Chapter 12 Business Ethics, Fraud, and Fraud Detection PDF

XAUDCIS Accounting Information Systems, 6th edition James A. Hall COPYRIGHT © 2009 South-West...

XAUDCIS Accounting Information Systems, 6th edition James A. Hall COPYRIGHT © 2009 South-Western, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license Business Ethics Why should we be concerned about ethics in the business world?  Ethics are needed when conflicts arise—the need to choose  In business, conflicts may arise between:  employees  management  stakeholders  Litigation Business Ethics Business ethics involves finding the answers to two questions:  How do managers decide on what is right in conducting their business?  Once managers have recognized what is right, how do they achieve it? Four Main Areas of Business Ethics Computer Ethics… concerns the social impact of computer technology (hardware, software, and telecommunications). What are the main computer ethics issues?  Privacy  Security—accuracy and confidentiality  Ownership of property  Equity in access  Environmental issues  Artificial intelligence  Unemployment and displacement  Misuse of computer Legal Definition of Fraud  False representation - false statement or disclosure  Material fact - a fact must be substantial in inducing someone to act  Intent to deceive must exist  The misrepresentation must have resulted in justifiable reliance upon information, which caused someone to act  The misrepresentation must have caused injury or loss Factors that Contribute to Fraud 2004 ACFE Study of Fraud  Loss due to fraud equal to 6% of revenues— approximately $660 billion  Loss by position within the company:  Other results: higher losses due to men, employees acting in collusion, and employees with advance degrees Enron, WorldCom, Adelphia Underlying Problems  Lack of Auditor Independence: auditing firms also engaged by their clients to perform nonaccounting activities  Lack of Director Independence: directors who also serve on the boards of other companies, have a business trading relationship, have a financial relationship as stockholders or have received personal loans, or have an operational relationship as employees  Questionable Executive Compensation Schemes: short-term stock options as compensation result in short-term strategies aimed at driving up stock prices at the expense of the firm’s long-term health.  Inappropriate Accounting Practices: a characteristic common to many financial statement fraud schemes.  Enron made elaborate use of special purpose entities  WorldCom transferred transmission line costs from current expense accounts to capital accounts Sarbanes-Oxley Act of 2002 Its principal reforms pertain to:  Creation of the Public Company Accounting Oversight Board (PCAOB)  Auditor independence—more separation between a firm’s attestation and non-auditing activities  Corporate governance and responsibility—audit committee members must be independent and the audit committee must oversee the external auditors  Disclosure requirements—increase issuer and management disclosure  New federal crimes for the destruction of or tampering with documents, securities fraud, and actions against whistleblowers Employee Fraud  Committed by non-management personnel  Usually consists of: an employee taking cash or other assets for personal gain by circumventing a company’s system of internal controls  Management Fraud  Perpetrated at levels of management above the one to which internal control structure relates  Frequently involves using financial statements to create an illusion that an entity is more healthy and prosperous than it actually is  Involves misappropriation of assets, it frequently is shrouded in a maze of complex business transactions Fraud Schemes Three categories of fraud schemes according to the Association of Certified Fraud Examiners: A. fraudulent statements B. corruption C. asset misappropriation A. Fraudulent Statements  Misstating the financial statements to make the copy appear better than it is  Usually occurs as management fraud  May be tied to focus on short-term financial measures for success  May also be related to management bonus packages being tied to financial statements B. Corruption  Examples:  bribery  illegal gratuities  conflicts of interest  economic extortion  Foreign Corrupt Practice Act of 1977:  indicative of corruption in business world  impacted accounting by requiring accurate records and internal controls C. Asset Misappropriation  Most common type of fraud and often occurs as employee fraud  Examples:  Skimming  Cash larceny  Billing Schemes  Vendor fraud, Shell company, pass through fraud, pay and return  Check Tampering  Payroll fraud  Expense reimbursement, Thefts of cash non cash misappropriations  making charges to expense accounts to cover theft of asset (especially cash)  lapping: using customer’s check from one account to cover theft from a different account  transaction fraud: deleting, altering, or adding false transactions to steal assets  Computer Fraud Schemes  Theft, misuse, or misappropriation of assets by altering computer-readable records and files  Theft, misuse, or misappropriation of assets by altering logic of computer software  Theft or illegal use of computer-readable information  Theft, corruption, illegal copying or intentional destruction of software  Theft, misuse, or misappropriation of computer hardware  Using the general IS model, explain how fraud can occur at the different stages of information processing? Data Collection Fraud  This aspect of the system is the most vulnerable because it is relatively easy to change data as it is being entered into the system.  Also, the GIGO (garbage in, garbage out) principle reminds us that if the input data is inaccurate, processing will result in inaccurate output. Data Processing Fraud Program Frauds  altering programs to allow illegal access to and/or manipulation of data files  destroying programs with a virus Operations Frauds  misuse of company computer resources, such as using the computer for personal business Database Management Fraud  Altering, deleting, corrupting, destroying, or stealing an organization’s data  Oftentimes conducted by disgruntled or ex-employee Information Generation Fraud Stealing, misdirecting, or misusing computer output Scavenging  searching through the trash cans on the computer center for discarded output (the output should be shredded, but frequently is not) Internal Control Objectives According to AICPA SAS 1. Safeguard assets of the firm 2. Ensure accuracy and reliability of accounting records and information 3. Promote efficiency of the firm’s operations 4. Measure compliance with management’s prescribed policies and procedures AUDITOR’S RESPONSIBILITY FOR DETECTING FRAUD  Fraudulent Financial Reporting  Misappropriation of Assets Auditor’s Repsonse to Risk Assessment  Engagement staffing and extent of supervision.  Professional skepticism  Nature, timing and extent of procedures performed FRAUD DETECTION TECHINIQUES  Payment to Fictitious Vendors  Sequential Invoice No’s  Vendors with PO Boxes  Vendors with Employee Addresses  Multiple Companies with Same Address  Invoice Amounts Slightly below Review Threshold  Payroll Fraud  Test for excessive Hours Worked  Test for Duplicate Payments  Test for Non-Existent Employees  Lapping of Accounts Receivable  Balance Forward Method  Open Invoice Method Limitations of Internal Controls  Possibility of honest errors  Circumvention via collusion  Management override  Changing conditions--especially in companies with high growth Exposures of Weak Internal Controls (Risk)  Destruction of an asset  Theft of an asset  Corruption of information  Disruption of the information system The Internal Controls Shield Preventive, Detective, and Corrective Controls THE END