Fraud

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Fraud

is an intentional act by one or more individuals among management, those charged with governance, employees or third parties, involving the use of deception to obtain an unjust or illegal advantage. (Auditing Practices Board – Glossary of Terms)

For example, managers may deliberately select inappropriate accounting policies.

Employees may seize the proceeds of cash sales and omit to enter the sale into the accounting records.

Third parties may send bogus (fake) invoices to the company, hoping that they will be paid in error.

The prerequisites of fraud

There are three prerequisites for fraud to occur: dishonesty, opportunity and motive

All three are usually required – for example an honest employee is unlikely to commit fraud even if given the opportunity and motive. 

Fraud is more likely to occur in a business environment with poor or no controls. 

If the control environment is soft and management has implemented few specific control activities, then the potential for fraud is high.

Factors that might increase the risk of fraud and error:

  • management domination by one person, or a small group of people

  • unnecessarily complex corporate structure

  • high turnover rate of key accounting personnel

  • personnel who do not take leave/holidays

  • understaffed accounting department

  • volatile business environment

  • inadequate working capital

  • deteriorating quality of earnings

  • inadequate segregation of duties

  • lack of monitoring of control systems

  • unusual transactions – in cash, or direct to numbered bank accounts

  • payments for services disproportionate to effort

  • significant transactions with related parties

  • inadequate IT systems.

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