FRAUD – is an intentional act involving the use of  Misrepresentation or omission of events,

deception that results in a Material Misstatement transaction, or the other significant

of the financial statement. information
 Intentional Misapplication of accounting
TWO TYPE OF MISSTATEMENT
principles.
1. Misstatement arising from misappropriation of
asset
2. Misstatement arising from fraudulent financial THE FRAUD TRIANGLE – Characterizes incentives,
reporting opportunities and rationalizations that enable fraud to
exist.

3 ELEMENTS OF FRAUD TRIANGLE

1. Incentive to commit fraud

1. MISSTATEMENT ARISING FROM
2. Opportunity to commit and conceal the fraud
MISAPPROPRIATION OF ASSET
3. Rationalization- The mindset of the fraudster to
ASSET MISAPPROPRATION justify committing the fraud.

- Occurs when a perpetrator steals or misuses an

organization’s asset.
1. Incentive to commit fraud
Asset Misappropriation can be accomplished in
various ways: INCENTIVES OR PRESURES TO COMMIT FRAUD
o Incentives relating to asset misappropriation
 Embezzling
include:
 Cash Receipts
 Personal factors, such as severe financial
 Stealing Assets
considerations
 Causing the company to pay for goods
 Pressure from family, friends or the culture
or services that were not received
to live a more lavish lifestyle than one’s
Asset Misappropriation occurs when personal earnings allow for
employees:  Addiction to gambling or drugs

 Gain access to cash and manipulate

accounts to cover up cash thefts.
o Incentives include the ff. for fraudulent
 Manipulate cash disbursements
financial reporting:
through fake companies.
 Management compensation schemes
 Steal inventory or other assets and
 Other financial pressures for either
manipulate the financial records to
improved balance sheet
cover up the fraud.
 Debt Covenants
 Pending wealth tied to either financial
2. MISSTATEMENT ARISING FROM FRAUDULENT
results or survival of the company.
FINANCIAL REPORTING
 Greed
- The intentional manipulation of reported financial
results to misstate the economic condition of the
organization.
2. Opportunity to commit fraud
3 Common ways in which fraudulent financial  Significant related-party transactions
reporting can take place include:  A company’s industry position, such as
the ability to dictate terms or conditions
 Manipulation, falsification, or alteration of
to supplier or customers that might allow
accounting records or supporting documents.
individuals to structure fraudulent
transaction
  Management inconsistency involving
subjective judgments regarding assets or
accounting estimates
 Simple transactions that are made
complex through an unusual recording
process
 Complex or difficult to understand
transactions, such as financial derivatives
or special-purpose entities.
 Ineffective monitoring of management by
the board, either because there is a
domineering manager
 Complex or unstable organizational
structure
 Weak or nonexistent internal controls.
3. Rationalizing the Fraud
o For Asset Misappropriation:
 Fraud is justified to save a family
member or loved one from financial
crisis.
 We will lose everything if we don’t take
the money.
 No help is available outside.
 This is “borrowing”, and we intend to
pay the stolen money back some point.
 Something is owed by the company
because others are treated better.
 We simply do not care about the
consequences of our actions or of
accepted notions of decency and trust;
we are for ourselves.
o For Fraudulent Financial Reporting:
 This is one-time thing to get us through
the current crisis and survive until things
better.
 Everybody cheats on the financial
statements a little; we are just playing
the same game.
 We will be in violation of all of our debts
covenants unless we will find a way to
get this debt off the financial statements
 We need a higher stock price to acquire
company XYZ, or to keep our employees
through stock options, and so fourth
RISK FACTORS CONTRIBUTORY TO MISAPPROPRIATION
OF ASSETS
Misappropriation of asset
- involves the theft of an entity’s asset and is often
perpetrated by employees in relatively small and
immaterial amounts.
-However, it can also involve management who are
usually more able to disguise or conceal
misappropriations in ways that are difficult to detect.
Misappropriation of asset can be accompanied
in a variety of ways including:
 Embezzling receipts
 Stealing physical assets or intellectual
property
 Causing an entity to pay for goods and
services not received
 Using an entity’s assets for personal use
A. INCENTIVES/PRESSURES
- Personal Financial obligations may create pressure
on management or employees with access to cash
or other assets susceptible to theft to
misappropriation those asset.
B. OPPORTUNITIES
- Certain characteristics or circumstances the
susceptibility of asset to misappropriation.
C. ATTITUDES/ RATIONALIZATION
- Disregard for the need for monitoring or reducing
risks related to misappropriation of asset.
- Disregard for internal control over
misappropriation of the asset by overriding
existing control or by failing to correct known
internal control deficiencies.
- Behavior indicating displeasure or dissatisfaction
with the entity or its treatment of the employee.
- Changes in behavior or lifestyle that may indicate
assets have been misappropriated.
- Tolerance of petty theft.
RISK FACTOR CONTRIBUTORY TO FRAUDELENT
FINANCIAL REPORTING
FRAUDELENT FINANCIAL REPORTING
- Involves international misstatement including
omission of amounts or disclosures in financial
statements to deceive statement users.