internal controls and fraud presented by katherine yuen, cpa, partner amy l. meyer, cpa, partner...

Internal Controls and Fraud

Presented by

Katherine Yuen, CPA, PartnerAmy L. Meyer, CPA, Partner

CMTA Essentials of Treasury Management WorkshopSeptember 30, 2010

www.MazeAssociates.com

Overview

Fraud – definitions and overview

Internal Controls – definitions and overview

Exercises – multiple choice discussions


Internal control is a process designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

– Reliability of financial reporting– Effectiveness and efficiency of operations– Compliance with laws and regulations


Ensuring Internal Controls are in place is not a new concept for municipalities or for auditors

Internal Controls reduce the risk that fraud can be perpetrated

Internal Controls & Cash and Investments

How does internal control help to achieve the objectives discussed earlier in the treasury function?


Reliability of Financial Reporting

– Investment Reports reflect the holdings and activities of the municipality


Effectiveness and efficiency of operations

– Investments meet cash flow requirements without the need to sell investments early


Compliance with laws and regulations

– Investments are in compliance with the municipality’s investment policy and the government code

What is Fraud?

Fraud - Defined

“Criminal deception intended to financially benefit the deceiver.” -- The Accountants Handbook of Fraud & Commercial Crime

Two Types of Fraud

Fraudulent Financial Reporting

Misappropriation of Assets

The “Fraud Triangle”

MOTIVE

OPPORTUNITY RATIONALIZATION

MOTIVE

“Something (as a need or desire) that causes a person to act”– Merriam-Webster Dictionary

Motive

Opportunity Rationalization

MOTIVE

Severe business pressures

Immediate financial needs

Motive


MOTIVE

Severe Economic Pressures– Unrealistic budgetary goals

– Cash flow pressures

– Economic decline

– Maturing debt or restrictive bond covenants

Motive


MOTIVE

Immediate Financial Needs– Substance abuse

– Involvement in an expensive relationship

– Excessive debt (facing foreclosure of one’s home)

Motive


MOTIVE

Immediate Financial Needs– Desire to keep up the

appearance of wealth

– Medical/financial emergencies of family members

Motive


OPPORTUNITY

“A favorable juncture of circumstances” – Merriam-Webster Dictionary

Examples include:– Weak design of internal

controls– No monitoring or periodic

review of internal control system

– Employee turnover/lay off

Motive


RATIONALIZATION

“To bring into accord with reason or cause something to seem reasonable” – Merriam-Webster Dictionary

Motive


RATIONALIZATION

Examples include:– “It was for the good of

the City”– “I was just borrowing

the money. I would have paid it back if I didn’t get caught”

Motive


RATIONALIZATION

Examples include:– “I was essentially getting a

pay cut with the furlough so I was just taking what I deserve”

– “If management cared more about this District, they would not have let anyone steal this easily”

Motive


RATIONALIZATION

An attempt to depersonalize his/her actions:– “I wasn’t stealing from my

boss, I was stealing from the Authority”

– “The only one to get hurt was the bank, and they can afford it”

– “It’s covered by insurance anyway.”

Motive


The Organizational Fraud Triangle

Leadership

(Motive)

Management Controls (Opportunity)

Culture (Rationalization)

Source: MANAGEMENT CONTROLS: THE ORGANIZATIONAL FRAUD TRIANGLE OF LEADERSHIP, CULTURE AND CONTROL IN ENRON by Clinton Free and Norman Macintosh and Mitchell Stein

Common Investment Frauds

Misappropriation of Assets– Theft of investment schemes– Borrowing schemes – pledging of investments

Fraudulent Financial Reporting– Improper accounting methods– Fictitious investments, investments not owned by

the municipality– Failing to record sales of investments


Theft of investment

– SymptomsUnexpected or unexplained fluctuations in

investment balances.Unexpected or unexplained fluctuations in

investment related income or expense accounts.Unexplained/ongoing reconciling items


Theft of investment

– Management ResponsesAuthorized signer of investments account should

not reconcile the investment accountsJournal entries should be reviewed by someone

other than the preparer before posting


Borrowing scheme

– Scheme “Borrowing” the investment for personal use (e.g.

pledging the asset as collateral for a loan or other financing arrangement.)

– Symptoms Securities held by unusual party. Indications that securities may be pledged.


Borrowing scheme

– Management Responses Investments should be held by a third party

safekeeper Segregation of duties:

– purchasing investments– reviewing statements– preparing Investment Report


Improper accounting methods

– Schemes Involve one or more of the following methods:

– Change of approach used to determine write-downs to manipulate earnings

– Misclassification or misstatement of the value of investments– Failure to disclose liens on securities

– Management Response Culture that does not heavily rely on aggressive financial goals

to determine employee rewards


Fictitious Investments

– Scheme Fictitious investments or investments that are not owned

by the entity are recorded in order to increase an entity’s asset base.

– Management Response Investment reports, safekeeping statements and

investment accounts reconciliation should be reviewed by another employee


Failing to Record Sales of Investments

– Scheme The sale of an investment is not recorded, resulting in

overstatement of assets. The cash may then be infused back into the municipality as a capital or debt transaction. However, many times the proceeds of the sale are diverted.

– Management Response Investment reports, safekeeping statements and

investment accounts reconciliation should be reviewed by another employee

Internal Controls

Internal Controls - Definition

As defined by the AICPA Auditing Standard, consists of five interrelated components:

Control Environment Risk Assessment Information and Communication Control Activities Monitoring

Internal Controls - Control Environment

Reflects management’s attitude, awareness and actions concerning the importance of controls and its emphasis in the organization.

It sets the tone for the organization and is the foundation for all other components of internal control.

Internal Controls - Risk Assessment

The identification and analysis of relevant risks to the achievement of its objectives, forming a basis for determining how the risks should be managed.

The auditing standard provides a checklist of factors that might increase the risk of improperly accounting for transactions or events – applying that checklist to the treasury function:

Internal Controls - Risk Assessment

Change in finance/treasury staff New elected or appointed treasurer New or revamped financial or treasury

system New investment types or new to investing Agency-wide restructuring New accounting pronouncements

Internal Controls - Information and Communication Systems

The systems or processes that support the identification, capture and exchange of information in a form and time frame that enable people to carry out their responsibilities

Internal Controls - Control Activities

The policies and procedures that help ensure management directives are carried out

Internal Controls - Control Activities

Specific control activities include:

– Authorization for use of investment accounts (transactions and setting up new accounts)

– Authorization for investment transactions

– Segregation of duties – physical control of investments vs. recordkeeping function

– Safeguarding – third-party safekeeper, transaction authorization

– Asset accountability – reporting to Council/Board

Internal Controls - Monitoring

Involves the continuous or periodic processes used to assess the quality of internal control performance over time

Internal Controls - Implementation

The design and implementation of internal controls vary with the size and complexity of each municipality. Specifically, smaller municipalities may use less formal means and simpler processes and procedures to achieve their objectives.

Internal Controls - Implementation

In all situations, the cost of a control should not exceed the benefits likely to be derived and the valuation of costs and benefits requires estimates and judgments by management.

Most investment policies contain an Internal Controls section that details functions and requirements that correspond to each of the five elements discussed previously

Excerpts from a county’s investment policy follow on the next slides

Internal Controls and the Treasury Function


The basic concept of investment return is based on a risk/reward relationship. Therefore, the higher the return, the higher the risk.– Risk management must be an integral part of any

investment policy. Risk management must include adequate internal controls so the public has confidence that public monies are secure.


The Chief Deputy Treasurer is responsible for establishing and maintaining an internal control structure designed to ensure that the assets of the entity are protected from loss, theft or misuse. The internal control structure shall be designed to provide reasonable assurance that these objectives are met.


The concept of reasonable assurance recognizes that:

– The cost of a control should not exceed the benefits likely to be derived; and

– The valuation of costs and benefits requires estimates and judgments by management.


Accordingly, the Chief Deputy Treasurer shall establish and maintain internal controls that shall address the following points:


Control of Collusion Separation of Transaction Authority from

Accounting and Record Keeping Custodial Safekeeping Avoidance of Physical Delivered Bearer

Securities Clear Delegation of Authority to Subordinate

Staff Members


Written Confirmation of Telephone Wire Transfers Development of a Wire Transfer Agreement with the

Lead Bank or Third Party Custodian Development of the Annual Treasurer’s Investment

Manual Provide for an annual independent review by an

external auditor to assure compliance with policies and procedures.

Questions?

Exercises

Exercise - #1

According to the 2004 American Certified Fraud Examiner (ACFE) Report to the Nation, the gender, age and education profile of a typical fraud perpetrator is:

a. Male, 36-50, at least a high school education.

b. Female, 45-60, at least high school education.

c. Female, under 50, college educated.

d. Male, under 35, at least high school education

Exercise - #2

According to the 2004 American Certified Fraud Examiner (ACFE) Report to the Nation, the most common scenario that uncovers fraud in an organization is:

a. External audit.

b. Internal audit.

c. By accident.

d. Tips from employees.

Exercise - #3

The concept of the “Fraud Triangle” consists of:

a. Motive, opportunity, need.

b. Ignorance, opportunity, pressure.

c. Motive, greed, rationalization.

d. Motive, opportunity, rationalization.

Exercise - #4

Which of the following is not considered to be an “immediate financial need” motivator for asset misappropriation?

a. Employee’s son was arrested.

b. City faces restrictive bond covenants.

c. Employee has a substance abuse problem.

d. Employee’s wife was injured in an accident.

Exercise - #5

Which of the following would not be a typical “rationalization” that a fraud perpetrator would use?

a. “What I stole was only 1% of the District’s portfolio.”

b. “I was doing this for the good of the City.”

c. “Hey, I know it’s wrong, but I needed the money.”

d. “I was just borrowing the money. I planned to pay it back.”

Exercise - #6

Which of the following is not considered an “opportunity” in the fraud triangle:

a. The employee who reconciles the bank accounts can also authorize wire transfers.

b. Finance Director is under extreme pressure to meet the budgetary goals.

c. Bank reconciliations are reviewed by an elected official who does not understand accounting.

d. Investment account reconciliation is only completed at year end.

Questions?

[email protected]

[email protected]

(925) 930-0902

internal controls and fraud presented by katherine yuen, cpa, partner amy l. meyer, cpa, partner...

Documents

fraudinternal controls

regulationsinternal

auditorsinternal controls

internal control help

cash flow requirements

treasury function

achievement of objectives

reasonable assurance