WEEK 4 NOTES

FRAUD TREE
Is a diagrammatical representation of the Occupational fraud with regard to the manner
in which they are classified.
Corruption: A scheme in which an employee misuses his or her influence in a business
transaction in a way that violates his or her duty to the employer in order to gain a direct
or indirect benefit. Include of:
a) Conflict of Interest – either in purchasing, sales or payroll cycles
b) Bribery: Inform of kickbacks from suppliers to rig the bids or to write-off sales
invoices.
c) Payment of illegal gratuities: Payment of end of contract gratuities that are
overstated or exaggerated.
d) Economic Extortion: By using threats to either employees or customers.
Asset Misappropriation: A scheme in which an employee steals or misuses the
employing organization’s resources. May either involve misappropriation of cash,
inventory or other assets of the employer. May include:
a) Theft of Cash at Hand: A scheme in which the perpetrator misappropriates cash
kept on hand at the victim organization’s premises.
b) Theft of cash receipts: This involves theft of cash received by the company
either before such cash is recorded (Skimming) or after it has been recorded
(Larceny). Skimming schemes may be carried out within the sales cycle and
may involve omitting to record sales receipts or understating the sales amount. It
may also be carried out within the receivables management cycle and may
involve writing off unpaid sales invoices as well as lapping schemes (postponing
to clear outstanding receivable until another debtor pays more or equal
amounts). Cash larceny schemes involves stealing of cash that has already
been accounted for in the company’s books of accounts and may involve:
Stealing the money and then writing personal checks to cover the difference.
These checks may bounce and bank reconciliations may be altered to cover the
fraud. The fraudster may reverse a cash receipt transaction and steal the
amount. The cash count may also be altered to ensure the figure balances.
c) Fraudulent payments: Involves disbursement of unauthorized payments and
may include: Billing schemes in which a person causes his or her employer to
issue a payment by submitting invoices for fictitious goods or services, inflated
invoices or invoices for personal purchases. Payroll Schemes in which an
 employee causes his or her employer to issue a payment by making false claims
for compensation. Expense Reimbursement Schemes in which an employee
makes a claim for reimbursement of fictitious or inflated business expenses.
Check Tampering in which a person steals his or her employer’s funds by
intercepting, forging or altering a check or electronic payment drawn on one of
the organization’s bank accounts. Register/Cash book disbursements in which
an employee makes false entries on a cash register to conceal the fraudulent
removal of cash.
d) Inventory or other assets misappropriation: May involve outright misuse of
inventory/assets or theft of the inventory/assets after they have been received in
the organization (Larceny) e.g. through assets requisitions and transfers or false
sales and shipping schemes.
Financial Statements Fraud: A scheme in which an employee intentionally causes a
misstatement or omission of material information in the organization’s financial reports.

FRAUD TRIANGLE
When business frauds are analyzed, it is ascertained that three components come
together when committing the white-collar crime. These are Incentive (pressure),
opportunity, and Rationalization (justification) that constitute the “fraud triangle.”
The fraud triangle is a framework commonly used in auditing to explain the reason
behind an individual’s decision to commit fraud.

OPPORTUNITY
Opportunity refers to circumstances that allow fraud to occur. In the fraud triangle, it is
the only component that a company exercises complete control over. Examples that
provide opportunities for committing fraud include:
1. Weak internal controls
Internal controls are processes and procedures implemented to ensure the integrity of
accounting and financial information. Weak internal controls such as poor separation of
duties, lack of supervision, and poor documentation of processes give rise to
opportunities for fraud.
2. Poor tone at the top
Tone at the top refers to upper management and the board of directors’ commitment to
being ethical, showing integrity, and being honest – a poor tone at the top results in a
company that is more susceptible to fraud.
3. Inadequate accounting policies
Accounting policies refer to how items on the financial statements are recorded. Poor
(inadequate) accounting policies may provide an opportunity for employees to
manipulate numbers.
Other Opportunity factors
Other factors which provide employees with the opportunity to commit fraud are as
following:
• Weak moral policies
• Undisclosed contracts made with third parties and partners
• Incapability to assess the quality of the job employees performed
• Absence of a well-disciplined environment in which fraudsters will be punished
• Weakness of the information flow among employees within the business
• Lack of healthy audit works
When there is a situation where environment to punish the fraudster is absent because
of the concerns such as loss of prestige and counter threat, the feeling of “you can get
away with it” will be evoked among employees, thus the business will be exposed to
frauds.
The control structure of the business and fraud has an inverse correlation. The most
effective way of reducing employee frauds is to establish an “Internal Control System.”
The important points when establishing the system are given below:
• A healthy internal control environment
• A proper accounting system
• Control procedures which operate effectively
INCENTIVE
Incentive, alternatively called pressure, refers to an employee’s mindset towards
committing fraud.
Generally, Pressure could be classified into three groups:
• Pressures with financial content
• Pressures stemming from bad habits
• Pressures related with job
Pressures with financial contents generally show up when people are in need of
cash. These pressures could be classified as below:
• Itching palm and greediness
• Desire to live well
• High amounts of personal debts
• High amounts of health expenditures
• Unexpected financial needs
Pressures arising from bad habits have attributes related with pressures with
financial content. Being a gambler, drug or alcohol addict, and keen on nightlife are
among the several reasons causing fraud. This kind of habit is accepted as the worst
kind of factors motivating fraud. There are many examples of women employees
committing fraud to buy drug or alcohol for their children or husbands; or of managers
who are very successful in their professional lives but commit fraud because of their
gambling ambition.
Pressures related with the job could be explained as being dissatisfied with the job,
the idea of an unfair attitude, not getting promoted when expected, having worked with
lower wage, or not being admired by supervisors

RATIONALIZATION
Rationalization refers to an individual’s justification for committing fraud. This factor
involves the fraudster developing defense mechanisms in order to justify his/her action.
Some efforts of the fraudsters to justify themselves and the excuse they made up are
given below:
(a) I had borrowed the money, I would pay back
(b) This is in return for my efforts for the business
(c) Nobody has suffered as a result of this
(d) I have taken the money for a good purpose
(e) I did not know that this was a crime
(f) Business had deserved this
(g) Since business evades tax, I have taken something which was already mine
“They treated me wrong”
“Upper management is doing it as well”
“There is no other solution”