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CHAPTER 5
FRAUD

Tengku Fairuz Binti Tengku Embong

Faculty of Accountancy

Learning Objectives
1 Explain the threats faced by modern information systems.

Define fraud and describe both the different types of fraud

2 and the auditor’s responsibility to detect fraud.

Discuss who perpetrates fraud and why it occurs, including

3 the pressures, opportunities, and rationalizations that are
present in most frauds.

Define computer fraud and discuss the different computer

4 fraud classifications.

5 Explain how to prevent and detect computer fraud and abuse.

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INTEGRATIVE CASE: Northwest Industries

Jason anticipated the following questions that management

was going to ask:

What constitutes a fraud, and is How can the company detect

the withholding problem a fraud? and prevent fraud?

How was the fraud perpetrated? How vulnerable is the

What motivated Don to commit company’s computer system to
it? fraud?

Why did the company not catch

these mistakes? Was there a
breakdown in controls?

AIS Threats

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4 Types of Systems Threats:

Software
Natural And Errors And Unintentional
Acts Intentional
Political Equipment
Acts
01 Disasters 02 Malfunctions 03 04
▪ Hardware or ▪ Human carelessness ▪ Sabotage
▪ Fire or excessive
software failures ▪ Failure to follow ▪ Computer fraud
heat
▪ Software errors or established ▪ Misrepresentation,
▪ Floods
bugs procedures false use, or
▪ Earthquakes
▪ Operating system ▪ Poorly trained or unauthorized
▪ High winds
crashes supervised personnel disclosure of data
▪ War and terrorist
▪ Power outages and ▪ Innocent errors or ▪ Misappropriation of
attack
fluctuations omissions assets
▪ Undetected data ▪ Lost, destroyed, or ▪ Financial statement
transmission errors misplaced data fraud

Operating system crashes are an example of:

A B C D

Natural And Intentional Unintentional Software

Political Acts Acts Errors And
Disasters Equipment
Malfunctions

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Which of the following causes the majority of

computer security problems?

A B C D

Human Software Natural Power

Errors Errors Disasters Outages

Fraud

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Definitions of Fraud (White-Collar Crime)

Fraud is any and all means a person uses to gain an unfair
advantage over another person.
Act must meet 5 conditions:

False Intent To Deceive Injury Or Loss

Representation Must Exist Or Suffered By The
False Statement Knowledge Victim
Or Disclosure Statement Is False
2 4

Material Fact Justifiable

1 That Induce 3 Reliance 5
People To Act People Take Action
Based On That
Misrepresentation

2 types of Fraud:

Misappropriation Of Assets
(Employee Fraud) Fraudulent Financial Reporting

Intentional or • Deceive investors and

Involves theft, E.g. billing
reckless conduct, creditors
embezzlement, schemes,
whether by act or • Cause a company’s
or misuse of check
omission, that stock price to rise
company tampering,
results in materially • Meet cash flow needs
assets for skimming,
misleading financial • Hide company losses
personal gain and theft of
statements and problems
inventory

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The Treadway Commission recommended 4 actions to reduce

the possibility of fraudulent financial reporting:

Establish an organizational environment

01 that contributes to the integrity of the
financial reporting process.

Identify and understand the factors that

lead to fraudulent financial reporting.
02
Assess the risk of fraudulent financial
03 reporting within the company.

Design and implement internal controls to

provide reasonable assurance that
fraudulent financial reporting is prevented.
04
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Auditor’s Responsibility
SAS No. 99 (AU-C Section 240) requires auditor’s to:

Identify, assess, and

Obtain information respond to risks

Discuss the risks of Evaluate the results

material fraudulent of their audit tests
misstatements

Document and
communicate
Understand fraud findings

Incorporate a
technology focus

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Which of the following statements is FALSE?

A B C D

Fraudulent Misappropriation SAS No. 99 SAS No. 99

financial of assets is requires was adopted
reporting are employee theft auditors to in 2002
large errors understand
in the fraud
financial
statements

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Who Perpetrates Fraud

and Why

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Fraud
Your Text Here
Triangle

Research shows that three

conditions are necessary for
Your Text Here fraud to occur:

✓ A Pressure
✓ An Opportunity
Your Text Here
✓ A Rationalization

Your Text Here

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Fraud Triangle

Refer Table 5-2 Refer Table 5-3

Financial Financial
Financial
Employee Statement
Pressure Pressure
Triangle Triangle

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Fraud Triangle
Commit
Opportunity Can sell the assets or get
Triangle personal gain

Has ability to cover his

track e.g lapping scheme,
kitting scheme Refer Table 5-4

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Fraud Triangle
Attitude
Rationalization
Triangle

A list of some of the rationalizations

people use:
✓ I am only “borrowing” the money
(or asset) and will repay my “loan.”
✓ What I did was not that serious.
✓ It was for a good cause (the Robin
Hood syndrome).
✓ Everyone else is doing it, so it is not
that wrong.
✓ No one will ever know.

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The three conditions that are present when

fraud occurs include:

A B C D

Attitude Opportunity Lack Of Control Financial

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The pressures that can lead to employee fraud include:

A B C D

Fear Of Losing Lack Of Control Family Or Peer A And C

Job Pressure

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Internal control factors that provide an opportunity for

employee and financial statement fraud includes

A B C D

Incompetent Operating On A Inadequate Low Employee

Personnel Crisis Basis Supervision Morale And
Loyalty

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Computer Fraud

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Unauthorized theft, use,
access, modification, copying,
and destruction of software
or data
Theft of assets by altering
computer records
Intent to illegally obtain
information or tangible
property through the use of
computers
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Computer
Fraud
Classifications
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Computer Fraud
Any illegal act for which
knowledge of computer
technology is essential
❖ Not everyone agrees on what
constitutes computer fraud.
❖ Many computer frauds go undetected.
❖ A high percentage of frauds are not
reported.
❖ Many networks are not secure.
❖ Internet sites offer step-by-step
instructions on how to perpetrate
computer fraud and abuse.
❖ Law enforcement cannot keep up with
the growth of computer fraud.
❖ Calculating losses is difficult
REFER TABLE 5-2
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Computer Fraud Classifications

Input Processor Computer Data Output

▪ The simplest and Instructions ▪ Stealing or
most common way ▪ Tampering with ▪ Altering or misusing system
▪ Committed
to commit a fraud is the software damaging a output
through
to alter computer that processes company’s data ▪ Screen output can
unauthorized
input company data files easily be read from
system use
▪ Requires little ▪ Copying software a remote location
computer skills ▪ Includes theft of illegally ▪ Copying, using, or using inexpensive
computer time and searching the electronic gear
▪ Perpetrator only ▪ Developing a
services data files without
needs to software program ▪ use computers and
authorization
understand how to carry out an peripheral devices
the system unauthorized to create
operates activity counterfeit outputs

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Computer fraud is increasing rapidly due to the

fact that:

A B C D

Not everyone Many computer The total All of the

agrees on frauds go dollar value above
what undetected of losses is
constitutes difficult to
computer calculate
fraud

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Which of the following is not a classification of

computer fraud:

A B C D

Data Fraud Input Fraud Processor Program

Fraud Fraud

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An employee downloaded new product development

plans after hours, is an example of:

A B C D

Data Fraud Output Fraud Computer Processing

Instructions Fraud
Fraud

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Preventing and Detecting

Fraud and Abuse

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Preventing and Detecting Fraud

Make Fraud Less Likely to Occur Make It Difficulty to Commit

Improve Detection Reduce Fraud Losses

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Ways to prevent and detect computer fraud include

A B C D

Develop a strong Install fraud Segregate the All Answers

system of internal detection accounting
controls software functions of
authorization,
recording, and
custody

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Thank you
End of Chapter 5

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