Chapter 4: Preventing Fraud

Chapter 4: Preventing Fraud
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.
1. Understand how to create a culture of honesty,
openness, and assistance.
2. Know how to eliminate opportunities for fraud.
3. Understand how to create an effective organization

to minimize fraud.
4. Understand the importance of proactive fraud

auditing.
5. Understand the importance of creating a

comprehensive approach to fighting fraud.
 Create a culture of honesty, openness, and
assistance by…
1. Hiring honest people and providing fraud
awareness training
2. Creating a positive work environment
3. Providing an employee assistance program
(EAP) that helps employees deal with personal
pressures
 Studies have indicated that
◦ Nearly 30 percent of Americans are dishonest
◦ 40 percent are situationally honest
◦ Only about 30 percent are honest all the time
 Hiring Honest People
 Recommendations:
◦ Verify applicant’s résumé and application
◦ Require applicant certification
◦ Train interviewers to conduct thorough and skillful
interviews
◦ Use industry-specific approaches as deemed
necessary
Fraud Awareness Training
Train on…
 The costliness of fraud
 The effects of fraud on pay and benefits

 The nontolerance of fraud
 Actions to take if fraudulent activity is
suspected
© 2016 Cengage Learning. All Rights
Reserved. May not be scanned, copied, or
duplicated, or posted to a publicly
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied,accessible
or duplicated,
website,
or posted
in whole
to aor
publicly
in part.accessible website, in whole or in part.
Positive Work Environment
 Create a positive work environment by:
 Setting expectations about honesty
◦ Having a code of conduct
◦ Conveying those expectations
 Having open-door or easy access policies

 Having positive personnel and operating
procedures.
 Setting Expectations
 The Pygmalion effect:
 People generally perform according to a
leader’s expectations
“What you expect is what you’ll get”.
 Code of Conduct
◦ Sarbanes-Oxley Act of 2002
◦ SEC – Code of Conduct for all employees
 Must be visible
 Must be communicated frequently
 Example:
◦ Hormel Foods Code of Conduct
 Open-Door or Easy Access Policies
 Helps prevent fraud by:
◦ Allowing employees share feelings
◦ Allow management to know of employees’ pressures,
problems, and rationalizations
 Personnel and Operating Policies
 Related to high- or low-fraud environments
 Examples producing high-fraud environments
◦ Inadequate pay
◦ Lack of recognition for job performance
◦ Perceived inequalities in the organization
◦ Inadequate expense accounts
◦ And so on
Employee Assistance Programs (EAPs)
 Help employees reduce pressure by helping

employees deal with:
◦ Substance abuse
◦ Gambling
◦ Money management
◦ Health, family, and personal problems
Employee Assistance Programs (EAP)
 Provide support systems with programs like:
◦ Wellness
◦ Team building
◦ Coaching
◦ Conflict resolution
◦ Critical incident response
◦ Assessment
◦ Counseling
◦ Referral
Way to Create a Culture of Honesty, Openness, and Assistance, How This Step Is Accomplished
1. Hire honest people and provide fraud awareness 1. Verify all information on the applicant’s résumé and
training. application.
2. Require all applicants to affirm the truth of the matters

set forth in their applications and résumé.
3. Train management to conduct thorough and skillful

interviews.
2. Create a positive work environment. 1. Create expectations about honesty by having a good
corporate code of conduct and conveying those
expectations throughout the organization.
2. Have open-door or easy access policies.
3. Have positive personnel and operating procedures.
3. Provide an employee assistance program (EAP). 1. Implement an EAP that helps employees deal with
personal and nonsharable pressures in their lives.
 Five ways to eliminate fraud opportunities:
1. Have good internal controls
2. Discourage collusion
3. Monitor employees and provide a whistle-
blowing system
4. Create an expectation of punishment
5. Conduct proactive auditing
 COSO’s Internal Control Framework
1. A good control environment
2. A good risk assessment process
3. Good control activities
4. A good information and communication
system
5. A good process of monitoring compliance
TYPE OF CONTROL CONTROL ACTIVITIES
Preventive controls 1. Segregation of duties
2. System of authorizations
3. Physical safeguards
Detective controls 1. Independent checks
2. Documents and records
 Collusive frauds have increased probably
because of…
◦ Employees solely responsible for large contracts
◦ Customers or vendors fearing loss of business
relationships
 Suggested method of discouraging collusion:

◦ Have a “right-to-audit” clause on the back of all
purchase invoices
 Section 806 of the Sarbanes-Oxley Act of 2002
requires all public companies to have a
whistle-blower system
 33 percent of all frauds are detected through
tips
 A good whistle-blowing program is one of the
most effective fraud prevention tools
 Not only companies in the US have whistle-
blowing systems but also government agencies
and foreign companies in major countries
 Effective systems have
the following:
1. Anonymity
2. Independence
3. Accessibility
4. Follow-up
 “One of the greatest deterrents to dishonesty is
fear of punishment.”
 “Real punishment involves having to tell family

members and friends about the dishonest
behavior.”
 “A strong prosecution policy that is well

publicized lets employees know that dishonest
acts will be harshly punished ….”
 Good fraud auditing involves four steps:
1. Identify fraud risk exposures
2. Identify the fraud symptoms of each exposure
3. Build audit programs to proactively look for
symptoms and exposures
4. Investigate fraud symptoms identified
 Statement on Auditing Standards No. 99
 Consideration of Fraud in a Financial
Statement Audit
◦ Brainstorming the risks of fraud
◦ Discussing with management about awareness of
fraud
◦ Using unpredictable audit tests
◦ Requiring on every audit, procedures responsive to
detecting management override

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Chapter 4: Preventing Fraud

2. Know how to eliminate opportunities for fraud.

3. Understand how to create an effective organization

4. Understand the importance of proactive fraud

5. Understand the importance of creating a

 The effects of fraud on pay and benefits

 Having open-door or easy access policies

“What you expect is what you’ll get”.

 Help employees reduce pressure by helping

2. Require all applicants to affirm the truth of the matters

3. Train management to conduct thorough and skillful

2. Have open-door or easy access policies.

3. Have positive personnel and operating procedures.

Preventive controls 1. Segregation of duties

Detective controls 1. Independent checks

2. Documents and records

 Suggested method of discouraging collusion:

 “Real punishment involves having to tell family

 “A strong prosecution policy that is well

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