A Comprehensive Structure to Help Analyze, Detect and Prevent Fraud

Abstract

Merely relying on historical events to test for fraud occurrence often provides an insufficient basis to detect-let alone to prevent-it. Fraud, a multidimensional cyclical dynamic, exists not only as an event but also as a concept, intention, action and object needing a comprehensive structure to capture its critical elements and interactions among these elements. SAS No. 82, which addresses the practical aspect of fraud and guides auditors to consider the potential occurrence of fraud in financial statement audits, adopts a limited view of fraud. This paper augments this new Standard by constructing a comprehensive view of fraud consisting of two principal components: (1) a definition of fraud broader than SAS No. 82's definition, and (2) an anatomy of fraud with all of the aforementioned dimensions.

The anatomy of fraud and its dynamic content raise the question of whether fraud is cyclical or merely repetitive. This question has not been addressed in the auditing literature despite its primacy in distinguishing intentional and non-intentional irregularities and understanding the fundamental nature of the auditing function. While non-intentional errors are repeatable due to their identities, fraud cases are cyclical because of their similarities (Deleuze, 1994).

Analyzing fraud merely by its detection and prevention elements can lead to two fundamental weaknesses: structure and predictability. Fraud's cyclical nature, coherent elements and direction imply that even partial detection, via professional skepticism as SAS No. 82 describes, can uncover all of its drives, intents, actions and objects. Moreover, an actual fraud event, as an effect with circumstantial causes, renders fraud predictable by projection (the macro cause) and by similarities among fraud cases (the micro cause). The proposed comprehensive structure, encompassing intentional and unintentional irregularities, can help contain and prevent fraud even at its inception stage. To demonstrate how the comprehensive structure can help explain fraud's intricate elements, we analyze seven prominent fraud cases into their cyclical components and their implications to independent auditors.

JEL Classification: M49