Fraud Examination Chapter 1 Summary

Chapter 1 – The nature of Fraud

Seriousness of the Fraud problem

It may seem like fraud is increasing, but it is hard to really tell. It is impossible to know what percentage of fraud perpetrators are caught. There are many frauds that are quietly settled and never made public.

The main sources of Fraud Statistics are:

• Government Agencies: FBI, FDIC, IRS, etc. They publish fraud statistics from time to time, but they only publish statistics that are directly related to their jurisdiction.
• Researchers: Data from actual frauds are hard to obtain. Therefore, research only provides an insight into the problem.
• Insurance Companies: When fraud occurs, insurance companies investigate. As a result they have some fraud statistics, but only to the extent they provided employee bonding or other insurance.
• Victims of Fraud
• The Association of Certified Fraud Examiners (ACFE) – The world largest anti-fraud organization. They conduct one of the most comprehensive studies in the U.S. Their latest study shows that U.S. Organizations lose five percent of annual revenues to fraud.

Fraud affects how much we pay for goods and services, each of us pays not only a portion of the fraud bill but also for the detection and investigation of fraud

Losses incurred from fraud reduce a firm’s income on a dollar-for-dollar basis.

For every $1 of fraud, net income is reduced by $1. It takes more revenue to recover the effects of the fraud, since fraud reduces the net income.

What is Fraud?

There are 2 ways of getting something from others illegally: robbery (force someone to give you what you want) and fraud (trick someone out of their assets).

Fraud is deception that includes the following 7 elements:

1. A representation                        2) about a material point        3) which is false                
   4) and intentionally or recklessly so,         5) which is believed                6) and acted upon by the victim                                 7) To the victim’s damage

Types of Fraud There are 3 different ways to classify Fraud.

FIRST - General Classification: Fraud can be classified in 2 groups - Committed against an organization and Committed on behalf of an organization.

SECOND - The ACFE also classifies fraud based on the definition of “Occupational Fraud”. Occupational Fraud is the use of one’s occupation for personnel enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.

With occupational fraud, the activity is clandestine and violates the employee’s obligations to the organization.  The fraudulent activity is for direct or indirect financial benefit of the perpetrator, and it costs the organization assets, revenues, or reserves.

Classifications of Occupational Fraud

1. Asset misappropriations: theft or misuse of the organization’s assets
2. Corruption: wrongful use of influence in a business transaction in order to procure some benefit for oneself or another person
3. Fraudulent statements: Falsification of an organization’s financial statements.

THIRD - Another way to classify fraud is based on who is the victim. (These are explained below)

1. Frauds where a company or organization is the victim:

1. Employee embezzlement
2. Vendor fraud
3. Customer fraud

1. Frauds where shareholders or debt-holders are the victims

1. Management fraud

1. Frauds where unwary individuals are the victims

1. Investment and other consumer fraud

1. Frauds where anyone is a victim

1. Miscellaneous fraud

Employee Embezzlement: This is the most common Occupational fraud. Employees deceive their employers by taking the company assets. The embezzlement can be direct or indirect.

Direct: employee directly steals company cash, inventory, tools, supplies, or other assets.

Indirect: employee takes bribes or kickbacks from vendors, customers, or others for lower sales prices, higher purchase prices, nondelivery of goods, or the delivery of inferior goods.

Vendor Fraud: There are two forms of vendor fraud: those perpetrated by vendors acting alone, and those perpetrated through collusion between buyers and vendors. Vendor fraud results in either an overcharge for purchased goods, the shipment of inferior goods, or the non-shipment of goods after payment is made.

Examples: bribery, bid rigging, overcharging for goods…

Customer Fraud: When customers do not pay for goods purchased, paying less than should pay for goods, or they get something for nothing. Example: defrauding a bank by asking for a cashier’s check for $500,000 when your account only has $15,000.