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Issue 5 | May 2016
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At-A-Glance
Fraud is a persistent nemesis in the
business world. As the study covered in
our first article demonstrates, the
extent of fraud has not changed
significantly over the past twenty
years, though the techniques and
preventive measures have become more
sophisticated.
An example of a modern sophisticated
approach to rooting out fraud is
described in our second article.
Forensic data analytics has the
potential to uncover fraudulent behavior
often before significant damage is done,
substantially reducing the financial
impact.
Finally, two studies from the United
Kingdom explore the relevance of the
audit in today’s complex business
environment. Implications for the future
and recommended priorities are
delineated in our third article.
Editor Gerald E. Herter, CPA |
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In This Issue
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Fraud Numbers Hold Steady
New study shows long ranging persistence of
duplicitous behavior
The Association of Certified Fraud Examiners
(ACFE) was established in 1988 with a mission to
“reduce the incidence of fraud and white-collar
crime and to assist the Membership in fraud
detection and deterrence.” Today the
organization boasts over 75,000 members and sets
high membership standards through education,
examination and ethics requirements.
The inaugural Report to the Nation on
Occupational Fraud and Abuse was published in
1988, providing the first such compendium of
statistical data, bringing visibility to the
magnitude of fraud in the business world, as
well as serving as a benchmark for ongoing
measurement and tracking. This initial report
covered 2,608 cases from the prior ten-year
period, collected from ACFE members who were
surveyed for detailed data, generally from their
more serious defalcation cases. A subsequent
survey report was issued in 2002, after which a
biennial schedule was instituted to facilitate
uniform comparison.
Which brings us to the latest edition of the
Report to the Nation on Occupational Fraud and
Abuse – 2016 Global Fraud Study. ACFE members,
with 7,497 submissions for consideration, were
asked to respond to 81 detailed questions, which
resulted in 2,410 cases accumulated into the
final report.
Looking back over the years, the overriding
observation is the consistency of the extent and
nature of fraud in business over the past twenty
years. The 1996 survey reported that the average
organization lost about 6% of annual revenue to
fraud and abuse. The 2016 survey reports a 5%
amount of loss.
The 1996 report estimated that the total cost
to US organizations from fraud and abuse was
more than $400 billion. The survey expanded in
2008 to cover the entire world. Consequently, in
the 2016 report, which includes cases from 114
countries, the authors project and theorize that
the potential cost of fraud worldwide could be
$3.7 trillion, which is equivalent to the Gross
Domestic Product (GDP) of Germany.
In 1996, the typical perpetrator was a
college-educated male, with men responsible for
almost 75% of the offenses, which were also four
times as costly as those caused by women. The
2016 report does not distinguish between the
sexes, possibly a reflection that the greater
proportion of women in the workplace today has
brought more balance to the results. However,
the higher the level of authority of the
perpetrators involved, the greater the loss that
occurred. Executive losses in 2016 were 11 times
greater than employee losses, while in 1996 the
gap was 16 times.
The median loss for all cases in the 2016
study was $150,000, with 23.2% of them losing at
least $1 million. These amounts were only
slightly more than the 2014 results. Also, the
forms of fraud were comparable between the two
most recent studies: 83-85% asset
misappropriation, 35-37% corruption, and about
9-10% financial statement fraud. (These total
more than 100% since some frauds encompassed
multiple forms).
The most prevalent anti-fraud control cited
in the 2016 study was the external independent
audit, employed in 82% of the companies studied.
Yet, as stated as far back as the 1996 study,
few frauds are detected by routine audits. From
2012-2016, only 3% were uncovered by external
audits. By far, over the past 20 years, tips
were the most common detection method,
representing about 40% in the last two studies.
The importance of an employee hotline, promoted
in 1996, was illustrated by the 2016 results,
which revealed that detection of fraud through
tips was about 20% higher in companies that had
hotlines. Overall, companies with anti-fraud
controls in place experienced lower fraud losses
and quicker detection than companies without
them.
The biggest organizational weaknesses that
factored into fraud were a lack of internal
controls and existing controls being overridden,
especially in smaller businesses where
prevention resources were more limited. Also,
smaller businesses tended to have more fraud
risks with “check tampering, skimming, payroll,
and cash larceny schemes,” while “corruption was
more prevalent in larger organizations.”
Most frauds were the work of first-timers,
with the most prevalent warning signs including
“living beyond means, financial difficulties,
unusually close association with a vendor or
customer, excessive control issues, a general
“wheeler-dealer” attitude involving unscrupulous
behavior, and recent divorce or family
problems.”
Other recommendations from the 1996 study
which still apply today are: 1) setting the tone
at the top; 2) having a written code of ethics
(81% of companies in the 2016 study reported
having one); 3) checking employee references; 4)
high level, independent examination of unopened
bank statements (modified for current
technological processes); and 5) creating a
positive work environment.
For further information, see
The 2016 ACFE Report to the Nations on
Occupational Fraud and Abuse
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Forensic Data Analytics: Current Benefits and
Untapped Potential
Ernst & Young Survey touts economic payback
along with fraud reduction
The ACFE’s Report to the Nation on
Occupational Fraud and Abuse pointed out that
companies implementing proactive data monitoring
and analysis experienced “frauds that were 60%
less costly and 50% shorter in duration.”
Unfortunately, many companies were found to be
overlooking this effective control measure. That
is also a key take away in the January, 2016,
Ernst & Young (EY) Global Forensic Data
Analytics Survey Shifting into high gear:
mitigating risks and demonstrating returns.
To assess the status of forensic data
analytics (FDA), EY interviewed 665 company
anti-fraud program decision-makers from across
the world during the third quarter of 2015. The
four major conclusions from the survey were:
- Demand for FDA is growing across
the board;
- The FDA landscape is maturing;
- There are several hurdles to the
attainment of FDA deployment; and
- Effective FDA deployment is
reflected by several factors.
The survey defines FDA as the “ability to
collect and use data, both structured (e.g.,
general ledger or transaction data) and
unstructured (e.g., email, voice or free-text
fields in a database), to prevent, detect,
monitor or investigate potentially improper
transactions, events or patterns of behavior
related to misconduct, fraud and noncompliance
issues.”
Cyber breaches and insider threats were
reported as the fastest growing threats, along
with the related regulatory measures responding
ever more stringently. The increasing frequency
and severity of these threats have created a
heightened sense of urgency and demand from the
topmost levels of management.
As a result, spending on FDA has increased.
Fewer companies feel that their FDA spending is
adequate compared to two years ago, and 60% are
looking to increase FDA spending in the next two
years. A large portion of the investment will be
directed toward proactive monitoring
initiatives, attempting to get out in front of
incoming threats.
While more advanced technology tools are now
available, spreadsheets are still in widespread
use as the typical tool for managing fraud risk.
The survey noted that “unstructured content
accounts for around 90% of an organization’s
digital information.” Social media, mobile
phones or web logs are extensive forms of
communication in the modern world. Combining
analysis of structured and unstructured data can
greatly enhance results. An example from the
report illustrates that “comments from sales
logs can show an individual’s intent to commit a
fraud, while a financial transaction can provide
the evidence.” A large percentage of respondents
were reported as currently analyzing both forms
of data.
Even with the growing attention and
investment in FDA, the survey report pointed out
that more than half of companies do not have an
awareness of a key added benefit. While most
recognize the expanded capability to detect a
broader range of fraud, and to detect fraud more
quickly, many have not yet grasped the
significant cost saving that can be reaped from
these results. Prevention is much cheaper than
the cost of picking up the pieces after the
fact.
Consequently, though there is recognition of
the need for FDA, top management has not
realized the investment level required for
effective deployment. There needs to be better
understanding of the total value of FDA, in
order to justify the adequate deployment of
resources to acquire and develop the specialized
skills and technology to get the job done.
Those companies that have overcome the
hurdles and succeeded with FDA are characterized
as using advanced technology “(including social
media and web monitoring, voice searching and
analysis, and visualization and reporting
tools),” analyzing more data “(over 10 million
records),” and investing a greater portion of
their total compliance and anti-fraud budgets
“(one-third).”
For further information, see
Global Forensic Data Analytics Survey 2016.
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Essentials for the Successful Audit Team of the
Future
Dual studies explore demands of a modern and
complex global business environment
Two common thrusts of recent articles in the
Integra Audit & Accounting Alert focus on the
current quality of the audit function as
measured by inspections, and the challenges for
maintaining audit relevance and effectiveness
into the future. In order to address these
issues, the Financial Reporting Council of the
United Kingdom (FRC) and The Institute of
Chartered Accountants of Scotland (ICAS) in 2013
commissioned two parallel studies “to
investigate what mix of attributes,
competencies, professional skills and qualities
need to be combined in an audit team in order
for it to perform a high quality public interest
audit in a modern and complex global business
environment,” both now and in the future.
The two teams of academic researchers used
different methodologies that produced
distinctive, yet complementary results. The
study The capability and competency
requirements of auditors in today’s complex
global business environment drew
from the three countries of the researchers:
Australia, South Africa and the United Kingdom.
Six of the largest companies from six different
industries were selected from each country. Then
the internal and external audit executives,
audit committee chairs, and non-auditor experts
participating on the audit were interviewed, as
well as individuals having regulatory and
educational oversight for the countries.
The study found a need for an ongoing debate
about the future of audit, in light of current
trends and changes in the business and societal
environment. As a result of the attempts of
increased regulation to improve audit quality,
dual audits are, in effect, performed: one a
checklist compliance audit and the other
assurance driven to express an opinion. At the
same time, changes and increases in complexity,
for example in technology, require an audit team
that is more diverse and specialized in
knowledge. There is an interesting paradox in
that junior audit staff are in need of closer
and more interactive supervision, while
mid-career and higher professionals are in need
of the deeper technical skills at which the
younger staff are often more adept. Also,
recruiting the talent that is needed to address
the complexities remains a challenge due to the
persistent negative perceptions of the
profession as being “risky, over-regulated,
offering poor work/life balance, possibly boring
and with onerous entry and complex update
requirements.”
The study calls for regulators, professional
bodies, audit firms, the global business
community, and educators to work together to
devise effective, practical solutions. Audit
teams of the future are visualized as comprised
of three components: audit accounting
specialists, industry specialists, and technical
specialists, i.e. actuaries, data analysts, and
information technologists. Specialists in each
area need a better overall understanding of the
other specialties in order to be most effective.
The study Skills, competencies
and the sustainability of the modern audit
used a focus group approach with a series of
meetings, bringing together similar participants
as the first study, as well as users of
financial statements. The groups included
participants from Belgium, France, Germany,
Sweden and the United Kingdom.
The findings from this study were organized
into four areas where challenges for auditors
are perceived. The first centers on the
context of the specific audit engagement,
where the complexities of the modern business,
the accounting and the systems are reasons for
concern. Understanding the business under audit
is crucial for determining an effective audit
approach. With the growing size, complexity and
diversity of business models, reporting
requirements and technological advances, the
expertise required and the nature of audit
evidence may be beyond the capabilities of the
auditor developed under traditional methods.
The second area for attention is the
development of audit personnel. Here the
importance of judgment and perceptive
discernment, for successful audit results, are
seen as eroded from the increased attention
given to checklists and routine procedures
geared toward standards compliance. Also, the
effectiveness of programs for attracting and
nurturing staff will impact the ability to
assure that the best auditors reach the partner
level.
Third is the standing of firms as
suppliers of audit services. The clear
image of the audit firm has diminished as other
service offerings become more prominent and firm
structures may no longer be conducive to a
long-term career model.
The final area addresses interactions
with stakeholders and society. In this
regard, there are several tensions to be
balanced. The auditor needs a depth of knowledge
of the client’s business, but not to the point
that independence is impaired from the potential
value which that knowledge can bring to the
client, aside from the audit. The benefit of
disclosures providing transparency and
describing the audit can be lost through
excessive content. Audit effectiveness is
enhanced from high quality communication with
those in governance, but to attain that goal
calls for appropriate recruiting and training.
Summing up, the report states: “The
'auditing' profession has to ask itself whether
the current state of affairs, with respect to
auditor education, training and practice is as
good as it gets? Is this really the best that
can be done? ... Auditing professionals, policy
makers and those on whose behalf the audit is
undertaken would do well to confront the
following issues and challenges if auditing is
to have a sustainable future and be regarded as
a valued and high skilled function relevant and
appropriate (i.e. 'competent') for the demands
of the modern, 21st century business environment
and broader society.” The issues and challenges
are:
- Conceptualizing the audit as a
skilled, judgmental activity;
- Recruiting and developing suitable
audit professionals; and
- Managing the delivery of the audit
as a professional service.
For further information, see
Major
ICAS/FRC research explores audit skills of the
future.
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Audit & Accounting Alert
is a publication of Integra International intended
to highlight emerging issues in the profession.
The goal is to give Integra members an awareness
of developments impacting the practice of Audit &
Accounting, enabling them to stay on the forefront
of industry trends.
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Editor Gerald E. Herter •
HMWC CPAs & Business Advisors, 17501 E. 17th
Street, Suite 100, Tustin, CA 92780-7924
• Tel: 1 714 505-9000 • Fax: 1 714 505-9200 •
Email:
[email protected]
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