CHAPTER
ONE
BACKGROUND TO'THE STUDY
1.1 INTRODUCTION
Saying that fraud is an important
(however not loved) part of business, is nothing new. Fraud is a million dollar
business, as several research studies reveal. Among them are important surveys
of Price Waterhouse & Coopers (PwC, 2007) and of the Association of
Certified Fraud Examiners (ACFE, 2006). The study conducted in the United
States by the ACFE in 2004-2005 and the worldwide study, held by PwC in
2006-2007 yields the following insights. No industry seems to be safe and
bigger companies seem to be more vulnerable to fraud than smaller ones. Small
businesses however suffer disproportionate fraud losses. 43% of companies
worldwide have fallen victim to economic crime in the years 2006 and 2007. The
average financial damage to companies subjected to the PwC survey was US$ 2.42
million per company over two years. Participants of the ACFE study estimate a
loss of 5% of a company’s annual revenues to fraud. Applied to the 2006 United
States Gross Domestic Product of US$ 13,246.6 billion, this would translate to
approximately US$ 662 billion in fraud losses for the United States only. These
numbers all address corporate fraud, more precisely internal fraud.
About the way fraud is detected, both
studies of PwC and the ACFE stress the importance of tips and chance. However,
as a number two detection means in studies, internal audit and internal control
systems can have a measurable impact on detecting fraud. The more control
measures a company puts in place, the more incidents of fraud will be
uncovered.
Organizations allocate lots of
resources to internal audit and control sto prevent internal fraud. These
costs, together with the costs of fraud, represent a large economic cost for
the business environment.
Academic literature is currently
investigating the use of data mining for the purpose of fraud detection.
Brockett et al. (2002), Cortes et al. (2002), Est´evez et al. (2006), Fanning
and Cogger (1998), Kim and Kwon (2006) and Kirkos et al. (2007) are just a few
examples of a more elaborated list of articles concerning the hot topic of
fighting fraud. Although a lot of this research may be framed in different
settings -going from different techniques to different fraud domains-, there
are two characteristics that stand for all executed research up till now: the
focus is on external fraud and a predictive data mining approach is applied for
fraud detection. We however are interested in internal fraud, since this
represents mainly these large costs in the PwC and ACFE surveys. Further, we
are convinced that not fraud detection alone, but detection in combination with
prevention, is of priceless value for organizations. We use the term fraud risk
reduction for encompassing both fraud detection and prevention.
1.2 STATEMENT OF THE
PROBLEM
Unfortunately, the problem is getting
worse. During the past year, both the number of fraud incidents and the dollar
value of fraud increased dramatically, with 55.4 percent of respondents
reporting increased fraud in the past twelve months.
The economy has driven much of the growth.
“Increased pressure” is cited as by far the biggest factor contributing to
fraud. At 49.1 percent, it is comfortably ahead of increased opportunity (27.9
percent) and more than twice the rate of “rationalized” acts by the
perpetrators (23.7 percent).
As in prior downturns, the problem is
expected to worsen. More than 80 percent of respondents indicated that they
expect the incidence of fraud to increase. Thirty-six percent expect it to
increase significantly.
The greatest emerging source of fraud is
employee embezzlement which accounted for a disturbing 48.3 percent of last
year’s increase. Internally generated fraud — e.g. corruption, financial statement
fraud, and embezzlement — are also expected to continue to grow substantially.
Unfortunately, the poor economy like
Nigeria is increasing the pressure to commit fraud in two ways. In addition to
placing more personal economic pressures on employees, layoffs are depleting
internal control systems. Nearly 60 percent of CFEs who work as in-house fraud
examiners reported their companies had layoffs in the past year. Among those
who had layoffs, almost 35 percent of companies had eliminated some internal
controls.
1.3 OBJECTIVES
OF RESEARCH STUDY
As previously mentioned, audit
quality is the output of audit practice, and one of the major elements of audit
quality is fraud detection. The objective of this study was to
·
Determine
the factors which may have a positive or negative affect on audit quality or
audit fraud detection.
·
Examine the free flow of
information needed by the management for proper auditing functions
·
Determine whether
objective evaluation and measurement of the effectiveness of other controls by
internal audit could put a stop to fraud.
·
Determine whether well
organized internal audit could change orientation of workers towards frauds?
1.4 RESEARCH QUESTIONS
-
Can objective evaluation and measurement of the effectiveness of
other controls by internal audit put a stop to fraud?
-
Can well organized internal audit change orientation of workers
towards frauds?
-
What factors of human errors undermine the effective operation of
the internal audit?
-
Why do client’s transactions go unchecked for arithmetical
accuracy?
1.5 HYPOTHESES
The operation of an effective internal audit system in the public
sector will surely reduce the incidence of fraud.
HYPOTHESES
1
-
Ho:
There is no significant relationship between an effective internal audit system
and occurrence of fraud in a public sector.
-
H1:
There is significant relationship between an effective internal audit system
and occurrence of fraud in a public sector.
HYPOTHESES
2
-
Ho:
An effective internal check will not make fraudulent practices and other
irregularity difficult to perpetrate in the public sector.
-
HI:
An effective internal check will make fraudulent practices and other
irregularity difficult to perpetrate in the public sector.
1.3 SIGNIFICANCE OF
THE STUDY
Of course, there are a number of specific
ways in which fraud can be thwarted. Many of them provide additional ways to
break up closed-off silos or encourage specific reporting.
This study can give an insight on how to
protect cash and cash receipts, have checks mailed by someone other than the
preparer after signing, have bank statements delivered to the owner unopened
and have the bank accounts reconciled by someone independent of the cash
receipts and disbursement functions.
It will also examine how to protect
inventory and minimize your cost of sales, periodically count cost and compare
inventory to control accounts and/or perpetual records. Pre-number documents
and account for the sequence when you develop forms for purchase orders,
receiving, inventory transfers and shipping. You will also want to take some very
concrete actions: Store expensive components, products or tools in a locked
closet. Designate a single exit door for your employees. And, of course, check
the trash.
Segregated functions and specific
purchases are your best strategies on the expense side. Separate
requisitioning, purchasing and receiving functions from invoice processing,
accounts payable, cash receipts and disbursements, and general ledger
functions. Develop an approved vendor list to discourage under-the-table
arrangements and shell vendors.
1.8 SCOPE OF THE STUDY
This research work covers internal audit system and how it could
be structured and operated as a measure against fraud perpetration in the
public sector i.e. how it can effectively prevent and detect fraud. Public
sector as practiced in the Power Holding Company of Nigeria (PHCN). The areas
to be covered will include the following.
-
Quality control in Auditing
-
Internal control in
Auditing
-
Investigation
-
Statutory Audit
-
All laws guiding the practice of audit in Nigeria
1.9 LIMITATIONS OF THE STUDY
However, the following are
the constraints encountered in the process of the research work.
-
Time: Being
a student with so much to do such as reading for the forthcoming examinations.
Etc., time therefore, constitutes a constraint in the writing of this
project.
-
Fund:
As a student with no steady sources of income, rather than the little form
home. The present economic situation in the country today, has an adverse
effect on the financial aspect of this research work.
Epileptic Power
Supply: The inadequate supply of electricity