Chapter 1

Introduction to Fraud Examination

2

Learning Objectives• Define fraud examination and differentiate it from auditing.• Understand the fraud theory approach.• Define occupational fraud.• Define fraud.• Define abuse.• Know the difference between fraud and abuse.• Describe the criminological contributions of Edwin H. Sutherland.• Understand Donald Cressey’s hypothesis.• Give examples of non-shareable problems that contribute to fraud.• Understand how perceived opportunity and rationalization contribute to fraud.• Explain W. Steve Albrecht’s “fraud scale.”• Summarize the conclusions of the Hollinger-Clark study.• Summarize the results of the 2012 Report to the Nations on Occupational

Fraud and Abuse.

3

Discipline of Fraud Examination

• Resolving allegations of fraud from tips, complaints, or accounting clues– Documentary evidence– Interviewing witnesses– Writing investigative reports– Testifying– Assisting in the detection and prevention of fraud

• Forensic accounting vs. fraud examination

4

Auditing vs. Fraud Examination

Issue Auditing Fraud ExaminationTiming Recurring Nonrecurring

Presumption Professional Proofskepticism

Objective Opinion Affix blame

Scope General Specific

Relationship Nonadversarial Adversarial

Methodology Audit techniques Fraud examinationtechniques

5

Fraud Examination Methodology

• Predication– 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

– Fraud examinations must be based on predication.

6

Fraud Theory Approach

• Analyze available data• Create a hypothesis• Test the hypothesis• Refine and amend the hypothesis

7

Tools Used in Fraud Examination

T

Observation

8

Defining Occupational Fraud and Abuse

The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets

9

Elements of Fraud

• A material false statement• Knowledge that the statement was false

when it was uttered• Reliance on the false statement by the

victim• Damages resulting from the victim’s

reliance on the false statement

10

Occupational Fraud and Abuse Research

• Edward Sutherland• Donald Cressey

– Cressey’s Hypothesis

11

Opportunity

Pressure Rationalization

Fraud Triangle

12

2012 Report to the Nations on Occupational Fraud & Abuse

• Global survey• Measuring the costs of occupational fraud

– 5 percent lost to fraud– $3.5 trillion worldwide

13

Position of Perpetrator

Other

Owner/Executive

Manager

Employee

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

3.2%

17.6%

37.5%

41.6%

Percent of Cases

Pos

itio

n o

f P

erp

etra

tor

14

Median Loss by Position

Other

Owner/Executive

Manager

Employee

$0 $200,000 $400,000 $600,000

$100,000

$573,000

$182,000

$60,000

Median Loss

Pos

itio

n o

f P

erp

etra

tor

15

Gender of Perpetrator

Female 35.0%

Male 65.0%

16

Median Loss by Gender

Female Male $0

$50,000

$100,000

$150,000

$200,000

$250,000

$91,000

$200,000

Gender of Perpetrator

Med

ian

Los

s

17

Department of Perpetrator

Internal auditLegal

Research and developmentMarketing/PR

Human resourcesBoard of Directors

Manufacturing & productionInformation technology

FinanceWarehousing, inventory

PurchasingOther*

Customer serviceExecutive/upper mgmt

SalesOperations

Accounting

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

0.6%0.6%0.7%1.1%1.2%1.4%1.9%2.0%

3.7%4.2%

5.7%5.9%

6.9%11.9%

12.8%17.4%

22.0%

Percent of Cases

Dep

artm

ent

of P

erp

etra

tor

18

Median Loss by Department

Customer serviceInternal audit

Warehousing, inventorySales

Research and developmentInformation technology

Other*Operations

Human resourcesManufacturing & production

Marketing/PRLegal

AccountingPurchasing

Board of DirectorsFinance

Executive/upper mgmt

$0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000

$30,000$32,000

$67,000$90,000$100,000$100,000$100,000$100,000

$121,000$160,000$165,000

$180,000$183,000

$200,000$220,000

$250,000$500,000

Median Loss

Dep

artm

ent

of P

erp

etra

tor

19

Criminal History of Perpetrator

Other

Had prior convictions

Charged but not convicted

Never charged or convicted

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

1.2%

5.6%

5.9%

87.3%

Percent of Cases

Per

pet

rato

r’s

Cri

min

al H

isto

ry

20

Median Loss per Number of Employees

10,000+

1,000-9,999

100-999

<100

$0 $50,000 $100,000 $150,000 $200,000

$140,000

$100,000

$150,000

$147,000

Median Loss

Nu

mb

er o

f E

mp

loye

es

21

Initial Detection of Frauds

Other

IT Controls

Confession

Surveillance/Monitoring

Notified by Police

External Audit

Document Examination

Account Reconciliation

By Accident

Internal Audit

Management Review

Tip

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

1.1%

1.1%

1.5%

1.9%

3.0%

3.3%

4.1%

4.8%

7.0%

14.4%

14.6%

43.3%

Percent of Cases

Det

ecti

on M

eth

od

22

Occupational Fraud and AbuseAsset

MisappropriationsCorruption

FraudulentStatements

Conflicts of Interest

Bribery

IllegalGratuities

Economic Extortion

Inventory & All Other Assets

Cash

Nonfinancial

Financial

23

Frequency of Types of Occupational Fraud and Abuse

  Percent of Casesa Median LossAsset Misappropriation 86.7% $120,000Corruption 33.4% $250,000Financial Statement Fraud

7.6% $1,000,000

aThe sum of percentages listed in this column exceeds 100 percent because some cases involved fraud schemes that fell into more than one category. The same is true for every scheme classification chart in this book that is based on the 2011 Global Fraud Survey.