Fraud 101

A straightforward guide explaining the nature of financial fraud

Fraud continues to be one of the fastest growing and most costly crimes in the United States and around the world. The more an organization can learn about fraud in general and the potential fraud risks that threaten the financial stability of the organization's cash flow, the better that organization will be equipped to design and implement measures to prevent schemes from occurring in the first place.

Fraud 101, Third Edition serves as an enlightening tool for you, whether you are a business owner or manager, an accountant, auditor or college student who needs to learn about the nature of fraud. In this invaluable guide, you will discover and better understand the inner workings of numerous financial schemes and internal controls to increase your awareness and possibly prevent fraud from destroying your organization's financial stability.

It offers guidance, understanding, and new, real-world case studies on the major types of fraud, including

• An understanding of why fraud is committed
• An overview of financial fraud schemes
• White-collar crime
• Uncovering employee embezzlements
• Establishing internal fraud controls
• The nature of collecting evidence

With case studies included throughout the book to gain insight to the real world of fraud, Fraud 101, Third Edition describes the features of fraud and then provides proven methods of prevention, as well as solutions to expose different types of fraud.

Preface ix

Acknowledgments xv

Introduction xvii

Chapter 1 The World of Fraud 1

Definition of Fraud 1

The Many Types of Fraud 2

Chapter 2 Why Is Fraud Committed? 19

A Rationalizing Society 20

Financial Statement Fraud 22

Financial Fraud Comes in Different Shapes and Sizes 23

Motivators Differ by Type of Business 25

Employee Schemes 27

In the End 32

Chapter 3 Financial Statement Fraud Schemes 33

Where Do Things Go Wrong? 34

Trend Analysis 42

Beyond Traditional Audits 45

Chapter 4 Employee Embezzlements 51

The Fraud Triangle 55

Areas for Concern 57

Chapter 5 Other Fraud Schemes 69

Duplicate Payment Fraud 71

Multiple Payee Fraud 72

Shell Fraud 73

Defective Delivery Fraud 77

Defective Receipt Fraud 88

Defective Shipment Fraud 89

Defective Pricing Fraud 91

Chapter 6 Contract Rigging Schemes 97

Stage One: Obtaining the Contract 97

Stage Two: Contract Change Orders 102

Unbalanced Bidding 114

Detection Recommendations 118

Rotation Fraud 119

Where Do We Go from Here? 121

Chapter 7 Responses to Fraud 123

Government’s Response to Fraud 124

Accounting Profession’s Response to Fraud 129

Internal Audit Profession’s Response to Fraud 133

New Credentials, More Training, Better Awareness 134

Articles, Books, and More Resources 136

Chapter 8 The Importance of Internal Controls and Internal Audit 143

Why Have Internal Controls? 144

Déjà Vu 148

Good Internal Controls 150

Internal Audit 152

Chapter 9 Evidence 159

What Is Evidence? 160

Documentation 163

Chapter 10 Conducting Fraud Investigations: A Practical Approach 171

Proactive Fraud Investigations 171

Discovery Investigations 172

Supportive Investigations 175

Strategy 178

Predication 180

The Investigative Plan 181

Conducting the Procedures 183

Findings 186

Use of the Findings 188

Chapter 11 Fraud Investigation Alternatives 189

Assessing the Feasibility of a Full Investigation 189

Monitoring Operational Areas at Risk of Fraud 197

Revamping Internal Controls: Closing the Barn Door 200

Doing Nothing? 203

Appendix A Vending 209

Lessons Learned 213

Appendix B Living a Façade 217

Prevention Techniques 221

Appendix C Disappearing Inventory 225

Internal Controls 230

Index 231

Stephen Pedneault, CPA, CFF, CFE, is the founder and Principal of Forensic Accounting Services LLC, a CPA firm located in Glastonbury, Connecticut, specializing in forensic accounting, employee fraud, and litigation support matters. Steve is also the author of the forthcoming Wiley title, Anatomy of a Fraud Investigation. He has written numerous articles appearing in local and national media and is a contributor to Fraud Casebook: Lessons from the Bad Side of Business (Wiley). For more information about Stephen Pedneault, go to www.forensicaccountingservices.com. If an employee brings home some office supplies for their kids to use with their school projects, is that fraud? How about when an employee charges personal items on the company's credit cards, receives vendor kickbacks, or inflates travel expenses? Instances of fraud occur every day and either go undetected, or are not deemed newsworthy enough to bring any attention to the matter. In fact, instances like these may be occurring right now in your organization—how will you know what to look for? And how can you stop it from taking place again?

Now fully revised, Fraud 101, Third Edition explains fraud in a practical, easily understood manner, serving as an enlightening tool for you, whether you are a business owner or manager, an accountant, or an auditor. A valuable introduction for dealing with fraud—from preventing and detecting it to investigating it, Fraud 101, Third Edition provides insightful advice on the inner workings of numerous financial schemes and the internal controls that will increase your awareness and possibly prevent fraud from destroying your organization's financial stability.

Offering guidance, understanding and new, real-world case studies on the major types of fraud, this new edition explores:

• Why fraud is committed

• An overview of financial fraud schemes

• White-collar crime

• Employee embezzlements

• Internal fraud controls

• The nature of collecting evidence

• Investigative issues, including alternatives for resolving fraud-related matters

• How to perform an effective investigation

• Sample investigation procedures for the major fraud categories

Regardless of why an individual perpetrates a fraud, the end result is usually the same: a substantial financial loss to the organization, often involving a significant amount of money that may never be recovered. Fraud 101, Third Edition will show you how fraud schemes are perpetrated, detected, and investigated, with practical advice on how to notice and prevent fraudulent activity, minimizing the loss experienced by your organization.

Highly readable and accessible, this timely book provides you with the methods and tips you need to readily recognize and investigate financial fraud and combat fraud in your organization.

Praise for Fraud 101 Third Edition

"With this new edition of Fraud 101, I am amazed at how much information Stephen delivers in such a concise and succinct manner. His descriptions are detailed, but easy to understand, and the case examples really help illustrate the schemes. This is an excellent reference book for anyone in the fraud prevention field, whether they are a seasoned veteran or just starting out."
—John D. Gill, JD, CFE Research Director, Association of Certified Fraud Examiners

"Awesome! Sit at the head of the class—read Fraud 101 and get an A+ in understanding fraud. This book takes the reader from the classroom to the real world with its insightful case studies and practical techniques. A must-read for accountants, other professionals, business owners, and students of fraud."
—Thomas Scanlon, CPA, CFP®President, Borgida & Company, PC, CPAs

"The author clearly demonstrates his mastery of the subject matter in this well-written, easy-to-read, comprehensive guide to understanding fraud. The case studies provide insight into the definition of fraud, the different types of fraud, the perpetrator's rationale and a practical approach to investigation and prevention. The ever evolving nature of this relevant subject matter makes this book a must-read for anyone interested in learning about fraud and its wide-reaching effects."
—Jeffrey Rossi, CPA, CVA, CFEPartner, J.H. Cohn, LLP

"This book is very readable and loaded with examples from the author's rich experience in forensic accounting services. The discussions of the types of fraud and the pitfalls to watch for were very practical guidance for accountants and business people in general."
—Lawrence J. Gramling, PhD, CPA Assistant Department Head, Department of Accounting, University of Connecticut

Root out fraud before it happens with the hands-on approach found in Fraud 101, Third Edition

The more your organization can learn about fraud and the potential risks that can threaten its financial stability, the better you will be equipped to prevent schemes from occurring in the first place. The only primer you need to fully understand financial fraud, Fraud 101, Third Edition expertly arms you with the tools to eliminate future frauds and reduce fraud losses.