Chapter 5
RECOGNIZING THE SYMPTOMS OF FRAUD
Discussion Questions
1. With fraud, it is not always apparent that a crime has been committed. Therefore, it is important that observers watch for red flags, or symptoms, in order to detect fraud. Without fraud symptoms, it would be very difficult to detect fraud.
2. When internal controls are absent or overridden, an opportunity is created, and the risk for fraud increases greatly. By focusing on the internal controls that are absent or overridden, we can identify possible areas and suspects, helping us to detect possible fraud.
3. Accounting symptoms or anomalies involve problems with source documents, faulty journal entries, and inaccuracies in ledgers. These also include any record, electronic or paper, that is unusual.
4. Analytical symptoms or anomalies are procedures or relationships that are unusual or too unrealistic to be believable. They include transactions or events that happen at odd times or places, or that include odd procedures, policies, or practices. They also include transactions and amounts that are too large or too small, that occur too often or too rarely, that are too high or too low, or that result in too much or too little of something. Basically, analytical anomalies are anything out of the ordinary.
5. Most people who commit fraud do so under financial pressure. Sometimes the pressures are real; sometimes they represent simple greed. Once perpetrators meet their financial needs, however, they often continue to steal, using the embezzled funds to improve their lifestyles. They buy new cars. They buy other expensive toys, take vacations, remodel their homes, or move into more expensive houses. Fraud investigators can detect fraud by focusing on these changes in suspected perpetrators’ lifestyles.
6. Research in psychology indicates that when people (especially first-time offenders, as many fraud perpetrators are) commit crimes, they are overwhelmed by fear and guilt. When perpetrators feel this fear and guilt, they change their behavior. For example, a nice person suddenly becomes mean or angry. Or a person who normally has lots of patience no longer is patient with anyone.
Although no particular behavior signals fraud, it is the changes in behavior that signal possible fraud. By focusing on these changes, we can identify possible perpetrators of fraud.
7. Tips and complaints are categorized as fraud symptoms rather than actual evidence of fraud because many tips and complaints turn out to be false. It is often difficult to know what motivates a person to complain or provide a tip. Customers, for example, may complain because they think they are being taken advantage of. Employees may phone in tips for reasons of malice, personal problems, or jealousy. Tips from spouses and friends may be motivated by anger, divorce, or blackmail. Therefore, tips and complaints must be treated with care and initially only as symptoms of fraud, not as evidence of it. Individuals must always be considered innocent until proven guilty.
8. Theft is the actual taking of cash, inventory, information, or other assets. Theft can occur manually, by computer, telephone, or other electronic means.
9. Conversion has to do with selling stolen assets or converting them into cash and then spending the cash. If the asset taken is cash, conversion is the spending of the stolen funds.
10. Concealment involves the steps taken by the perpetrator to hide the fraud. In concealment, financial records are altered, cash or inventory is miscounted, or evidence is destroyed.
11.
a. If you are an auditor, you are responsible to report internal control weaknesses to the Board of Directors or management. If the company is a public company then you will be required under Sarbanes-Oxley Act, Section 404, to audit the internal controls. The severity of the weakness will determine the extent of your reaction to a control weakness. Auditing concepts such as materiality come to play in this decision but that discussion is beyond the scope of this text.
b. If you believe the coworker is exhibiting signs that he or she has been committing fraud you might report this to someone in the organization who can investigate it. Many companies have whistle-blowing systems in place that would allow you to report this activity anonymously. You might also investigate the opportunities for this coworker to commit fraud. Perhaps there is inadequate segregation of duties or other control weaknesses that the company is not aware of.
c. If you are in a position to embezzle from the company then you will want to notify someone above you of the control weakness so that you are not tempted to take advantage of the situation. You can present this information to your superior in the spirit of improving the company’s controls and preventing future problems.
Multiple Choice
1. b
2. c
3. e
4. a
5. a
6. d
7. d
8. d
9. c
10. d
11. b
12. a
13. b
14. c
15. d
16. d
17. b
Short Cases
Case 1
1. The business is at risk because there is no separation of duties. Cal Smith, Jr. works the night shift alone and then accounts for and deposits the money at the bank in the morning.
2. Possible symptoms:
• Cal has never missed a day of work.
• Cal feels he is overworked and underpaid.
• Numerous doughnuts are thrown away for over baking.
• Cal was hired because he was friendly; he is now often angry and frustrated.
• Cal has not been getting very much sleep.
• Cal recently purchased the car of his dreams.
3. Possible steps to reduce opportunities for fraud:
• Have other employees work at night.
• Do not allow Cal to make the deposits or handle cash.
• Force Cal to take some time off periodically.
• Pay Cal more money so he does not feel overworked and underpaid.
Case 2
1. It is possible that James could be committing fraud.
• Fraud symptoms:
• Outstanding bills need to be paid.
• Lawsuits are pending from lack of payment.
• James drives nice cars.
• James has a very expensive home.
• James will not update equipment.
• James is known for losing his temper.
• Many customers are complaining.
2. Most businesses experience customer complaints. While customer complaints are common, they can be possible fraud symptoms, especially if customers do not believe their accounts or charges appear appropriate. Whenever tips or complaints are received, they must be treated with care and considered as possible fraud symptoms but not as actual evidence of fraud.
Case 3
Several symptoms of fraud exist. The first is the fact that the ranch has a patented new breeding technique that can increase the population from 20 to 100 steers in two years. If this is true, why has it not been chronicled on TV or in newspapers? Next, the business has just started, and companies with a short history are not tried and tested by the business world. Performance seems suspicious with the immediate growth and phenomenal success. If it seems too good to be true, it probably is. The location in Hawaii is also suspicious, since most people cannot afford to fly to the islands and observe operations. The large growth in assets and revenues, the pressure to invest quickly, and the fact that investors have only 10 days after the initial offering to invest are all possible signs of fraud. Furthermore, the words “double your money,” “sure thing,” and “very exclusive” should tip off any educated person to the possibility of fraud.
Case 5
First, vendors with the same address are a symptom in the source documents. Lack of the needed signatures is a sign of weak internal controls or the overriding of controls. The expensive stereo system could be a sign of an extravagant lifestyle, and these symptoms could indicate the existence of fraud.
Case 10
Although fraud could be occurring, there is no conclusive proof. Several fraud symptoms do exist, but all of these symptoms could have other possible explanations. You may want to discuss possible symptoms identified in the case and even how the students would proceed in investigating the symptoms. For example, the missing receiving documents may be for goods that were personal items but recorded as inventory or legitimate business expenses. You could investigate this possibility by looking at the other supporting documents for these purchases including vendor invoices and/or cancelled checks. Also, overcharging customers may be a means for John to take funds out of the company. He may be refunding money when the customers complain but keeping it when they don’t notice. You could investigate this possibility by reviewing customer complaints and ensuring that customers are sent monthly statements for amounts due to the store.RECOGNIZING THE SYMPTOMS OF FRAUD
