Fraud 101: Identification Techniques and Response Strategies

Author: Howard R. Davia
Publisher:
Publish Date: 2004-01-01
Features: Although fraud has long been a serious threat to both private and public enterprises, fraud itself has also been continuously evolving as investments in effective anti-fraud methods, resources, and training mechanisms have increased. Statistics on fraud over the past decade are simply staggering. A recent audit of private companies managing Medicare for the U.S. government revealed that $20 billion is spent annually to combat fraud in Medicare, with 4,008 cases traced back to contractors from 1996, and only 5% of fraud cases being extensions of prior incidents. The U.S. Business Council estimates that annual employee wages and management costs for fraud prevention efforts exceed $100 billion. Only 20% of fraud cases are detected and legally addressed, while most are discovered by chance, making their educational significance minimal. Clearly, traditional methods cannot solve these pervasive problems, and increasingly, early warning mechanisms are needed. For business owners, managers, accountants, consultants, CFOs, fraud monitors, and auditors who audit fraud, this comprehensive guide can serve as an independent tool. Fraud 101, written by Howard R. Davia, a certified public accountant with over 30 years of experience in anti-fraud, offers a fresh perspective on fraud characteristics, including detailed descriptions of different fraud types and proven prevention methods—this is the only book of its kind. By reading this book, you can learn:
(1) A step-by-step guide to effective audits;
(2) Numerous real-world case studies, many based on the author’s actual experience;
(3) Discussions on the main types of fraud commonly discovered during audits. Fraud 101 uncovers the true nature of fraud and provides methods for detection.
HOWARD R. DAVIA is a certified public accountant with 30 years of experience in government, industry, and public utility accounting. He has worked as an auditor for the U.S. General Accounting Office and the Service Management General Administration, later serving as a section chief in the Service Management General Administration. These experiences have equipped HOWARD R. DAVIA with extensive knowledge in the likelihood, detection, and prevention of fraud. Mr. Davia is the president and one of the founders of Manager Education Series, a company that provides training and consulting services for fraud detection and control. As an associate professor, Davia has collaborated with the University of Wisconsin-La Crosse’s School of Business to conduct nationwide seminars on fraud detection and control. He has delivered presentations on fraud detection and control to members of the Management Accounting Association, CPA associations, and corporate management personnel. He is also a co-author of The Accountant’s Guide to Fraud Detection and Control (2nd Edition).
The 20/40/40 ratio is significant. However, we must remember the practical context in which this ratio was derived—it was determined in an environment where society lacked practical fraud early warning audits and the effectiveness of specific fraud internal controls was unknown. In such a society, most fraud cases are exposed by chance. But if the social environment changes—meaning businesses at risk of fraud no longer ignore its existence and instead hire independent auditors and/or internal auditors to conduct fraud audits, providing necessary training to guide them in performing specific fraud early warning audits—how would the proportions of different fraud types change under such conditions? We believe that if such a change occurs, the number of fraud cases would decrease at an accelerating rate. The overall improvement in social auditing levels would increase the risks faced by fraudsters, leaving them with very limited space to operate. Consequently, as the risk grows, individuals inclined toward fraud may abandon their original intentions.
With the widespread training in specific fraud early warning audits in the auditing industry and the continuous accumulation of auditors’ experience, the proportions of different fraud types will shift. If society’s awareness of fraud prevention increases, the status of the auditing profession will also rise. On one hand, as most auditors improve their abilities in specific fraud audits, the detection rate of fraud will also rise. The proportion of the third type of fraud will begin to decline. Of course, the third type of fraud will always exist, but its proportion will eventually drop to 20%. On the other hand, the auditing profession’s improved ability to gather fraud evidence will also contribute to solving more fraud cases. The number of the second type of fraud will also decrease. This is because many companies do not pursue legal action against fraudsters. One view is that this happens because companies are reluctant to be publicly exposed, which is indeed true in some cases. However, based on the author’s years of experience, the real reason is often that companies lack sufficient evidence to ensure a win, so they prefer not to pursue legal action and let the fraudsters go free.
Assume a randomly selected audit subject is a $5,000 payment for construction machinery parts to contractor ABC. The auditor discovers that all terms of the contract are entirely fictitious. In reality, contractor ABC never sent any goods. Further investigation reveals this as a fraud case. The total fraud amount is $5,000. This payment lacks any legitimate basis. In such a case, determining the total fraud amount and the fraudster is straightforward. Most fraud cases involve major journal entry fraud. When fraud occurs, the total fraud amount is often masked by seemingly legitimate transactions. If the auditor selects a $5,000 payment for purchasing 1,000 small tools, they might discover what is appropriate. If all accounting vouchers and documents are complete, and the 1,000 small tools are received and recorded in inventory, then