UK: The Inside Story - The Changing Role of Internal Audit in Dealing with Financial Fraud

Last Updated: 26 November 2010
Article by Deloitte Corporate Finance Group

Most Read Contributor in UK, August 2017

Introduction

The economic downturn of the last two years has brought a number of high profile frauds to the surface and in doing so has created a heightened awareness of fraud risk. This has focussed the minds of senior executives on how their businesses might be vulnerable to fraud and whether or not they are sufficiently protected.

As the mandate and role of Internal Audit continues to evolve and grow, management are increasingly depending on Internal Audit functions to monitor, detect and investigate incidences of fraud as and when they arise.

Has the recent recession had an impact on organisations' approach to fraud risk management? Do management increasingly expect that Internal Audit have a wider role to play in this area? Are today's Internal Auditors suitably equipped to respond to these increased expectations and assess incidences of suspected fraud which occur?

Deloitte's inaugural Internal Audit Fraud Survey sought to ascertain how businesses are being impacted by fraud and explore how the position of Internal Audit may have changed over the past 18 months. We examine the role of the Internal Audit function in preventing and detecting fraud, as well as their appetite and ability to fulfil this role.

The results of this cross-industry survey are based on responses to a number of quantitative questions answered by 75 Heads of Internal Audit during May and June 2010.

Executive Summary

The results highlight some interesting apparent contradictions between senior management's perceptions, and the practical realities of how fraud risk is controlled. For example, the last 18 months has seen a relatively significant increase in Board level discussion on introducing or improving fraud monitoring – but not a corresponding enhancement in monitoring activity to enable this – emphasising that this is not yet a risk that is adequately covered.

Respondents indicated that their vulnerability to, and the impact of, fraud on their organisations had increased – and the main cause of this was perceived to be due to ineffective internal controls. Concern over disgruntled employees committing fraud is rising and is expected to be a key contributor to fraud related incidents in the coming year.

The position of Internal Audit in preventing, detecting and investigating fraud had increased for most organisations as a result of economic uncertainty, and for those organisations where Board focus on fraud had also increased this was an added driver to Internal Audit's fraud focus. However, despite this focus, Internal Audit functions remain under resourced to be able to respond. Whilst most respondents are satisfied they have the skills to provide effective fraud assurance services in their organisations, they recognise they do not have sufficient numbers of trained staff to be able to scale up when circumstances demand and investigations arise – though many functions provide additional training to staff in an effort to overcome this.

Perhaps more concerning is that Internal Audit recognise the value in conducting fraud risk assessments regularly but are not doing so which makes it difficult to determine how to effectively focus scarce resource on the most important fraud risks.

Internal Audit clearly acknowledge they have a role to play in fraud prevention, detection and investigation. Senior management also look to them to support detection and investigations in organisations when suspected frauds occur. Having the skills and resources to be able to meet these demands is a key challenge on which Internal Audit functions will need to focus in the future

The position of Internal Audit in preventing, detecting and investigating fraud has increased for most organisations as a result of economic uncertainty

A top table issue

63% of respondents said that their organisation's vulnerability to fraud risk has increased in the last 18 months and of this group just under two thirds said that there had been an increase in the levels of both internal and external fraud.

The results reveal there may be a disconnect between senior management's tone from the top and what is actually happening on the ground. On the face of it, it is apparent that companies are promoting a robust fraud risk management culture: 96% of respondents stated that senior management endorse and encourage a strong approach to fraud risk management and ethical culture within their organisation.

This, however, would be typically evidenced by having both a formalised fraud policy and a code of ethics that are both documented and communicated. However, whilst for the majority this is the case, the results show that a surprising 20% don't have a documented fraud policy (two thirds of these were listed companies with turnover of over £500m) and 30% don't communicate their fraud policy to the business on a regular basis.

Overall, 77% of respondents said that economic uncertainty had generated Board level discussion on either introducing and/or enhancing fraud risk monitoring but of the 96% who said they were receiving the right tone from the top a fifth said, in contrast, that there was no board level discussion on the specific matter of either introducing or enhancing fraud risk monitoring.

Furthermore, 80% of respondents said that economic uncertainty has increased the level of Internal Audit coverage of fraud risk. Of those who said they were getting senior management endorsement, encouragement and Board level discussion, 84% said Internal Audit were increasing the coverage of fraud risk in their organisation. Conversely, for those who received general endorsement and encouragement but didn't find the specific topic of fraud risk on the Board agenda, just over half (53%) had a resultant increase in Internal Audit fraud coverage

Our perspective

Actions speak louder than words: The engagement of senior management and the Board is an absolute prerequisite when it comes to ensuring that Internal Audit are given the appropriate mandate to deal with what is clearly acknowledged by survey respondents as a growing problem, both in terms of vulnerability and actual financial fraud suffered.

"The fact that in some organisations the basics of formalised and communicated fraud and code of conduct polices is not in place is a concern" says Nic Carrington, Forensic and Dispute Services Partner at Deloitte. "This along with a lack of practical Board engagement for others has meant that, in times of heightened risk, Internal Audit have not been given the remit to increase their work in this area."

Key findings

  • 96% said senior management encourage and endorse a strong approach to fraud risk management and ethical culture.
  • 80% said economic uncertainty has increased the level of Internal Audit coverage of fraud risk within organisations.
  • A fifth of respondents said their organisation doesn't have a fraud policy and almost a third of organisations don't communicate their fraud policies to staff.

Almost two thirds of respondents said that their organisation's vulnerability to fraud risk has increased in the last 18 months

Equipped for the task in hand?

Just over half (51%) of respondents said they don't have enough staff to identify/provide assurance over fraud risk within the organisation, with smaller companies, perhaps unsurprisingly, finding themselves more constrained. Of the companies surveyed which had less than 500 employees, this figure rose to 67%. For those who said that economic uncertainty hadn't generated board level discussion around implementing or enhancing fraud risk monitoring, the overall number was 65%.

Whilst 83% thought that they had the right skills and knowledge in the area of fraud risk awareness the scores were much lower for key investigation related competencies. Overall skills and knowledge in the areas of interview techniques and handling evidence were just 43% and 37% respectively. Furthermore, 55% acknowledged that they don't have skills or knowledge in the area of data analysis, another key fraud prevention and detection skill-set.

38% said they never receive training in the area of identifying and evaluating fraud schemes (over half of these are listed companies). Despite the fact that 65% said they are responsible for running investigations, regulatory investigations (49%) investigative interviewing (61%) and gathering and handling evidence (62%) are also areas where training is lacking. Interestingly, 25% said they have not received training on bribery and corruption despite the regulatory focus on this area with the Bribery Act 2010 and just under half of these are listed companies.

Only 52% of respondents stated that they use technology to prevent, detect and investigate fraud and even then this is mainly during an investigation which is the stage that most respondents said they would consider using IT experts and other external resources such as business intelligence specialists.

Our perspective

"Some organisations are walking a dangerous tightrope where executive senior management believe that Internal Audit are providing assurance in respect of financial fraud risk assessment, detection and investigation, and yet the reality at the coal face is that Internal Audit are under resourced and constrained in their ability to deliver this broad remit" says Kirsty Searles, Business Process & Risk Consulting Partner at Deloitte.

Putting aside questions of inadequate levels of staff resources, it is also clear that significant gaps exist in the levels of support and training that are provided to Internal Audit in these areas meaning their ability to be effective is significantly compromised. A surprising number of respondents said they do not avail themselves of technology and IT solutions when it comes to preventing, detecting or investigating financial fraud, and whilst 65% of respondents are responsible for running investigations they acknowledged key skills and training gaps in this area.

Kirsty Searles notes "Senior management need to face up to these contradictions and either provide additional support and funding to address these gaps internally or make provisions for external assistance."

Key findings

  • Over half of respondents said they don't have enough staff to identify or provide assurance over financial fraud risk within their organisation.
  • 83% of respondents think they have the right skills and knowledge in the area of fraud risk awareness and 85% in fraud control awareness but when it comes to conducting investigations there are some key shortfalls: 60% don't have skills in the area of handling evidence, 56% in interview techniques and 55% in data analysis.
  • 38% of respondents have never received training on identifying and evaluating fraud schemes, whilst 25% have never received training on bribery and corruption

The fact that in some organisations the basics of formalised and communicated fraud and code of conduct policies is not in place is a concern.

Over half of respondents said they don't have enough staff to identify or provide assurance over financial fraud risk within their organisation.

Current trends and what the future holds

In the last 18 months, respondents told us that the top three frauds experienced in their organisations were misappropriation of assets (31%), improper expenditures (22%) and procurement fraud (16%).

As to the enablers of these, ineffective internal controls within key financial processes had been the main driver of fraud in the past 18 months (22%), second to this was collusion between employees and third parties (17%) and joint third was other external pressures on individuals (16%) and disgruntled employees/ management (16%).

Respondents believe that in the next 12 months this will change such that disgruntled employees/management will form the greatest source of fraud risk (20%).

Meanwhile, whilst ineffective controls are currently viewed as the top enabler for encouraging fraudulent behaviour respondents believe this may be a less significant driver going forwards. Is this because fraud controls continue to strengthen or simply because other factors will provide greater motivation in the future?

When asked how Internal Audit's role or focus on fraud has changed over the past 18 months, the top three responses were:

  • fraud risk has been included in the scope of reviews undertaken (22%);
  • increased coverage of fraud risk within the audit plan (20%); and
  • staff have received additional fraud related training (19%).

Over the next 12 months, as well as continuing to include fraud risk in the scope of reviews undertaken and providing fraud related training, Internal Audit will also undertake fraud risk assessments (16%).

57% said their Internal Audit department does not perform fraud risk assessment exercises to consider, identify and prioritise risks of fraud but when asked what would help them be more effective in providing assurance over fraud risk in their organisation, the second highest response was more robust fraud risk assessment.

Our perspective

"Many organisations tend to consider fraud risk from an external perspective where, for example, they might fall victim to schemes perpetrated by organised crime and third parties" says Nic Carrington. "The reality is that internal fraud is a significant risk too. With expectations that disgruntled employees and management will pose the greatest fraud risk in the coming months, businesses would be advised to keep vigilant in this area."

Kirsty Searles adds "In terms of prevention, effective fraud risk assessment is a key and crucial step in directing what can be limited resources to key risk areas, so the fact that such a large percentage of respondents said they did not do this is surprising.

In the absence of having identified and prioritised risk areas it is difficult to see how Internal Audit teams or their executive management teams could have comfort that they are managing their financial fraud risks effectively."

Key findings

  • The main types of fraud experienced over the past 18 months were misappropriation of assets, improper use of expenses and procurement fraud.
  • Key fraud drivers over the past 18 months were ineffective controls within key financial processes, collusion between employees and third parties and disgruntled employees/management and other external pressures on individuals.
  • Main drivers of fraud expected over the next 12 months are disgruntled employees/ management, collusion between employees and third parties and other external pressures on individuals

Survey respondents' key demographics

The top three industries represented in the survey sample are financial services (24%), manufacturing (17%) and public sector (17%) organisations.

  • The majority are employed by organisations with 10,000+ employees: 10,000+ (43%); 5,001 – 10,000 (21%); and 1,001-5,000 (19%).
  • Most work for an organisation which has a turnover of £500m+ (68%).
  • Most work for an organisation listed on a stock exchange (56%) or government/public sector organisation (20%).
  • Most have in-house Internal Audit resources (75%).
  • Most have an Internal Audit team of 25 or less employees (less than 5 staff (34%) and 5-25 (50%)).

Key contacts

The reality is that internal fraud is a significant risk.With expectations that disgruntled employees and management will pose the greatest fraud risk in the coming months, businesses would be advised to keep vigilant in this area

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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