Audit

1. The three aspects of fraud - Perceived pressure, Rationalization, and Opportunity were present in the CIT case as follows:

With different industry definitions and viewpoints, fraud can be a tough issue for audit committee members to grasp for oversight purposes. The legal obligations of audit committee members have intensified because their standard duty of care and loyalty to the entity has increased in light of management fraud activities.

Professional auditing standards discuss the three key “conditions” that are typically present when a financial fraud occurs and identify a lengthy list of “fraud risk factors.”

It is important to first gain an understanding of the various types of fraud, in order to aid understanding in regards to the prevention of fraudulent activity. This paper begins with a review of the definition of financial fraud, and identification of the different fraud types. Further, included is an examination of what motivates individuals to commit fraud, including an identification of some of the method in which people commit fraud. A discussion of the importance of the fraud triangle, and how rationalization contributes to fraud is a key area of focus. Finally, there is an examination of some controls that prevent and detect fraudulent behavior, including the value and importance of understanding the nature of fraud for

Three conditions are necessary for financial statement fraud to occur. There must be (1) an incentive to commit fraud. (2) the opportunity to commit fraud, and (3) the ability to rationalize the misdeed. These conditions make up what antifraud experts call the fraud tringle (Libby, Libby, & Short, 2017, p 232). Some well-known names come to mind when I think of financial fraud (e.g. Bernie Madoff and his $50 billion Ponzi Scheme, WorldCom. Arthur Anderson). Also, the Sarbanes-Oxley Act of 2002 (SOx) comes to mind. SOx was a law that was implemented to oversee

Fraud knowledge benefits stakeholders in multiple ways. By understanding how financial statement fraud occurs, stakeholders can recognize red flags in financial statements. Outside accounting, fraud knowledge enables stakeholders to be productive members of a corporate governance. Corporate governances work as principal catalysts for stakeholders to raise corporate awareness and expectations regarding appropriate behavior and practices. Stakeholders use their fraud knowledge to contribute to the company’s Code of Conduct and Code of Ethics for management and employees as well as participate in risk mitigation efforts. Stakeholders can also participate in boards that create programs that focus on the prevention, detection, and deterrence of criminal and fraudulent acts. The goal of the programs is to ensure that everyone is making ethical decisions and reporting policies that are not followed. Maintaining corporate ethics is critical to company success (Managing the Business Risk of Fraud: A Practical Guide n.d.)

The best theoretical model of fraud to describe why HealthSouth committed fraud is the fraud diamond not the fraud triangle. Both methods require that these three elements are present for committing fraud: perceived pressure, perceived opportunity, and rationalization. Understanding what motivated HealthSouth’s Chief Executive Officer (CEO) Richard Scrushy to commit fraud, how the accounting staff committed and concealed the fraud, and how the staff justified their participation are crucial. However, anti-fraud professionals believe that changes in social behavior require the addition of a fourth element called capability. Capability includes “personal traits and abilities that play a major role in whether fraud will actually occur” (Fighting Fraud in the Government n.d.). For example, Scrushy’s persuasiveness and Cathy Edward’s position as Michael Vines’ boss increased their capabilities to commit fraud. If capable employees refused to participate, fraud occurrences decrease (Fighting Fraud in the Government n.d.) (Hamilton n.d.).

The manipulation of accounts fraud scheme is generally fulfilled by employees in top management positions and it usually involves making understatements or overstatements on financial statements making it very hard to detect. The process followed as Troy Adkins, (2015) explains is very simple. The financial statements are either overstated to show different figures in the earnings on the income statements making them look better than they actually are or the earnings in the current periods are manipulated in such a way that the revenue is understated or they inflate the current year’s expenses. The second process includes making the financial statements look worse than they are in reality. Deloitte, (2009) explains a number of ways which the accounts are manipulated where as one of the ways is to manipulate the reported earnings directly. They further explained that overstating the

According to paragraph 65 of AS 12, “fraud risk factors are events or conditions that indicate (1) an incentive or pressure to perpetrate fraud, (2) an opportunity to carry out the fraud, or (3) an attitude or rationalization that justifies the fraudulent action.” It is important to note that these three factors do not necessarily indicate the existence of fraud; however, they often are present in circumstances in which fraud exists.

Some industry-specific factors, such as having valuable near-cash assets, can increase the organization's vulnerability. Also they will need to rationalize the actions as justifiable. The individuals committing the fraud must first convince themselves that their behavior is acceptable or will be temporary. For example, Barry Minkow’s believed that the lies and deceit are for the betterment of his company and that with time everything will eventually return to normal.

The second part is opportunity. The opportunity to commit fraud usually arises through weak internal controls.

Fraudulent, erroneous, and illegal acts committed by a public company, usually at a managerial or executive level, have been a very serious problem for many years and have prompted development of strict and updated regulations, such as the Sarbanes-Oxley Act, in an attempt to prevent these occurrences. Unfortunately, these new or updated regulations are not enough to prevent these acts from happening, thus not alleviating the auditors of their responsibility to detect fraud. Some methods that management and auditors can employ to prevent and detect fraud, errors, and illegal acts are: improving knowledge, improving skills,

Fraud is defined as a deliberate misrepresentation that causes a person or business to suffer damages, often in the form of monetary losses through deception or concealment. And Occupational Fraud as defined by the ACFE is the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets. Traditional fraud triangle theory by Donald Cressey explains that propensity of fraud occurring in an organization lies on three critical elements which are Pressure, Opportunity, and Rationalization.

Essentially, all three elements of the fraud triangle must be present for fraud to be committed: pressure, opportunity, and rationalization. Additionally, nine factors provided the atmosphere for the perfect fraud storm of 2000 through 2002. The nine factors included: economy, moral values, incentives, expectations, debt, accounting rules, auditor dependence, greed, and educator failures (Albrecht et al., 2012). When combined with the elements of the fraud triangle these factors enabled organizations such as Enron and WorldCom to commit the fraudulent activities that resulted in this perfect storm.

employees, or third parties. Therefore, it is important to place a strong emphasis on fraud