Understanding organizational structure may enhance fraud detection

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This report is prepared as the audit committee chairman in the firm wants to know more on the issue which related on understanding organizational structure may enhance fraud detection and prevention.

After reading it he was unsure on the new method and wants to conduct further related research. Due to this she has ordered me, as an internal auditor to prepare the report to brief her on these issues.

The finance director expects that the report will focus more on the aspect of other information sources on the issues that might inform the direction of the organization and accessing the nature of this information sources using the relevance and reliability method.

4.0 Introduction

Today, when someone asked us about what causes fraud and how the people does it, we will link back to the case related to Enron, World Com and Barings Bank.

Until today, there are question still arises on the reason why the fraud still occurs even though the company practices good corporate governance and having an audit committee to monitor the company.

In order to explain this we will take a look at Enron. According to Free, Macintosh & Stein (2007) Enron has won award on a management control and governance system when the company was under Richard Kinder as the company's president. Richard Kinder has been replaced by Jeffery Skilling during 2006. Skilling appointment has made Enron undergone a huge changes in terms of culture and the management control system (Free, Macintosh & Stein, 2007).

A year later, Skilling leadership has been bought into question when Enron collapsed due to serious material misstatement in he company's profit and on going corruption by the top management (Beams, 2002; Zahra, Priem & Rashid 2007). The collapsed has brought the auditor credibility into doubt as Enron collapsed a day after unqualified report is released (Lee, Ali & Kandasamy, 2008, p19)

Although Enron cases has passes almost about two years, most of the media and related sources only give the reason that the collapsed of Enron is caused by the issue of auditor independence, the usage of special purpose vehicle (SPV) and other issues related to financial reporting. This caused everyone questioned on why issues related management control systems, organizational ethics, organizational structure, organizational culture and leadership did not brought up (Free, Macintosh & Stein, 2007)

Base on the storyline regarding on Enron earlier on, it is clearly shown that the fraud is caused by the top management and the changes in organizational structure hence there is more consideration needed to be put on these issues as it is one of the factors which caused fraud to happen and should not been overlooked.

Since the issue identified should not been neglected, the auditor now have to consider looking at the organization structure when audit the firm rather than just looking at the company's control system and the outcome from the sample when auditing the company in order to detect and prevent fraud from happening (Glover & Aono 1995 p 1). The effectiveness on understanding organizational culture to detect and prevent fraud will be discuss later on in the report

5.0 Organizational Structure

According to Bnet (2010), organizational structure comprise of different division,

departments, and the way people communicate with each other. Bnet further elaborate that organizational structure is best explain using the organization chart which indicates the position and the responsibility. An example of the organizational

chart is as shown below.

Diagram A

Adopted from FAO corporate document repository

6.0 Relationship between Organizational Culture and Organizational Structure

Martins & Terblanche (2003, p 70 cited in Clayton et.al , 2005 p3), stated that organizational structure and culture co exist each other as they are interrelated. Organizational culture and structure are interrelated in such a way that organizational structure is form the culture within the organization whereas organizational culture able to influence the structure and operational systems in the organization.

This can be seen in the example of Technical and Further Education (TAFE) institution which have a similar structure and system which operates in a different way (O'Neill, Beauvis and School, 2001 cited in Clayton et.al 2006 p 3).This situation can be rephrase as differences in organizational culture in the same industry with same structure may have high influence on it's operation

7.0 Understanding organizational structure to prevent and detect fraud

In order to understand organizational structure, we will take a look at the structure of the organization which comprises of top management, the employee and internal auditor.

7.0.1 Top management

The top management plays a crucial part in the structure of the

company as they are the one who setting up 'tone at the top' (Crowe

Horwath , 2009 p 1). Setting up tone at the top is important as it may influence the company corporate culture hence change the whole structure

of the company (ICAC n.d). This is proven by the conversation below

"JofA: What kinds of cultures usually are breeding grounds for fraud?

Johnigan: A typical environment is one whose top leader has an autocratic management style…. ruled with an iron hands are an emphasis on dollars and cents; their goals are short-term and solely profit-focused and there's a highly emotional and feared CEO."

(Sacks, 2004)

From the Johnigan conversation, it is proven that fraud might happen if

the top management did not set the right tone to the top. Her statement

is supported by Crown Howarth (2009 p 1) stated that most company in the US actually done the same thing and being sued by the public for committing white collar crimes.

As a summary we can see that the top management has direct influence on how the organizational structure will be as they play a huge role in determine what the direction that the organization structure will be.

Crowe Horwath is a one of the top ten accounting and consulting firms in the US. The firm has provided assistant for the firms and organization to achieve their goals through various areas such as audit and tax risk. Since the article is written by a well known accounting form, we can conclude that the article is reliable as the author has accounting background. Although it is reliable, it might still contain some biasness as it is written by the people in the same field which will makes the article lose its credibility. Speaking on the article itself, it is relevant to the topic highlighted in this assignment as it stress more on the importance of the management to maintain a correct 'tone at the top'.

Steven E Sacks has a CPA qualification and is the owner of Solutions to Results LLC. He is the former head of consultant in AICPA. The article is published by the Journal of Accountancy. The journal of accountancy publishes article which wrote by respective AICPA member that focuses on the latest issue related to accounting. Since the article is published by a well known website which related to accounting, we can conclude that the article is reliable. Although the article is published by a well known publisher, the reliability of the article in terms of its content can be still questioned especially on the interview section. This is because we do not know whether the interview is really conducted and it might be fake as well.

Sacks article is published during the year 2002 which might affect the relevance of the article to be used in the report as well. Since Sacks idea is supported by Crowe, there will be no issue in terms of relevance anymore as it is still applicable in the current situation

7.0.2 Individual (employee)

Krummeck (2000 p 269) research shows that the percentage of employee involvement in fraud can be ranged around 30 percent to 80 percent.

The outcome of the research has highlighted on how important it is to look at the employee perspective when it comes to fraud besides than just looking at the top management.

Murdock (2008) stated that in order to prevent fraud caused by employee, we must look at the reason why that particular individual commits fraud .

According to ICAC (n.d.), among the reason why employee commit fraud is because of the supervisor unable and unwilling to do what they are suppose to do as in monitor the staff. When this happens, the employee will do whatever as they like and this will cause the management having difficulties in exercising their control due to lack knowledge on the worker.

ICAC (n.d.) further elaborate that another reason on why employee willing to commit fraud is because they know that there is no one will report to the top management if he/she suspects that there is any fraud as the observer thinks that reporting it will only make their life difficult. This makes the employee more motivated to commit fraud as they are confident they will not get caught after committing it.

ICAC statement is further supported by Murdock (2008) stated that dishonest individual is the one who represent highest fraud risk as they always find advantage to commit corruption without the organization knowledge. Murdock (2008) also says that dishonest employee is always ignore the working ethics and disrupting positive working environment. His statement is truly true as it is inline with the findings from the ICAC through the case study provided earlier on

So, after all the point highlighted by Murdock and the ICAC is enough to justify on the need for us to look at the employee's perspective rather than just the top management because it might influence the organizational culture hence encourages the change in the company structure indirectly.

Steve Krummeck is the owner of 2 companies where one of it is a fraud prevention company. He is a certified transformation coach and have other qualification such as project management, human resource management and ethics. His main focus is more on stuff related on fraud prevention and ethics.

Base on Krummeck qualification, we can say that he is a qualified person to write the article which related to fraud and that makes the article reliable as well but to certain extent. If we take a look at the findings of the article where he indicate that the studies shows that the involvement in fraud can range anywhere from 30% to 80% raised on the question on how true can this be as he did not put anyone to support the studies and we might not know where he get the information from. In the other hand the rate of 30% to 80% may only apply in South Africa banks not for the UK and US.

In terms of relevance, I can say that the article is not so relevant because the article was published 10 years ago from now and things might have change a lot and might be outdated.

Hernan Murdock is the president of an internal audit and corporate governance consulting firm. Besides that, he is also a lecturer at Northeastern University where he teach subject such as leadership and ethics. He has wrote articles and books on internal audit and fraud. He holds a 3 different qualification such as DBA, International Business, CSS, Administration and Management and BSBA & MBA, Finance and Management in 3 universities such as Argosy University Sarasota, Harvard University and Sullfolk University.

Base on the qualification that he holds, he is deem to be suitable one to writes on articles related to fraud. Therefore this makes the article which written by him is reliable. Although the article is reliable, it still might be bias as he might give an opinion in favour of the profession.

There is not much issue on Murdock article in terms of relevance as the article is published last 2 years and it still can be used as his idea is supported by ICAC as stated above.

Independent Commission Against Corruption (New South Wales) was established in 1989 as an independent organization to protect public interest in the New South Wales (NSW). The commission aim is to:

investigate and expose the corruption which has been conducted in the public sector in NSW

to educate the public on corruption and its effect

ICAC inform its investigation result and findings through articles published in their website.

Regarding on reliability, we can conclude that article written by ICAC is reliable because it is all written based on the case which they investigate so there is no further judgment which can be made.

Although the article is reliable, there is an issue on relevance of the article as it does not contain when the article is published. When the article does not contain any date, this creates doubt on whether it can still be applied today or not. In ICAC case, the article since to be applicable since it is supported by Murdock studies.

7.0.3 Internal Auditor

In every organization, internal auditor plays an important role as they evaluate the internal control of the company, developing the business ethics program, contributing to the reliability of the financial reporting and advising the audit committee on external auditing (Lundin, 2009; The Financial Express, 2005).

Base on the points, we can see the importance of internal auditor in the organizational structure in the company. Due to this we have to look at internal audit perspective besides than top management and workers. But the question arises in what way can internal auditor contributed corruption such as fraud to happen?

According to Moore (cited in Steen 2008) stated it is difficult for an auditor to achieve their objective accomplishing the entire role as there is always a conflict of interest involved. Moore further elaborates that in order to protect the firm and client relationship, the internal auditor will not ask any awkward question to their client. Another reason why internal auditor refuses to asking more question is also because they do not want to get fired by their client.

Moore explanation is basically true as it is applicable in Enron's case where the internal auditor (Arthur Andersen) did not do anything even though they know there is something is wrong with Enron's account. As this situation continues longer, Enron collapsed.

So it is clearly shown that internal auditor may cause fraud to happen as well and further understanding on how to prevent this from happening is needed.

Margaret Steen is a freelance writer and instructor who reside around the San Francisco Bay Area and have experience in writing for daily newspaper and well known website. She has no qualification which relates to business, finance and management.

Since Margaret Steen does not have any qualification on ethics nor accounting the article reliability might be in doubt as she is just writing based on her experience. However, since the article is published by Stanford Business Magazine, we can say that the article reliability is restored. The reliability has been restored mainly due to the reason that Stanford Business Magazine is a well known magazine published by Stanford University and will not simply publish articles by a writer which has no qualification without valid reason.

8.0 Conclusion which could be made on whether understanding organizational culture able to prevent and detect fraud

After all base on the points highlighted above it is clearly shown that understanding the organization structure may help the company to prevent and detect fraud effectively.

In order to support the points further, we will take a look at Glover and Auno (1995 p 7) article. This article is more on the external auditor's perspective. In the article, they indicate that if the auditor understands the organizational culture and structure well, he will definitely understand where, when and how the fraud will occur. Glover and Auno (1995 p 7) explain this points by looking at the case of Mini Scribe where they stated that the auditor will be able to discover more fraudulent reporting if they investigated the nature of the compensation plan the employee ethics and whether the internal auditor take against it or not.

In the nut shell, there is no doubt that the understanding corporate culture may assist the company and the auditor to prevent and detect fraud.

Hubert D Glover is the Director of Enterprise Advisory Services Inc where as June D. Aono is an assistant professor in the University of Hawaii USA. Regarding about the profile on the two authors, it is hardly found in the website and it is only available in the article. This made the reliability of the article is questionable as we do not know what qualification that those two people have.

Another argument can be made it's year of publication which is on 1995 and it is almost 15 years back. This might made the article might not be applicable to the current issues now. Since the content of the article is fully supported by another author, we can conclude that it is relevant in certain aspect.

9.0 Understanding organizational structure may not able to prevent and detect fraud

When there are someone who agree, there will me someone who will oppose the idea as well. The reason people think that understanding organizational structure will not be able to prevent and detect fraud is because of there is a human factor involved.

9.1 Human factor

According to Sammathan (cited in Ang , 2008) stated that fraud cannot be

fully prevented but only able to minimize it. Sammathan further state that

the organization and people have to realize that the root of fraud is caused by human and nothing can prevent them if they have motivation to commit it.

Sammathan statement is supported by Staats (1980) and Olatunji (2009) where they stated that even an effective internal control cannot prevent fraud from happening in the organization.

Base on the points above, it clearly shown that fraud cannot be prevented at any cost. If an effective internal control and anti fraud system cannot prevent fraud from happening, what can understanding organizational structure do to prevent and detect fraud from happening? It definitely will not work!

In order to prove the accurateness of the statement where understanding organizational structure unable to prevent and detect fraud, we will look at the outcome of the research conducted by Singleton et.al (2003).

Before touching on the research conducted by Singleton, I would like to highlight that majority of the company has revamp their company code of ethics and organize more activities related to ethics after the Enron scandal (Koh 2008). As we all know, change in code of ethics may result a change in corporate culture and this will result the whole organizational structure to change.

The research conducted by Singleton et.al (2003) is regarding on whether pro-ethics activities able to prevent fraud or not. They have conducted research on business firms, utility firm and credit union. Below are the findings on their research.

(Adopted from Singleton et.al , 2003 p 90)

The report above clearly shows that firms which do not have any ethics policy experience lesser fraud cases than firms which exercise ethics policy. This shows that understanding organizational structure, ethics, and organizational culture does not help the organization to prevent and detect fraud.

In conclusion for this section, we can say that understanding organizational structure is not effective in detecting and preventing fraud

Elmer B. Staats is a Comptroller General in the US from 1966 to 1981. He holds an bachelor of arts degree in University of Kansas and Ph.D from Minnesota University. During his reign as a comptroller, he has publish many articles related to accounting and finance. Since Staats is a comptroller and holds a Bachelor of Arts degree, we can say that the article which written by him is reliable.

However, the relevance of the content is still in doubt as the article is written during the 1980's which is 30 years from now which might be outdated and this issue has been erased as Staats statement is supported by Olatunji (2009). Looking about the year and time gap, it is surprising to see that Staats point regarding on corporate governance is still applicable in today's era.

Tommie Singleton is a professor of accounting at the University of North Albama. He has published many articles and performs presentation on issues related to accounting. Base on his experience on writing many articles, we can say that the article is credible and reliable.

In terms of the relevance to the topic of this report, I will say that it is only relevant to the certain extent because the research only focuses on ethics and does not clearly shows how it really effect the organizational structure thus promote fraud.

In the nutshell….

10.0 Conclusion that understanding organizational culture unable to detect fraud due to human factors