5.4 Environmental, institutional, or individual pressures and opportune situations, which
are present to some degree in all companies, motivate individuals and companies to
engage in fraudulent financial reporting. Fraud prevention and detection require that
pressures and opportunities be identified and evaluated in terms of the risks they pose
to a company. Adapted from the CMA Examination.
a. Identify two company pressures that would increase the likelihood of fraudulent
financial reporting.
Sudden decreases in revenue or market share
Financial pressure from bonus plans that depend on short-term economic
performance
Intense pressure to meet/exceed earnings expectations or improve reported
performance
b. Identify three corporate opportunities that make fraud easier to commit and
detection less likely.
Weak or nonexistent internal controls
Failure to enforce/monitor internal controls
Management not involved in control system or overriding controls
c. For each of the following, identify the external environmental factors that should
be considered in assessing the risk of fraudulent financial reporting
The company’s industry
oSpecific industry trends such as overall demand for the industry’s products,
economic events affecting the industry, and whether the industry is expanding
or declining.
The company’s business environment
The company’s legal and regulatory environment
d. What can top management do to reduce the possibility of fraudulent financial
reporting?
Set the proper tone to establish a corporate environment contributing to the
integrity of the financial reporting process.
5.5 For each of the following independent cases of employee fraud, recommend how to
prevent similar problems in the future. Adapted from the CMA Examination
a. Due to abnormal inventory shrinkage in the audiovisual department at a retail
chain store, internal auditors conducted an in-depth audit of the department. They
learned that a customer frequently bought large numbers of small electronic
components from a certain cashier. The auditors discovered that they had colluded
to steal electronic components by not recording the sale of items the customer took
from the store.
While collusion is difficult to prevent, the store could improve its control system by:
Implementing job rotation so that the same employees are not always performing
the same duties.
b. During an unannounced audit, auditors discovered a payroll fraud when they
distributed paychecks instead of department supervisors. When the auditors
investigated an unclaimed paycheck, they discovered that the employee quit four
months previously after arguing with the supervisor. The supervisor continued to
turn in a time card for the employee and pocketed his check.
The payroll fraud could be prevented with better internal controls, including:
Separation of duties. A supervisor with the authority to approve time cards should
not be allowed to distribute paychecks. An individual with no other payroll-related
duties should distribute checks.
c. Auditors discovered an accounts payable clerk who made copies of supporting
documents and used them to support duplicate supplier payments. The clerk
deposited the duplicate checks in a bank account she had opened using a name
similar to the supplier’s.
The accounts payable fraud could be prevented with better internal controls, including:
Implement and enforce a policy that prohibits the payment of invoices based on
copies of supporting documents.
5.6 An auditor found that Rent-A-Wreck management does not always comply with its
stated policy that sealed bids be used to sell obsolete cars. Records indicated that
several vehicles with recent major repairs were sold at negotiated prices. Management
vigorously assured the auditor that performing limited repairs and negotiating with
knowledgeable buyers resulted in better sales prices than the sealed-bid procedures.
Further investigation revealed that the vehicles were sold to employees at prices well
below market value. Three managers and five other employees pleaded guilty to
criminal charges and made restitution. Adapted from the CIA Examination
a. List the fraud symptoms that should have aroused the auditor’s suspicion.
Failure to follow the established policy of requiring sealed bids to dispose of
b. What audit procedures would show that fraud had in fact occurred.
Review thoroughly the sales documentation that identifies the people who bought
Determine whether the company received fair value when the vehicles were sold.
This could be accomplished by one or more of the following:
Review maintenance records for salvaged vehicles looking for recent charges that
indicate the vehicle might have been fixed before it was sold.
5.7 A bank auditor met with the senior operations manager to discuss a customer’s
complaint that an auto loan payment was not credited on time. The customer said the
payment was made on May 5, its due date, at a teller’s window using a check drawn
on an account in the bank. On May 10, when the customer called for a loan pay-off
balance so he could sell the car, he learned that the payment had not been credited to
the loan. On May 12, the customer went to the bank to inquire about the payment and
meet with the manager. The manager said the payment had been made on May 11.
The customer was satisfied because no late charge would have been assessed until
May 15. The manager asked whether the auditor was comfortable with this situation.
The auditor located the customer’s paid check and found that it had cleared on May
5. The auditor traced the item back through the computer records and found that the
teller had processed the check as being cashed. The auditor traced the payment
through the entry records of May 11 and found that the payment had been made with
cash instead of a check.
What type of embezzlement scheme does this appear to be, and how does that scheme
operate? Adapted from the CIA Examination
The circumstances are symptomatic of lapping, which is a common form of embezzlement
by lower-level employees in positions that handle cash receipts.
5.8 An accountant with the Atlanta Olympic Games was charged with embezzling over
$60,000 to purchase a Mercedes-Benz and to invest in a certificate of deposit. Police
alleged that he created fictitious invoices from two companies that had contracts with
the Olympic Committee: International Protection Consulting and Languages
Services. He then wrote checks to pay the fictitious invoices and deposited them into a
bank account he had opened under the name of one of the companies. When he was
apprehended, he cooperated with police to the extent of telling them of the bogus
bank account and the purchase of the Mercedes-Benz and the CD. The accountant
was a recent honors graduate from a respected university who, supervisors stated,
was a very trusted and loyal employee.
a. How does the accountant fit the profile of a fraudster?
The accountant fit the fraud profile in that he was
Young
How does he not fit the profile?
b. What fraud scheme did he use to perpetrate his fraud?
c.What controls could have prevented his fraud?
All the accountant had to do was create fictitious invoices, as he had custody of checks
before and after they were signed and he had the authorization to approve payments and
sign checks. The fraud could have been prevented by separating accounting duties
Restrict access (custody) to company checks and the check signing machine to
Do not permit the person that prepares the check to disburse the check (mail it to
Have someone familiar with the contractors authorize payments – someone who
Require that someone other than the people with custody and authorization
d. What controls could have detected his fraud?
A bank reconciliation prepared by someone else. An Olympic Committee official
5.9 The Association of Certified Fraud Examiners periodically prepares an article called
“What Is Your Fraud IQ?” It consists of 10 or more multiple choice questions dealing
with various aspects of fraud. The answers, as well as an explanation of each answer,
are provided at the end of the article. Visit the Journal of Accountancy site
(http://www.journalofaccountancy.com) and search for the articles. Read and answer
the questions in three of these articles, and then check your answers.
There should be 5 or 6 of these articles on the Journal of Accountancy web site. No
5.10 Select the correct answer(s) for the following multiple choice questions. Note that
there may me more than one correct answer. Correct answers are bolded
1. In a typical misappropriation, the perpetrator:
a. Gains the trust or confidence of the entity being defrauded.
b. Uses trickery, cunning, or false or misleading information to commit fraud.
c. Does not make an attempts to conceal the fraud.
2. Which of the following actions did the Treadway Commission recommended to reduce
fraudulent financial reporting?
a. Establish financial incentives that promote integrity in the financial reporting
process.
3. SAS No. 99 requires auditors to:
a. Understand fraud and why it is committed.
b. Due to confidentiality concerns, limit discussion among audit team members of
how and where the company’s financial statements have been susceptible to fraud
in prior years.
4. Which of the following statements is (are) true about computer fraud perpetrators?
a. They are typically younger and are motivated by curiosity, the challenge of
beating the system, and gaining stature in the hacking community.
5. Which of the following statements is (are) true?
a. To prevent detection when an asset is stolen, the perpetrator must inflate liabilities
or decrease assets.
6. Which of the following statements is (are) true?
a. Perpetrators who do not steal cash or use the stolen assets usually convert the
assets to a spendable form.
7. The number of incidents and the total dollar losses from computer fraud are increasing
rapidly for several reasons:
a. Many instances of computer fraud go undetected and many frauds are not
reported.
8. Cyber sleuths need the following skills:
a. Ability to do complex programming so they can develop their own software to
examine corporate data and records.
9. A group of immigrants moved from town to town in the Pacific Northwest perpetrating
the same fraud. An advanced member of the group obtained a paycheck from the
largest employer in the town by paying a premium to the check’s value. He then
scanned the check and used a variety of software packages to prepare fictitious
paychecks from the employer. The group arrived on the next payday, cashed the checks
at local establishment, and moved to another town before the check were presented for
payment at the local bank. This is an example of what type of fraud?
a. Input fraud
10. Which of the following statements is (are) true?
a. The type of computer fraud that is simplest and most common and that requires
the least amount of skill is data