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Fraud & Internal Control “Hot” Ten!

Presented By: Billy Morehead, Ph.D., CGFM, CPA AGA National President and Chair, Division of Accountancy, CIS & Finance Delta State University, Cleveland, MS. Fraud & Internal Control “Hot” Ten!. Fraud Trivia. Results of ACFE 2008 Report to the Nations on Occupational Fraud and Abuse :

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Fraud & Internal Control “Hot” Ten!

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  1. Presented By: Billy Morehead, Ph.D., CGFM, CPAAGA National President andChair, Division of Accountancy, CIS & FinanceDelta State University, Cleveland, MS Fraud & Internal Control“Hot” Ten!

  2. Fraud Trivia Results of ACFE 2008 Report to the Nations on Occupational Fraud and Abuse: • 959 actual cases of occupational fraud investigated between Jan. 2006 & Feb. 2008 • Median loss - $175,000 • >25% of cases - $1M or more • 29 cases - $50M median loss • 32.4% of cases were in government & non-profit organizations (median loss ~ $100,000)

  3. Cost of Fraud and Abuse • $994 billion annually • 7% of revenues • 42% recover nothing after fraud is discovered

  4. Damages to Victims go Beyond Dollars & Cents • Reputation • Loss of Public Confidence • Detrimental to attracting new potential customers, employees, donors & volunteers • Damage to relationships • Sagging staff morale • Distraction from the mission

  5. ACFE 2008 Report to the Nation The term “occupational fraud” may be defined as: The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.” Measuring the Cost of Occupational Fraud: At the outset, it should be clear to anyone who has spent time dealing with the subject of occupational fraud that attempts to accurately measure the frequency or cost associated with occupational fraud in the United States will be, at best, incomplete.

  6. How Occupational Fraud is Committed Occupational Frauds by Category — Frequency ©2008 by the Association of Certified Fraud Examiners, Inc.

  7. How Occupational Fraud is Committed Occupational Frauds by Category — Median Loss ©2008 by the Association of Certified Fraud Examiners, Inc.

  8. How Occupational Fraud is Committed Median Duration of Fraud Based on Scheme Type ©2008 by the Association of Certified Fraud Examiners, Inc.

  9. Victim Organizations ©2008 by the Association of Certified Fraud Examiners, Inc.

  10. Detection of Fraud Schemes Initial Detection of Occupational Frauds The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method. ©2008 by the Association of Certified Fraud Examiners, Inc.

  11. Detection of Fraud Schemes Percent of Tips by Source The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one source of the initial tip. ©2008 by the Association of Certified Fraud Examiners, Inc.

  12. The Perpetrators Position of Perpetrator — Frequency ©2008 by the Association of Certified Fraud Examiners, Inc.

  13. The Perpetrators Position of Perpetrator — Median Loss ©2008 by the Association of Certified Fraud Examiners, Inc.

  14. The Perpetrators Number of Perpetrators — Frequency Number of Perpetrators — Median Loss ©2008 by the Association of Certified Fraud Examiners, Inc.

  15. The Perpetrators Age of Perpetrator — Frequency

  16. The Perpetrators Age of Perpetrator — Median Loss ©2008 by the Association of Certified Fraud Examiners, Inc.

  17. The Perpetrators Education of Perpetrator — Frequency ©2008 by the Association of Certified Fraud Examiners, Inc.

  18. The Perpetrators Education of Perpetrator — Median Loss ©2008 by the Association of Certified Fraud Examiners, Inc.

  19. The Perpetrators Tenure of Perpetrator — Frequency and Median Loss ©2008 by the Association of Certified Fraud Examiners, Inc.

  20. The Perpetrators Annual Income of Perpetrator — Frequency ©2008 by the Association of Certified Fraud Examiners, Inc.

  21. The Perpetrators Median Loss Based on Perpetrator’s Annual Income ©2008 by the Association of Certified Fraud Examiners, Inc.

  22. The Perpetrators Gender of Perpetrator — Frequency Gender of Perpetrator — Median Loss ©2008 by the Association of Certified Fraud Examiners, Inc.

  23. The Perpetrators Perpetrator’s Criminal History Perpetrator’s Employment History ©2008 by the Association of Certified Fraud Examiners, Inc.

  24. The Perpetrators Types of Background Checks Conducted Before Hiring Perpetrators The sum of percentages in this chart exceeds 100 percent because some organizations conducted more than one type of background check. ©2008 by the Association of Certified Fraud Examiners, Inc.

  25. The Fraud Triangle Perceived pressure facing individual Perceived opportunity to commit fraud Person’s ability to rationalize or lack of integrity

  26. The Perpetrators Behavioral Red Flags Present During Fraud Scheme The sum of percentages for each scheme type exceeds 100 percent because in several cases the perpetrator exhibited more than one behavioral red flag. ©2008 by the Association of Certified Fraud Examiners, Inc.

  27. 10 The HOT ten #10 – Weak Internal Controls

  28. Victim Organizations Breakdown of Primary Internal Control Weaknesses by Scheme Type ©2008 by the Association of Certified Fraud Examiners, Inc.

  29. Deficiency in Internal Control • A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect and correct misstatements on a timely basis. (SAS 115)

  30. Deficiency in Internal Control • Significant deficiency is defined as a deficiency or combination of deficiencies, in internal control that is less severe than a material weaknesses, yet important enough to merit attention by those charges with governance. (SAS 115)

  31. Deficiency in Internal Control • A material weakness is a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis. (SAS 115)

  32. Weak Controls In all areas including: • Information Technology • Regarding changing circumstances • Related to Significant Manual Elements to Relevant Control

  33. Accounts Receivable Fraud • 3 month period • $7,000 in billings • Sharp accounting clerk – good IC • Bogus (yet very good) documentation • Good Internal Audit Staff • 3rd party internal audit staff involved • Perpetrator fired & charged – no time

  34. Accounts Payable & Purchasing Schemes • Personal bills • Fictitious suppliers • Kickbacks • Ordering personal items • Petty cash funds • Employee expense accounts • Credit cards

  35. Payroll Schemes • Ghost employees • Manipulated time records • Unclaimed payroll checks • Writing extra payroll or bonus checks • Leave time manipulation • Withholding fraud • W-2 fraud

  36. Sick & Vacation Leave Fraud • September, 1997: • Top city official convinces City Council to allow him to sell (cash out) unused leave time back to the City he worked for • Added an amendment to his existing employment contract • City Council approves

  37. Sick & Vacation Leave Fraud • So the pattern was to… • Get City Council to approve new contract • Pass it off as a “minor” change • After approval: Sell batches of leave time • A few months (or weeks) later – another contract Sample Leave Fraud Activity: Leave time: June 11, 2002 contract 442 days Leave sold back in next 8 weeks (107 days) 335 days

  38. Leave Buyback Scheme: End Result • 7 year period: over 2000 days of leave sold • Equivalent to 60 years worth of leave • Final tally: $675,000 in leave time cashed out • He became bolder: other benefits added • Convicted • Sentenced to 51 months in federal prison

  39. Cash Schemes • Stealing cash funds process or on hand • Not recording & stealing the cash receipts • Under ringing & stealing the difference in cash receipts • Altering bank deposits

  40. Municipal Court Embezzlement • Trusted head accounting clerk • Employee for 10+ years • Well liked & trusted by her direct supervisor • Began taking small amounts of cash • Her stealing quickly snowballed • End result: over $1.3 M in cash stolen over 10-year period

  41. Municipal Court Embezzlement • How did she do it? • Old computer system with few controls • Multiple cash drawers – she swapped cash for checks and credit card slips • Almost always failed to report one cash drawer • Decent internal controls on cashier end, but… • No controls with the “trusted” employee

  42. Municipal Court Embezzlement • What were the warning signs? • Continuing pattern of small unreconciled items • Confusing explanations • Lifestyle: People thought she inherited money • Husband became disabled • Wanted to work more “flex hours”

  43. Municipal Court Embezzlement • How did it all end? • Initially charged with 3 felony counts • November 2006: Pleads not guilty • July 2007: Changes plea to guilty • October 2007: Judge sentences her to maximum of 10 years in state prison

  44. Protect Your Organization • Fraud Risk Assessment • Internal Controls • Proper Environment • External Review • Reporting Mechanism • Proper Hiring Practices • Fidelity Bonding • Establish “Perception of Detection” • Mitigating Controls

  45. #9 – Lack of or Poor Assessment of Internal Controls by Management

  46. Victim Organizations Internal Controls Modified or Implemented in Response to Fraud ©2008 by the Association of Certified Fraud Examiners, Inc.

  47. Victim Organizations Frequency of Anti-Fraud Controls* *”External Audit of F/S” = independent external audits of the organization’s financial statements “Internal Audit / FE Department” = internal audit department or fraud examination department “External Audit of ICOFR” = independent audits of the organization’s internal controls over financial reporting “Management Certification of F/S” = management certification of the organization’s financial statements “Management Review of IC” = regular management review of internal controls ©2008 by the Association of Certified Fraud Examiners, Inc.

  48. Victim Organizations ©2008 by the Association of Certified Fraud Examiners, Inc.

  49. Victim Organizations ©2008 by the Association of Certified Fraud Examiners, Inc.

  50. Exhibit 4: Management’s Commitment to Professional and Technical Competence

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