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Preventing and Detecting Fraud:

Also know as, Why does this


always seem to happen to us?
Prepared and presented by Frank Crawford, CPA
www.crawfordcpas.com
frank@crawfordcpas.com

The Fraud Triangle


Perceived
opportunity
to commit
fraud

Perceived
pressure
facing
individual

Exacerbated in
economic downturn
Persons rationalization
or integrity

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

Victim Organizations
Occupational Fraud Schemes in Government
and Public Administration (106 cases)12

The sum of percentages in this chart exceeds 100 percent because several cases involved multiple schemes from more than one category.

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2008 by the Association of Certified Fraud Examiners, Inc

Profile of Fraud
Perpetrator
Male or female
No prior criminal history (<8%)
Well liked by co-workers
Likes to give gifts/compulsive shopper
Gambling problems not unusual
Long-term employee
Rationalizes: Starts small or borrows
Lifestyle clues

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

Accounts Receivable
Schemes
Lapping
Forging checks received
Altering credit card
receipts
Granting bogus credits
Bogus bad debt writeoffs or account
adjustments

Accounts Payable &


Purchasing
Personal bills
Fictitious suppliers
Kickbacks
Ordering personal
items
Petty cash funds
Employee
expense accounts
Credit cards

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

Top

Ten Reasons Frauds


Beat Internal Controls in
Government and What You
Can Do About It

1. Goin Through the


Motions

Process mentality
Just doing the steps in the process
Not thinking about what one is doing

Example: Two signatures required on checks.


Both check signers fail to notice the check
has no payee and still sign the check.
Remedy: Reinforce the need to pay attention
and the consequences for failure.

2. See No Evil, Hear No Evil

Blind trust
Failure to acknowledge warning signals

Example: Failure to follow up on a customer


complaint of an incorrect bill for service and
relying on the experienced and valued billing
clerks response that it was just an error.
Remedy: Realize that anyone can commit
fraud. Assume discrepancies are fraud and
prove to yourself it is only an error.

3. Its Good to be The King

Positional immunity
Rationalizing that controls dont apply to me
because I am in upper management.
Often referred to as management override.

Example: Executive director doesnt report leave


used, but still gets paid for unused leave
annually.
Remedy: Identify someone within or outside the
entity that you can report these circumstances
to and not jeopardize your job.

4. New Kid on the Block

Situational incompetence
New employee not in a position to question why

Example: New accounts payable clerk questions


why purchases from a certain vendor do not
require bids, and is told that such purchases are
exempt.
Remedy: If you are the supervisor, dont assume
new employee just doesnt understand. Take
their questions seriously and ask your self why.
If you are the employee, ask more than one
person.

5. Wheres All the Time


Gone?

Workload overload
Not enough time to perform control
procedures

Example: Knowing that the supervisor is too


busy to reconcile accounts receivable, a
billing clerk steals cash and posts
unauthorized adjustments.
Remedy: Reevaluate assignment of duties, and
when needed, demand more resources by
focusing on the consequences of fraud.

6. Cant We All Be Happy?

Conflict avoidance
Responsible employees not comfortable in
confronting other employees

Example: A supervisor recognizes that the cash


drawer is always short at the end of the day,
but is uncomfortable in confronting the
employee.
Remedy: Reinforce supervisory responsibilities.
Provide employee management training.
Dont tolerate poor performance.

7. Wheres the Beef?

Informational restraint
Responsible employees lack the information
they need to identify an improper transaction

Example: An accounts payable clerk is not


provided a contract that includes a not-toexceed price limit and vendor takes
advantage by over-billing.
Remedy: Reinforce with employees the
openness and availability of records and
information.

8. Its None of My Business

Behavioral ignorance
Responsible employees ignore behavioral
signs or indicators of possible fraud

Example: Management and other employees


fail to investigate or question an employee
that is living well above their means or salary
level.
Remedy: Create an environment within the
government that fosters ethical and
responsible behavior. Create an anonymous
hotline.

9. Its Over My Head

Informational ignorance
Officials ignore fraud warning signs in
reports because they dont understand the
reports

Example: Highway patrol fine revenue was


embezzled and monthly budget report
shows a potential problem, but the report is
too complicated for management and
governing board to understand.
Remedy: When it comes to reports, use the
KISS principle and train the users.

10. A Bad Apple in the


Bunch

Ethically challenged
Employees responsible for controls are just
not ethical and morally responsible
individuals

Example: Purchasing supervisor is dishonest


and convinces an accounts payable employee
to process fake invoices for payment and split
the money between them.
Remedy: Dont hire crooks.

Protection Mechanisms
Fraud risk assessment
Internal controls
Proper environment
External review
Reporting mechanism
Hire right
Fidelity bonding
Establish Perception of Detection
Forensic data mining

Protection Mechanisms
Segregation of duties
Effective bidding processes
Vendor approval controls
Policies

Code conduct, fraud policies


Conflict of interest, gifts,
gratuities
Etc.

Fraud awareness training


Internal audit

Detection of Fraud Schemes


Initial Detection of Occupational Frauds4

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.

Resources
Managing the Business Risk of Fraud: A
Practical Guide (AICPA & IIA) REQUIRED
READING
Management Anti-Fraud Programs &
Controls (exhibit to SAS 99)
ACFE Fraud Prevention Check-Up
ACFE Best Practices in Ethics Hotlines
ACFE Sample Code of Conduct
ACFE Sample Ethics Policy

Management Antifraud
Programs and Controls
Creating a
Culture of
Honesty & High
Ethics
Developing an
Appropriate
Oversight
Process

Evaluating
Antifraud
Processes &
Controls

Creating Culture of Honesty and


High Ethics
Setting the tone at the top
Creating a positive workplace environment
Hiring and promoting appropriate
employees
Providing sufficient training
Confirming accountability for code of
conduct
Implementing effective discipline

Evaluating Antifraud Processes


and Controls
Identifying and measuring fraud risks
Mitigating fraud risks
Designing and implementing appropriate
internal controls
Monitoring compliance with internal
controls
Dont miss the obvious

Developing and Appropriate


Oversight Process
Oversight by the audit committee or
equivalent
Oversight by management
Use of an effective internal audit function
Open and candid dialogue with
independent auditors
Take advantage of the COSO internal
control element Risk Assessment by
taking some time to aim

Lets talk a little more


about Honesty and High
Ethics for a bit

Applying Ethics is About


Living a Life Worth Living

Ethics refer to the standards that tell us how we ought to act in situations we
find ourselves in as parents, children, family members, friends, citizens,
elected officials, professionals, employees, teachers, etc.

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What Ethics is Not!

Ethics is not just following the law. The fact that it is


possible or legal to do something doesnt mean it
ought to be done.
Ethics is not just following our feelings. Our feelings
can betray our ethics. Often we may feel it is
uncomfortable to do the right thing.
Ethics is not just following our religion. Ethics applies
to all people, whether religious or not. Some ethical
dilemmas are not addressed by ones religion.
Ethics is not just following culturally accepted norms.
Some cultures may be blind to certain basic issues,
such as human rights.
Ethics is not just following science. While science may
provide us better information to make decisions, just
because something is scientifically or technologically
possible, does not mean it is ethical.
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Ethics in 21st Century


As a Society are We Living a Life Worth
Living?

Corporate officers, greed, and accounting scandals


Athletes and performance-enhancing drugs
Martha Stewart and broker/dealer scandals
College students and increased cheating
Hackers, internet viruses, and identity theft
Politicians and government corruption
Catholic priests and sex scandals
Danny Almonte and little league baseball

32

Ethics in 21st Century


Recent study found that nearly 1/3 of U.S.
workers called in sick in the past year
when if fact they were fine.
Most common reasons given:
Had plans with family and friends
Needed to relax or catch up on sleep
Just didnt feel like going to work
Source: Harris Interactive Survey for CareerBuilder.com
(Aug-Sept. 2007)

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Ethics in 21st Century

Advertising Prepaid Bail Bonds


Is this Really Necessary?

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Ethics in Work and Life


Hard to separate moral behavior in
personal life from moral behavior in public
life
Where there are ethical lapses in private
life, there are often ethical lapses in public
life (and vice versa)
Ethical lapses in private life can result in
lack of trust in public life

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Unethical Behavior
Triangle
Motive/Pressure

Potential for
Unethical
Behavior

Opportunity

Rationalization

36

Rationalizing Bad Behavior


Do we rationalize bad behavior?
In what ways?
The Broken Window Rationalization
Theory - if we allow inappropriate
behavior to go unchallenged, we create
the invitation for rationalizing that such
behavior is considered acceptable

37

An Individuals Ethics
Evolution
Stage 1 Educational Level

Stage 2 Societal Level

Stage 3 Independent Level

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Educational Level

Right and wrong defined in terms of what


authority figures say is right and wrong or
what rewards and punishment result
Parents
Teachers
Ministers

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Societal Level

Right and wrong defined in terms of what


society believes and law requires

Family
Friends
Peers
Community
Nation

Circle of Morality Theory

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The Circle of Morality


CONCEPT:
For a shift to higher
Ethics, there must be
meaningful enough
Consequences to the
Actions of individuals to
cause a shift in the Beliefs
Ethics
of a majority of society
that is significant enough
to change individual
Values.

Values

Beliefs

The Circle
of Morality
Consequences

Actions

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Effective Consequences

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Independent Level

Right and wrong defined from an independent


point of view based on our individual ideals of
justice or human rights and welfare

These ideals are acquired through our


knowledge, experiences, and personal feeling

These ideals may differ from the norm of society

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Ethical Orientation
Question
You are driving on a highway (with a normal speed
limit of 70 mph) with no other vehicles around.
The highway has recently been repaved.
Construction is now complete and all
construction barriers have been removed.
However, the temporary speed limit signs of 55
mph are still posted. You are driving 70 mph.
Are you doing anything wrong?

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An Individuals Ethics
Orientation

Whatever our level of moral development, we


have all developed our own individual
ethical orientation or tendencies we follow
when faced with making decisions that
involve ethical dilemmas.
Lets determine our own ethical orientation.

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What is my Ethical
Orientation?
1.

Which is worse?

a. Hurting someones feelings by telling the


truth
or
b. Telling a lie and protecting their feelings

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What is my Ethical
Orientation?
2. Which is the worse mistake?

a. To make exceptions too freely


or
b. To apply rules too rigidly

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What is my Ethical
Orientation?
3. Which is it worse to be?
a. unmerciful
or
b. unfair

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What is my Ethical
Orientation?
4. Which is worse?

a. Stealing something valuable from someone


for no good reason
or
b. Breaking a promise to a friend for no good
reason

49

What is my Ethical
Orientation?
5. Which is it better to be?
a. Just and fair
or
b. Sympathetic and feeling

50

What is my Ethical
Orientation?
6. Which is worse?

a. Not helping someone in trouble


or
b. Being unfair to someone by playing
favorites

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What is my Ethical
Orientation?

7. In making a decision, on which do you rely


more?
a. Hard facts
or
b. Personal feelings and intuition

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What is my Ethical
Orientation?

8. Your boss or superior orders you to do


something that is hurtful to someone. If
you carry out the order, have you actually
done anything wrong?
a. Yes
or
b. No

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What is my Ethical
Orientation?

9. Which is more important in determining


whether an action is right or wrong?
a. Whether anyone actually gets hurt
or
b. Whether a rule, law, commandment, or
moral principle is broken

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What is my Ethical
Orientation?

Ethics of Justice (J orientation)


Based on equal application of moral principles and
laws or policies with little flexibility or exceptions
Actions are either inherently right (truthfulness,
respect, honoring promises) or inherently wrong (lying,
theft, manipulation, broken promises)
Generally more common of men than women

Ethics of Care (C orientation)


Based on sense of responsibility to reduce harm and
suffering with considerable flexibility for individual
cases
Actions that produce more good than harm are right;
those that dont are not as right
Generally more common of women than men

(Based on Ethical Orientation Questionnaire


developed by the Center for Ethics and Business at
Loyola Marymount University)

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Contemporary Ethics
Theories

Another perspective:

1. Ethics of Justice Orientation


RIGHT versus WRONG
2. Ethics of Care Orientation
RIGHT versus Not As RIGHT

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What is an Ethical
Dilemma?
A situation where there are compelling
reasons for taking an action and
competing compelling reasons for not
taking the action
Ethical dilemmas exist because of these
conflicting or competing compelling
reasons

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An Ethical Dilemma

You want to borrow another individuals


truck, without approval (compelling reason
not to do it), and use it to deliver food,
clothing, and sleeping bags to desperately
hungry and homeless families immediately
after a natural disaster strikes (compelling
reason to do it).

What action should the individual take?

In what direction would an Ethics of Justice thinker lean?


In what direction would an Ethics of Care thinker lean?
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Resolving Ethical Dilemmas


1.
2.

3.

4.

First get all the facts and consider alternative


actions.
Analyze the actions themselves (ethics of justice
considerations)
Do they comply with the law
Are they honest, fair and equitable
Are they respectful of others rights

Analyze the potential results or consequences of the


actions (ethics of care considerations)
Do they advance the common good
What is the extent of good versus harm to others
What is the extent of good versus harm to me

Combine both analyses and make a decision (none


of the considerations should be ignored, each acts
as a check on the limitations of the other)
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Ethical Dilemma Decision


Test
Ask yourself whether or not you would
feel good about your decision while
appearing on prime-time television being
interviewed by a highly-skilled, wellinformed, and hard-hitting journalist,
knowing that your family, friends and
peers are watching.
Quote from Warren Buffet

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My 10 Basic Principles of Ethics


1.
2.
3.
4.
5.

6.
7.

8.
9.
10.

Avoid conflicts of interest in fact and appearance


Dont misuse nonpublic information for personal gain
Dont accept or solicit gifts or items of value
Put forth honest effort in duties
Make no unauthorized or unfullfilable promises or
commitments
Be impartial and avoid giving preferential treatment
Dont misuse or misappropriate company funds or
property
Exercise civility and respect others opinions and beliefs
Comply with laws and meet all obligations as a citizen
Expose corruption and report fraud, waste and abuse

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Avoid The Sergeant Shultz Approach


to Responding to Immoral Behavior
I know nothing,
I see nothing, and
I say nothing!"

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Living a Life Worth Living

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QUESTIONS???