Louisiana Association of School Business Officials · Control Environment If the “tone at the...
Transcript of Louisiana Association of School Business Officials · Control Environment If the “tone at the...
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Louisiana Association of School Business
Officials
Fraud & Internal Controls
Spring ConferenceMay 18, 2010
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The Government Environment
Why Fraud Risks are Different
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Unique Aspects of Governments
Public organizations Involuntary resource providers Political environment Lack of profit motive
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Unique Aspects of Governments
Public organizations Government in the Sunshine Notice requirements Access requirements
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Unique Aspects of Governments
Involuntary resource providers AKA taxpayers Public goods Accountability
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Unique Aspects of Governments
Political environment Varies by type, size, & nature Special interest groups Partisan politics Economic sensitivity
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Unique Aspects of Governments
Lack of profit motive Relates to concept of public goods Cost recovery Disparities among governments
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Special Concerns & Considerations for SLGs
Significant intregovernmental revenues
More with less Low paid & insufficient number of
employees Lack of profit motive Lack of ownership interests
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Internal Control Basics
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Management & Internal Control
Management is responsible for internal control including Fraud
PreventionDetectionDeterrence
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Internal Control Over financial reporting A process effected by an entity’s board of
directors, management & other personnel, designed to provide reasonable assuranceregarding the achievement of objectives in the following categories Effectiveness & efficiency of operations Reliability of financial reporting Compliance with applicable laws & regulations
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Types of Controls Preventive
Prevent a misstatement from being recorded
Detective Detect & correct misstatement
before FS issued
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Examples of Controls Preventive
Approval of POs by CFO Governing body approval for
certain purchases Integrated subsidiary systems
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Examples of Controls Detective
Bank reconciliations Account analysis Internal audit
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COSO InternalControl Framework
Five elements PermeateOperations Financial reporting Compliance
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COSO InternalControl Framework
Control environment Tone at the top Bedrock on which all other elements based
Risk assessment Risk of material FS misstatement
Control activities Based on risk assessment Evaluate in light of cost-benefit
Information & communication What, who, how, when
Monitoring To determine IC continues to operate effectively
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Control Environment
If the “tone at the top” is one of zero tolerance & if fraudsters are promptly disciplined, employees may be less likely to commit fraud. A positive & open work environment, at all levels of the organization, also helps in preventing, detecting, & deterring fraud.
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The Government Control Environment
Cost-benefit considerations Diminishing benefits related to internal
controls Governing body & management focus
more on operations than control environment
Lack of administrative and/or accounting staff to perform control activities
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Risk of Material Misstatement
How & where financial statements may be susceptible to material misstatement due to error or fraud Specific accounts Classes of transactions Financial statement presentation or disclosures Financial statements as a whole
Fraud risks Financial statement misstatement Misappropriation of assets
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Risk Assessment Consider
Size & complexity of governmentManagement override
Number of personnelSegregation of duties
Experience & expertise of personnelFinancially literate governing body
or audit committee can compensate Extent technology used
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Characteristics ofSmall Governments
Fewer levels of management & wider spans of control within them
Less complex transaction processing systems
Employees with wider ranges of duties Limited ability to maintain a depth of
human resources in line & support staff positions
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Attributes of Small Governments
Tend to be flat organizations Leadership concentrated in Chief executive position AND Chief financial officer position (in some
cases) Often over-reliance on one individual Operations Accounting Administration
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Attributes of Small Governments
Operate in an atmosphere of trust Long-time employees are often considered
“family” Tend to outsource more operations Lock box service Payroll processing & reporting Financial statement preparation
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Attributes of Small Governments
Few written and/or formal policies & procedures have been developed
Senior management typically will communicate directly with employees
Key positions often held by persons lacking requisite expertise to perform duties of the position.
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Risk Assessment What could go wrong?
Initiation Authorization Processing Recording Reporting
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Significant Processes Routine transactions Non-routine processes Estimates Spreadsheets
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Examples Routine
Transactions Payroll Cash
disbursements
Utility receipts
InitiationAuthorizationProcessingRecordingReporting
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Examples Non-Routine
Transactions Sale of capital
asset Issuance of
bonds/LTD Purchase of
capital asset
InitiationAuthorizationProcessingRecordingReporting
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Examples Year-End
Transactions Accruals Analysis
adjustments Investments Pension/OPEB
liabilities Fund to GWS
reconciliations
InitiationAuthorizationProcessingRecordingReporting
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Risk Assessment IT Concerns
Improper segregation of duties Lack of qualified staff in IT
function System access granted to a
number of individuals System administration is sole
responsibility of one individual
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Risk Assessment IT Concerns
Changes in operating environment New personnel
Key positions New IT systems
Operations or accounting Rapid growth
Systems & controls lag operations Reorganizations
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Mitigating Management Override Potential
Corporate culture of integrity & ethical values
Hiring qualified accounting personnel Effective internal audit function A qualified governing body and/or audit
committee willing to assume responsibility to prevent/detect management override
An effective whistleblower program
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Mitigating Missing & Ineffective Controls
Increase management involvement in monitoring Reviewing detail transaction reports Reviewing selected transactions Performing periodic counts of assets typically
subject to misappropriation Review reconciliations prepared by staff having
incompatible duties
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Mitigating Missing & Ineffective Controls
Hire qualified accounting personnel Financially literate governing body/audit committee
can be compensating control Use controls built into many purchased
software packages
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Challenges to Effective Internal Controls in Small Governments
Limited staff or no staff with expertise in the area of accounting and finance
Executives & managers may also function as operations personnel
Governing body and/or executive management not financially literate
Difficult to attract qualified individuals to fill position vacancies
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Challenges to Effective Internal Controls in Small Governments
Outsourcing of accounting function to auditor Non audit services for audit firm
Calculate adjustments Errors found through substantive & analytical
procedures Accrual adjustments Receivables & payables
Depreciation Investment income Fair value measurements Non-exchange transactions
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Challenges to Effective Internal Controls in Small Governments
Outsourcing of accounting function to auditor Non audit services for audit firm
Prepare Account analyses Trial balance Depreciation schedule Draft financial statements & notes Income tax return & schedules Management rep letter
Independence issues
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Fraud Risks in Governmental Organizations
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Introduction
Fraud a major focus among FS users Investors Watch dogs Donors Citizens
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Financial Statement Users
Citizens Legislative & oversight bodies Investors & creditors
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Workplace Fraud
2008 ACFE Report, major findings Median loss during the two-year study period was
$175,000 Fraud loss size strongly related to position of
perpetrator in the organization From time fraud began to time it detected was two
years Over 30% of the frauds studied involved
employees in the accounting function Almost 20% of frauds investigated involved
executive-level employees
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Workplace Fraud
2003 Ernst & Young survey 20% lost to some type of workplace
fraud Theft of office items Claiming extra hours worked Expense accounts Taking kickbacks from suppliers
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Profile of a Fraudster Equally line employees or managers Long-term &/or trusted employees Male 31-50 years of age College educated Work in the accounting function Dedicated & often works long hours Dislike mandatory vacation policies Resents cross-training Seen as likeable & generous Deceptive & usually an adept liar
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Financial Statement Fraud
Intentional misstatement Due to
Fraudulent financial reporting
Misappropriation of assets
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Fraudulent Financial Reporting
Intentional misapplication of accounting principles Improper disclosures Misrepresentation or intentional omissions related to
events, transactions, or other significant information Manipulation, falsification, or alteration of accounting
records or supporting documentation related to Concealed liabilities Fictitious revenues Improper asset valuations Timing or cut-off differences
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Fraudulent FinancialReporting
Management override Difficult to detect
Management withholds evidence Misrepresentation of information in responding
to auditor inquiries Falsification of documents
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Fraudulent FinancialReporting
Manipulation, falsification, or alteration of accounting records or supporting documentation
Misrepresentations or intentional omissions
Intentional misapplication of accounting principles
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Misappropriation of Assets
Typically occur through Embezzlement of receipts Stealing assets Skimming (before recorded) Cash larceny (after recorded) Causing the entity to pay for goods/services
it has not received
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Misappropriation of AssetsCash Disbursement Schemes
Billing schemes causing an organization to pay for goods or services at inflated prices or that are for personal use
Expense reimbursements for fictitious or inflated business expenses
Altering or forging checks drawn on accounts of the organization
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Misappropriation of AssetsCash Disbursement Schemes
Payroll disbursements for fictitious employees or for hours not actually worked
Fraudulent wire transfers from the organization’s accounts
Regular disbursements to conceal the theft of cash receipts or cash on hand
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Concealment Indicators
Discrepancies in records Conflicting/missing evidential matter Problematic/unusual relationship with
auditor & client
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Fraud Basics
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Elements of Fraud
Fraudulent activities are covert Perpetrator of fraud violates his/her
fiduciary duties to organization Fraud typically committed for direct
or indirect personal financial gain Defrauded organization loses assets
or revenues Citizens of the SLG
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Typical Fraud Steps
Fraud is committed
Perpetrators receive the benefits of the fraud
Fraud is concealed
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Fraud Triangle
Incentive/pressure Placed on or perceived
Opportunity Circumstances conducive to fraud
Rationalization/attitude Character, ethical values
Effect of collusion
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Incentive or Pressure
Governmental organizations often feel pressure to provide more and/or higher quality services when elected officials are reluctant to Increase tax rates or user charges Cut service levels
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Opportunity
• Number of locations taking cash payments • Cash may be received at either central or offsite
locations by persons lacking knowledge of existing internal controls
• Over-reliance on CFO position
• Lack of personnel or lack of adequately trained personnel
• Employee turnover• Low in SLGs
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Rationalization or Attitude
• Employees often paid less than their counterparts in private sector
• Inadequate staff in accounting/support positions creates high work load levels
• Working out of class issues
• Feeling there is a lack of support or appreciation from management & those charged with governance
• Often from citizens as well
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Fraud & the Auditor
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Marketplace Expectations
Purpose of a financial statement audit is to provide reasonable assurance the statements are free from material misstatement due to error or fraud
2008 Treasury report indicates auditor’s obligation to detect fraud is single most confusing issue for executives & nonauditors to understand
2002 survey of executives & other finance professionals indicated 80% of this financially literate group believed job of external auditor was to prevent fraud
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Professional Auditing Standards
• Auditor required to exercise professional skepticism throughout the audit
• Effect of long-term client relationships
• Fraud risks in every audit• Revenue recognition
• Management override
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Auditor Communication of Fraud
• Required to communicate fraud
• Immaterial, low level
• Material
• Any fraud, management
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Communication Challenges in Reporting Fraud
Written or oral Documentation of communication required
Consideration of reporting to third parties Legal/regulatory requirements Successor auditor Subpoena Funding agency/other specified agency
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Special Communication Concerns
General concerns “May” exist Confidentiality issues
Form of communication Public meetings Public records
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Unique Fraud Risk Areas
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Common Fraud Areas in Governments
Overstatements Earnings/change in net assets/fund equity
Fictitious revenues Improper revenue recognition
Assets Inventories Property values Fictitious assets
Understatements Expenses/expenditures Allowances Impairments
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Unique Fraud Areas in Governments
Fund accounting Interfund transactions Functional allocation of expenses Internal accounting controls Repeat control deficiencies
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Fund Accounting
Using the fund structure, governmental organizations are able to conceal, misrepresent, or manipulate transactions whether with the intent to defraud or not
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Interfund Transactions
• Conceal a number of irregularities
• May result in fraudulent financial reporting if not detected
• Examples
• Offsetting operating losses in business type activities
• Concealing budget shortfalls
• Infusing working capital to meet covenant ratios
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Functional Allocationof Expenses
Some governmental agencies may misstate functional amounts to circumvent legal requirements or to comply with grant provisions or bond covenants
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Internal Accounting Controls
Lack of staff or lack of qualified staff in administrative and/or accounting & finance functions
Employee compensation & longevity
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Repeat Control Deficiencies
• Reasons for not correcting control deficiencies may indicate an attitude of rationalization throughout the entire governmental organization
• Continued existence of missing or ineffective internal controls might create incentives and/or opportunities for fraud to occur
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Fraud Risk Areas
Revenue RecognitionManagement Override
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Revenue Recognition
Governments Really a fraud risk? Exchange vs. non exchange FS classifications
Charges for servicesSpecial taxes
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Revenue Recognition –Timing Issues
If current year revenue estimates have not been met, an incentive to prematurely recognize revenuemay exist
Conversely, if budget levels for the current year have already been achieved an incentive to move revenue from the current period into the subsequent period may exist
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Revenue Recognition Fraud Indicators
Significant or unusual adjustments to receivables at or near year-end
Documentation relating to cash receipts is missing or altered
Cash flow from operating activities is inconsistent with actual cash flow
Significant or unusual entries to reconcile major revenue accounts
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Revenue Recognition Fraud Indicators
Unusual or unexplained significant fluctuations in major revenues from year to year or from budgeted amounts
Significant (in amount or frequency) related party transactions
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Revenue Recognition Fraud Indicators
Revenue transactions that have been pre or post dated from the actual transaction date
Significant journal entries made to major revenue accounts rather than flowing through from adjustments to subsidiary accounts
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Management Override &Public Accountability
Balanced budget Finance services Debt obligations
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Management Override
Journal entries Estimates
Functional expenses/expenditures Allocating costs to grants Useful lives Actuarial assumptions
Business rationale for transactions Bribes & kickbacks Billing schemes
Rationale is often public accountability concerns
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Bribes & Kickbacks
On average the most expensive corruption scheme committed by employees
#2 Undisclosed conflicts of interest#3 Accepting illegal gratuities#4 Economic extortion
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Management Override & Expense Recognition
In many governmental organizations, appropriations that are not expended by year end are lost
Having actual expenditures significantly less than appropriated amounts may negatively affect the amounts appropriated in subsequent years
Personnel may also overstate expenses by charging additional costs to grants with remaining funds or those that are terminating
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Fraud Risk Areas
Misappropriation of Assets
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Misappropriation of Assets
Typical focus of controls is on cash receipts Cash disbursements
Causing entity to pay for goods/services it does not receive
Contributing factors Highly technical transactions Insufficient number of trained personnel Lack of personnel in support functions
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Assets Subject to Misappropriation
Cash & cash equivalents Legally confiscated items Inventories of supplies, etc., and physical assets
Small in size, high in value High in consumer demand Easily convertible to cash Lacking in ownership identification
Equipment subject to personal or non-program use Physical assets susceptible to personal use or redirection
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Common Schemes
Personnel frauds
Diversion of physical assets including property, plant, and
equipment
Embezzlement of cash receipts and fraudulent disbursements (including
accounts receivable frauds)
Diversion of
program benefits and
assets
Procurement & contracting
frauds
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Indicators of Procurement and/or Contracting Fraud
Unusual vendor names & addresses Copies of invoices, purchase orders, or receiving
documents rather than original documentation Orders for materials/supplies already on hand in
sufficient quantities or that are scheduled for disposal/discontinued use due to obsolescence
Orders for materials/supplies not consistent with the operations and/or mission of the organization
Delivery addresses not part of the purchaser’s physical locations
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Indicators of Procurement and/or Contracting Fraud
Purchases falling just below the threshold for required next-level approval (in quantity or amount)
Split purchases using purchase orders, vendor invoices, change orders, etc.
Payments to vendors not on approved vendor lists Signature of management or supervisory personnel
on documents typically signed by subordinate personnel
Supplier/contractors receiving significant amounts of business from the organization
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Indicators of Procurement and/or Contracting Fraud
Prices in excess of market Complaints from vendors/suppliers
regarding not being allowed to bid, stringent bid specifications or procedures, inadequate time allowed for responding to bid requests
Contract award patterns that may indicate bids are being rotated
Sole source procurements in significant number or without adequate justification
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Indicators of Cash Receipts & Disbursements Fraud
Missing or out-of-sequence blank checks Significant bank reconciling items without reasonable
explanation Second payee or unusual endorsements on checks Missing cancelled checks Unusual disbursement transactions or transactions
with lacking/insufficient supporting documentation Citizen/customer complaints about amounts they owe
(for taxes, services rendered, etc.)
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Indicators of Accounts Receivable Fraud
Unexplained differences noted on receivable confirmations received
Significant or unusual adjustments to receivable records
Amounts deposited that are inconsistent with amounts due
Significant credit balances in receivable accounts
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Indicators of Inventory Fraud
Significant inventory shrinkage
Unusual inventory turnover
Significant unusual or unexplained entries to control or subsidiary inventory records
Significant unusual or unexpected relationships in inventory and inventory related ratios
Receiving reports differing from purchase orders, contracts, or vendor invoices
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Procurement Cards
Increased use of procurement or purchasing cards may result in increased fraud risks if adequate controls over their use and distribution are not in place
Unfortunately, not all governmental organizations have effective controls in place to ensure proper use of these cards
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Indicators of Personnel Fraud
Unusual or second-party endorsements Employees without usual withholdings related to employer
provided or offered benefits (i.e., insurance, retirement, savings bonds, etc.)
Missing, unusual looking, or altered time & attendance records in general or frequently for the same employee(s)
Time & attendance records signed by someone other than usual supervisor in general or frequently for the same employee(s)
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Payroll & Personnel Control Procedures
Typically focus on Time card/sheet Personnel file info
Often lack focus on Legitimacy of approvals Overtime
Types of overtime controls
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Indicators of Misappropriations of PP&E
Missing/lacking policy re: personal use
Physical inventory performed less often than each year
Missing/ineffective asset identification system
Poor controls over sales/disposals
Poor controls over contributed assets
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Personal Use of Public Assets
Contributing factors Management override Inadequately trained personnel Lack of personnel Attitude
Controls Cost-benefit issues
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Assets Subject to Personal Use
Computers Cell phones Vehicles Audio-visual equipment Buildings Others
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Other Fraud Issues - PP&E
Lack of periodic physical inventory Identification tags
Sales & disposals may lack effective controls
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Program Benefits Subject to Misappropriation
Unemployment Food stamps Housing assistance Financial aid Health care Legal assistance Child care
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Indicators of Diversion of Program Benefits and Assets Include
Copies of or missing application forms & underlying supporting documentation
Participant files lack required information Decentralized intake centers or centralized intake centers with
little or no monitoring by management or supervisory personnel
Inadequately trained and/or supervised program personnel Multiple operations/locations Inadequate or ineffective controls over program assets Lack of periodic physical inventories of program assets
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Fraud Prevention & Detection Procedures
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How to Prevent, Detect, & Deter Fraud
Being aware of situations that have the potential to create fraud risks is the first step in designing effective programs & controls to prevent, detect, & deter fraud.
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Warning Signs
An organizational culture of arrogance and management entitlement.
Accounting policies relying too heavily on management’s judgment.
Accounting policies that seem too aggressive especially in light of accounting and finance staff expertise.
Overly centralized control over financial reporting especially in organizations with larger or more adequate staff in the areas of accounting and finance.
Departure of key senior management personnel.
Warning!
Warning!
Warning!
Warning!
Warning!
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Warning Signs
Failure to listen to key accounting/finance personnel within the organization.
Receivables growing at a faster rate than the related revenues.
Periods of prolonged success especially when economic, industry, or organizational conditions indicate otherwise.
Difficulty in paying bills on a timely basis or less timely than in prior years.
Transactions lack economic purpose (may be indicative of kickbacks as well as misappropriation of assets or financial statement fraud).
Warning!
Warning!
Warning!
Warning!
Warning!
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Computer Fraud
Internal accounting controls that may be effective in preventing detecting, and deterring computer fraud include the following:
Separation and rotation of duties both within and external to the technology function.
Timely update of accessible computer applications when personnel change jobs or when the requirements of their current position change.
Periodic and surprise inspections and security reviews.
All control policies and procedures required to be written (zero tolerance for deviations from this policy).
Offline controls and limits such as batch controls and hash totals where indicated and cost-effective.
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Detection Procedures
Ascertaining if any significant budget adjustments were made at, near, or after year end and the reasons therefore
Determining all budget adjustments made at, near, or after year end were properly and timely approved by appropriate personnel or governing body, if required
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Detection Procedures
Reviewing significant interfund transactions made at, near, or after year end
Consider changes in the specific funds constituting major funds Inquire as to the reasons for significant
changes resulting in reclassification from the previous year
Does this make sense?
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Detection Procedures
Review responses to inquiries regarding analytical relationships Vagueness Plausibility Inconsistency with other known circumstances
Evaluate whether observations affect the previous assessments of risk relating to Fraudulent financial reporting Misappropriation of assets