Presentation shows the various redflags to prevent and detect internal fraud in a company

1. Preventing a Koss Meltdown at your
Company:
How to Prevent and Detect Fraud:
Implementing Internal Controls

2. Presenters
 David Buslee
– MBA UC Irvine
– Certified Managerial Accountant
– Certified Financial Manager
– Partner – B2BCFO
 Paul Rodrigues
– Certified Public Account
– Masters in Tax
– Certified Fraud Examiner
– Certified in Financial Forensics
– Principal at Chortek and Gottschalk

3. Goal
 To Educate You on What is Happening
 To Scare You to Death
 To Make You Paranoid
 To Provide Best Practices
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4. What is Fraud
The elements of fraud are:
– A representation about a material fact
– Which is false
– And made intentionally, knowingly, or recklessly
– Which is believed
– And acted upon by the victim
– To the victim’s damage
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5. Common Myths About Fraud
 It can’t happen on MY watch
 No one would do that here...
 We have an excellent accounting system
 My accounting clerk is my best employee
 We don’t handle cash - What’s to steal
 Problem Employees are likely suspects
 I wouldn’t know where to start looking
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6. The Fraud Triangle
Opportunity - Generally provided through
weaknesses in the internal controls.
Pressure - Can be imposed due to problems or
vices
Rationalization - Occurs when the individual
develops a justification for their fraudulent
activities.
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7. Fraud Schemes
 Three categories of fraud schemes according
to the Association of Certified Fraud
Examiners:
A. fraudulent statements
B. corruption
C. asset misappropriation
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8. A. Fraudulent Statements
 Misstating the financial statements to make the
copy appear better than it is
 Usually occurs as management fraud
 May be tied to focus on short-term financial
measures for success
 May also be related to management bonus
packages being tied to financial statements
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9. B. Corruption
 Examples:
– bribery
– illegal gratuities
– conflicts of interest
– economic extortion
– Kickbacks
 Foreign Corrupt Practice Act of 1977:
– indicative of extent of corruption in business world
– impacted accounting by requiring accurate records
and internal controls
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10. C. Asset Misappropriation
 Most common type of fraud and often occurs as
employee fraud.
 Examples:
– making charges to expense accounts to cover theft of
asset (especially cash)
– lapping: using checks from one account to cover theft
from a different account
– transaction fraud: deleting, altering, or adding false
transactions to steal assets
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11. How Management
Encourages Fraud
 Management Attitude - Do Nothing
 Little or poor Applicant screening
 No written policies or procedures
 Inadequate training - classroom or OJT
 Responsibility, accountability, and authority not established or
documented
 Goals and objectives neither established nor monitored for
success
 Weak Enforcement Policy
 Break accounting and policy rules - “Too Much Bureaucracy”
 Inconsistent application of policies or procedures - may result in
unfair treatment of employees - favoritism - low morale
 Not listening to employees - treatment of whistleblowers
 We’ll get them to resign - the problem will go away
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12. Employee Fraud
 Committed by non-management personnel
 Usually consists of: an employee taking cash
or other assets for personal gain by
circumventing a company’s system of internal
controls
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13. Management Fraud
 It is perpetrated at levels of management
above the one to which internal control
structure relates.
 It frequently involves using the financial
statements to create an illusion that an entity is
more healthy and prosperous than it actually is.
 If it involves misappropriation of assets, it
frequently is shrouded in a maze of complex
business transactions.
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14. Who Commits Fraud ?
Almost anyone, rationalize they are just in
borrowing, believe they deserve what they
take, plan to repay - never do. Will continue to
commit fraud until caught.
– Has an addictive need - alcohol, drugs, gambling, sex, shopping
– Is intelligent
– Has a position of trust and responsibility
– Understands and skillfully uses technology
– Is well respected in the community
– Is married, 2 children, owns home
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15. Perpetrator’s History
Perpetrator's Employment
Perpetrator's Criminal History
History
Never Never
charged or Punished or
6% 7% convicted Terminated
5%
12%
Charged but Previously
not 83% Punished
87%
convicted
Prior Previously
Convictions Terminated
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16. 16

17. Victim Organizations
Organization Type of Victim - Median Loss
Not-for-Profit
Type of Victim Organization
Government
2008
2006
Public Companies
Private Companies
$0 $50,000 $100,000 $150,000 $200,000 $250,000 $300,000
Median Loss
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18. Victim Organizations
Size of Victim Organization - Frequency
<100
Number of Employees
100 - 999
2006
2008
1,000 - 9,999
10,000+
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0%
Percent of Cases
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19. Victim Organizations
Primary Internal Control Weakness Observed by CFE
Lack of Reporting Mechanism
Lack of Employee Fraud Education
Most Important Contributing Factor
Lack of Clear Lines of Authority
Lack o f Independent Audits
Lack of Competent Oversight
Poor Tone from the Top
Override of Existing Controls
Lack of Management Review
Lack of Internal Controls
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%
Percent of Cases
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20. What is a RED FLAG of Fraud?
 A red flag is a set of circumstances that are
unusual in nature or vary from normal activity.
It is a signal that something is out of the
ordinary and may need to be investigated
further. These are warning signs.
 Some Red Flags are easily discerned, while
others may be more subdued and/or
concealed.
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21. Initial Detection Method by Organization Type8
Detection of Fraud Schemes
21 8The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.
©2008 by the Association of Certified Fraud Examiners, Inc.

22. How Costly is Fraud
 The direct amount that is misappropriated is
oftentimes only a small portion of the cost to an
organization.
 Intangible Costs
– Distraction of organization
– Employee morale
– Embarrassment
– Loss of customer confidence
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23. Red Flags
 Knowing how to spot and investigate Red Flags is
imperative in a proactive fraud deterrence program.
 Learn to spot the behavioral and data red flags.
 When red flags are present, investigate and
document.
 Data mining is an effective tool for identifying red
flags in the company data files
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24. Behavioral Red Flags
 Fraudsters oftentimes demonstrate behaviors
that may serve as warning signs
 Some perpetrators may act irritable, may
spend lavishly or become secretive.
 The presence of these signs do not, in and of
itself, indicate fraud is occurring
 Management and anti fraud professionals
should be trained to identify potential warning
signs so that they may be investigated.
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25. 25 ©2008 by the Association of Certified Fraud Examiners, Inc.

26. Behavioral Red Flags Present During Fraud Scheme24
24The sum of percentages for each scheme type
exceeds 100 percent because in several cases
the perpetrator exhibited more than one
behavioral red flag.
26 ©2008 by the Association of Certified Fraud Examiners, Inc.

27. Cash Fraud
Red Flags
 Discrepancies between cash count and account
balance
 Mutilated/destroyed cash register receipts
 Employee working from open cash drawer
 Unexplained inventory adjustments
 Unexplained increase in the use of petty cash
 Personal checks included in cash funds
 Unusual journal entries affecting cash accounts
 Differences between daily receipts and bank deposits
 “Less Cash” line on deposit tickets indicates cash
taken
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28. Accounts Receivable Fraud
Red Flags
 Customer complaints regarding amounts owed
 Discrepancies between deposit tickets and customer
records
 Different dates between deposits and customer
payments
 Unusual discounts or credits
 Increase in delinquent accounts
 Increase in the amount of write-offs
 Receivables with unusual characteristics
 Customers with unusual name, address or phone
number
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29. Inventory Fraud
Red Flags
 Unexplained inventory shrinkage
 Excessive inventory adjustments
 Decrease in gross margins
 Unusual journal entries to inventory
 Unusual trash removal practices
 Increase in credit memos
 Temporary workers with access to
inventory
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30. Fixed Asset Fraud
Red Flags
 Unusual or unexpected asset purchases
 Missing assets
 Unusual increases in repairs and
maintenance on assets that could be subject
to personal use
 Unusual fluctuations in depreciation accounts
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31. Accounts Payable/Vendor
Fraud
Red Flags
 Higher-than-usual costs or expenses
 Vendor complaints
 Altered or modified vendor invoices
 Unexplained fluctuations in payables
 Unusual vendor names and addresses
 Unusual payees on checks
 Discrepancy between payees on checks and check
register
 Unusual increase in purchases from vendor(s)
 Copies of vendor invoices instead of originals
 Missing cancelled checks
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32. Payroll Fraud
Red Flags
 Unusual fluctuations in payroll expense or hours
 Checks to employees with minimal personnel records
 Missing payroll checks
 Number of paychecks do not match the number of
employees
 Employee complaints regarding W-2 amounts
 Employees who pick up paychecks for other
employees
 Highly compensated employees who elect no
withholdings
 Dual endorsements on cancelled payroll checks
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33. Expense Reporting
Fraud
Red Flags
 Improper or inadequate receipts underlying expenses
 Information on expense report differs from receipts
 Photocopies of expense receipts submitted instead of
originals
 Repeated entertainment expenses with customer with
no associated business
 Failure to utilize company credit cards when available
 Expenses submitted not in line with other employees
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34. The Perpetrators
Fraud Schemes By Accounting Personnel
Register Disbursements
Payroll
Cash Larceny
Fraudulent Statements
Type of Scheme
All Cases
Cash on Hand
Accounting
Expense Reimbursement
Check Tampering
Non-Cash
Skimming
Billing
Corruption
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0
Percent of Cases
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35. Reduce Risk of Fraud:
Tools of Protection
 Segregation of Duties
 Environment
 Internal Control Procedures
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36. Segregation of Duties
• No employee should be in a position to commit
fraud and then conceal it
• Example: Person collecting/receipting cash
should not:
• Post cash receipts to the general ledger system
• Process cash disbursements
• Prepare billings
• Make bank deposits, wire transfers
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37. Environment
 The same rules apply to all
 Don’t belittle internal control procedures
 Don’t allow management to override
procedures
 Be alert to employee’s outside interests
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38. Internal Controls – Who?
 As the owner, you are pulled in a variety
of directions
 Need to focus on the overall business
 No experience in creating controls
 As the “Finder” you can’t be constantly
involved in “Minder” activities
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39. Controls - Part-time CFO
 Experienced partner to CEO
 Knowledgeable in creating controls and
enforcing controls
 Enables the “Finder” to concentrate on
building the business
 Cost effective alternative – can help build
sales and gross margins
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40. Controls - Part Time CFO
 Physical security
 Segregation of duties
 Employee monitoring
 Surprise audits
 Job rotation
 Examination of Documentation
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41. Your Bank – Account Control
 Specify what, if any, ACH debits can hit your
accounts
 Require 2 signatures for any outbound wire
 Make sure they don’t give cash back on business
deposits
 Make sure they only deposit to business accounts
 Use a “token” for all account inquiries
 Only signors should access accounts
 Positive Pay and Reverse Positive Pay
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42. Suspected Fraud ?
•Seek out a Fraud Practitioner…
– Type of fraud:
– Employee fraud - dismissal or prosecution of employees?
– Vendor fraud?
– Any misconduct involving a high-level officers, executives or
managers
– Financial reporting fraud?
– Complaints involving the Foreign Corrupt Practices Act (FCPA)
– Certain industry practices
•Who should be in the know before any action is
taken?
•How was the (potential) fraud detected?
•Involvement of authorities?

43. Legal Considerations of Fraud
 Intentionally false representation
– Not an error
– Lying or concealing actions
– Pattern of unethical behavior
 Personal material benefit
 Organizational or victim loss
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44. Summary
 Anyone can be a Fraudster – they tend to be
the most trusted employee
 Fraud Prevention Checkup
 Most Frauds are discovered by accident or tips
 Be vigilant for Red Flags
 Part Time CFO will create and enforce internal
and external controls
 Your Bank has many tools to prevent fraud
 Have a game plan for when fraud is suspected
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45. Contact Information
David Buslee
Partner
B2BCFO LLC
(262) 271-2522
dbuslee@b2bcfo.com
Paul Rodrigues
Principal
Chortek and Gottschalk
(262) 522-8227
PRodrigues@c-gcpa.com
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