The fraud triangle helps explain the mechanics of fraud by examining the common contributing factors of perceived opportunity, incentive, and rationalization.
Due to the nature of their functions, internal and external auditors, through the implementation of effective internal controls, are in excellent positions to prevent opportunity-based fraud.
A system of internal control is the policies combined with procedures created by management to protect the integrity of assets and ensure efficiency of operations.
The system prevents losses and helps management maintain an effective means of performance.
Principles of an effective internal control system include having clear responsibilities, documenting operations, having adequate insurance, separating duties, and setting clear responsibilities for action.
Internal controls are applicable to all types of organizations: for profit, not-for-profit, and governmental organizations.
The purpose of a petty cash fund is to make payments for small amounts that are immaterial, such as postage, minor repairs, or day-to-day supplies.
A petty cash account is an imprest account, so it is only debited when the fund is initially established or increased in amount. Transactions to replenish the account involve a debit to the expenses and a credit to the cash account (e.g., bank account).
It is the responsibility of management to assure that internal controls of a company are effective and in place.
Though management has always had responsibility over internal controls, the Sarbanes-Oxley Act has added additional assurances that management takes this responsibility seriously, and placed sanctions against corporate officers and boards of directors who do not take appropriate responsibility.
Sarbanes-Oxley only applies to public companies. Even though the rules of this act only apply to public companies, proper internal controls are an important aspect of all businesses of any size. Tone at the top is a key component of a proper internal control system.
The bank reconciliation is an internal document that verifies the accuracy of records maintained by the depositor and the financial institution. The balance on the bank statement is adjusted for outstanding checks and uncleared deposits. The record balance is adjusted for service charges and interest earned.
The bank reconciliation is an internal control document that ensures transactions to the bank account are properly recorded, and allows for verification of transactions.
Financial statement fraud has occurred when financial statements intentionally hide illegal transactions or fail to accurately reflect the true financial condition of an entity.
Cooking the books can be used to create false records to present to lenders or investors. It also is used to hide corporate looting of funds and other resources, or to increase stock prices. Cooking the books is an intentional action and is often achieved through the manipulation of the entity’s revenues or accounts receivable.
Health South and Enron were used as examples of past corporate financial fraud.
The section takes a brief look at the current state of SOX compliance.