Chapter 7 Reading Notes : Internal Control

Fraud is defined as the intentional deception or misrepresentation of facts that can result in unauthorized benefit or payment. Abuse is

Kadushin describes a supervisor as someone "to whom authority is delegated to direct, coordinate, enhance, and evaluate on-the-job performance of the supervisees for whose work he/she is held accountable. In implementing this responsibility, the supervisor performs administrative, educational, and supportive functions in interaction with the supervisee in the context of a positive relationship" (Powell, 1993).

According to the SAICA (South African Institute of Chartered Accountants) Handbook (2011: 240), “fraud refers to the ‘intentional act’ by one or more individuals amongst the management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage.” The primary function of the auditor is not to unearth fraudulent acts , but while performing the audit , the auditor is concerned acts of fraud which result in material misstatements in the financial statements. Cases of fraud involving one or more members of management or those charged with governance of an institution is referred to as Management Fraud.

Professional auditing standards discuss the three key “conditions” that are typically present when a financial fraud occurs and identify a lengthy list of “fraud risk factors.”

Throughout history and in our own time, legitimate accounting methods have been utilized to fraudulently engage in manipulating activities that results in illicit gains to the perpetrators and losses to individuals and financial institutions.

Fraudulent financial reporting is one form of corporate corruption and may involve the manipulation of the documents used to record accounting transactions, the misrepresentation of accounting events or transactions, or the intentional misapplication of Generally Accepted Accounting Principles (GAAP) (Crumbley, Heitger, and Smith, 2013). Examples of fraudulent schemes befitting of this category abound and usually involve financial statement items that have been misclassified, omitted, overstated, undervalued, or prematurely recognized. One case involving CEO Bill Smith of Moonstay

2 Managing fraud risk: The audit committee perspective Fraud in a fi nancial statement audit

Questions: 1. What is fraud? (1 mark) Fraud is the intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right. 2. List some examples of medical fraud.

The manipulation of accounts fraud scheme is generally fulfilled by employees in top management positions and it usually involves making understatements or overstatements on financial statements making it very hard to detect. The process followed as Troy Adkins, (2015) explains is very simple. The financial statements are either overstated to show different figures in the earnings on the income statements making them look better than they actually are or the earnings in the current periods are manipulated in such a way that the revenue is understated or they inflate the current year’s expenses. The second process includes making the financial statements look worse than they are in reality. Deloitte, (2009) explains a number of ways which the accounts are manipulated where as one of the ways is to manipulate the reported earnings directly. They further explained that overstating the

Some industry-specific factors, such as having valuable near-cash assets, can increase the organization's vulnerability. Also they will need to rationalize the actions as justifiable. The individuals committing the fraud must first convince themselves that their behavior is acceptable or will be temporary. For example, Barry Minkow’s believed that the lies and deceit are for the betterment of his company and that with time everything will eventually return to normal.

More fundamentally giving each division manager the responsibility of its divisions operations and not allowing it to interfere with other divisions.

Fraud is defined as a deliberate misrepresentation that causes a person or business to suffer damages, often in the form of monetary losses through deception or concealment. And Occupational Fraud as defined by the ACFE is the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets. Traditional fraud triangle theory by Donald Cressey explains that propensity of fraud occurring in an organization lies on three critical elements which are Pressure, Opportunity, and Rationalization.

Edens ensures that his employees work properly under his order at the right time to achieve the efficiency of productivity. He watches his employees on the TV monitor that showed by the eight cameras posted through the plant. He zooms in and out the flashes images by using remote control in order to watch carefully about every detail. Supervisors and managers keep watch of the employees from behind from a raised platform. They are ordered to observe the employees’ action to figure out how someone’s day is going and avoid any error to make sure everything goes smoothly. Besides that, computer system in Mr. Edens’ organization is set to assist and check the employees on the work. For instance, if an employee makes a mistake, the computer will buzz up a message as a reminder of error. This will remind the employees to do the right things and applying the principle of control figure out the mistake and take the corrective action. His organization also provide the control card that listing the ‘time in’ and ‘time out’ for the tray of envelopes. As we can see, Mr Edens organization is functioning under good order and control. Mr Edens has close surveillance over his workers through the cameras to ensure everything is under good control. As a manager, keeping watch of his employees’ actions will give him an advantage of acknowledging every move of his employees to reduce the tendency of them making work-related mistakes as they know that they are being watched. Even if a mistake has occurred and they do not how to handle it and take corrective action, Mr Edens can immediately come up with a solution as he was looking at the whole process. Furthermore, if a worker overlooked a mistake regardless of it being major or minor, Mr Edens would already identify it through his close surveillance over his workers. This can reduce the impact of the mistake if it is treated instead of being ignored by the careless workers who

The fraud has two different kinds, un-management fraud and management fraud. The un-management means individual fraud is the company’s employee use the defect of the management, illegal to get assets from the company, it has some ways to get the assets, forged documents, complicity or collusion with others. It commonly the employees use their duties to make some profit for themselves from the company. When the company loss internal control, the individual can commit the fraud, this is dishonest. The defect of the internal control is the circumstance for these individual fraud. The company has this background, even

Fraud refers to an intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage, such as: