Detection and Prevention of Fraud: When something is being done with an intent to deceive, to mislead or to conceal the truth, it is an art of fraud. It is done knowingly and intentionally to defraud the owners of the business. Frauds are more difficult to detect than unintentional errors. The detection of frauds is one of the objects of auditing.
Frauds may be divided into the Following categories:
- Embezzlement Misappropriation of cash
Misappropriation of cash is usually done by theft of cash receipts, cheques, negotiable instruments, showing fictitious payments to workers, creditors, purchases etc. When a person is not subject to any form of check, such person has a number of opportunities and methods of committing frauds in a small business, the possibility of such fraud remaining undetected is remote. But with the increase in size of business, the opportunities of committing fraud also increase because the owners of business have no direct control over receipts and payments of cash. The transactions relating to the receipt of cash are omitted from the records or recorded with the lesser amount in the cash book, thereby all such cash or a part of it is pocketed by the cashier. Similarly, false payments of. cash or over -payment of cash is shown in the cash book. A strict internal control system shall be adopted for receipts and payments of cash so that work of one clerk is automatically checked by another. It may be a good practice to check misappropriation of cash. The auditor should check cash transactions thoroughly.
- Misappropriation of goods
This type of misappropriation is difficult to detect unless proper stock records are maintained. It is easy to misappropriate goods which are less bulky and of high value. The goods may be removed by a member of the staff for his personal benefit. The sales return may be misappropriated before such goods are received by the stokeeper. Efficient system of record keeping, periodical checking, internal check and adequate external security arrangements will be helpful to avoid misappropriation of goods. Misappropriation of goods can be detected by thorough checking of records and physical verification of stock.
- Manipulation of Accounts
The accounts of a business can be falsified or manipulated by making false entries regarding fictitious purchases, sales, expenses etc. Whenever such fraud is committed it usually involves large amounts and is intentional. The information is manipulated to suit the intentions of persons involved there in. Normally the intention is to increase or decrease the profits. This type of fraud is usually committed by owners, managers, directors, board of directors etc. The object of showing low profits than the actual ones may be as follows: (a) To purchase shares from the market at’ a low price, (b) To reduce tax liability, and (c) To give wrong impression in the market about success of business.
The object of showing more profits than the actual ones may be as follows:
- To increase market price of shares
- To mislead the competitors
- To mislead shareholders in the Annual General meeting
- To get more commission when it is paid on the basis of profits
The manipulation of accounts may be done e.g.
- Showing losses to avoid taxes and to deceive shareholdes,
- Falsification of accounts to deceive creditors, bankers etc
- Showing high profits than the actual to inflate the rate of dividends
- Increasing sales by fictitious entries by certain officers to earn more commission
The financial position is shown in such a way that it seems to be better than what it is. Window dressing is more of misrepresentation than fraud. Window dressing may be done in any of the following ways:
- Purchase of a year, may be shown as of next year
- Income of preceding year may be recorded in the current year.
- Expenses of current year may be shown as of next year
- Showing short-term liabilities as long-term liabilities
- Providing inadequate depreciation and bad debts
- Charging revenue expenditure as capital expenditure
- Over or under valuation of assets and liabilities
- Inflating the profits, or deflating losses by entering non- existent items of sales, purchases returns.
- Utilizing secret reserves during the depression period without making the fact known to shareholders