Fraud Detection and Investigation

Abstract

Fraud involves misappropriation of a company’s assets or misrepresentation of the company’s financial position through financial statements. Fraud is common in both small enterprises and public quoted companies. Fraud is perpetuated through manipulation of the internal control system.

Sources of information on fraudulent activities include tips from employees. The following paper is a case study of suspicion of fraudulent activities perpetuated by the plant’s controller. The audit department director gets an anonymous tip on the plant controller’s override of internal controls.

Therefore, the audit director through the audit department undertakes to investigate the allegations. The paper, therefore, is an outline of the investigative procedure undertaken by the audit director through audit department. It encompasses interviews with employees and other senior management personnel. Finally, it looks into the procedure for a successful admission seeking interview with the plant controller.

Introduction

Fraud refers to the embezzlement of company assets for personal gain or intentional misreporting of a company’s accounts in order to improve perception on a company’s financial performance. Two major forms of fraud therefore, include defalcations and financial reporting fraud. Defalcation refers to the situation where an employee uses the company’s assets for personal gain. This is either in form of corruption or asset misappropriation.

Financial reporting fraud is common in public quoted companies. It is the intentional misrepresentation of a company’s financial statements in order to increase investor confidence. Financial reporting fraud takes place in three different forms. Firstly, it involves manipulation and alteration of accounting records and supporting documents.

This includes falsified transactions. Secondly, financial reporting fraud can involve deliberate omission of a transaction, events or other significant information. Finally, financial reporting fraud can involve intentional misapplication of accounting principles.

In the following case study, Donald Reynolds, an internal audit department director receives information regarding plant controller. The information is related to the plant’s controller’s sudden change in lifestyle. Therefore, there is suspicion that he may be engaging in fraudulent activities while overriding the plant’s internal control mechanisms.

The paper looks into appropriate fraud detection measures that can be used to establish the accuracy of the above information. Secondly, it delves into investigative techniques that can be used to get evidence on the above activities.

Discussion

Fraud detection

The Association of Certified Fraud Examiners estimates that 35% of all fraudulent activities investigations are launched from anonymous tips (Association of Certified Fraud Examiners, 2010). This resulted in decreased loss associated with employee fraud. For companies that had instituted tip lines, loss from fraudulent activities was estimated at $ 100,000. On the other hand, for companies that hadn’t instituted tip lines, losses were estimated at $ 245,000.

In the above case, the director of the audit department gets an anonymous tip regarding the activities of the plant controller. The director can take several actions in to address the situation. Firstly, the director is obliged to undertake a critical analysis of the information provided by the employee.

The analysis encompasses comparison of the plant controller’s income with the lifestyle changes that the employee has indicated. Using personnel records and other sources of information, he has to establish that the plant controller is living beyond his means. This is to preserve both the plant controller’s and company’s reputation. Also, it saves the company money and time that could have been spent on the investigation.

Secondly, the director can discuss the anonymous tip with the audit department. Therefore, Donald Reynolds, director of internal audit department, can organize brain storming sessions with the audit team. He should present all the information that he was able to dig on the plant controller’s personal life to the audit team.

Also, an analysis of the weaknesses of the internal control system is then compared with the allegations of overrides as reported by the employee. A good source of potential weaknesses of the internal control system is recommendations from previous audit reports. This can be used to establish a basis from which an investigation can be launched.

It is important for the employee who provides the tip to remain anonymous. Where the director is aware of the employee, he can contact him or her for more information and clarifications. However, there are several requirements that the employee observes in the course of investigation (The Practitioner, 2010).

The employee is required not to have any contact with the person on whom the allegations have been made against. Secondly, the employee should not discuss information regarding the suspicion of fraudulent activities with anyone in the organization. Finally, the employee is should not discuss the information regarding the investigation with persons that are not part of the organization. An investigation can only be conducted after establishing the authenticity of the suspicions as presented by the employee.

Investigating embezzlement

Investigation of fraud consists of four major steps. The first step is document examination. This entails an in-depth analysis of all the firm’s transactions. This analysis encompasses provision of supporting documents relevant to a transaction. The audit team can use both internal and external documentation during the investigation.

Internal documentation includes legal agreements, business documents, accounting documents and planning and control documents. Legal agreements include leases and sales contracts while business documents include purchase orders (The Practitioner, 2010). External documentation on the other hand, refers to documents in client’s possession. The audit team is tasked to reconcile all the transactions as indicated on various documents.

The second step entails conducting interviews. Interviews are a major tool of audit. Interviews should be conducted in a logical fashion. Therefore, the audit team should start by interviewing the junior employees before interviewing the senior management. In the above case, the audit team should start by interviewing junior employees in the plant. Thereafter, they can interview the various heads of division. The procedure enables the audit establish any coconspirators in fraudulent activities.

Planning for the interviews entails several things. Firstly, the audit team has to establish clear goals of the interview (Khan, 2010). Goals include gathering facts on the fraudulent activities within the plant and ensuring confidentiality is maintained at the highest level.

Secondly, it’s important for the audit team to establish any relationships that exist between the plant controller and any of the plant’s employees. This is achieved by using personnel records to establish the history of relations between employees and plant controller. Finally, ensure that all evidence as documented from the allegations by the employee is available as it acts as a guide in formulating some of the interview questions.

Interviews should be conducted in presence of a third party. This can be a member of the management including the company secretary or a legal advisor. Documentation of the interview entails encouraging interviewees to give written statements. The statements are witnessed by the third party to ensure authenticity of the evidence collected from the interview.

Conducting an admission seeking interview

An admission seeking interview is conducted where enough evidence has been collected and linking the suspected person with fraudulent activities. In order to conduct a successful admission seeking interview, the audit team should use the following methodology. In the above case, the audit should ensure that they allocate ample time for the plant controller interview. This ensures that both the interview and plant controller have time to ask and respond to questions respectively.

To start with, there is need for the audit team to give the main aim of the interview (Carnie & Wildman, 2003). The interviewer proceeds to ask informal questions in order to establish rapport with a plant controller. The interviewer also has to observe the plant controllers reactions in order to establish the progress of the interview.

After establishing rapport the interviewer, he proceeds to informal questions. Informal questions are related to the fraudulent activities that the plant controller is suspected of engaging in. It is important that the interviewer to strike conversation in order to avoid close ended answers.

In order to prepare for a confession, the interviewer invites a third party who is responsible for taking notes from the confession. It is prudent that the third party remains anonymous to the plant controller. The interviewer thereby confronts the plant controller with evidence gathered in order to seek explanation. Finally, the confession obtained is put is writing and the plant controller is asked to sign against it.

The audit team is required to prepare a report which is presented to the management for further action. The report contains confession by the plant controller, documentary evidence and a summary of the other employees’ interviews. The plant controller can thereby face charges for engaging in fraudulent activities. For example, in 2008, Douglas Zuber indicted for defrauding his employer, Harvard Investments Inc., over $ 11 million between 1999 and 2006(Cassachi, 2008).

Conclusion

Companies are charged with establishing strong internal controls to reduce the incidence of fraud in their companies. Internal controls include establishing employee tip lines where employees tip the audit department on fraudulent activities perpetrated by the management. This ensures that companies do not suffer losses related to employee fraud.

Reference List

Association of Certified Fraud Examiners. (2010). Report to the Nations. Retrieved from http://www.acfe.com/rttn.aspx

Carnie, B. R., & Wildman, H, A. (2003). Investigating Employee Embezzlement. Retrieved from http://library.findlaw.com/2003/Feb/18/132550.html

Cassachi, C. (2008). Douglas Zuber indicted on charges of defrauding Harvard Investments. Retrieved from http://www.bizjournals.com/phoenix/stories/2008/10/13/daily47.html

Khan, L. (2010). Important Fraud Investigation Interview Tips. Retrieved from

The Practitioner. (2010). An Introduction To Corporate Regulation and Standardization. Retrieved from