaknesses of those controls.
2. Design scenarios of potential fraud losses based on identified weaknesses in internal controls.
3. Identify questionable and exceptional situations in account balances.
4. Identify questionable and exceptionaltransactions (too high,too low,too often, too rare, too much, too little, odd times, odd places, odd people).
5. Distinguish between simple human errors, and omissions in entries and fraudulent entries (international error, such as recurring small errors versus unintentional random error and ignorance).
6. Follow the flow of documents that support transactions.
7. Follow the flow of funds into and out of an organization’s account.
8. Search for underlying support documents for questionable transactions.
9. Review such documents for peculiarities such as raised amounts; forgery; counterfeiting; fake billings; invoicing of claims; destruction of data; improper account classification; irregularities in serial sequences, quantity, pricing, extensions, footings; & substitution of copies for original docs.
10. Gather and preserve evidence to corroborate asset losses, fraudulent transactions, and financial statements.
11. Document and report a fraud loss, criminal, civil, or insurance claims.
12. Be aware of management, administrative, and organizational policies, procedures, and practices.
13. Test the organization’s motivational and ethical climate.

Types of Interviews

Interview Techniques

• On the scene interviews
• Formal interviews
• Group interviews

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• Questioning
• Documenting
• Recording

Sequence of Events in Interview

• Getting engaged
• Seek explanation for interview
• Keep Account
• Evaluation and Learning

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Interviewing in Investigations

Open questions

Probing questions

Reflective questions

Closed questions to confirm

Hypothetical questions

Quiz

?

Thank You

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Vinay Kr Saini

vinay.kr.saini@gmail.com

9811703596