Professional Skepticism

Professional skepticism attitude of the internal auditor in fraud related matters
Contents
Why is professional skepticism important?

What is professional skepticism? Professional skepticism when responding to Fraud
Case study
Why do good people do bad things? Conclusions
2012 KPMG Romania SRL, a Romanian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative("KPMG International"), a Swiss entity. All rights reserved. PDC no.8229.
Section heading Professional skepticism
Definition of skepticism Skepticism or scepticism is generally any questioning attitude towards knowledge, facts, or opinions/beliefs stated as facts, or doubt regarding claims that are taken for granted elsewhere. Professional skepticism is synonymous with:
A questioning mind Careful thought Critical assessment of information

Internal auditors must apply the care and skills expected of a reasonably prudent and competent internal auditor. Due care does not imply infallibility. (Standard 1220) Theres a saying that sums up auditing very well: 'Trust, but verify. This gets to the essence of why professional skepticism is just so important on all internal auditing engagements. It adds balance and perspective to our work and helps us assure that important risk and control issues arent overlooked.
Professional skepticism when responding to Fraud
In the Practice Guide the internal auditor should:
Consider fraud risks in the assessment of internal control design and

termination of audit steps to perform
Have sufficient knowledge of fraud to identify red flags indicating fraud may
have been committed
Be alert to opportunities that could allow fraud such as control deficiencies Evaluate whether management is actively retaining responsibility for
oversight of fraud risk management program and whether sufficient measures have been taken to any noted control deficiencies or weaknesses
Evaluate the indicators of fraud and decide whether any further action is
necessary
Recommend investigation when appropriate, in accordance with a welldefined response plan consistent with professional and legal standards.
When do frauds happen?
Motive
The offenders impulse to commit fraud.
Opportunity
The situation that enables fraud to occur.
Rationalization
The mindset of the fraudster that justifies them to commit fraud.
Financial pressure resulting from excessive lifestyle; Gap between the financial remuneration earned and the responsibility held by individual; Pressure to meet financial targets
Weaknesses in the internal controls Trust /confidence in certain employees, Dominate position.
The fraudsters convince themselves that they are owed extra remuneration by the employer; Not enough appreciation, regarding the person, or the professional activity.
Case study - Background
A Romanian Company subsidiary of a large Group of Companies registered in

Europe operates in trade with specialized materials for advertising. The appointed General Manager of the company is a non Romanian individual that is not present every day at the subsidiary; he is present two to three days per month. The day to day operation is maintained by the Sales Manager.
The Romanian subsidiary does not have an internal audit function, but it is
supervised by the Internal Audit Function at Group level. However, since inception it was not included in the Group internal Audit plan as it has been considered a low risk.
The General Manager of the Company received several complaints from the
Companys customers claiming they had not received the merchandise ordered.
As a result of those claims the General Manager organized an inventory count

of the merchandise stocks at the warehouse.
Result of the inventory count
375 rolls of merchandise stocks were missing from the companys warehouse,
valued at approximately RON 700,000. Further action taken by the Company
KPMG was appointed to investigate how the loss occurred and if there were
other areas potential impacted by fraud
Case study issues identified
The stocktaking organized twice a year by the Sales Manager together with
warehouse keepers;
The Sales Manager was performing the reconciliation of physical count

results to the accounting records
The physical count sheets were not maintained in the Companys records
after the reconciliation was performed in the system
Chief Accountant recorded the results based on an excel spreadsheet

received from the Sales Manager
The Company was not usually performing confirmation balances to the

customers on a regular basis;
There were sales invoices issued manually and not in the Sales application There were orders and delivery notes sent to customers manually prepared
by the Sales Assistant and the Sales Manager, although the practice was to prepare them in the sales application
The collection of receivables was performed in cash by each sales agent

directly from the customer or using checks or promissory notes.
The Cashier issued cash receipts without receiving the money from the
sales agent, but only on the telephonic instruction from the Sales Manager.
The Company did not have an internal policy for performing petty cash
reconciliations on a regular basis.
Red flags
Lack of supervision from the General Manager
No proper monitoring from the Group Internal Audit Function
No reconciliation of the receivables
No proper internal controls in respect of inventory
Red flags
Stock reconciliations performed by the Sales Manager
Manual invoices issued to the customers
Manual delivery documents issued for goods
No reconciliation of the petty cash
How the losses occurred Scheme A
Sales of goods for cash to various companies, which were not

regular customers.
The goods sold for cash was invoiced to a regular customers

account, but the invoice was never sent to the regular customer and no proof of the actual delivery was kept.
Cash for the goods sold was collected directly by the Sales Manager
from the recipient of this merchandise stock.
Actual invoice issued from the accounting system of the Company

was never delivered to the customer, it was never paid by this customer and remained therefore unpaid in the books of the Company.
When the Accounting department requested balance confirmations

with its customers, the regular customers did not recognize such invoices recorded in the books of the Company against them.
The warehouse records would have been accurate as the physical

removal of goods from the warehouse was also recorded in the accounting records when the invoice was issued.
How the losses occurred Scheme B
Deliveries were made to regular and occasional customers from the

Companys warehouse.
Fabricated invoices were issued by the Sales Manager to these

customers. The transactions were not recorded in the Companys invoicing system.
There were also some delivery notes for merchandise removed

from the premises of the Company that appear to be fabricated, have been prepared by the Sales Manager outside of the invoicing and accounting systems and which were not recorded in the sales application.
As the invoices were not issued through the system, the physical
removal of goods from the warehouse was never recorded in the accounting records of the Company, resulting in the warehouse records being inaccurate. The accounting records consequently reflected more merchandise stock than was actually in stock.
The Company did not receive payment in cash or to its bank

accounts for these deliveries.
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How the losses occurred Scheme C
The Sales Manager instructed the person acting as Company

Cashier to issue cash receipts reflecting that cash had been received from the customer, although no cash had in fact been received.
The Sales Manager failed to deposit cash receipts into the

cash register/bank accounts of the Company, and he has misappropriated it.
Consequently the cash balance in the accounting records of

the Company would have been higher than the actual cash balance held.
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Result of the investigation
Following the internal disciplinary enquiry, the Sales Managers

employment contract was terminated.
The Company provided a criminal complaint that was filed with

the Prosecutors Office attached to the Tribunal against the Sales Manger for embezzlement provided for and punished according to Romanian Criminal code and forging documents under private signature.
Why do you think the Sales Manager was inclined to perpetrate the fraud? What could have been the motivation factors?
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Why good people sometimes to bad things?
Psychologists have proven that people are capable of distinguishing right and wrong from a very early age, even before they can speak and that we also have a tendency to choose the good; however, when faced with temptation the question is not so much whether people are honest, as how long and under what conditions, what temptations they can resist, and at what point they relinquish their integrity; That is why, when considering and organizational control environment is therefore important for organizations not only to establish values and communicate them, but also to ensure that these are activated at the right moment to nudge employees in the right direction; Giving ones initials or a signature, for example, creates a moment in which the concept of responsibility is activated, as does working through a checklist or step-by-step plan.
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How authority works?
In organizations people gain authority through factors such as experience, age, income, status, education, communication skills, clothing and jewelry, and the size and interior design of their office. Even when the effects of their behavior are clear, relatively few people have the strength to resist authority if they are asked to continue. Under the pressure of authority peoples morals melt away. Power corrupts, but not always
people in influential positions are more permissive towards themselves than throw who are less influential. The more influence a person has the more he places himself above the others such as his employees in order to supervise their adherence to the rules.
Usually, the management of an organization sets rules which are carried out by employees and which the management oversees. Also, is important how people in authority positions react to negative behavior. Studies show that when the rotten apple is seen as belonging to their group it infects the other apples. When the rotten apple is seen as a rival, an outsider, it has had a cleansing effect. People distance themselves from the reprehensible behavior of the other.
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Overview of KPMG Forensic in Central & Eastern Europe
KPMG in Central & Eastern Europe

Sub-region covering 18 countries 3,473 professional staff including 164 partners Number of professional staff (as at September 2012) Audit (1,727) Tax (789) Advisory (957)
KPMG Forensic in CEE

2 Partners Regional approach Central Forensic function, a centre of excellence, based in Prague
Dedicated multi-skilled Forensic team members in Bulgaria, Czech Republic, Hungary, Latvia, Poland, Romania, and Slovakia. Experienced resources in Albania, Belarus, Bosnia, Croatia, Estonia, Lithuania, Macedonia, Moldova, Montenegro, Serbia and Slovenia.
Services offered include: Fraud & Misconduct Investigations, Fraud Risk Management Services, Forensic Technology Services, Dispute Advisory Services, Intellectual Property and Contract Governance, Corporate Intelligence.
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Contact details
Jimmy Helm Partner, Head of Forensic Services KPMG Central & Eastern Europe Direct: +420 222 123 430 Mobile: +420 724 924 164 Email: jhelm@kpmg.com
Richard Perrin Partner, Head of Risk & Compliance KPMG in Romania Direct: +40 372 377 792 Mobile: +40 744 557 302 Email: rperrin@kpmg.com Oana Coman Manager, Forensic Services KPMG in Romania Mobile: +40 747 333 029 Email: oilie@kpmg.com
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Thank you!
2012 KPMG Romania S.R.L., a Romanian limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. Printed in Romania. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International Cooperative (KPMG International).

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Professional skepticism attitude of the internal auditor in fraud related matters

Why is professional skepticism important?

Section heading Professional skepticism

A questioning mind Careful thought Critical assessment of information

Professional skepticism when responding to Fraud

In the Practice Guide the internal auditor should:

Consider fraud risks in the assessment of internal control design and

When do frauds happen?

Case study - Background

A Romanian Company subsidiary of a large Group of Companies registered in

As a result of those claims the General Manager organized an inventory count

Case study issues identified

The Sales Manager was performing the reconciliation of physical count

Chief Accountant recorded the results based on an excel spreadsheet

The Company was not usually performing confirmation balances to the

The collection of receivables was performed in cash by each sales agent

Lack of supervision from the General Manager

No proper monitoring from the Group Internal Audit Function

No reconciliation of the receivables

No proper internal controls in respect of inventory

Stock reconciliations performed by the Sales Manager

Manual invoices issued to the customers

Manual delivery documents issued for goods

No reconciliation of the petty cash

How the losses occurred Scheme A

Sales of goods for cash to various companies, which were not

The goods sold for cash was invoiced to a regular customers

Actual invoice issued from the accounting system of the Company

When the Accounting department requested balance confirmations

The warehouse records would have been accurate as the physical

How the losses occurred Scheme B

Deliveries were made to regular and occasional customers from the

Fabricated invoices were issued by the Sales Manager to these

There were also some delivery notes for merchandise removed

The Company did not receive payment in cash or to its bank

How the losses occurred Scheme C

The Sales Manager instructed the person acting as Company

The Sales Manager failed to deposit cash receipts into the

Consequently the cash balance in the accounting records of

Result of the investigation

Following the internal disciplinary enquiry, the Sales Managers

The Company provided a criminal complaint that was filed with

Why good people sometimes to bad things?

How authority works?

Overview of KPMG Forensic in Central & Eastern Europe

KPMG in Central & Eastern Europe

KPMG Forensic in CEE

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