Type:
Solution Manual
Resource:
Principles of Fraud Examination
Edition:
3rd Edition
Author(s):
Joseph T. Wells
Instructor's Manual for PRINCIPLES OF FRAUD EXAMINATION CHAPTER ONE – INTRODUCTION LECTURE OUTLINE I.
Fraud Examination vs. Auditing A. Fraud Examination is the discipline of resolving allegations of fraud. B. An audit is a general examination of financial data for the purpose of expressing an opinion on the financial statements.
TEACHING TIP The table entitled "Auditing vs. Fraud Examination" may be used to provide an overview to summarize the differences between Fraud Examination and Auditing. C. Fraud Examination Methodology – logical steps are taken to narrow the focus from the general to the specific. Beginning with a hypothesis, additional evidence is used to amend and refine the hypothesis as the fraud examination progresses. TEACHING TIP The graphic entitled "Evidence-Gathering Order in Fraud Examinations" may be used to provide an understanding of the steps taken to focus a fraud examination. D. Predication – the totality of circumstances that would lead a reasonable, professionally-trained, and prudent individual to believe a fraud has occurred, is occurring, and/or will occur. There must be proper predication in order to initiate a fraud examination (e.g., a tip or complaint from a third party). II.
Fraud Theory Approach A. Analyze available data B. Create a hypothesis (using a "worst-case" scenario) C. Test the hypothesis (involves developing a "what if" scenario) D. Refine and amend the hypothesis
NOTE: The goal is not to "pin" the crime on a particular individual but to determine "if" a crime was committed and "how." Tools used in fraud examinations: 1. Skill in the examination of the financial statements, books and records, and supporting documents, as well as knowledge of the legal ramifications of evidence and how to maintain the chain of custody over documents 2. Skill in interviewing witnesses with the purpose of obtaining relevant information from those with knowledge of it 3. Observation (i.e., observe behavior, displays of wealth, or specific offenses)
Internal frauds – committed by the people who work for the organization (also known as occupational fraud and abuse) III.
IV.
Occupational Fraud and Abuse – "The use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets." A.
Common elements of fraudulent activity: 1. it is clandestine, 2. it violates the employee's fiduciary duties to the organization, 3. it is committed for the purpose of direct or indirect financial benefit to the employee, and 4. it costs the employing organization assets, revenues, or reserves.
B.
"Employee" – any person who receives regular and periodic compensation for his or her labor.
Fraud – any crime for gain that uses deception as its principal mode of operation A.
The four elements of fraud include: 1. a material false statement, 2. knowledge that the statement was false when it was spoken, 3. reliance on the false statement by the victim, and 4. damages resulting from the victim's reliance on the false statement.
B.
The four elements of larceny (stealing) are: 1. there was a taking or carrying away; 2. of the money or property of another; 3. without the consent of the owner, and 4. with the intent to deprive the owner of its use or possession.
C.
Conversion – is "an unauthorized assumption and exercise of the right of ownership over goods or personal chattels belonging to another, to the alteration of their condition or the exclusion of the owner's rights."
D.
Embezzle – " willfully to take, or convert to one's own use, another's money or property of which the wrongdoer acquired possession lawfully, by reason of some office or employment or position of trust."
E.
Breach of fiduciary duty entails: 1. the existence of a fiduciary relationship between the plaintiff and the defendant; 2. the defendant (fiduciary) breached his duty to the plaintiff; and 3. the breach resulted in either harm to the plaintiff or benefit to the fiduciary.
NOTE: Fraud always entails some form of deception.
V.
(Occupational) Abuse – This category consists of a variety of petty crimes and other counterproductive behavior that have become common and even silently condoned in the workplace. It includes, for example, using company equipment for personal use, arriving at work late or leaving early, or using employee discounts to purchase goods for friends and relatives.
VI.
Research in Occupational Fraud and Abuse A.
Edwin H. Sutherland 1. coined the term "white collar crime" 2. developed the "theory of differential association" a. crime is learned i. techniques to commit the crime ii. attitudes, drives, rationalizations, and motives of the criminal mind b. this learning usually occurs within intimate personal groups
B.
Donald R. Cressey 1. studied embezzlers ("trust violators") 2. developed the hypothesis known as the "fraud triangle" a. a perceived non-shareable financial need – Circumstances that might lead to embezzlement: i. violation of ascribed obligations ii. problems resulting from personal failure iii. business reversals iv. physical isolation v. status gaining vi. employer-employee relations b. perceived opportunity – Two components to commit a trust violation: i. general information – the knowledge that the employee's position of trust could be violated ii. technical skill – the abilities necessary to commit the violation c. rationalization – Embezzlers generally rationalize their crimes by viewing them as: i. non-criminal ii. justified iii. part of a general irresponsibility for which they were not completely accountable
C.
Dr. W. Steve Albrecht – developed the "Fraud Scale" 1. situational pressures 2. perceived opportunities 3. personal integrity
D.
Richard C. Hollinger 1. The Hollinger-Clark Study a. found that employees steal primarily as a result of workplace conditions, and b. concluded that the true costs of employee theft are vastly understated 2. Five Hypotheses of Employee Theft a. external economic pressures b. contemporary employees are not as honest and hardworking as those in past generations c. every employee could be tempted to steal from his employer d. job dissatisfaction e. broadly shared formal and informal structure of organizations 3. Employee Deviance – Hollinger and Clark identified two categories of employee deviant behavior: a. acts by employees against property, and b. violations of the norms affecting productivity 4. Income and Theft – There is a statistical relationship between employees' concern over their financial situation and the level of theft. 5. Age and Theft – There is a direct correlation between (younger) age and (higher) level of theft. 6. Position and Theft – The research of Hollinger and Clark indicated that thefts were highest for those with greater access to the things of value in the company. 7. Job Satisfaction and Deviance – Employees who are dissatisfied with their jobs are more likely to engage in counterproductive or illegal behavior in order to right the perceived "inequity." 8. Organizational Controls and Deviance – Formal organizational controls do not provide a strong deterrent effect on employee theft. 9. Employee Perception of Control – Increasing the perception of detection provides a significant deterrent to employee theft.
E.
Uniform Occupational Fraud Classification System (also known as the Fraud Tree) – There are three categories of occupational fraud: 1. Asset misappropriations – involves the theft or misuse of an organization's assets. 2. Corruption – involves an act done with the intent to give some advantage inconsistent with official duty and the rights of others. 3. Fraudulent statements – involves the intentional misreporting of financial information about a company to mislead the users of the financial statements.