Fraud Risks to Organization

Fraud Risks to Organization

            All businesses may face the risk of loss through the employees’ fraudulent activities including activities of management. The list of potential risks of fraud below is partially based on a type of fraud risks given in the old auditing standard of United Kingdom Auditing Practices Board called SAS 110 Fraud and error. You can observe that a number of the examples listed are signs of poor procedures of corporate governance, such as overcoming by one person or pressures on the internal audit and accounting departments.

Previous experience or incidents which call into question the integrity or competence of management

• Management dominated by one person (or a small group) and no effective oversight board or committee
• Complex corporate structure where complexity does not seem to be warranted
• High turnover rate of key accounting and financial personnel
• Personnel (key or otherwise) not taking holidays
• Personnel lifestyles that appear to be beyond their known income
• Significant and prolonged under-staffing of the accounting department
• Poor relations between executive management and internal auditors
• Lack of attention given to, or review of, key internal accounting data such as cost estimates
• Frequent changes of legal advisors or auditors
• History of legal and regulatory violations

Particular financial reporting pressures within an entity

• Industry volatility
• Inadequate working capital due to declining profits or too rapid expansion
• Deteriorating quality of earnings, for example increased risk taking with respect to credit sales, changes in business practice or selection of accounting policy alternatives that improve income
• The entity needs a rising profit trend to support the market price of its shares due to a contemplated public offering, a takeover or other reason
• Significant investment in an industry or product line noted for rapid change
• Pressure on accounting personnel to complete financial statements in an unreasonably short period of time
• Dominant owner-management
• Performance-based remuneration

Weaknesses in the design and operation of the accounting and internal controls system

• A weak control environment within the entity
• Systems that, in their design, is inadequate to give reasonable assurance of preventing or detecting error or fraud
• Inadequate segregation of responsibilities in relation to functions involving the handling, recording or controlling of the entity's assets
• Poor security of assets
• Lack of access controls over IT systems
• Indications that internal financial information is unreliable
• Evidence that internal controls have been overridden by management
• Ineffective monitoring of the operation of system which allows control overrides, breakdown or weakness to continue without proper corrective action
• Continuing failure to correct major weakness in internal control where such corrections are practicable and cost effective

Unusual transactions or trends

• Unusual transactions, especially near the year end, that has a significant effect on earnings
• Complex transactions or accounting treatments
• Unusual transactions with related parties
• Payments for services (for example to lawyers, consultants or agents) that appear excessive in relation to the services provided
• Large cash transactions
• Transactions dealt with outside the normal systems
• Investments in products that appear too good to be true, for example low risk, high return products
• Large changes in significant revenues or expenses

Problems in obtaining sufficient appropriate audit evidence

• Inadequate records, for example incomplete files, excessive adjustments to accounting records, transactions not recorded in accordance with normal procedures and out-of-balance control accounts
• Inadequate documentation of transactions, such as lack of proper authorization, supporting documents not available and alteration to documents (any of these documentation problems assume greater significance when they relate to large or unusual transactions)
• An excessive number of differences between accounting records and third party confirmations, conflicting audit evidence and unexplainable changes in operating ratios
• Evasive, delayed or unreasonable responses by management to audit enquires
• Inappropriate attitude of management to the conduct of the audit, eg time pressure, scope limitation and other constraints

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United Kingdom Major Governance Codes

United Kingdom Major Governance Codes

The Cadbury Report

            UK Cadbury committee was set up due to the lack of confidence observed in financial reporting and in the aptitude of auditors to present the assurances needed by the stakeholders of financial statements. The most important difficulties were identified in the relationship between boards of directors and auditors. Especially, the commercial stress on both auditors and directors caused stress to be brought to bear on external auditors by the board of directors and the auditors often surrender. Harms were also expected in the ability of the board of directors to direct and control their organisations.

1. Corporate governance responsibilities

The responsibilities of those people concerned with the financial Statements are presented in the Cadbury report that was published in 1992.

• The directors are accountable and responsible for the company’s corporate governance.
• The shareholders are associated to the directors through the system of financial reporting.
• The auditors present the shareholders with an external purpose check on the financial statements of directors.
• Other concerned stakeholders, generally employees (to whom the directors owe some accountability) are ultimately addressed by the financial statements.

2. Code of Best Practice

The Code of Best Practice incorporated in the Cadbury report and afterward amended by reports that were published aimed at the directors of all United Kingdom public companies, but all companies’ directors were encouraged to implement the Code. Provisions in the Cadbury report included;

                     i.            The board of directors should meet on a regular basis, retain full control over the company and monitor executive management. Certain matters such as major acquisitions or disposals of assets should be referred automatically to the board. There should be a clear division of responsibilities at the head of a company, with no one person having complete power. Generally this would mean the posts of chairman and chief executive being held by different people.

                   ii.            The report sees non-executive directors as important figures because of the independent judgment they bring to bear on important issues. There should be at least three non-executive directors on the board, a majority of whom should be independent of management.

                  iii.            The report contains provisions about the length of directors' service contracts and disclosure of remuneration that are developed further in the Greenbury and Hampel reports.

                 iv.            The audit committee was soon by the Cadbury committee as a key board committee. The audit committee should liaise with internal and external auditors, and provide a forum for both to express their concerns. The committee should also review half yearly and annual statements.

                   v.            The annual report should present a balanced and understandable assessment of the company's position. The directors should explain their responsibilities for preparing accounts. Statements should also be made about the company s ability to continue as a going concern, and the effectiveness of its internal controls.

The Greenbury code

In 1995, the Greenbury committee published a code which established principles for the determination of directors' pay and detailing disclosures to be given in the annual reports and accounts. The Greenbury code went beyond the Cadbury code. The Greenbury code recommends that the remuneration committee should determine executive director’s remuneration and that this committee should be comprised solely of non-executive directors. Directors' service contracts should be limited to one year.

The Hampel report

The Hampel committee followed up in 1998 matters raised in the Cadbury and Greenbury reports, as we have seen aiming to restrict the regulatory burden on companies and substituting principles for detail whenever possible. Under Hampel:

a)      The accounts should contain a statement of how the company applies the corporate governance principles.

b)      The accounts should explain their policies, including any circumstances justifying departure for best practice.