CHAPTER 10

INVESTIGATION OF
FRAUD
 INTRODUCTION

• Fraud has negatively impacted organisations in different

ways, including financial, reputational, psychological and
social. Organisations have been forced to cease
operations due to the impact of financial and reputation
damages. Victims of fraud also suffer mental and
emotional harm and stress related physical effects in
addition to financial losses.

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 DEFINITION OF FRAUD
Fraud encompasses a wide range of irregularities and illegal acts
characterized by intentional deception or misrepresentation. In
general, fraud is defined as an act or course of deception, an
intentional concealment, omission or perversion of truth, to
• gain unlawful or unfair advantage,
• induce another to part with some valuable item or surrender a 
legal right, and/or
• inflict injury in some manner.
• Wilful fraud is a criminal offense which calls for severe
penalties, and its prosecution and punishment (like that of a
murder) is not bound by the statute of limitations.

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Fraudulent financial reporting involves intentional
misstatements, in one or more ways as stated below:
• Deception such as manipulation, falsification or alteration
of accounting records or supporting documents
• Misrepresentation in, or intentional omission from
financial statements of significant events, transactions or
other information
• Intentional misapplication of accounting principles
relating to measurement, recognition, classification,
presentation or disclosure of material transactions

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FRAUD TRIANGLE

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 PRESSURE
Pressure is what causes a person to commit fraud. Pressure
can include almost anything such as medical bills, expensive
tastes, addictions and so on. Most of the time, pressure
comes from a significant financial need/problem. Often this
need/problem is non-sharable in the eyes of the fraudster.
That is, the person believes, for whatever reason, that their
problem must be solved in secret. However, some frauds
are committed simply out of greed alone.

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 OPPORTUNITY

Opportunity provides a situation to commit fraud. Because

fraudsters do not wish to be caught, they must also believe that their
actions will not be detected. Opportunity is created by weak internal
controls, poor management oversight and/or through the use of
one’s position and authority. Failure to establish adequate
procedures to detect fraudulent activity also increases the
opportunities for fraud to occur. Of the three elements, opportunity
is the leg that organisations have the most control over. It is essential
that organisations build processes, procedures and controls that do
not needlessly put employees in a position to commit fraud and
effectively detect fraudulent activity when it occurs.

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 RATIONALIZATION
• Rationalization is a crucial component in most frauds. Rationalization involves
a person reconciling his/her behaviour (stealing) with the commonly accepted
notions of decency and trust. Some common rationalizations for committing
fraud are:
• The person believes committing fraud is justified to save a family member or
loved one;
• The person believes he/she will lose everything — family, home, car, and so on.
if he/she does not take the money;
• The person believes that no help is available from outside;
• The person labels the theft as ’borrowing’; and fully intends to pay back the
stolen money at some point;
• The person, because of job dissatisfaction (salaries, job environment,
treatment by managers, etc.), believes that something is owed to him/her; and
• The person is unable to understand or does not care about the consequence of
his/her actions or of accepted notions of decency and trust.

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 TYPES OF FRAUD
Asset Misappropriation
• Involves stealing of cash or assets (supplies, inventories, equipment and information) from the
organisation. In many cases, the perpetrator tries to conceal the theft, usually by adjusting the
records.
 
Financial Statement Fraud
• Involves misrepresenting financial statements, often by overstating assets or revenue or
understating liabilities and expenses. Financial statement fraud is typically perpetrated by
managers who seek to enhance the economic appearance of the organisation. Members of the
organisation may benefit directly from the fraud by selling stock, receiving performance bonuses,
or using the false report to conceal another fraud.
 
Corruption
• Misused of entrusted power for private gain. Corruption includes bribery and other improper uses
of power. Corruption is off–book fraud meaning that there is little financial evidence available to
prove that the crime occurred. Corrupt employees do not have to fraudulently change financial
statements to cover up their crimes. They simply received cash payments under the table. In most
cases, these crimes are uncovered through tips or complaints from third parties. Corruption often
involves the purchasing processes.

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Bribery
• Is offering, giving, receiving or soliciting of anything of value to influence an outcome.
Bribes may be offered to key employees or managers who are purchasing agents and
who have the ability to award businesses to vendors.
 
Falsification of Expense Claims
• An old favourite with both senior and junior staff. Common ‘ruses’ include inflating
mileage claims, entertaining friends and relatives at the company’s expense and
claiming for expenses that were never incurred.
 
Stealing Money from the Company Bank Account 
• The perpetrator having gotten away with stealing once will keep on doing it again.
 
Manipulating Sales Figures  to Reach Target and Achieve Bonuses
• A simple version of this involves booking sales in one month then crediting them back
the next, unless the perpetrator keeps this up, the overstatement in one month will
naturally show as a shortfall in the next.

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Falsifying Supplier Invoices
• A senior manager who had renovation work carried out on his house and then
arranged for the invoices to be sent to the company, booked as costs for work
carried out on the company’s premises.

Stock Theft
• A time-honoured way to make a ‘fast buck’. The perpetrator will over a period of
time abscond with a number of items from the warehouse and resell them. So
long as the stock losses are within tolerance, then it is possible for this to remain
undetected for a significant period of time.

Transactions That Are Not ‘Arms Length’ 

• When a company asks for tenders for a contract, they usually obtain at least three
quotes from third parties. The best value quote should then be selected. When the
system does not run effectively, there is an opportunity for friends and relatives of
the purchasing department to send in quotes that are accepted, bypassing the
quotes from reputable suppliers.

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Tax Evasion
• Fraud at corporate level. Excessively complex organisational structures are created and
designed to obfuscate the revenue streams to hide the reality from tax authorities.
 
Fictitious Invoicing
• Where there are poor accounting controls, fraudsters can arrange for fake invoices from
connected parties to be passed for payment.
 
Acquisition of Company Property at Less Than Market Value
• This requires the collusion of at least two people (usually quite senior in position). Company
property is ‘sold’ to one of the individuals at a bargain price approved by the other. The
property is then resold at market value and the profit is split between the two individuals.
 
Theft of Raw Materials
• Manufacturers should measure the quantities and costs of the raw materials used in the
manufacturing process. Some processes use expensive materials such as gold. When the
measurement system is compromised or management does not investigate adverse yield
variances, fraudsters have the opportunity to steal the raw material.

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 RED FLAGS
1. Common Personality Traits of Fraudsters
• Wheeler and dealer
• Domineering/controlling
• Do not like people reviewing their work
• Strong desire for personal gain
• Have a ‘Beat the System Attitude’
• Live beyond their means
• Close relationship with customers or vendors
• Unable to relax
• Often have a ‘too good to be true’ work performance
• Do not take vacation or sick time or only take leave in small amounts
• Often work excessive overtime
• Outwardly appear to be very trustworthy
• Often display some sort of drastic change in personality or behaviour
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 2.Common Sources of Pressure

• Medical problems — especially for a loved one

• Unreasonable performance goals
• Spouse loses a job
• Divorce
• Starting a new business or current business is struggling
• Criminal conviction
• Civil lawsuit
• Purchase of a new home, a second home, or a home renovation
• Need to maintain a certain lifestyle (‘champagne tastes’ or ‘keep up with the
Jones’) —person (or spouse) either likes expensive things or feels pressure to
‘keep up with’ or out-do others in regards to material possessions
• Excessive gambling
• Drug or alcohol addiction

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 3.Changes in Behaviour
• Suddenly appears to be buying more material items — houses, cars, boats, clothes, jewellery,
electronics, and so on.
• Brags about new purchases
• Starts to carry unusual amounts of cash
• Creditors/bill collectors show up at work or call frequently
• Borrows money from co-workers
• Becomes more irritable or moody
• Becomes unreasonably upset when questioned
• Becomes territorial over their area of responsibility
• Would not take vacation or sick time or only takes it in small increments
• Works unnecessary overtime
• Turns down promotions
• Starts coming in early or staying late
• Redoes or rewrites work to ‘make it neat’
• May start or mentions family or financial problems
• Exhibits signs of drug or gambling addiction (absenteeism, becomes manipulative, looks ill, inconsistent
or illogical behaviour, loss of sleep or appetite, etc.)
• Exhibits signs of dissatisfaction (decrease in productivity, change attire, irregular schedules, frequent
complaining about inequities or work issues)

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 RESPONSIBILITIES OF FRAUD
PREVENTION AND DETECTION

The role of the board is:

• To oversee and monitor management’s actions to
manage fraud.
• To evaluates management’s identification of fraud risks.
• To implement anti-fraud measures.
• To set the tone at the top.

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 Role Of The Audit Committee
• To evaluate management’s identification of fraud risks.
• To implement anti-fraud measures.
• To provide the tone at the top that fraud will not be accepted in any
form.
• To hire external auditors to report on the financial statements of the
organisation.
• To provides recommendations on internal control.
• To be responsible for overseeing management’s compliance with
appropriate financial reporting.
• To be responsible for preventing senior management from overriding
the controls or other inappropriate influence over the reporting process.

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 Role of Management
• Responsible for overseeing the activities of employees and
typically does so by implementing and monitoring processes
and internal controls.
• Assess the vulnerability of the entity to any fraudulent activities.
• Responsible for establishing and maintaining an effective
internal control system at a reasonable cost.
• Maintain discussions with investigators and legal counsel to
develop controls over the investigation process, including
developing policies and procedures for effective fraud
investigations and for handling the results of investigations,
reporting and communications.

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 Role of Internal Auditor
• To launch initial or full investigation of suspected fraud, to
perform root cause analysis and control improvement
recommendations, to monitor a reporting/whistle-blowing
hotline and provide ethics training
• To obtain sufficient skills and competencies including
knowledge of fraud schemes, investigation techniques and laws
• To conduct proactive auditing to search for misappropriation of
assets and information misrepresentation using CAAT
techniques and data mining
• To employ analytical and other procedures of high-risk
accounts and transactions to identify potential fraud

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 Role of External Auditor

• External auditors have the responsibility to comply with

professional standards and to plan and perform audit for
an organisation’s financial statements to obtain
reasonable assurance whether these statements are free
from material misstatements and if misstatements were
found, whether they were caused by error or fraud.

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 Role of Fraud Investigators

• Fraud investigators are usually responsible for the

detection and investigation of fraud as well as the
recovery of assets. They also have a role in fraud
prevention.
• Senior management and the audit committee need to
support investigators and to let all stakeholders know
that the business entity is ready to respond quickly and
appropriately to fraud risks.

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 Role of Other Employees
• Employees are the eyes and ears of an organisation, and
they should be empowered to maintain a workplace of
integrity.
• Employees can report their suspicion of fraud to the
employee hotline, the internal audit department or a
member of management.
• To deter and detect fraud and abuse, many experts believe
an employee hotline that is appropriately monitored is the
single most cost-effective fraud detection and deterrence
mechanism.

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 FRAUD RISK ASSESSMENT

A fraud risk assessment is a tool that assists management

and internal auditors to systematically identify where and
how fraud may occur and who may be in the position to
commit fraud. A fraud risk assessment concentrates on
fraud schemes and scenarios and wheher or not the
controls can be circumvented

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 FRAUD RISK ASSESSMENT

A fraud risk assessment generally includes FIVE KEY STEPS:

• Identify Relevant Fraud Risk Factors
• Identify Potential Fraud Schemes and Prioritize Them Based
on Risk
• Map Existing Controls to Potential Fraud Schemes and
Identify Gaps
• Test Operating Effectiveness of Fraud Prevention and
Detection Controls
• Document and Report of the Fraud Risk Assessment
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 FRAUD PREVENTION
The Committee of Sponsoring Organizations of the Treadway Commission (COSO)
presented a framework for assessing and improving the internal control systems to fight
fraud.
 
Control environment
• Elements of a strong control environment to help prevent fraud include the following:
• A code of conduct, ethics policy or fraud policy to set the appropriate tone at the top.
• Ethics and whistle-blower programmes to report fraud.
• Hiring and promotion guidelines and practices.
• Oversight by the audit committee, board or other oversight body.
Risk assessment
• Establishing a fraud risk assessment process that considers fraud risk factors and fraud
schemes by involving appropriate personnel in the process. Also, fraud risk assessments
should be conducted on a regular basis.

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Control activities
• Are policies and procedures for business processes, including appropriate authority
limits and segregation of duties.
 
Information and communication
• Promoting the importance of the fraud risk management programme and the
organisation’s position on fraud risk both internally and externally through corporate
communications programs by:
• Designing and delivering fraud awareness training.
• Ascertaining affirmation or creating a certification process to ensure that employees
have read and understood corporate policies and that the employees are in compliance
with the policies.
 
Monitoring
• Providing periodic evaluation of anti-fraud controls by:
• Using independent evaluators for the fraud risk management programme by internal
auditors or other groups.
• Using technology to aid in continuous monitoring and detection activities.

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 FRAUD DETERRENCE

• Training is usually a key factor in deterring fraud. Training

can cover the organisation’s expectations of its
employees’ conduct, the procedures and standards
necessary to implement internal controls and employee
roles and responsibilities to report misconducts.

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 FRAUD DETECTION

Detective control are designed to provide warnings or

evidence that fraud is occuring or has occured.
Fraud detection methods need to be flexible, adaptable and
continuously changing to meet the changes in the risk
environment. While preventive measures are apparent and
readily identifiable, detective controls may not be as
apparent.

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Ways to collect the information on fraud
Code of conduct confirmation
• When employees sign an annual code of conduct outlining their responsibilities in the prevention and
detection of fraud, they can be asked to report any known violations.
 
Whistle-blower hotline
• This can take the form of a telephone call or a web-based reporting system where the whistle blower can
remain anonymous.

Exit interviews
• Conduct exit interviews for terminated employees or those who have resigned can help identify fraudulent
schemes. These interviews may also determine whether there are issues regarding management’s
integrity, and may provide information regarding conditions conducive to fraud.

Proactive employee survey

• Routine employee surveys can be conducted to solicit employees’ knowledge of fraud and unethical
behaviour within the organisation. A proactive survey could elicit anonymous information from e
mployees, which would aid the organisation in catching fraud sooner than waiting for employees to
volunteer the information.

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 FORENSIC AUDIT
• Forensic audit is defined as the application of accounting
methods to the tracking and collection of forensic evidence ].
• Financial auditing may be defined as a concentrated audit of all
the transaction of the entity to find the correctness of such
transactions and to report whether or not any financial benefits
has been attained by way of presenting unreal picture.
• Forensic audit involves examination of legalities by blending the
techniques of propriety (VFM audit), regularity, investigative and
financial audits. The objective is to find out whether or not true
business value has been reflected in financial statements and in
the course of examination to ascertain if any fraud has taken
place

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 Differences between Statutory
NO
Audit and Forensic Audit
PARTICULARS STATUTORY AUDIT FORENSIC AUDIT
1. Objective Express opinion as to ‘true & fair’ Determine correctness of the
presentation. accounts or whether any fraud has actually
  taken place.
2. Techniques ‘Substantive’ and ‘compliance’ Analysis of past trend and substantive or
  procedures. ‘in depth’ checking of selected
    transactions.
 

3. Period Normally all transactions for a No such limitations. Accounts

particular accounting period. may be examined in detail from
  the beginning.
4. Verification of stock, Relies on the management Independent verification of
estimation of realisable value certificate/representation of suspected/selected items carried out.
of current assets, management.
provisions/ Liability  
estimation, and so on.

5. Off balance-sheet items (like Used to vouch the arithmetic accuracy Regularity and propriety of these
contracts etc.) & compliance with procedures. transactions/contracts are examined.
 

6. Adverse findings, if any Negative opinion or qualified Legal determination of fraud and naming
opinion expressed, with/without persons behind such frauds.
quantification.  

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 Skills for Forensic Audit

• Knowledge of entity’s business and legal environment.

• Awareness of computer assisted audit procedures.
• Innovative approach and sceptics of routine audit
practices.

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 Application
Forensic Accounting and Audit may be applied in the
following areas besides fraud detection:
• Conducting due-diligence (especially for segment wise
profitability analysis)
• Business valuation
• Management auditing
• Assessing loss before settling insurance claims.

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 Examination methods
• Tests of reasonableness
-includes check weaknesses of internal control, identify
questionable transactions and review questionable
transaction documents.
• Historical Comparisons
- includes develop profile, identify questionable accounts
and gather and preserve evidence

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 FRAUD INVESTIGATION

• A fraud investigation consists of gathering sufficient

information about specific details and performing those
procedures necessary to determine whether fraud has
occured, the loss or exposure associated with the fraud,
who was involved and how it happened

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 FRAUD INVESTIGATION

• Investigation Processes
• Internal Auditing’s Role
• Conducting the Investigation
• Reporting
• Communication of Fraud Incidents

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