Auditors Anticipate Finding Fraud At Clients

Auditors Anticipate Finding Fraud At Clients

15 October 2012

By Richard Cornelisse

“While 37.6 percent of respondents expected to find fraud among the accounts they audit, they anticipated their competitors would find fraud at a much higher rate of 66.9. That represents a disconnect between a given auditor’s expected fraud exposure risk and the general expectations for the industry.” Auditors Anticipate Finding Fraud at Clients: Accounting Today.

Top Official Arrested for Bribery

In the Netherlands, a top official of a housing organization was arrested. The housing organization had invested in derivatives and speculated on interest rates. It went wrong and the housing organization needed EUR 1.6 billion to make the payments to the banks.

According to the prosecutor, the top official received a kickback for purchasing these financial products and is now under investigation for bribery, tax fraud and money laundering.

In order to survive, the housing organization had to raise rents and sell 15,000 houses (within a period of 10 years). The housing organization is the biggest Dutch provider of affordable housing, owning about 89,000 houses.

KPMG withdrew its approval for Vestia’s 2010 annual account. KPMG said it doubts whether all derivatives had been processed properly in the annual account (Bloomberg).

VAT Fraud

Evaluating post-Enron hasn’t really changed much from an internal and external control perspective if top officials can still execute their ‘evil’ plans.

I have written about VAT fraud in my recent blogs.

Do external auditors investigate and review companies’ indirect tax policies and controls?

The same question can be raised about the mandate and the associated risks of top officials.

From: Netherlands Intensifies Efforts to Combat VAT Fraud:

Nasir Khan had a successful accessories business, a jet-set lifestyle and reputation as a pillar of the community. But all that vanished in December when he was jailed for his part in a £250m VAT fraud - March, 2012. According to a PwC report: “11 percent of VAT revenue is lost annually through fraud – principally ‘missing trader’ or ‘carousel fraud’ – which equates to roughly €100 billion.

Based on benchmark findings, it is doubtful whether VAT fraud (caused internally or externally) is generally managed and monitored closely via properly functioning internal VAT controls.

“Only 32 percent rate their VAT / GST policies as very good or excellent. Worse still, only 20 percent rate their implementation as very good or excellent. Sounds like most businesses are well behind where they need to be” - KPMG Benchmark Survey 2012.

According to survey findings, C-level executives (including external auditors) still often consider VAT a ‘cash in’ and ‘cash out’ phenomenon. That impacts prioritization and thus likely the investment in time and money to set up of properly functioning internal VAT controls. I refer to my blog ‘How To Manage C-level Perception and Realize Tax Objectives‘.

However, due to the intensified efforts to combat VAT fraud by the governments, causing an increase in tax authority scrutiny, it is recommended to reevaluate the prioritization of VAT overall and set up the right detection controls to manage VAT risks.

From: VAT Throughput – Calculating the Taxes:

“What is the effect of increasing VAT/GST rates on this “VAT throughput”? Governments increase the VAT rates to balance their budget. More VAT/GST in the system equates to more tax authority scrutiny and higher penalties for errors – the greater the amount of tax in the system, the greater the tax risk. Could be that an update of the tax risk register and tax risk evaluation is necessary.”

KPMG says that fraud is on the rise

We have seen similar fraud where goods or companies were sold at lower than market value and where a company official received either a kickback or direct or indirect ownership of the property sold.

Property traders were suspected of forgery, corruption and money laundering and were involved in stealing some €250 million from their companies. The two most important suspects were the former heads of Bouwfonds (Rabobank) and the Philips pension fund.

‘The case came to light when a tax inspector checked out one of top official’s (red: name removed) expense reports (red: a former director at Rabobank’s property development arm Bouwfonds).

‘He asked questions but did not get a clear answer. He then came across a money trail which led to more dubious bills.” DutchNews

KPMG says that fraud is on the rise. According to the latest KPMG Fraud Barometer, a total of 546 large frauds were brought before the courts between 2008 and 2011, costing the Australian economy an aggregate value of over $1 billion.

“We have previously found a positive correlation between levels of fraud and periods of financial instability. We are seeing the first of frauds committed against organizations with gaps in internal controls in this cash-constrained environment” Gary Gill, National Head of KPMG Forensic

Significant findings in this Fraud Barometer include:

“80 percent of frauds against commercial businesses are ‘inside jobs’ committed by rank-and-file employees or managers, averaging $1.8 million per fraud. The largest recorded fraud in the Barometer ($45 million) and the largest against an Australian listed company ($19 million) were both insider frauds. Frauds committed by management cost Australian businesses $400 million over four years, averaging over $2.78 million per fraud, almost triple the average for non-managers. Managers were the culprits in nine of the eleven ‘superfrauds’ (frauds greater than $10 million). Accounting fraud, which invariably involves insiders, weak controls and a lack of detection processes, remains the most common type of fraud; cases related to bribery and corruption are starting to come before the courts as Australia plays catch-up with many other developed economies in toughening its anti-bribery and corruption regime.”

The above study and findings relate to Australia. Are these findings also applicable for the rest of the world?

A Game Plan for Detection and Management

Based on the above examples, it might seem that this relates to the real estate industry. That is not the message I want to get across, since greed by top officials – Enron scandal, Parmalat scandal, Ahold scandal, Barings Bank (rogue trader Nick Leeson), Societé Générale (rogue trader Jerome Kerviel), Global Financial Crisis, etc. – is not restricted to one industry.

Sometimes it relates to the budget-based incentives of the top brass. Artificially boosting a company’s performance is not ethical, but it can be profitable when your bonus is related to that KPI. Often, simple greed and the opportunity suffice where proper oversight is lacking.

I have written about the pitfalls of Budget-based Compensation Targets in my blog “Pitfalls of Actual-to-Budget Exercises, Especially in the Downturn.“ In that blog, I focused on the disconnect and internal competition among employees within an organization. But a code of conduct that includes integrity and common values is something that has to be common practice throughout the organization. Top brass have to be role models.

People are getting caught because the fraud itself becomes unmanageable or the company is suddenly not able to fulfill its financial obligations or somebody had a reason to blow the whistle. According to Accounting Today, it is not because of proper risk management and controls:

“… typically shows that external audits historically have been among the least effective means of uncovering wrongdoing—well behind accidental discoveries and whistle-blowing” Auditors Anticipate Finding Fraud at Clients: Accounting Today.

An example of a game plan

“Fraud continues to cost Australian organizations and in many cases it’s an internal problem, but fraud should never be seen as an unavoidable cost of doing business. Undertaking robust risk assessments, using data analytics to identify potential fraudulent activity, providing staff with fraud-awareness training and putting in place an effective plan for responding to fraud will go a long way in minimizing or avoiding losses,” Gary Gill, National Head of KPMG Forensic

The game plan above can be copy/pasted from the perspective of a VAT strategy and VAT control framework.

What is your view? Do you agree?

Related Topics

From: Management of Reputational Risk:

“The contribution of a tax professional nowadays is not only to prevent paying more tax than is necessary and evaluating associated tax risks when implementing (level of risk tolerance rated on a scale), but also to consider the impact of such planning on the company’s reputation.”

From: Recognizing Tax Avoidance Schemes:

“Check out this video by Paul Clitheroe, a financial expert and financial commentator. Recommended as it is entertaining and educational at the same time.”

From: Audit Defense: Key Considerations:

“The new trend is to have an open dialogue among revenue bodies, taxpayers and tax intermediaries.”

” (…) written ‘agreement’, by which the taxpayer undertakes principally to “actively notify the Tax Administration of any issues with a possible and significant tax risk.”

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Take aways 

We combine technical knowledge with industry understanding and knowhow of technologically advanced tools and methodologies available in the market or developed by ourselves.

  • Focus on tax processes that could be improved
    • Manual process: same data requests are made by different stakeholders
  • As Is assessment
  • Anticipate future changes and the data needed
    • What are tax trends?
    • What is happening locally and what should be considered across jurisdictions where you operate?
    • Anticipate new stakeholders and their data needs or requests (internal and external)
  • Define scope and actions for short, mid and long term
  • Write business case for change
  • Realize sponsorship for implementation
  • What tax data is requested and by whom?
  • What tax process can be improved and what can be automated?
    • CIT, VAT, tax data warehouse
  • What is the Return on Investment?
    • Hard saving: process improvement
    • Meeting (new) tax requirement
  • What systems are in use: SAP, Oracle, etc
    • By which entities?
  • How many end-use computing tools (e.g. excel spreadsheet) do we have?
  • How do we avoid an ad-hoc solution?
    • Understand the bigger picture
    • Real problem and not the symptom

Technology-related tax risk: understand and address the potential harms and benefits of (new) technology.

Ascertaining proper IT support for ensuring efficient, timely and reliable reporting.

VAT should be considered in every aspect of the process, from concept through completion and beyond. Managing by design — looking at any process or transaction from end to end and factoring in all the requirements and controls essential to designing and optimizing a compliant VAT process.

We speak the language of the business and IT and no translation is needed.