Fraud and Corruption

June 18, 2024 1

 Overview of fraud

June 18, 2024 2

 Ovewrview of ethics
What is Ethics:
 They include the way we make decisions when it is not completely
clear what is right. And they are about doing the right thing: even
when alternative options are legal and procedurally correct some
choices may be better than others.

 Ethics are not simply about acting according to the law or in

compliance with policy; they are also about acting with consideration
for values, perspective, judgment and consequences
 The law is one basic promoter of ethic behaviour. The law, however, only set a
minimum standard for ethical conduct. Just because an act is legal, does not
automatically mean it is ethical (think of the apartheid laws, for instance). Nor is an
illegal act necessarily immoral (sometimes it can be justified to break the law).

June 18, 2024 3

 Overview of public sector ethics
What is Ethics:
 Ethics can be categorised into:
 Normative ethics which describes the standards for the rightness and
wrongness of acts
 Descriptive ethics which is an empirical investigation of people’s
moral beliefs.

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 Overview of public sector ethics
Why public sector ethics:
 The public sector is composed of two core elements; at the political
level there are the political institutions where policies are formulated
and the (major) decisions are made, and at the administrative level
there is the public sector administration, which is in charge of
implementing these policies and decisions.

 This implementing level is also called the civil service or state

administration or bureaucracy (i.e. public sector managers). The
distinction between politics and administration is not entirely clear,
however, because the administration also have quite some
discretionary powers.

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 Overview of public sector ethics
Why public sector ethics:
 Public sector activities range from delivering social security, administering
urban planning and organising national defence to the provision of health,
schools and roads. In principle, there is no limit to what the state can do.
There is, however, much debate on how much the state should intervene,
like in the economic sectors and in the private life of their citizens.
 This is a political question, and the debate about the role and the size of
the state and the public sector (as opposed to the private sector) is
probably the single most important dividing line in political philosophy,
with the socialists preferring greater state involvement, libertarians
favouring only minimal state involvement (security and property
protection), whereas conservatives and liberals are favouring state
involvement in some aspects of the society but not others.


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 Overview of public sector ethics
Why public sector ethics:
 Ethics is rarely a matter of concern in the ideology debate on the role
of the state, but ethics is a natural concern in the discussion on the
actual role of the politicians and the state administration. No matter
how big and what role the state is playing (and supposed to be
playing), both politicians and civil servants have discretionary powers;
they make decisions that affects a lot of people. Therefore, these
decisions ought to be based on some form of ethics. For instance, the
public (a nation’s citizens) will normally expect the country’s politicians
and public servants to serve in the public interest, and to serve in a
rational and efficient way. They will not want them to pursue narrow
private, personal, or group interests.

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 Overview of public sector ethics
Why public sector ethics:
 There are also some differences between public sector ethics and
private sector (business) ethics. The aim of the private corporation or
business is, in general, to make money, whereas the public sector is
meant to perform functions for the society as a whole, according to
general and political priorities. For instance, a private company can
choose to donate some of its profits to charity, but a public agency
may be prohibited from such largesse with public funds (without a
specific mandate to do so).

 Ethics of public sector is (should be) based on five basic virtues;

fairness, transparency, responsibility, efficiency and no conflict of
interest.

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 Ethics and public sector auditing
Why ethics are important to public sector auditors:
 Ethic principles should be embodied in an auditor’s behaviour. The
SAIs ethical policies should address ethical requirements and
emphasise the need for compliance by each individual auditor.

 Ethics ensure that the audit is conducted with a professional attitude.

The key principles of ethics are integrity, objectivity, professional
competence and due care, confidentiality and professional behaviour.
Auditors should be honest, reliable and truthful when conducting an
audit. Auditors should remain independent so that their
opinions/conclusions/findings will be impartial and be seen as such by
third parties.

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 Ethics and public sector auditing
Why ethics are important to public sector auditors:
 Management of the audit organization sets the tone for ethical
behavior throughout the organization by maintaining an ethical culture,
clearly communicating acceptable behavior and expectations to each
employee, and creating an environment that reinforces and
encourages ethical behaviour throughout all levels of the organization.
The ethical tone maintained and demonstrated by management and
staff is an essential element of a positive ethical environment for the
audit organization.

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 Ethics and public sector auditing
Why ethics are important to public sector auditors:
 The ethical principles that guide the work of auditors who conduct
audits are
1. the public interest;
collective well-being of the community of people and entities the auditors serve
2. integrity;
Public confidence in government is maintained and strengthened by auditors'
performing their professional responsibilities with an attitude that is objective, fact-
based, nonpartisan, and non-ideological with regard to audited entities and users of the
auditors' reports.
3. objectivity;
Objectivity includes being independent in fact and appearance when providing audit
and attestation engagements, maintaining an attitude of impartiality, having intellectual
honesty, and being free of conflicts of interest.

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 Ethics and public sector auditing
Why ethics are important to public sector auditors:
 The ethical principles that guide the work of auditors who conduct
audits are
4. proper use of government information, resources, and position; and
Government information, resources, or positions are to be used for official purposes and
not inappropriately for the auditor's personal gain or in a manner contrary to law or
detrimental to the legitimate interests of the audited entity or the audit organization.
This concept includes the proper handling of sensitive or classified information or
resources.
5. professional behaviour
High expectations for the auditing profession include compliance with laws and regulations and
avoidance of any conduct that might bring discredit to auditors' work, including actions that would
cause an objective third party with knowledge of the relevant information to conclude that the
auditors' work was professionally deficient. Professional behavior includes auditors' putting forth an
honest effort in performance of their duties and professional services in accordance with the
relevant technical and professional standards.

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 Ethics and public sector auditing
Why ethics are important to public sector auditors:
 Hence ethics are important to auditors because they help them
1. Perform duties with skill, care, diligence and integrity
2. Comply with applicable laws
3. Treat members of the public sector organizations with courtesy and respect
4. Avoid waste and extravagance in the use of public resources
5. Disclose possible conflicts of interest and suggest actions to avoid those conflict of
interest
6. Not to use status, duties, power, authority or inside information to gain personal
benefits or seek personal benefits

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 Fraud
What is Fraud:
 What is fraud, anyway? You hear the term
“fraud” thrown around a lot, but, what does
it mean? One court wrote: “the law does not
define fraud; it needs no definition; it is as
old as falsehood and as versatile as human
ingenuity.

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 Fraud
 Fraud is an activity that takes place in a social
setting and has severe consequences for the
economy, corporations, and individuals. It is an
opportunistic infection that bursts forth when
greed meets the possibility of deception.
 The fraud investigator is like the attending
physician looking and listening for the signs and
symptoms that reveal an outbreak.

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 Fraud definitions

The Association of Certified Fraud Examiners:

the use of one’s occupation for personal enrichment through
the deliberate misuse or misapplication of the employing
organization’s resources or assets.
Black’s Law Dictionary:
A knowing misrepresentation of the truth or concealment of
a material fact to induce another to act to his or her
detriment. It could be a tort (civil matter) or it could be
criminal

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 Fraud definitions

William L. Jennings
Fraud is an intentional material misrepresentation or other
deceit reasonably relied upon by a person or persons
resulting in economic loss or other detrimental consequence
to that person or persons in the case of business or other
entities.
the deceit must be

√ material,
√ intentional, and
√ reasonably relied upon in causing the loss or other damage

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 Fraud
What is Fraud:
 For explanation of materiality and other characteristics
 ..\..\Fraud Investigation and Forensic Accounting in the Real World.pdf
page 1
Fraud function
 DESIRE > FEAR = ACT
 When someone’s desire to obtain something (e.g. travel,
clothes, jewelry, real estate, aircraft, drugs, gambling, debt
relief, medical care, revenge, etc.) not obtainable by ethical
or legal means exceeds their fear of getting caught; the
threshold criminal will act.

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 Fraud
What is Fraud:
 What happens after a person commits a
crime and is not caught?
 the fear of getting caught drops dramatically;
the person concludes, “Well that was easier
than I thought; no one was even checking .
 the desire remains the same or even increases
as is often the case with gambling problems.

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 Fraud
What is Fraud:
 You don’t think they are able to build all
those giant casinos by letting the patrons
walk out with their money, do you?
 In fact it is a mathematical certainty that if
you continue gambling in a casino for long
enough, no matter any interim winnings you
may have, the casino will end up with all of
your money.
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 Fraud
What is Fraud:
 It is useful to think of the Fraud Function when
designing systems to prevent fraud and when
investigating fraud.
 For example, increasing fear increases the threshold to
act and reduces its likelihood.
 The Fraud Function also provides a convincing
proof that even small frauds left undetected can
grow quite large over time.

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 Fraud
 A person’s perception of reality is their reality. If you are
able to create the perception, with employees and other
stakeholders, that you are watching and will always catch
any criminal conduct and violations of company policy, no
matter how real that expectation is, it will raise the
threshold for commission of an inappropriate act
significantly. If, on the other hand, you create a perception
of lax oversight and security, you will provide license to
every employee and stakeholder who is motivated to
commit fraud.

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 Fraud
 Impact of fraud in the organization
√ Direct Cost = Assets Lost + Encumbrances Incurred – Mitigation
√ Brand Value = Loss in Intrinsic Value of the Organization’s Brand
√ Market Cap = Loss in the Value of Shares of the Company’s Stock
√ Internal Investigation = Cost of Professionals + Internal Resources to
Conduct Internal Investigation
√ Securities Litigation = Cost of Defending and Settling Shareholder
Lawsuits
√ Personnel = Increased Recruiting, Training, and Monitoring Costs
√ Other Stakeholder = Increased Cost of Doing Business
√ Cost of capital = Additional costs or raising capital
√ Legal = Cost of Additional Regulatory or Legal Structures
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 Types of Fraud

1. Sales and Collections/Receipts

2. Purchases and Payments (Disbursements)
3. Personnel and Payroll
4. Inventory and Warehousing
5. Monthly Reconciliations and Reporting

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 Sales and Collections/Receipts
 The sales and collections cycle invoices customers or
clients for sales of goods or services, and subsequently
collects payments on the sales.
 This cycle is the most cash-intensive of the five cycles, with
the access and opportunity to divert customer payments
(cash and other forms) at greatest risk.
 Theft of cash or other customer payments
 Theft of other assets
 Kickbacks to customers
 Front-end frauds

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 Purchases and Payments (Disbursements)
 This cycle includes the purchasing of and payments for
goods, equipment, and services used in an organization’s
operations.
 In this cycle a number of schemes could occur, within the
purchasing process as well as the payment process.
 Payments may be made by an organization through traditional means,
such as by cash or more likely cheque, or could be in the form of electronic
payments, such as wire transfers, electronic funds transfers (EFTs),
Automated Clearinghouse (ACH) transactions, debit cards, credit cards, or
any other electronic means.
 Payments may be completed by telephone or via online access through the
organization’s banking systems, and can even be made using common
hand-held wireless devices found in many of today’s business
environments.
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 Purchases and Payments (Disbursements)
 Schemes committed in this cycle:
 Setting up shell companies to receive goods misdirected from the
company by false invoices
 A bookkeeper paying personal bills through the company’s bank
account or often can be extremely complex and involve multiple
bank accounts, mail drops (deceiving addresses), and even
corporate filings for dummy entities.
 Payment fraud may involve an individual processing unauthorized
disbursements, either to him- or herself or for purchases directly
benefiting the individual.
 Procurement fraud

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 Purchases and Payments (Disbursements)
 Procurement fraud
Procurement fraud is frequently a collusive employee–vendor scheme.
The vendor typically will provide a bribe or kickback in return for business

In the case of tendered contracts, for the employee to rig the bidding in favor of

the fraudulent vendor.

Once the vendor has been awarded the contract, the cost of the bribe may be

recovered and profits increased by substituting products inferior to contract

specifications
Billing for work not completed,

Shipping lesser quantities than ordered, or

Padding (inflating) overhead expenses, etc

Collusive fraud is the most common form of acquisition-and-payment

fraud.

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 Personnel and Payroll Cycle)
 This cycle comprises:
 hiring, maintaining, and terminating employees;
 establishing salary and benefit amounts;
 maintaining timekeeping;
 tracking and approving employee expense
reimbursements; and
 all other aspects relating to compensating employees.

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 Personnel and Payroll Cycle)
 hiring, maintaining, and terminating employees;
 establishing salary and benefit amounts;
 maintaining timekeeping;
 tracking and approving employee expense
reimbursements; and
 all other aspects relating to compensating employees.
 Once personnel have been hired, measures are needed to ensure
access to employee profiles and payment information is limited, along
with ensuring terminated employees are deactivated promptly from the
payroll system.
 The payroll process involves capturing, recording, reviewing, verifying,
and approving the time worked by employees, to ensure only
legitimate individuals are appropriately and accurately paid.
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 Personnel and Payroll Cycle)
 Common fraud schemes perpetrated within this cycle:
 paying ghost employees (fictitious employees on the system that do not
exist),
 paying terminated employees beyond their termination date and diverting
their paycheques,
 overstating hours worked,
 overstating expenses incurred and submitted for
 reimbursement, and
 filing false medical claims
 Cause: submission of false expense account, improper
vetting of job applicants, collusion between a personnel
department employee and an applicant which could
result in the hiring of a fraudster

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 Inventory and Warehousing Cycle
 This cycle controls the purchase and storage of goods for
later processing and sale, or for direct sale.
 The most common frauds in this cycle are:
 ordering unnecessary or excess inventory, and then stealing it for personal
use;
 committing outright theft of inventory; and
 charging embezzlements occurring elsewhere in the company to inventory
losses.
 In some schemes the inventory is never physically received
at the business, but rather is diverted on the truck or on
the loading dock, or shipped directly to an address of the
individual or co-conspirator.

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 Monthly Reconciliations and Reporting Cycle
 This is perhaps the most important cycle for detecting
frauds and embezzlements.
 Every business and organization must have a properly
designed and timely performed month-end process, if for
no other reason than to have the ability to detect potential
unauthorized or fraudulent transactions and activity as
quickly as possible.
 Month-end procedures typically start with the bank reconciliations and
continue with the recording of standard monthly entries.
 If the system used is not integrated (some system areas do not
automatically post to the general ledger), each nonintegrated area needs
to be posted manually to the general ledger.
 Accounts are then reconciled, and once the activity is posted, draft
financial reports are generated and reviewed.
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 Monthly Reconciliations and Reporting Cycle
 Here there is a need of segregation of duties
within this area to ensure the individual performing
the bank reconciliations is not the same person
who handles any aspects of accounts receivable
(processes deposits) and accounts payable
(processes cheques).
 Individuals independent of the day-to-day
accounting must be involved to either perform or
review much of the month-end process if
unauthorized activity is going to be detected.
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 Other types of fraud
 Management fraud –Financial statements fraud
 management manipulation of the financial statements that enriched
a few but caused the collapse of company pension plans, enormous
losses to innocent shareholders, and unemployment for thousands
of individuals.

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 Categories of Occupational fraud (per
ACFE)
 Asset misappropriation
 the theft or misuse of funds or assets, and accounts for 86 percent of all
occupational fraud according to the 2010 study
 Fraudulent statements
 those involving the intentional misstatement or omission of material
information in the organization’s financial reports.
 Common methods of fraudulent financial statement manipulation include
recording fictitious or premature revenues, concealing liabilities or
expenses, and artificially inflating reported assets
 Corruption
 involve the employee’s use of his or her influence in business transactions
in a way that violates his or her duty to the employer for the purpose of
obtaining a benefit for him- or herself or someone else. Examples of
corruption schemes include bribery, extortion, and conflicts of interest
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 Fraud investigation
Fraud Investigation:
 A fraud investigation is an examination of evidence to
determine if someone deliberately deceived others to
unfairly advance their own interests.
 In terms of Trust and Safety, it involves identifying
marketplace rules violations and other behaviors that could
pose risks to users and the system.

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 Fraud investigation
Auditing vs. Investigation:
 What is the difference between auditing and investigation?
 Investigation is the act of detail examination of activities so as to achieve a certain
objectives. Specifically investigation is made in suspected places. It finds out the
nature and reasons of suspected areas but auditing is the act of examining books of
accounts so as to prove true and fairness of operating results and financial position
of the organization.
 In other words; investigation is a term that generally applies to an inquiry aiming at
uncovering hidden facts and establishing the truth. This includes, but not limited to,
probing and deep and extensive searching with intent to detect wrongdoing.
However auditing may investigate but the investigation is different. Auditing imply
objectivity.

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 Fraud investigation
Auditing vs. Investigation:
 What is the difference between auditing and investigation?
1. Purpose
 An audit is carried out for the purpose of ascertaining whether or not the balance sheet and profit
and loss account show true and fair view of the state of company's affairs and its profit or loss. But
an investigation aims at establishing a fact or is carried out for some particular purpose i.e. to know
the financial position of the concern or the earning capacity of the concern etc.
2. On Behalf
 An audit is carried out on behalf of the proprietor of the business, while an investigation may be
conducted on behalf proprietors when they suspect any fraud in their business or on behalf of outside
parties who wish to lend money or intend to purchase business or at the instance of the government
on the request of the shareholders.
3. Scope
 An audit includes only an examination of the accounts of a business whereas an investigation covers
not only an examination of the accounts but also an inquiry into other relevant matters connected
with the purpose for which it is undertaken.

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 Fraud investigation
Auditing vs. Investigation:
 What is the difference between auditing and investigation?
4. Use Of Techniques
 An audit is usually a test checking but an investigation is a much more thorough examination of the
books of accounts. It goes into the depth of the problem and keeps on looking for far more definite
evidence to arrive at a conclusion that it can firmly substantiate. Further, investigation may be
conducted even after the audit of the accounts.
5. Period
 An audit is related to only a year or six months while investigation may cover several years.
6. Statutory Obligation
 In most cases, audit is compulsory under law while there is no such statutory obligation with regard
to investigation.
7. Examination Use Of Policies
 In audit, an auditor has to see whether the methods of valuation and other accounting policies have
been consistently followed or not and he has to ensure that all disclosures have been properly made
in the financial statements, while an investigation is not at all bound by accounting conventions,
policies and disclosure requirements.

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 Corruption
 Corruption is related to public governance.
 The term governance is generally used to encompass all
aspects of the way a country, corporation, or other entity is
governed.
 Good governance is a precondition for the sustainable
development of societies and regions.
 Corruption is a narrower concept than governance as it is
often defined as the abuse of public authority or trust
for private benefits.

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 Corruption
 Types of corruption
 Individualized corruption –
 involving a definite number of people
 collective corruption –
 extending to entire interest groups, leading to
dependencies in which the donor becomes the
recipient and vice versa

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 Corruption
Using actor-centric approach (giving and accepting
corruptive advantages)
 Passive corruption –
 involves the deliberate action by an official, who, directly or through an
intermediary, requests or receives advantages of any kind whatsoever,
for himself or for a third party, or accepts a promise of such an
advantage, to act or refrain from acting in accordance with his duty or
in the exercise of his functions in breach of his official duties
 Active corruption –
 involves the deliberate action of whoever promises or gives, directly or
through an intermediary, an advantage of any kind whatsoever to an
official for himself or for a third party in order for him to act or refrain
from acting in accordance with his duty or in the exercise of his
functions in breach of his official duties

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 Corruption
Using actor-centric approach (giving and accepting
corruptive advantages)
 Petty corruption –
 involves substantial amount of money and usually high-level officials
 Grand corruption –
 involves smaller sums and typically more junior officials.

Corruption is associated with nepotism or

favoritism, clientelism, cronyism, patronage,
graft, bribery, extortion, embezzlement, theft
and fraud.
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 Corruption
Causes of corruption
Flaws of human nature (the urge to enrich one quickly by dishonest
means makes this phenomenon persistent in any society, regardless of a political
system)
The tolerance for corrupt behavior based on cultural and
historical background
Mistakes of state economic policies (in the circumstances of a
shortage economy, with mismatched supply and demand, a desire to get some
consumer goods may generate corrupt behavior)
 Fraud Triangle model (Incentive/pressures: The need a corrupt person is
trying to satisfy by committing a dishonest act. • Opportunity: The ability of the
corrupt person to act dishonestly due to his/her position. • Rationalization: The
corrupt person’s ability to justify the act in his/her mind.)

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 Corruption
Causes of corruption
Restriction on the freedom of business (by imposing restrictions on
business transactions may give rise to secret agreements, various informal groups,
which can affect the existing society system)

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 Corruption
 Why the corrupting party pays bribes:
 access to restricted goods, for instance contracts,
licenses, permits, real property in attractive city districts,
 access to information, for instance on the contractual
terms and conditions, on a bill of quantities with prices,
on the activities planned by decision makers,
 favorable treatment of some matter, which allows
avoiding or cutting some costs, depriving other entities
of some benefits.

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 Cost of Corruption
 Corruption generates costs. However, the problem
with corruption is that unlike other crimes, those
that are victims of corruption are often not directly
linked, either in place or in time, with the corrupt
activities.
 Costs:
 Cost to the economy (the money looted usually leaves the country and is
thus not accessible there anymore for other productive or redistributive
purposes)
 Detrimental effects on overall governance and on the quality of public
services
 Negatively affects productivity and deters investments
 Environmental quality suffers
 Undermine the system of democracy

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 Role of auditors on corruption
 Incorporating corruption and wrongdoing issues in auditor’s
routine audit work;
 Heightening public awareness of corruption and other
wrongdoing through timely and public disclosure of audit
findings;
 Improving methods and tools of combating corruption and
other types of wrongdoing;
 Providing a means for whistleblowers to report instances of
wrongdoing; and
 Cooperating with other institutions in the fight against
corruption

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