Accounting information systems controls and process 2nd tunnwe weickgenannt chapter 03

Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
Chapter
3-1


Fraud, Ethics, and
Internal Control
Chapter
3-2

Accounting Information Systems, 2nd Edition


Study
Study Objectives
Objectives
1.

An introduction to the need for a code of ethics and good internal controls

2.

The accounting related fraud that can occur when ethics codes and
internal controls are weak or not correctly applied

3.

The nature of management fraud

4.

The nature of employee fraud

5.

The nature of customer fraud

6.

The nature of vendor fraud

7.

The nature of computer fraud

8.

The policies that assist in the avoidance of fraud and errors

9.

The maintenance of a code of ethics

10.

The maintenance of accounting internal controls

11.

The maintenance of information technology controls

Chapter
3-3


Need
Need for
for Code
Code of
of Ethics
Ethics and
and Internal
Internal Controls
Controls
During the early 2000s, several companies were named in
regards to fraudulent financial reporting.

WorldCom

(Audit firm)

Chapter
3-4

SO 1 An introduction to the need for a code of
ethics and good internal controls

Need
Need for
for Code
Code of
of Ethics
Ethics and
and Internal
Internal Controls
Controls
When management is unethical, fraud is likely to occur.
Management obligations:
► Stewardship.
► Provide accurate reports.
► Maintain internal controls.
► Enforce a code of ethics.

Chapter
3-5

SO 1 An introduction to the need for a code of
ethics and good internal controls


Need
Need for
for Code
Code of
of Ethics
Ethics and
and Internal

Internal Controls
Controls

Question
The careful and responsible oversight and use of the
assets entrusted to management is called
a. control environment.
b. stewardship.
c. preventive control.
d. security.

Chapter
3-6

SO 1 An introduction to the need for a code of
ethics and good internal controls


Accounting
Accounting Related
Related Fraud
Fraud
Fraud - theft, concealment, and conversion to personal gain
of another’s money, physical assets, or information.
► Misappropriation of Assets - defalcation or internal theft.
► Misstatement of Financial Records - earnings

management or fraudulent financial reporting.

Chapter

3-7

SO 2 The accounting related fraud that can occur when ethics codes and
internal controls are weak or not correctly applied


Accounting
Accounting Related
Related Fraud
Fraud
Fraud, three conditions must exist.
Exhibit 3-1
The Fraud Triangle

Chapter
3-8

SO 2 The accounting related fraud that can occur when ethics codes and
internal controls are weak or not correctly applied


Accounting
Accounting Related
Related Fraud
Fraud
Categories of Accounting-Related Fraud
Exhibit 3-2

Chapter
3-9

SO 2 The accounting related fraud that can occur when ethics codes and
internal controls are weak or not correctly applied


Accounting
Accounting Related
Related Fraud
Fraud
Question
Which of the following is not a condition in the fraud
triangle?
a. rationalization.
b. incentive.
c. conversion.
d. opportunity.

Chapter
3-10

SO 2 The accounting related fraud that can occur when ethics codes and
internal controls are weak or not correctly applied


The
The Nature
Nature of
of Management
Management Fraud
Fraud

Management Fraud is usually in the form of fraudulent
financial reporting.
Managers misstate financial statements in order to:
1. Increased stock price.
2. Improved financial statements.
3. Enhanced chances of promotion, or avoidance of firing or
demotion.
4. Increased incentive-based compensation.
5. Delayed cash flow problems or bankruptcy.
Chapter
3-11

SO 3 The nature of management fraud


The
The Nature
Nature of
of Management
Management Fraud
Fraud
Management Fraud may involve:

 Overstating revenues and assets.
 Understating expenses and liabilities.
 Misapplying accounting principles.
Two Examples:

Enron’s top management had been
hiding debt and losses by using

special purpose entities (SPEs).

Managers at Xerox approved and encouraged accounting
practices that violated GAAP and accelerated revenue
recognition.
Chapter
3-12

SO 3 The nature of management fraud


The
The Nature
Nature of
of Management
Management Fraud
Fraud
Question
There are many possible indirect benefits to management
when management fraud occurs. Which of the following is
not an indirect benefit of management fraud?
a. delayed exercise of stock options.
b. delayed cash flow problems.
c. enhanced promotion opportunities.
d. increased incentive-based compensation.
Chapter
3-13

SO 3 The nature of management fraud

The
The Nature
Nature of
of Employee
Employee Fraud
Fraud
Employee Fraud usually means that an employee steals
cash or assets for personal gain.
Kinds of Employee Fraud:

Chapter
3-14

1.

Inventory theft.

2.

Cash receipts theft.

3.

Accounts payable fraud.

4.

Payroll fraud.

5.

Expense account fraud.

Kickback
Collusion
Larceny
Skimming

SO 4 The nature of employee fraud


The
The Nature
Nature of
of Management
Management Fraud
Fraud
Question
Which of the following is not an example of employee
fraud?
a. skimming.
b. larceny.
c. kickbacks.
d. earnings management.

Chapter
3-15

SO 4 The nature of employee fraud

The
The Nature
Nature of
of Management
Management Fraud
Fraud
Question
The most difficult type of misstatement to discover is fraud
that is concealed by
a. over-recording the transactions.
b. nonrecorded transactions.
c. recording the transactions in subsidiary records.
d. related parties.

Chapter
3-16

SO 4 The nature of employee fraud


The
The Nature
Nature of
of Customer
Customer Fraud
Fraud
Customer Fraud occurs when a customer improperly
obtains cash or property from a company, or avoids a liability

through deception.
Kinds of Customer Fraud:
1. Credit card fraud.
2. Check fraud.
3. Refund fraud.

Chapter
3-17

SO 5 The nature of customer fraud


The
The Nature
Nature of
of Vendor
Vendor Fraud
Fraud
Vendor Fraud occurs when vendors obtain payments to
which they are not entitled.
Vendors may:
1. Submit duplicate or incorrect invoices.
2. Send shipments in which the quantities are short.
3. Send lower-quality goods than ordered.

Chapter
3-18

SO 6 The nature of vendor fraud

The
The Nature
Nature of
of Vendor
Vendor Fraud
Fraud
Question
The review of amounts charged to the company from a
seller that it purchased from is called a
a. vendor audit.
b. seller review.
c. collusion.
d. customer review.

Chapter
3-19

SO 6 The nature of vendor fraud


The
The Nature
Nature of
of Computer
Computer Fraud
Fraud
Computer Fraud may include:
1. Industrial espionage.
2. Software piracy.

Chapter
3-20

SO 7 The nature of computer fraud


The
The Nature
Nature of
of Computer
Computer Fraud
Fraud
Internal Sources of Computer Fraud
1. Input manipulation
2. Program manipulation
a. Salami technique
b. Trojan horse programs
c. Trap door alterations

3. Output manipulation

Chapter
3-21

SO 7 The nature of computer fraud


The
The Nature

Nature of
of Computer
Computer Fraud
Fraud
External Sources of Computer Fraud
In most cases conducted by someone outside the
company who has gained unauthorized access to the
computer.
Two Common Types:
1. Hacking.
► Denial of Service attack (DoS)

2. Spoofing.

Chapter
3-22

SO 7 The nature of computer fraud


The
The Nature
Nature of
of Vendor
Vendor Fraud
Fraud
Question
Which of the following is generally an external computer
fraud, rather than an internal computer fraud?
a. spoofing

b. input manipulation
c. program manipulation
d. output manipulation

Chapter
3-23

SO 6 The nature of vendor fraud


Policies
Policies to
to Assist
Assist in
in the
the Avoidance
Avoidance of
of Fraud
Fraud
and
and Errors
Errors
Actions to assist in prevention or detection of fraud and
errors:
1. Maintain and enforce a code of ethics.
2. Maintain a system of accounting internal controls.
3. Maintain a system of information technology controls.

Chapter
3-24

SO 8 The policies that assist in the avoidance of fraud and errors


Maintenance
Maintenance of
of aa Code
Code of
of Ethics
Ethics
Sarbanes–Oxley Act of 2002
► Requirement - public companies adopt and disclose

a code of ethics.
Concepts usually found in code of ethics:
► Obeying applicable laws and regulations.
► Conduct that is honest, fair, and trustworthy.
► Avoiding all conflicts of interest.
► Creating and maintaining a safe work environment.
► Protecting the environment.
Chapter
3-25

SO 9 The maintenance of a code of ethics