CHAPTER ONE

1.0. INTRODUCTION

Fraud detection is becoming increasingly important to managers of organizations, to internal and external auditors, and to regulators. Recent events, such as revelations of fraud-related problems at HealthSouth, Enron, and WorldCom, and the Sarbanes-Oxley Act stress the importance of early detection of fraud. Financial statement frauds have weakened investor confidence in corporate financial statements, led to a decrease in market capitalization, and have contributed to four of the 10 largest bankruptcies in history. Because a $1 fraud against an organization reduces net income by $1 and because organizations usually have profit margins (net income / revenues) of 10 to 20 percent, additional revenue of 5 to 10 times the amount of the fraud must usually be generated to restore net income to its pre-fraud level. For example, a major automobile manufacturing company had a $436 million fraud a few years ago. At the time, the company’s profit margin was just under 10 percent, meaning that additional revenues of approximately $4.36 billion had to be generated to bring net income to what it would have been without the fraud. Assuming automobiles sell for an average price of $20,000 each, the company had to make and sell 218,000 additional automobiles to restore net income to its pre-fraud amount. If this fraud had been proactively detected earlier, the fraud loss would have been much smaller and the effect on the firm much less severe. It is because frauds are so costly that statement on Auditing Standards No. 99 (AICPA 2002)—recently issued by the American Institute of Certified Fraud Examiners—requires auditors to assess the risk of material misstatement in financial statements due to fraud.

1.1 STATEMENT OF PROBLEMS

The computers are indispensable in fraud detection. The role of computer becomes more important when the fraudulent activities are on the rise. Data can be stored in computers for immediate use or can be stored in auxiliary memories like floppy discs, compact discs, universal serial buses (pen drives) or memory cards, so that the same can be retrieved later. The computers assist the auditors throughout different phases of fraud detection. Improving fraud detection capabilities through the use of computers is by no means an easy feat as auditors needs to get use to the fact that computers can go along way to assist in the detection process as would be seen in subsequent sections and chapters in this project report.

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