Internal Control Issues in Fraud Cases
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The document discusses the COSO internal control framework and its five components for organizational and functional levels. It then examines common internal control weaknesses that can contribute to fraud, examples of internal fraud, and specific factors that allowed fraud to occur in cases of embezzlement, billing fraud, corruption, payroll fraud, and expense reimbursement schemes. Finally, it lists internal controls that were modified or implemented in organizations after fraud was discovered.
Internal Control Issues in Fraud Cases
- 1. A Global Reach with a Local Perspective www.decosimo.com
- 2. CONTACT ME Pam Mantone, CPA, CFF, CFE, CITP, FCPA Senior Manager pammantone@decosimo.com 423-756-7100 The contents and opinions contained in this presentation are my opinions and do not reflect the representations and opinions of Decosimo.
- 4. COSO Control Framework • Control environment Organizational • Risk assessment level • Communications • Monitoring Functional • Control activities level • Information systems
- 5. Control Environment Principles Hard Controls • Attention and direction by a board of directors and/or audit committee • Organizational Structure • Manner of assigning authority and responsibility • Policies and procedures Soft Controls • Integrity and ethical values • Commitment to competence • Management’s philosophy and operating style
- 6. Control Environment Factors  Appropriate oversight  Hiring practices  Demonstration of integrity in every day dealings with customers, employees, suppliers and other parties  Workload  Communication to employees on management’s views of business practices and ethical behavior  Management takes appropriate action to address known departures from approved policies and procedures or unacceptable business practices or conduct  Investigation of alleged fraud incidents
- 7. Inherent Limitations Judgment Cost/benefit Breakdowns considerations Point-in-time Management evaluation override Materiality Collusion
- 8. Control Weaknesses that Contributed to Fraud Primary Internal Control Weaknesses Poor Tone at the Top 2010 Report Lack of Competent Personnel in Oversight Roles to the Lack of Independent Checks/Audits Nations Lack of Employee Fraud Education Lack of Clear Lines of Authority Lack of Reporting Mechanism Lack of Internal Controls Override of Existing Internal Controls 6.9% Lack of Management Review 8.4% 5.6% 17.9% 1.9% 19.2% 1.8% 37.8% 0.6%
- 9. Internal Fraud • Embezzlement – skimming, check tampering, cash larceny, wire fraud, check fraud • AP – Billing Fraud • Theft of confidential information • Kickbacks - corruption • Payroll fraud • Expense reimbursement schemes
- 10. Internal Fraud • Financial statement fraud • Illegal financial transactions • Embezzlement/theft • Concealing material facts • Giving/accepting bribes • Expense reimbursement schemes
- 11. What Went Wrong – Embezzlement  Trust and absence of skepticism (think Madoff)  Open access to blank checks, financial records, and/or cash  Improper or no bank statement reconciliation or review  No monitoring of customer complaints  No verification/approvals of discounts, credit memos  No review of delinquent accounts  Did not perform analytical procedures that compare adjusted inventory levels to sales  No review of journal entries posted to balance accounts  No detailed review of inter-bank and/or inter-company transfers  No review of the allowance for doubtful accounts
- 12. What Went Wrong – Billing Fraud  No review of vendor transactions for non- consecutive vendor invoice numbers  Hint: Many vendors will assign the same beginning invoice number to each customer, i.e. 98XXXXXX  POs not required and/or not pre-numbered  Did not maintain a listing of outstanding POs  No management approval of purchases and payments  No review of vendor monthly statements for O/S items  Did not develop or maintain an approved vendor list  Did not use competitive bids
- 13. What Went Wrong – Corruption  No review of recent purchases to see whether the same vendor is winning bids let by a specific purchasing agent  Did not include a right-of-audit and access to vendor’s books clause in contract  Did not conduct background checks on new vendors or obtained references  Competitive bids opened by one employee  No company policy addressing the receipt of gifts by an employee  No conflict-of-interest policy  Lack of independent review of vendor pricing  No follow-up discussions with vendors who did not win the contracts
- 14. What Went Wrong – Payroll  Lack of appropriate approvals for overtime, rate of pay, commission rates  Did not use a separate bank account (impress account) or use direct deposit  No approvals for all changes in the employee master file  No external review of payroll registers and general ledger to tax reporting  Did not designate someone outside of payroll as contact for taxes, etc.  No comparison of the number of employees to actual number of payroll checks issued  No periodic review of paid leave and vacation totals per employee
- 15. What Went Wrong – Expense reimbursements  Original receipts not required  P-Card statements, credit card statements, etc. not reconciled or not reconciled timely  No requirement to close out cash advances  No comparison to prior year’s expenses  No review of support documentation for duplicates, sequential numbers, or unusual amounts.  No comparison of dates of expenditures to expected travel dates  No review and approval of expense reports  No established policies regarding travel, hotel and meal guidelines and limits on entertaining
- 16. What Went Wrong – Financial Statement Fraud  Lack of effective oversight  Organizational structure complex with no clear lines of reporting authority  Lack of the appropriate “Tone at the Top”  Setting unachievable financial goals and applying excessive pressure to employees to achieve them  Unfair compensation systems with compensation based upon incentives  Lack of physical security or restricted access  No clear and uniform accounting procedures
- 17. Internal Controls Modified or Implemented Increased Segregation of Duties Management Review Surprise Audits 2010 Report to 4% 3% 2% Fraud Training for Employees the Nation 4% 3% 2% 2% 1% Job Rotation/Mandatory Vacation 5% 26% Internal Audit/FE Department Anti-Fraud Policy 9% 21% Code of Conduct 5% External Audit of F/S 6% 7% Hotline External Audit of ICOFR Independent Audit Committee Management Certification of F/S Rewards for Whistleblowers Employee Support Programs