Chapter 3: Ethics, Fraud, & Internal Control Flashcards by tin’s visual diary

Q

Why should we be concerned about ethics in the business world?

Ethics are needed when conflicts arise—the
people need to choose

A

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Q

In business, conflicts may arise between:

A

● employees
● management
● stakeholders
● Litigation

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Q

____ ____ involves finding the answers to two
questions:
● How do managers decide on what is right in
conducting their business?
● Once managers have recognized what is right, how
do they achieve it?

A

Business ethics

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Q

concerns the social impact of computer technology (hardware,
software, and telecommunications).

A

Computer Ethics…

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Q

What are the main computer ethics issues?

A

▪ Privacy
▪ Security—accuracy and confidentiality
▪ Ownership of property
▪ Environmental issues
▪ Artificial intelligence
▪ Unemployment and displacement
▪ Misuse of computer

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Q

Legal Definition of Fraud

A

● False representation
● Material fact-
● Intent to deceive must exist
● The misrepresentation must have resulted in
justifiable reliance upon information, which
caused someone to act
● The misrepresentation must have caused
injury or loss

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Q

Legal Definition of Fraud

false statement or disclosure

A

False representation

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Q

Legal Definition of Fraud

a fact must be substantial in inducing someone to act

A

Material fact-

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Q

Legal Definition of Fraud

______ must exist

A

Intent to deceive

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Q

Legal Definition of Fraud

The misrepresentation must have resulted in
______ ______ upon information, which
caused someone to act

A

justifiable reliance

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Q

Legal Definition of Fraud

The misrepresentation must have caused
______ or ____

A

injury or loss

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Q

Fraud Triangle

A

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Q

Enron, WorldCom, Adelphia Underlying Problems

A

• Lack of Auditor Independence:
● Lack of Director Independence
● Questionable Executive Compensation Schemes:
● Inappropriate Accounting Practices

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Q

Enron, WorldCom, Adelphia Underlying Problems

Auditing firms also engaged by their clients to perform nonaccounting activities

A

Lack of Auditor Independence:

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Q

Enron, WorldCom, Adelphia Underlying Problems

directors who also serve on the boards of other companies, have a business trading relationship, have a financial relationship as stockholders or have received personal loans, or have an operational relationship as employees

A

Lack of Director Independence

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Q

Enron, WorldCom, Adelphia Underlying Problems

short-term stock options as compensation result in short-term strategies aimed at driving up stock prices at the expense of the firm’s long-term health.

A

Questionable Executive Compensation Schemes:

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Q

Enron, WorldCom, Adelphia Underlying Problems

: a characteristic common to many financial statement fraud schemes.
● Enron made elaborate use of special purpose entities
● WorldCom transferred transmission line costs from current expense accounts to capital accounts

A

Inappropriate Accounting Practices

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Q

Employee Fraud

Committed by _______

A

non-management personnel/employee

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Q

T or F?

Employee Fraud usually consists of: an employee taking cash or other assets for personal gain by circumventing a company’s system of internal controls

A

T

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Q

Perpetrated at levels of management above the
one to which internal control structure relates

Frequently involves using financial statements to
create an illusion that an entity is more healthy
and prosperous than it actually is

A

Management Fraud

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Q

T or F?

Management Fraud involves misappropriation of assets, it frequently is shrouded in a maze of complex business transactions

A

T

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Q

Fraud Schemes
Three categories of fraud schemes according to the
Association of Certified Fraud Examiners:

A

A. fraudulent statements
B. corruption
C. asset misappropriation

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Q

● Misstating the financial statements to make the copy appear better than it is
● Usually occurs as management fraud
● May be tied to focus on short-term financial measures for success
● May also be related to management bonus packages being tied to financial statements

A

Fraudulent Statements

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Q

Corruption

Examples:

A

● bribery
● illegal gratuities
● conflicts of interest
● economic extortion
● Foreign Corrupt Practice Act of 1977:
● indicative of corruption in business world
● impacted accounting by requiring accurate
records and internal controls

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Most common type of fraud and often occurs as employee fraud

Asset Misappropriation

making charges to expense accounts to cover theft of asset (especially cash)

Asset Misappropriation

using customer’s check from one account to cover theft from a different account

Asset Misappropriation lapping:

deleting, altering, or adding false transactions to steal assets

Asset Misappropriation transaction fraud:

Internal Control Objectives According to AICPA SAS

1. Safeguard assets of the firm 2. Ensure accuracy and reliability of accounting records and information 3. Promote efficiency of the firm’s operations 4. Measure compliance with management’s prescribed policies and procedures

Modifying Assumptions to the Internal Control Objectives

1. Management Responsibility 2. Reasonable Assurance 3. Methods of Data Processing

The establishment and maintenance of a system of internal control is the responsibility of management

Management Responsibility

The cost of achieving the objectives of internal control should not outweigh its benefits.

Reasonable Assurance

The techniques of achieving the objectives will vary with different types of technology

Methods of Data Processing

Limitations of Internal Controls

● Possibility of honest errors ● Circumvention via collusion ● Management override ● Changing conditions--especially in companies with high growth

Exposures of Weak Internal Controls (Risk) ● ____ of an asset ● ____ of an asset ● ____ of information ●_____ of the information system

● Destruction of an asset ● Theft of an asset ● Corruption of information ● Disruption of the information system

The Internal Controls Shield Undesirable Events

1 Access 2 Fraud 3. Errors 4. Mischief

SAS 78 / COSO Describes the relationship between the firm’s…

● internal control structure, ● auditor’s assessment of risk, and ● the planning of audit procedures

T or F? The weaker the internal control structure, the higher the assessed level of risk; the higher the risk, the more auditor procedures applied in the audit.

T

Five Internal Control Components: SAS 78 / COSO

1. Control environment 2. Risk assessment 3. Information and communication 4. Monitoring 5. Control activities

● Integrity and ethics of management ● Organizational structure ● Role of the board of directors and the audit committee ● Management’s policies and philosophy ● Delegation of responsibility and authority ● Performance evaluation measures ● External influences—regulatory agencies ● Policies and practices managing human resources

The Control Environment

● Identify, analyze and manage risks relevant to financial reporting which includes: ● changes in external environment ● risky foreign markets ● significant and rapid growth that strain internal controls ● new product lines ● restructuring, downsizing ● changes in accounting policies

Risk Assessment

● The AIS should produce high quality information which: ● identifies and records all valid transactions ● provides timely information in appropriate detail to permit proper classification and financial reporting ● accurately measures the financial value of transactions ● accurately records transactions in the time period in which they occurred

Information and Communication

Information and Communication

The process for assessing the quality of internal control design and operation Accomplished by : ● Separate procedures—test of controls by internal auditors ● Ongoing monitoring: ● computer modules integrated into routine operations ● management reports which highlight trends and exceptions from normal performance

Monitoring

● Policies and procedures to ensure that the appropriate actions are taken in response to identified risks ● Fall into two distinct categories: ● IT controls—relate specifically to the computer environment ● Physical controls—primarily pertain to human activities

Control Activities

Control Activities Fall into two distinct categories: ______ —relate specifically to the computer environment

IT controls

Control Activities Fall into two distinct categories: _____ —primarily pertain to human activities

Physical controls

Two Types of IT Controls

1. General controls 2. Application controls

________ _____ —pertain to the entitywide computer environment ● Examples: controls over the data center, organization databases, systems development, and program maintenance

General controls

____ ___ —ensure the integrity of specific systems ● Examples: controls over sales order processing, accounts payable, and payroll applications

Application controls

Six Types of Physical Controls

● Transaction Authorization ● Segregation of Duties ● Supervision ● Accounting Records ● Access Control ● Independent Verification

Physical Controls ● used to ensure that employees are carrying out only authorized transactions ● general (everyday procedures) or specific (non- routine transactions) authorizations

Transaction Authorization

Physical Controls ● In manual systems, separation between: ● authorizing and processing a transaction ● custody and recordkeeping of the asset ● subtasks ● In computerized systems, separation between: ● program coding ● program processing ● program maintenance

Segregation of Duties

Physical Controls ● a compensation for lack of segregation; some may be built into computer systems

Supervision

Physical Controls ● provide an audit trail

Accounting Records

Physical Controls ● help to safeguard assets by restricting physical access to them

Access Controls

Physical Controls ● reviewing batch totals or reconciling subsidiary accounts with control accounts

Independent Verification

Physical Controls in IT Contexts ● The rules are often embedded within computer programs. ● EDI/JIT: automated re-ordering of inventory without human intervention

Transaction Authorization

Physical Controls in IT Contexts ● A computer program may perform many tasks that are deemed incompatible. ● Thus the crucial need to separate program development, program operations, and program maintenance.

Segregation of Duties

Physical Controls in IT Contexts ● The ability to assess competent employees becomes more challenging due to the greater technical knowledge required.

Supervision

Physical Controls in IT Contexts ● ledger accounts and sometimes source documents are kept magnetically ● no audit trail is readily apparent

Accounting Records

Physical Controls in IT Contexts ● Data consolidation exposes the organization to computer fraud and excessive losses from disaster.

Access Control

Physical Controls in IT Contexts ● When tasks are performed by the computer rather than manually, the need for an independent check is not necessary. ● However, the programs themselves are checked.

Independent Verification