POTENTIAL FRAUD INDICATORS AND HIGH RISK AREAS

Dr. Sadu Israel, IA&AS, CISA, CIA, CFE, CRISC, CIPSFR

Principal Director of Audit

In this session, with the help of some case studies, we will

• Review of basic concepts of frauds

• Identify some high risk areas

• What is a fraud indicator?

• Identify fraud indicators for selected high risk area

• Prepare for anti-fraud framework

Tackling Fraud – Be Proactive

What facilitates fraud?

Identify High Risk Areas

• Contracts of service/procurement; • Inventory management; • Sanctions/clearances; • Revenue receipt; • Cash management; • General expenditure; and • Other areas with public interface• Relief and rehabilitation programmes

Contract Fraud and Corruption

• Procurement of goods and services is a majoractivity in the government sector and istraditionally prone to fraud and corruption.

• Understanding fraud and corruption incontracts may therefore be beneficial to theauditor.

Four steps to a successful audit of fraud

Cash Management

• Identify the high risk areas

Segregation of duties

• Identify the risk factors influencing these areas

Reconciliation in arrears

•Notice and investigate the out of place happenings and oddities(Red flags or fraud indicators) by analytical review procedures andassessment of the quality of internal controls

Audit Testing •Escalate substantive testing to get assurance that there no frauds

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Red Flags or Fraud Indicators

• Anomalies associated with past cases of fraud

• Auditors build on such past experiences

• Auditors should be aware of them, know how to use them and understand their strength and limitation

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Red Flags...

• Red flags are not significant in themselvesbut if these are many it may oftenindicate material fraud

• A red flag alone does not prove fraud. Butpresence of one or more of these shouldalert the auditors

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Red flags..

• Timing(day,week, month,year)

• Place(too many , too few)

• Frequency(too high, too low)

• Quantity(too high,too low, too consistent,too alike,too different)

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Ben ford's Law

Digital/Frequency Testing

Benford Analysis

Why do these values occur

more often?

Analytical Testing – Income Statement Items

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Analytical Testing – User Activity by Month

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Bsimpson Glopez Cbrown Nfine Ijones

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Accounts Payable

Duplicate vendors

Duplicate invoices

Structured payments

Conflicts of interest

Kickbacks

Bid-rigging

Purchase Cards

Duplicate purchasing and reimbursement schemes

Unauthorized and/or improper purchases

Unauthorized users

Inadequate segregation of duties

Payroll

Ghost employees

Improper supplemental payments

Improper bonus or incentive compensation payments

Inflated salaries

Inflated hours

Inadequate segregation of duties

Travel and Entertainment

Expense

False or inflated reimbursement submissions

Improper use of corporate credit card

Purchase for personal use

Duplicate purchasing and reimbursement schemes

Journal Entries

Unbalanced journal entries

Improper management override

Improper expense capitalization

Improper revenue recognition

Entries to unusual or seldom used accounts

Improper or unauthorized user activity

Entries during non-business hours

Identification or setting Red flags

Accounts Receivable

Fictitious customers

Credit balance fraud

Offsets with unauthorized or improper expenses

Improper AR aging

Inventory

Fictitious, inflated, duplicate or unnecessary purchases

improper write-off

Excessive shrinkage

Sales

False or inflated sales

Fictitious customers

Improper commission or bonus payments

Revenue recognition abuses including channel stuffing, liberal return policies or bill and hold schemes

Non-Financial

Weblog analysis

Building access logs

Computer print reports

Client proprietary database analysis

Identification of Red flags contd.,

Illustrative lists of Fraud in Contracts

• Tailored specifications• Changes in Original Contracts • Duplicate Payments • Collusive or Cartel Bidding • Conflict of Interest • Defective Pricing • False Invoices • False Representations • Splitting of Purchases• Phantom Contractor • Pilferage of Public Assets

Prepare Red flags (warning signs)- Contracts

• Requirements defining stage

• Inadequate needs analysis

• Inadequate information about potential suppliers

• Inadequate review of existing and required inventory

• Unduly short supply period

• Needs analysis is product rather than needs oriented

• Someone other than the user defines the user requirements

• Unwarranted involvement of senior officials

• Bidding and selection stage

• The specifications are not clearly defined

• A very limited number of offers is received

• Documentation indicates unusual involvement of an official

• Suspicion about conflict of interest

• Evidence of early receipt of information by some contractors

• Request for proposal is not properly advertised

Prepare Red flags (warning signs)-Contracts--2

• Unusual handling of the bidding process

• Evaluation criteria is not consistent for different offerors

• Exceptions to the tender deadlines

• Changes in the bids made after their formal receipt

• Lowest responsive bidder is not selected

• Contractor submits unrealistic bid indicating collusion or bid rotation

• Unusual withdrawal of bids

• Re-bid results identical to original bids

• Successful contractors use competitors as sub-contractors

• Justification for single source procurement is inadequate

Prepare Red flags (warning signs)-Contracts--3

• Contract performance and evaluation stage

• Changes in a contract result in the large increase in the cost of goods and services

• Changes made without adequate explanations

• Unwarranted contract extension

• Complaints about the quality of goods and services received

• Inadequate inspections and quality assurance of goods and services received

• Evidence of over charging and duplicate billings

• Dubious invoices

• Insufficient pre-audit of contractor payments

• Contracts repeatedly awarded to one contractor

• Unduly high labor payments

Prepare Red flags (warning signs)-Contracts---4

Red Flags in budget/ expenditure in government

• Persistent excess over budget in some items /departments without valid explanation

• Unwarranted increase in expenditure in some programmes/activities

• Drastic change in the composition of expenditure

• Budget prepared in haste/on ad hoc basis• Unresolved audit objections of serious nature• Non production of records for audit

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Red flags in Procurement

• Sudden spurt in purchase

• Delivery to a non business location

• Unused inventory-quality problem

• Payments in a special mode and special amount

• Appearance of new vendor

• Who makes the purchase

• Unqualified /unregistered vendors

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Red flags in staff cost

• Unexplained increase in staff cost

• Staff authorisation tables ignored/non existent

• Increase in certain category of non technical staff

• Increase in other payments - arrear pay, overtime,leave pay, travel allowance,overseas pay

• Large number of staff in basic stage of basic grade

• Increase in work charged and casual staff

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Red Flags...

• Ability to spot and assess red flags increases with experience, judgement and common sense

• Intuition and hunches also play a role

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Red Flags...

• Auditors should not overlook the obvious

• Seek straight- forward explanation of red flagsand examine their veracity

• Extend audit testing if doubt is not clarified atthis stage

• Frame audit approach accordingly

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Anti-Fraud measures

• Red flags

• Anti-fraud measures

– Preventive

– Detective

• See the Illustrative list prepared

Thank you

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