Page 147 - Accounting Information Systems

118 PART I Overview of Accounting Information Systems

the most difficult. It may be relatively easy for a storeroom clerk to steal inventories from the employer’s
warehouse, but altering the inventory records to hide the theft is more of a challenge.
Management fraud is more insidious than employee fraud because it often escapes detection until the
organization has suffered irreparable damage or loss. Management fraud usually does not involve the
direct theft of assets. Top management may engage in fraudulent activities to drive up the market price of
the company’s stock. This may be done to meet investor expectations or to take advantage of stock
options that have been loaded into the manager’s compensation package. The Commission on Auditors’
Responsibilities calls this performance fraud, which often involves deceptive practices to inflate earnings
or to forestall the recognition of either insolvency or a decline in earnings. Lower-level management fraud
typically involves materially misstating financial data and internal reports to gain additional compensa-
tion, to garner a promotion, or to escape the penalty for poor performance. Management fraud typically
contains three special characteristics: 10
1. The fraud is perpetrated at levels of management above the one to which internal control structures
generally relate.
2. The fraud frequently involves using the financial statements to create an illusion that an entity is
healthier and more prosperous than, in fact, it is.
3. If the fraud involves misappropriation of assets, it frequently is shrouded in a maze of complex busi-
ness transactions, often involving related third parties.
The preceding characteristics of management fraud suggest that management can often perpetrate
irregularities by overriding an otherwise effective internal control structure that would prevent similar
irregularities by lower-level employees.

THE FRAUD TRIANGLE
The fraud triangle consists of three factors that contribute to or are associated with management and
employee fraud. These are (1) situational pressure, which includes personal or job-related stresses that
could coerce an individual to act dishonestly; (2) opportunity, which involves direct access to assets
and/or access to information that controls assets, and; (3) ethics, which pertains to one’s character and
degree of moral opposition to acts of dishonesty. Figure 3-1 graphically depicts the interplay among
these three forces. The figure suggests that an individual with a high level of personal ethics, who is
confronted by low pressure and limited opportunity to commit fraud, is more likely to behave honestly
than one with weaker personal ethics, who is under high pressure and exposed to greater fraud
opportunities.
Research by forensic experts and academics has shown that the auditor’s evaluation of fraud is
enhanced when the fraud triangle factors are considered. Obviously, matters of ethics and personal stress
do not lend themselves to easy observation and analysis. To provide insight into these factors, auditors of-
ten use a red-flag checklist consisting of the following types of questions: 11
Do 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 any of the key executives appear to lack personal codes of ethics?
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?

10 R. Grinaker, ‘‘Discussant’s Response to a Look at the Record on Auditor Detection of Management Fraud,’’ Proceedings of the
1980 Touche Ross University of Kansas Symposium on Auditing Problems (Kansas City: University of Kansas, 1980).
11 Ibid.