Tools Used for Examining Frauds - Term Paper Example

 Tools Used for Examining Frauds Introduction Financial Fraud can be defined as the pre-meditated act of deceit that involves monetary transactions with the objective personal benefits. It is considered to be a crime and is also the violation of civil law (Academic and Business Research Institute, 2005). Many fraud cases occur because of the engagement of many by financially inspired non-violent criminals like business specialists and government professionals with an expertise and criminal intentions. Fraudsters usually perform a long and extensive research on the potential victims. They contact clients through phone, post, messages and emails or through face to face interactions. They grab the attention of the clients by promising them quick money (Coderre, 2009). Detection of financial frauds required experienced forensic accountants. They are basically accountants, auditors and investigators of financial and legal documents who are hired by the company to look into possible financial frauds taking place. Types of Financial Frauds There are different varieties of financial frauds. The range can spread from a simple theft to more complicated frauds and identity thefts. Some of the common types of financial frauds are; check fraud, banking/identity fraud, directs theft, invoices and payments fraud. Four basic frauds that occur in a business are; Embezzlement, internal theft, payoffs and kick backs and skimming (Imoniana, Antunes & Formigoni, 2013). Embezzlement which is also known as larceny occurs when the personnel who are appointed to control the funds, use them illegally for their personal gain (Petrucelli, 2013). Internal theft takes place when company assets such as company products or supplies are stolen by the employees. This causes inventories to shrink down. Pay-offs and kick backs are kinds of bribery which are often reported by the companies. These occur when employees take money from the receipt and that transaction is not recorded. Other important frauds are Money laundering, Mortgage fraud, Racketeering/ RICO, Securities fraud, payroll-fraud, manipulation of sales figures, tax evasion, use of fictitious invoicing, stealing money from company accounts, duplicate billing, accounts receivable fraud, financial statement fraud, etc. Money Laundering is the process of movement of illicit money and other profits through legitimate channels with the purpose of disguising the illegal source of the money to prevent from tax officials (Wells, 2010). Mortgage fraud is a crime committed by intentionally misrepresenting or omitting important information from the mortgage loan application with the objective of misleading other party. According to Fich and Shivdasani (2007), the RICO and federal laws, criminal organizations are prohibited from making profit with operations of the legitimate business. Securities fraud/stock fraud/investment frauds occur in stock or goods market in which investor’s sale or purchase stocks is based on the false information and hence suffers loss. Payroll-frauds occur when payrolls are not reconciled to the company’s time-keeping system. Manipulation is done with the purpose of achieving bonus and reaching target. The process includes booking and crediting sales in different months. Evasion of taxes by formulating complex structures to conceal the revenue streams from tax authorities. Fictitious voices are used for the payment from the connected parties (Hopwood, 2011). When employees redirect money or check which was meant to enter company’s account into their personal account, then that type of fraud is known as the accounts receivable fraud. Financial statements frauds can be perpetrated even by the top management officials. In such fraud, the managers falsely showcase the failing company as a profitable one with the aim of obtaining larger perks. Understating liabilities and expenses and overstating assets are examples of financial statement frauds. Methods of Detecting Frauds So far, we have identified the types of financial frauds. It shows how adversely it can affect not only the smooth functioning of a business, but also the profit levels. In such a scenario, a forensic accountant plays a major role. Imoniana, Antunes and Formigoni (2013) explained that a forensic accountant analyses, interprets, summarizes and presents complicated financial and business issues. They apply different techniques using different software packages for detecting frauds. They support their finding with the help of reports and other collections of documents, assists in legal proceedings, testify in court as an eye witness, etc. Owing to the advent of internet and technology, advanced techniques and methodologies are applied for detecting frauds. Techniques for detecting frauds can be broadly classified into two broad classes: statistical techniques and artificial techniques. Kranachar, Rile and Wells, (2010) observed that the statistical techniques consist of a series of steps. They are detection, error corrections, validations and filling up of missing data; proper calculations of mathematical parameters, probability distributions and models of various business processes, applying time series analysis for processing of time dependent data, to find degree of associations between different groups of data. To detect abnormalities in the behavior of users or transactions compared to previously formed models, algorithms are matched. Techniques are also applied to erase false alarms, risks, etc. Some forensic accountants apply forensic analyzing techniques, which is the acquisition and analysis of electronic data. The steps involved in forensic analytics are: data collection, data preparation, data analysis and reporting. Forensic analytics can be useful in detecting invoicing activity. Fraud management includes extensive knowledge based scientific procedures like data mining. Data mining is a procedure of evaluating data and structuring descriptive and complex models for finding optimal solutions. Two most important categories of data mining are Decision Tree and Neural networks (Petrucelli, 2013). To classify the type of problem, decision tree is used. It is basically a tree like graph of decisions and their results. Neural networks try to imitate the workings of a human brain towards information. These are also statistical models influenced by biological neural channels. Artificial Techniques also comprises of some steps: applying data mining techniques to classify and combine data to discover possible associations in the data which may indicate patterns which are related to fraud, including expert systems, patterns are recognized to detect formations of suspicious behavior, techniques applied with the help of machines to detect characteristics of a fraud, using neural networks that can identify suspicious behavior of samples. According to Stamler, Marschdorf and Possamai, (2014), there are other modern techniques like Land Sequence Matching, Link Analysis, Bayesian Networks, Decision Theory, etc. Artificial Intelligence and Machine learning solutions are categorized into supervised and unsupervised learning (Hopwood, 2011). In supervised learning, random sampling is applied and the resulting sub samples are named either as fraudulent or non-fraudulent. These data are then run in administered machine learning algorithm. After the construction of the model, the new records are classified as either fraudulent or non-fraudulent. On the other hand, labeled records are not used in unsupervised methods. According to the Statement on Auditing Standards (SAS) No. 82, auditor access the liability of fraud during individual audit and requires the auditors to take into account the management’s attitude and internal control system (Baldwin & DiPerna, (2007). Mysterious swings in the assets and liabilities balance reflect that the revenues and expenses have been manipulated. This is another simple way of detecting fraud. Prevention of Fraud The financial frauds cause malfunctioning of business. So precautions must be taken beforehand. First step towards prevention of fraud is the creation of ethical environment by the top managers. They are expected to invigilate the financial matters themselves. They should enquire complex transactions, investigate financial outcome that are always accurate because business are always prone to market risks and stock exchange fluctuations. So, if the numbers are always on target, which hints that, they are being manipulated. To avoid check fraud is either to avoid check or insists on bank check. Even if they want to pay through check, before providing goods and services they must wait for their checks to get clear (Coderre, 2009). If invoices that are received are checked against the order of commodities, then the problem of invoices can be checked. Also, engagement of more than one personnel in the payments processing system can help in reducing the invoices and payments fraud. Any employee working with the accounts of the company should be cross checked by another employee at another stage. However, this has to be consistent in nature to avoid implying that any employee is not trustworthy. Other steps include guiding and educating management to avert fraudulent activities by implementing internal controls and to identify which situations to search for. Isolating accounting functions like recordkeeping, authorization and review functions reduce the chance of committing fraud. Isolating duties of different sectors involves more than one individual who mitigates the occurrence of fraud (Academic and Business Research Institute, 2005). Establishment of a strong environment is needed. Stringent policies must be implemented mentioning the consequences when policies are violated. Hire an outside party to conduct an annual investigation of financial statements. This measure should be taken place when the management itself is engaged in the fraud. The method of preventing payroll fraud is to coordinate all payroll records and balance sheet accounts monthly or quarterly. Tools Used for Examining Frauds Financial frauds not only cause financial loss but also damages working environment. So, along with methodologies, technological facilities must also be enforced. Computer-assisted audit techniques (CAATs) or computer-assisted audit tools and techniques (CAATTs) are used widely in examining frauds related to auditing (Baldwin & DiPerna, 2007). In CAATs, computer aided procedures are used in audit process. It basically incorporates basic software’s like spreadsheets, text editing packages, word processors and other software packages which involve business intelligence and statistical analysis tools. Sometimes, even fraud theory approaches are used. They consist of steps, which starts with analyzing the available data, creating and testing the hypothesis and then the final step ends with the refinement and amendment of the hypothesis. Three tools are also implemented for examining frauds: Proper examination of financial statements, rigorous interview process, and critical observation of all the procedures. Use of fraud triangle was coined by Donald Cressey. Fraud Triangle is made up of three components. They are pressure, opportunity and rationalization. According to Cressey, pressure leads to the crime. When the employee goes through financial crisis, he starts to commit illegal actions like falsifying a financial statement or stealing cash. Opportunity here can be defined as the plan with the help of which he/she will commit the crime. He analyses methodology by which he can handle his position of trust to defraud the company without getting caught. People commit “white collar crime” to maintain their social and financial status (Stamler, Marschdorf & Possamai, 2014). The third and the last segment is the Rationalization. This is an intellectual stage where the fraudster requires high level planning for valid justification of his crime. He considers himself to be innocent and blames his financial circumstances. They are usually first time offenders (Petrucelli, 2013). Wells (2010) believes that skimming can be detected by either accidents or from tips from employees. It is either receivables or sales. Sales skimming can be detected by maintaining oversight on entrance of cash deposits into the company, installation of security cameras, providing incentives to those employees who provide reports and information on the ongoing frauds inside the company. For the prevention of receivables trend analysis is required for overdue accounts. Internal audit and internal control are two other methods for examining frauds. Audit tests are generally done to detect billing schemes with the aid of tampering. There are five important methods of identifying tampering, that is, authorized maker scheme, forged maker schemes, forged endorsement schemes, altered payee schemes and concealed check schemes (Hopwood, 2011). Conclusion Financial crime, also known as the White Collar Crime, does not capture human attention as vividly as other crimes. It is basically because these crimes bear social costs but provide benefits to the fraudsters. When financial crime is committed on a company, it becomes an issue of less concern because it is targeted on wealthy people. This perception is completely wrong because fraudsters can target common people as well. A corrupt investment broker compels his clients to purchase shares and make investments in some project. They pour heavy cash and receive bond in returns. The clients later discover that the project was false, bonds were worthless and the broker walked away with a large sum of money. Hence, awareness campaigns have to be conducted. It is essential to detect fraud as early as possible. So, with the application of scientific techniques and expertise planning fraud can be prevented to some extent. References Academic and Business Research Institute. (2005). The Role of forensic Accountants in Fraud Investigations: Importance of Attorney and Judge’s Perceptions. Retrieved from http://www.aabri.com/manuscripts/111027.pdf . Baldwin, J.N. & DiPerna, T.A. (2007). The rule of law: An essential component of the financial war against organized crime and terrorism in the Americas. Journal of Financial Crime, 14(4), 290-350. Coderre, D. (2009). Computer Aided Fraud Prevention and Detection: A Step By Step Guide. New York: John Wiley and Sons. Fich, E.M. & Shivdasani, A. (2007). Financial Frauds: Director Reputation and Shareholder Wealth. Journal of Financial Economics, 86(2), 306-336. Hopwood, W. (2011). Forensic Accounting and Fraud Examination. (2nd ed.). New York: McGraw Hill Higher Education. Imoniana, J.O., Antunes, M.T.P. & Formigoni, H. (2013). The Forensic Accounting and Corporate Fraud. Journal of Information System and Technology Management, 10(1), 1775-1807. Kranachar, M.J., Rile, R. & Wells, J. T. (2010). Forensic Accounting and Fraud Examination. New York: John Wiley and Sons. Petrucelli, J. (2013). Detecting Fraud in Organizations: Techniques, Tools and Resources. New York: John Wiley and Sons. Stamler, R.T., Marschdorf, H.J & Possamai, M. (2014). Fraud Prevention and Detection. Florida: CRC Press. Wells, J. T. (2010). Principles of Fraud Examination. (3rd ed.) New York: John Wiley and Sons. Read More