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How to Detect Fraud

Mary-Jo Kranacher, MBA, CPA/CFF, CFE

For several years, I've asked my accounting students why they decided to major in accounting; overwhelmingly, the answer is the same: they like working with numbers. But no one—not even an accountant—is left-brained only. This works to our advantage because, although numbers might provide evidence of wrongdoing, numbers generally fall short as a means of detecting fraud. The Association of Certified Fraud Examiners (ACFE) founder and chairman, Joseph T. Wells, has said that “books and records don't commit fraud, people do.” So, it's not surprising that one of the most effective ways to detect fraud is to talk to people. Yet some auditors shy away from talking to staff at organizations where they've been engaged to conduct an audit.

The public has placed a higher expectation on an auditor's responsibility to detect and report fraud than statute or auditing standards require. The AICPA's Statement on Auditing Standards (SAS) 99 (codified as AU-C section 240, effective for audits of financial statements for periods ending on or after December 15, 2012) and the Public Company Accounting Oversight Board's (PCAOB) AU section 316, both of which are titled Consideration of Fraud in a Financial Statement Audit, require the auditor to inquire of management, the audit committee, internal auditors, and others about the organization's risks of material misstatement due to fraud. Too often, however, auditors confine their inquiries to management and the accounting staff, when some of the most productive information can be gleaned from secretaries, janitors (yes, janitors—you'd be surprised at the wealth of information that is found in office trash), and other non-accounting employees.

In our current environment, auditors are expected to do more than ever to detect fraud.

According to the ACFE's 2012 global fraud study, Report to the Nations on Occupational Fraud and Abuse (www.acfe.com/uploadedFiles/ACFE_Website/Content/rttn/2012-report-to-nations.pdf), the typical profile of a fraudster is a male executive or manager between 35 and 45 years old. But that covers a lot of ground, so how can we narrow the field? Below are a few commonsense tips to improve the odds of detecting fraud.

Tip 1: Identify areas of vulnerability

The incidence of fraud increases with access. Look for breakdowns in the organization's internal control system that create an opportunity for fraud—an undisputed constant in fraud cases. Reduced budgets can consolidate responsibilities, compromise the segregation of duties, and negatively impact employee morale, all of which may increase the risk for fraud.

Tip 2: Ask questions

To learn if fraud is occurring in an organization, ask people the question—Do you have knowledge of fraud, alleged fraud, or suspected fraud?—clearly and without hesitation. And don't feel compelled to apologize for asking. Although many individuals won't volunteer information, they generally won't lie if asked a direct question.

Tip 3: Talk to people at ad levels

Useful information doesn't recognize rank, experience, or compensation level. According to the ACFE report, tips are the most common method (43%) of initial detection of occupational frauds. So, interview other individuals within the organization besides management. This can provide an auditor with a different perspective from that of those involved in the financial reporting process. interviews can also be used to verify information or identify inconsistencies in responses.

Tip 4: Allow for flexibility

An audit plan establishes the overall strategy for assessing and responding to the risks of material misstatement. But, too often, these plans are used as a checklist instead of a mere guide. Be prepared to respond to unexpected information.

Tip 5: Engage an anti-fraud specialist when needed

In our current environment, auditors are expected to do more than ever to detect fraud. If you have reason to believe that fraud has occurred or is occurring, enlist the services of an antifraud expert. Partnering with other professionals who have a specialization in this field can provide the tools, techniques, and resources necessary to meet this challenge.

As always, I welcome your comments.

The opinions expressed here are my own and do not reflect those of the NYSSCPA, its management, or its staff.

Mary-Jo Kranacher, MBA, CPA/CFF, CFE. Editor-in-Chief. ACFE Endowed Professor of Fraud Examination, York College, The City University of New York (CUNY), mkranacher@nysscpa.org.

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