IT Auditing & Assurance, 2e, Hall & Singleton Chapter 11: Introduction to Business Ethics and Fraud IT Auditing & Assurance, 2e, Hall & Singleton
IT Auditing & Assurance, 2e, Hall & Singleton
Chapter 11:Introduction to Business
Ethics and Fraud
IT Auditing & Assurance, 2e, Hall & Singleton
IT Auditing & Assurance, 2e, Hall & Singleton
Pertains to the principles of conduct that individuals use in making choices and guiding their behavior in situations that involve the concepts of right and wrong.
ETHICS
Business EthicsHow do managers decide on what is right
in conducting business?Once managers have recognized what is
right, how to they achieve it?
The necessity to have an articulate foundation for ethics and a consistent application of the ethical standards.
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BUSINESS ETHICSBasis of Ethical Standards
Ethical Issues in Business [Table 11-1]
Religious Philosophical Historical IBM combination of all three
Equity Exec. salaries Pricing
Rights Health (screening) Privacy Sexual harassment Equal opportunity Whistleblowing
Honesty Conflicts of interest Security of data & records Foreign practices [FCPA] Accurate F/S reporting
Exercise of Corp. Power PAC, and politics Workplace safety Downsizing, closures
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IMPLEMENTING BUSINESS ETHICS1990 Business Roundtable
Greater commitment of top management Written codes (policy) that clearly
communicate standards and expectations Programs to implement ethical guidelines Techniques to monitor compliance
Boeing Uses line managers to lead ethics training Toll-free number to report violations
General Mills Published guidelines with vendors, competitors, customers
Johnson & Johnson Creed integral to its culture Uses surveys to ascertain compliance
SAIC Toll-free number, required training, separate dept.
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IMPLEMENTING BUSINESS ETHICS
Role of Management Create and maintain appropriate ethical atmosphere Limit the opportunity and temptation for unethical
behavior Management needs a methodology for including
lower-level managers and employees in the ethics schema Many times, lower-level managers responsible to uphold
ethical standards Poor ethical standards among employees are a root cause of
employee fraud and abuses
Managers and employees both should be made aware of firm’s code of ethics
What if management is unethical? e.g., Enron
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IMPLEMENTING BUSINESS ETHICSReported Abuses
Typically junior employees (Wall Street Journal) Half of American workers believe the best way
to get ahead is politics and cheating One-third of a group of 9,175 surveyed had
stolen property and supplies from employers Ethics Resource Center: 1994 study
41% falsified reports 35% committed theft
Ethical Development Most people develop a personal code of ethics from
family, formal education, and personal experience Go through stages of moral evolution [Figure 11-2]
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IMPLEMENTING BUSINESS ETHICSMaking Ethical Decisions
Business schools can and should be involved in ethical development of future managers
Business programs can teach students analytical techniques to use in trying to understand and properly handle a firm’s conflicting responsibilities to its employees, shareholders, customers, and the public
Every ethical decision has risks and benefits. Balancing them is the manager’s ethical responsibility:
Ethical Principles Proportionality: Benefits of a decision must outweigh the
risks. Choose least risky option. Justice: Distribute benefits of decision fairly to those who
share risks. Those who do not benefit should not carry any risk
Minimize Risk: Minimize all risks.
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COMPUTER ETHICS
Levels of Computer Ethics POP: the exposure to stories and reports in popular media PARA: taking a real interest in computer ethics cases and
acquiring some level of skill and knowledge THEORETICAL: multi-disciplinary researchers who apply the
theories of philosophy, sociology, and psychology to computer science, intending to bring some new understanding to the field. That is, ethics research.
The analysis of the nature and social impact of computer technology and the
corresponding formulation and justification of policies for the ethical use of such
technology.
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COMPUTER ETHICS
A new problem or just a new twist to an old problem?
Although computer programs are a new type of asset, many believe that they should not be considered as different form other forms of
property; i.e., intellectual property is the same as real property and the rights associated with real
property.
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COMPUTER ETHICAL ISSUES1. Privacy:
Ownership of personal information Policies
2. Security: Systems attempt to prevent fraud and abuse of
computer systems, furthering the legitimate interests of firm
Shared databases have potential to disseminate inaccurate info to authorized users
3. Ownership of Property: Federal copyright laws
4. Race: African-Americans and Hispanics constitute 20%
of population but 7% of MIS professionals
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COMPUTER ETHICAL ISSUES5. Equity in Access:
Some barriers are avoidable, some are not Factors: economic status, affluence of firm,
documentation language, cultural limitations
6. Environmental Issues: Should firms limit non-essential hard copies? What is non-essential? Disposal of equipment and supplies (toner)
7. Artificial Intelligence: Who is responsible for faulty decisions from
an Expert System? What is the extent of AI/ES in decision-making
processes?
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COMPUTER ETHICAL ISSUES8. Unemployment & Displacement:
Computers and technology sometimes replace jobs (catch-22, productivity)
Some people unable to change with IT, get displaced and find it difficult to obtain new job
9. Misuse of Computer: Copying proprietary software Using a firm’s computers for personal benefit Snooping through firm’s files
10. Internal Control Responsibility: Unreliable information leads to bad decision, possible
financial distress Management must establish and maintain a system of
appropriate internal controls to ensure integrity and reliability of data (antithetical)
IS professionals and accountants are central to adequate internal controls
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FRAUD & ACCOUNTANTSThe lack of ethical standards* is fundamental to the occurrence of
business fraud.No major aspect of the independent auditor’s role has caused more
difficulty for public accounting than the responsibility for detection of fraud during an audit. [article]
This issue has gathered momentum outside the accounting profession to the point where the profession faces a crisis in public confidence in its ability to perform independent attest functions. [SAS 82]
Fraud denotes a false representation of a material fact made by one party to another party with the intent to deceive and induce the other party to
justifiably rely on the fact to his/her detriment, i.e., his/her injury or loss.
Synonyms: White-collar crime, defalcation, embezzlement, irregularities.
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FRAUD
A fraudulent act must meet the following 5 conditions:
1. False representation2. Material fact3. Intent4. Justifiable reliance5. Injury or loss
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FRAUD TREE Asset misappropriation fraud
1. Stealing something of value – usually cash or inventory (i.e., asset theft)
2. Converting asset to usable form3. Concealing the crime to avoid detection4. Usually, perpetrator is an employee
Financial fraud1. Does not involve direct theft of assets2. Often objective is to obtain higher stock price (i.e., financial fraud) 3. Typically involves misstating financial data to gain additional
compensation, promotion, or escape penalty for poor performance
4. Often escapes detection until irreparable harm has been done 5. Usually, perpetrator is executive management
Corruption fraud1. Bribery, etc.
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FRAUD SCHEMES Fraudulent financial statements {5%} Corruption {10%}
Bribery Illegal gratuities Conflicts of interest Economic extortion
Asset misappropriation {85%} Charges to expense accounts Lapping Kiting Transaction fraud
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EMPLOYEE FRAUD
Employee Theft
1) Theft of asset2) Conversion of asset (to cash, to
fraudster)3) Concealment of fraud
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MANAGEMENT FRAUD
Special Characteristics:
1. Perpetrated at levels of management above the one where internal controls relate
2. Frequently involves using the financial statements to create false image of corporate financial health
3. If fraud involves misappropriation of assets, it frequently is shrouded in a complex maze of business transactions, and often involves third parties. [e.g., ZZZZ Best fraud]
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FRAUD TRIANGLE People engage in fraudulent activities as a result of forces
within the individual (their ethical system) and without (from temptation and/or stress from the external environment)1. Situational Pressures2. Opportunity3. Rationalization
A person with a high level of personal ethics and limited pressure and opportunity to commit fraud is most likely to behave honestly [Figure 11-2]
A person with low level of integrity, and moderate to high pressures, and moderate to high opportunity is most likely to commit fraud
Auditors can develop a “red flag” checklist to detect possible fraudulent activity
A questionnaire approach could be used to help auditors uncover motivations for fraud
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POSSIBLE QUESTIONNAIREDo key executives have unusually high personal debt?
Do key executives appear to be living beyond their means?
Do key executives engage in habitual gambling?
Do key executives appear to abuse alcohol or drugs?
Do key executives appear to lack personal codes of ethics?
Do key executives appear to be unstable (e.g., frequent job or residence changes, mental or emotional problems)?
Are economic conditions unfavorable within the company’s industry?
Does the company use several different banks, none of which sees the company’s entire financial picture?
Do key executives have close associations with suppliers?
Do key executives have close associations with members of the Audit Committee or Board?
Is the company experiencing a rapid turnover of key employees, either through quitting or being fired?
Do one or two individuals dominate the company?
Does anyone never take a vacation?
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FINANCIAL LOSSES FROM FRAUD
1996, 2002, and 2004 study by Association of CFE (“Report to the Nation”) estimated losses from fraud and abuse at 6% of annual revenues! Based on GDP in 2002, that would be $600B, and in 2004 $660B in losses.
Actual cost is difficult to quantify because:1. All fraud is not detected2. Of ones detected, not all are reported3. In many cases, incomplete information is gathered4. Information is not properly distributed to management or law
enforcement authorities5. Too often, business organizations decide to take no civil or
criminal action against the perpetrator of fraud
Organizations with 100 or fewer employees were the most vulnerable to fraud SEC fraud violations reported in COSO “Landmark Study”
1998
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FINANCIAL LOSSES FROM FRAUD
Profile of perpetrator: By position – Table 11-3 By gender – Table 11-5 By age – Table 11-6 By Education – Table 11-7 Conclusions about profile?
Fraudsters do not look like crooks!
Collusion – Table 11-4
1. Significant reason to adhere to segregation of duties
2. Risks associated with a key position held by a trusted employee who unknowingly has weak ethics
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UNDERLYING PROBLEMS
Lack of auditor independence Lack of director independence Questionable executive
compensation schemes Inappropriate accounting practices
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SARBANES-OXLEY ACT PCAOB Auditor independence
List of services considered non-independent
Corporate governance Issuer and management disclosure Fraud and criminal penalties
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ANTI-FRAUD PROFESSION Fraud auditors Forensic accountants Association of Certified Fraud Examiners
Certified Fraud Examiner certification – http://www.acfe.org
Forensic Accounting Investigation Evidence for court Litigation CFE – Association of Certified Fraud
Examiners See newsletter sample at ACFE web site
IT Auditing & Assurance, 2e, Hall & Singleton
Chapter 11:Introduction to Business
Ethics and Fraud
IT Auditing & Assurance, 2e, Hall & Singleton