(This paper is an effort to explain that sniffing out frauds is an art and needs a mind-set, which comes through Experience and mere knowledge of accounting principles and standards may not help)
The fertility of man’s invention in devising new scheme of fraud is never ending, the new business methods and the speed, which are making business dynamic, are also making them vulnerable to financial fraud. At the same time technology dependency through ERP application generates unrealistic expectations, where as there is thick fog behind the screen, leaving much to be desired, thus creating ideal environments for the wrongdoers to exploit the weaknesses for their personal gains. Therefore Frauds and White-collar crimes in the corporate sector have been increasing at an alarming pace, which of late was the primary concern at Government Establishments
Fraud is a generic term; No definite, explicit or formal statement can be laid in defining fraud. Fraud, theft, and embezzlement are terms that are often used interchangeably. Although they have some common elements, they are not identical in the criminal law sense. Theft is referred to as larceny- the taking and carrying away of the property of another with the intention of permanently depriving the owner of its possession. In larceny the perpetrator comes into possession of the stolen item illegally. In embezzlement, the perpetrator comes into initial possession lawfully, but then converts it to his or her own use.
Embezzlers have a fiduciary duty to care for and to protect the property. In converting it to their own use, they breach that fiduciary duty. Therefore theft and embezzlement have different legal consequences.
Fraud is intentional deception, commonly described as lying, cheating and stealing. There is no end to the types of frauds that is why, The Indian Penal Code, 1860 has not strictly defined a fraudulent act, even the courts have not explicitly elaborated and have kept it to them selves to interpret. In nutshell, fraud in books of account comes in two major categories, transaction and statement frauds. Statement frauds involve intentional misstatement of certain financial values to enhance the appearance of profitability and deceive shareholders and creditors, which will also benefit the perpetrator indirectly in one way or the other. World Com and Enron are the outstanding examples of this category. Transaction frauds are intended to facilitate the theft or conversion of organizational assets to one’s personal use and the perpetrator is the direct beneficiary. The recent case of Parmalt, an Italian company, which is also the largest dairy product group in Europe, where the management allegedly produced fake bank documents to claim that it possesses Four Billion Euro in cash that was non-existent and the Bank of America denied the authenticity of a document is an example of transaction fraud.
There are varieties of ways the individual might fraudulently steal or embezzle the company’s assets. The size, complexity and ownership characteristics of the entity have a significant influence on fraud risk factor. In large entity focus on effectiveness of those charged with the governance, internal audit function, and formal code of conduct, are important issues, in small entity may be these factors are not applicable. There fore in general, procedure and methods of White-Collar Crime are based on inherent risk prevalent in the system.
We must understand that fraud is no simple conduct. Most of the white-collar crimes are committed for economic reasons. Loose or lax controls and a work environment that does not value honesty, provides the opportunity. Motivations and opportunities are interactive, the greater the economic need, the less weakness in internal controls is needed to accomplish the fraud. The greater the weakness in control, the less motivation is needed. So when one has the motivation and opportunity, it’s the right recipe for the fraud because; it pays to do it, it is easy to do it, it is unlikely that you will get caught. The opportunities to commit fraud are rampant in the presence of loose or lax management or administrative and internal accounting controls at any corporate. These controls become vulnerable by half hearted and inadequate compliance of computerization and ERP applications. The recent years have seen the frauds growing both in size and complexity, at the same time, well-planned fraud is too complicated to be unearthed by any plain investigating agency.
Fraud may surface through an allegation, complaint or discovery, which may be incidental or looked for. The visible part of a fraud transaction may involve a small amount of money, but the invisible portion can be substantial, so don’t let it go if you have suspicion though small. Surfacing fraud by design involves a proactive approach and methodology to discern fraud that looks for evidence of fraud. Financial auditing generally is not intended to search for fraud but to attest that financial statements are presented fairly. Though in the present time, the pressure is mounting on the statutory auditor to look for frauds, but how far they would succeed would depend on individual’s capability, as detecting frauds is a knack and not mere knowledge of accounting standards and practices.
To understand and appreciate the early warning you got to look for missing link in the chain of evidence that brings the insight to the front. A general belief in the auditing profession is “Most frauds are discovered by accident, not by audits or accounting system design.” This has been repeated so many times by so many accountants and auditors that the general public accepts it as a gospel truth. I do not contribute to this belief, but yes there is no commonly accepted fraud detection methodology. It is a mind-set. The mind-set that I am addressing is not of paranoid, who trusts no one and sees evil everywhere. The mind-set that I talk of, can be described as seeing the wholesome and the hole at once, this knack of seeing the wholesome and the hole all at once comes with experience and the right-aptitude, which requires innovative and creative thinking as well as logic of science, which is able to see the wholesome and the hole together to establish the missing links, that brings the insight to the front and provides pragmatic approach to locate the vulnerable area, read the culprit’s mind and then sniff out frauds.
There are large numbers of frauds, which never hit the radar screen and have stealth in built; and at the same time fraud travel to grow geometrically over the period as a learning curve, if not detected on time. Therefore the prevention through right-controls and early detection by professionals with right mind-set could save fortunes.