2. 1 INTRODUCTION TO FRAUD Doug Kalesnikoff CA-IFA, CFE Tel # (306) 966-1471 Email: kalesnikoff@commerce.usask.ca

3. 2 DEFINITION OF FRAUD CICA HANDBOOK S. 5135.04 CICA HANDBOOK S. 5135.04 “The term “fraud” refers to an intentional act by one or more individuals among management, other employees, those charged with governance, or third parties, involving the use of deception to obtain an unjust or illegal advantage” “The term “fraud” refers to an intentional act by one or more individuals among management, other employees, those charged with governance, or third parties, involving the use of deception to obtain an unjust or illegal advantage”

4. 3 DEFINITION OF FRAUD ACCOUNTANT’S HANDBOOK OF FRAUD AND COMMERCIAL CRIME ACCOUNTANT’S HANDBOOK OF FRAUD AND COMMERCIAL CRIME Fraud is criminal deception intended to financially benefit the deceiver. Fraud is criminal deception intended to financially benefit the deceiver.

5. 4 DEFINITION OF FRAUD THE CRIMINAL CODE S. 380(1) THE CRIMINAL CODE S. 380(1) Every one who, by deceit, falsehood or other fraudulent means, whether or not it is a false pretence with the meaning of this Act, defrauds the public or any person, whether ascertained or not, of any property, money or valuable security or any service. Every one who, by deceit, falsehood or other fraudulent means, whether or not it is a false pretence with the meaning of this Act, defrauds the public or any person, whether ascertained or not, of any property, money or valuable security or any service.

6. 5 DEFINITION OF FRAUD REGINA v. OLAN (1978) REGINA v. OLAN (1978) “Dishonest Deprivation” “Dishonest Deprivation”

7. 6 THE ELEMENTS OF FRAUD DISHONEST active passive indirect active passive indirect DEPRIVATION DEPRIVATION risk of lossactual loss

8. 7 Fraud v. Theft Fraud Fraud hidden hidden willingly part with property based on representation willingly part with property based on representation time lag time lag Theft Theft overt overt unwillingly part with property unwillingly part with property immediate immediate

9. 8 WHO COMMITS FRAUD?

10. 9 Who Commits Fraud Externally? Suppliersfalse invoicing, Suppliersfalse invoicing, short shipments Competitorsespionage, price fixing Competitorsespionage, price fixing Con Menfalse advertising Con Menfalse advertising Customersplanned bankruptcy, Customersplanned bankruptcy, false credit information

11. 10 Who Commits Fraud Internally? Employeestheft of assets, Employeestheft of assets, lapping schemes Managersmanipulate system, Managersmanipulate system, kickbacks, expenses Officersfalse financial reporting Officersfalse financial reporting Directorsmanipulate share price, Directorsmanipulate share price, related party transactions

12. 11 Opportunity PressureRationalization Fraud Triangle

13. 12 Pressure What motivates the crime in the first place What motivates the crime in the first place Examples: Examples: –Inability to pay one’s bills –Gambling or drug addiction –Meeting of earnings’ targets for investors –Meeting of productivity targets at work –Desire of status symbols, houses, cars etc –Family problems including marital and sickness

14. 13 Opportunity Must see a way to abuse the position of trust with low perceived risk of getting caught Must see a way to abuse the position of trust with low perceived risk of getting caught Place $500 in a coffee room with note that says “please do not steal”. How long would the money remain untouched? Place $500 in a coffee room with note that says “please do not steal”. How long would the money remain untouched? Internal controls Internal controls Honesty Scale Honesty Scale

15. 14 Why People Commit Fraud

16. 15 Rationalizations for Fraud I’m just borrowing the funds! I’m just borrowing the funds! I deserve it, I’m underpaid! I deserve it, I’m underpaid! I should have been promoted by now! I should have been promoted by now! It’s only the government! It’s only the government! I’m not hurting anyone! I’m not hurting anyone! Others are doing it! Others are doing it!

17. 16 Fraud Behaviour Equations B = f (O,E) C = P – A C = P - A

18. 17 What is a red flag? An irregularity that may relate to: Time Frequency Place Amount

19. 18 Personal Red Flags Living beyond means Personal financial losses Addiction problems Change in personal circumstances Outside business interests Rarely takes vacations

20. 19 More Personal Red Flags Rationalizes poor performance Rationalizes poor performance Provides unreliable work Provides unreliable work Dissatisfied with job Dissatisfied with job Close association to suppliers or competitors Close association to suppliers or competitors Likes to “beat the system” Likes to “beat the system”

21. 20 FRAUD IN THE REVENUE CYCLE 4 FRONT END FRAUD 4 FALSE SALES INVOICES 4 LAPPING OF ACCOUNTS RECEIVABLE

22. 21 Front End Frauds cash sales not recorded and cash diverted cash sales not recorded and cash diverted customers directed elsewhere customers directed elsewhere misappropriation of purchase rebates misappropriation of purchase rebates misappropriation of miscellaneous revenue misappropriation of miscellaneous revenue

23. 22 False Sales Invoices invoices altered to reflect lower sale amount invoices altered to reflect lower sale amount invoices altered to reflect higher sale amount invoices altered to reflect higher sale amount

24. 23 Lapping of Accounts Receivable robbing Peter to pay Paul robbing Peter to pay Paul subsequent receipts used to cover earlier misappropriations subsequent receipts used to cover earlier misappropriations

25. 24 FRAUD IN THE COST CYCLE 4 FALSE INFORMATION 4 FALSE SUPPLIER INVOICES 4 FALSE EXPENSE REPORTS 4 SECRET COMMISSIONS & KICKBACKS 4 PAYROLL 4 OTHER

26. 25 False Information false financial statements false financial statements overstated accounts and loans receivable overstated accounts and loans receivable over or understated accounts payable over or understated accounts payable fictitious suppliers fictitious suppliers false asset valuations false asset valuations false journal entries false journal entries altered internal company records altered internal company records

27. 26 False Supplier Invoices goods not received goods not received inferior quality goods received inferior quality goods received service not rendered service not rendered invoice for higher value than received invoice for higher value than received invoice for higher quantity than received invoice for higher quantity than received

28. 27 Example – Garry’s Construction Identify the suspicious characteristics of these two invoices.

29. 28 False Expense Reports non-business items non-business items inflated items inflated items fictitious items fictitious items duplicate items duplicate items

30. 29 Secret Commissions & Kickbacks gifts gifts cash cash travel travel entertainment entertainment consulting fees consulting fees future benefits future benefits

31. 30 Payroll fictitious employees fictitious employees inflated hours inflated hours inflated rates inflated rates manipulated deductions manipulated deductions lump sum payments lump sum payments

32. 31 Other Cost Cycle Fraud Procurement Fraud Procurement Fraud Bid-rigging Bid-rigging Employees in collusion with vendors Employees in collusion with vendors Vendor fraud Vendor fraud

33. 32 FRAUD POLICY increases probability of discovery increases probability of discovery decreases probability of occurrence decreases probability of occurrence defines acceptable conduct and dealings defines acceptable conduct and dealings defines responsibilities for prevention & detection defines responsibilities for prevention & detection states consequences states consequences

34. 33 CODE OF CONDUCT Relates to all aspects of employee: honesty honesty integrity integrity actions actions

35. 34 Deterrents to Internal Fraud SYSTEM DETERRENTS 4 hiring practices 4 supervision and control 4 adequate books & records 4 proper authorization 4 segregation of duties 4 employee programs 4 internal audit 4 red flag program

36. 35 Deterrents to Internal Fraud (5) PHYSICAL DETERRENTS 4 combination locks 4 card access 4 security 4 password controls

37. 36 Deterrents to External Fraud (1) USE HONEST SUPPLIERS 4 background checks 4 due diligence reviews 4 feasibility studies

38. 37 Deterrents to External Fraud (2) DEAL WITH HONEST CUSTOMERS 4 background checks 4 credit ratings 4 prior lawsuits

39. ASSESSING YOUR RISK What is your organization’s risk of fraud?

40. 39 Fraud Risk Matrix Likelihood of Occurrence Impact on the Organization

41. 40 Risk Assessment 4 management characteristics 4 industry conditions 4 operating characteristics 4 susceptibility of assets to misappropriation 4 employee relationships and pressures 4 controls

42. 41 Management Characteristics 4 failure to display, communicate and support appropriate attitude regarding internal control and financial reporting 4 high management turnover 4 domination by an individual or small group 4 compensation related to the achievement of unduly aggressive operating targets

43. 42 Susceptibility of Assets to Misappropriation large amounts of cash on hand large amounts of cash on hand small size, high demand, high value inventory small size, high demand, high value inventory easily convertible assets easily convertible assets fixed assets marketable or lack ownership identification fixed assets marketable or lack ownership identification

44. 43 Control Risk Factors lack of appropriate segregation of duties lack of appropriate segregation of duties lack of independent checks lack of independent checks lack of appropriate management oversight lack of appropriate management oversight lack of job application screening lack of job application screening lack of mandatory vacations lack of mandatory vacations poor physical safeguarding of assets poor physical safeguarding of assets lack of timely and appropriate transaction documentation lack of timely and appropriate transaction documentation