INCORPORATING FRAUD RISK ASSESSMENTS INTO FEDERAL GOVERNMENT INTERNAL AUDIT ACTIVITIES PRESENTATION BY CHERILYN MONTMINY

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1 INCORPORATING FRAUD RISK ASSESSMENTS INTO FEDERAL GOVERNMENT INTERNAL AUDIT ACTIVITIES PRESENTATION BY CHERILYN MONTMINY January 8, 2013

2 Poll #1 In which industry do you work? a) Federal government internal audit b) Federal government external audit c) Federal government - other d) Provincial/municipal government e) Private industry f) None of the above 2

3 Disclaimer The following presentation is based on my work experience and reflects my personal opinions This presentation may not reflect the opinions of Treasury Board of Canada Secretariat or the Government of Canada 3

4 Acknowledgement I would like to thank the Senior Director of Internal Audit and Evaluation Bureau (IAEB) in Treasury Board of Canada Secretariat for allowing me to use IAEB s documents during this presentation 4

5 Outline of Presentation Internal auditing in the federal government Definition of fraud Enterprise level fraud risk assessment Audit Engagement fraud risk assessment 5

6 INTERNAL AUDITING IN THE CANADIAN FEDERAL GOVERNMENT 6

7 Internal Auditing In The Canadian Federal Government Internal audit function within the federal government was strengthened in 2006 with the introduction of the Federal Accountability Act and new internal audit policy instruments 7

8 Legislation Federal Accountability Act Amendments to the Financial Administration Act (Section 16.1, 16.2, 16.21) Deputy head must ensure an appropriate internal audit capacity to needs of department Deputy head must establish an audit committee for department (subject to Treasury Board directives) Appointments to audit committees (approvals, term of office, remuneration) 8

9 Federal Government Policy Instruments As of October 1, 2012, there are the following internal audit policy instruments: Treasury Board Policy on Internal Audit Treasury Board Directive on Internal Auditing in the Government of Canada Treasury Board Internal Auditing Standards for the Government of Canada (Note: As per section 4.2 of the Treasury Board Internal Auditing Standards for the Government of Canada, the Government of Canada has adopted the IIA International Professional Practices Framework and departments are required to meet requirements when undertaking work unless there is a conflict with Treasury Board internal audit policy instruments, which prevail.) 9

10 DEFINITION OF FRAUD 10

11 Poll #2 What definition of fraud is used by your internal audit group? a) Legal definition b) IIA definition c) Other d) Don t know/not applicable

12 Definition of Fraud Potential Pitfall: Depending on your industry, there could be several definitions of fraud that may have to be considered by audit staff when performing fraud risk assessments Suggestion: Adopt a common definition to be used by audit staff 12

13 Definition Of Fraud - Example In the federal government, there are several definitions that have to be considered: Criminal Code section 121 definition (frauds on the government): section 380(1) definition (fraud): Every one who, by deceit, falsehood or other fraudulent means, whether or not it is a false pretence within the meaning of this Act, defrauds the public or any person, whether ascertained or not, of any property, money or valuable security or any service,... 13

14 Definition Of Fraud - Example Treasury Board Directive on Losses of Money or Property: Is a criminal deception involving the use of false representation with the specific intent of gaining an unfair or dishonest advantage. Fraud ordinarily involves either wilful misrepresentation or deliberate concealment of material facts for the purpose of inducing another person to either part with cash or something else of value or to surrender a legal right Institute of Internal Auditors (IIA): Any illegal act characterized by deceit, concealment, or violation of trust. These acts are not dependent on threat of violence or physical force. Frauds are perpetrated by parties and organizations to obtain money, property, or services; to avoid payment or loss of services; or to secure personal or business advantage.

15 Definition Of Fraud Example (Continued) Within the federal government, individual departments have determined the most appropriate definition for their internal audit organizations Criminal code definition IIA definition Adaptation of IIA definition an intentional act by individuals or organizations which violates legislation or regulations; as well as, Treasury Board policies, directives and standards; Is characterized by deceit, concealment or violation of trust; and Is perpetrated to obtain money, property, or services; or to avoid payment; or loss of services; or to secure personal business advantage. (Note: A fraud is not dependent upon threat of violence or physical force.) 15

16 ENTERPRISE-LEVEL FRAUD RISK ASSESSMENT 16

17 Enterprise-Level Fraud Risk Assessment Disclaimer: Any examples used in this section of the presentation are fictional and are for illustration purposes only 17

18 Enterprise-level Fraud Risk Assessment (Continued) IIA standard 2120.A2 The internal audit activity must evaluate the potential for the occurrence of fraud and how the organization manages fraud risk. 18

19 Poll #3 Who performs your internal audit group s enterprise-level fraud risk assessment? a) Professional Practices Group b) Internal Audit staff c) Fraud expert d) Other e) Do not know f) Does not apply 19

20 Enterprise-Level Fraud Risk Assessment (Continued) Suggestions: Internal audit fraud risk expert perform or assist in performing the assessment Perform assessment on annual basis Perform as a standalone exercise or include as part of another activity, e.g. risk-based audit planning process 20

21 Resources To Assist In Enterprise-level Fraud Risk Assessment Internal Audit and Fraud - International Professional Practices Framework (IPPF) Practice Guide Responsibilities and Accountability of Internal Audit for the Detection, Investigation, and Reporting of Possible Fraud - Office of the Comptroller General Internal Audit Practice Guide Managing the business risk of fraud: A Practical Guide sponsored by The Institute of Internal Auditors, The American Institute of Certified Public Accountants and Association of Certified Fraud Examiners 21

22 Enterprise-Level Fraud Risk Assessment (Continued) There are two distinct requirements based on IIA standard 2120.A2: The internal audit activity must evaluate: 1) The potential for the occurrence of fraud 2) How the organization manages fraud risk 22

23 Enterprise-Level Fraud Risk Assessment (Continued) Assessment of How the Organization Manages Fraud Risk 23

24 Assessment of How the Organization Manages Fraud Risk Potential Pitfall: Creation of an overly complex assessment tool Suggestions: Use a simple grid to assess Consult to determine whether internal audit can use work performed by other groups 24

25 Assessment of Management of Fraud Risk - Example Requirement Evidence Assessment - There is a code of conduct and ethics program that sets the tone at the top - There are policies and procedures to govern the conduct and reporting of fraud investigations - The department follows the Values and Ethics Code for the Public Sector. Also a draft Departmental Code of Conduct is in the stages of being finalized. - Departmental Security Officer has approved manual outlining the process and procedures to conduct and report investigations, including fraud investigations - Partially met Departmental Code of Conduct not yet finalized (expected to be finalized before end of March) - Met - Department has policies and procedures in place 25

26 Enterprise-Level Fraud Risk Assessment (Continued) Assessing the Potential for the Occurrence of Fraud 26

27 Assessing the Potential for the Occurrence of Fraud Potential Pitfalls: Confusion over fraud risk assessments performed by internal audit and other groups, e.g. Internal control group Duplication of work between internal audit and other groups Suggestions: Define the purpose and differences from other groups related to fraud risk assessment performed by internal audit Consult to determine whether internal audit can use work performed by other groups 27

28 Assessing the Potential for the Occurrence of Fraud (Continued) If another group s work is not sufficient, the following are suggested steps for internal audit to perform an assessment: 1. Determine ultimate usage of assessment information» e.g. link to risk-based audit plan, standalone assessment 2. Develop fraud risk factors 3. Identify and assess risk of potential fraud schemes 28

29 Poll #4 Our internal audit group s enterprise-level fraud risk assessment: a) Is linked to risk-based audit plan b) Is a standalone assessment c) Do not know d) Does not apply 29

30 Assessing the Potential for the Occurrence of Fraud Example Fraud risk assessment linked to risk-based audit plan Use the audit universe as basis for the fraud risk assessment 30

31 Likelihood Fraud Risk Indicators Example Risk Factor Probability of occurrence Definitions Considers the probability of a fraud occurring that could impact the area. Probability of occurrence (percentage) was assigned using the following scale: Occurrence unlikely (< 25%) L Link to Riskbased Audit Plan To be considered as part of the calculation of complexity risk factor under Likelihood Occurrence sometimes (25% to 75%) M Occurrence in most circumstances (> 75%) H 31

32 Impact Fraud Risk Indicators Example (Continued) Risk Factor Materiality Definitions Considers the organization s estimated expenditures within the area in which a potential fraud risk could occur. Materiality was assigned using the following scale: Low materiality (< $1,000,000) L Moderate materiality (between $1,000,000 and $5,000,000) M High materiality ( > $5,000,000) H Note: After review of expenditures, level of materiality may be adjusted based on auditor s judgement. Link to Riskbased Audit Plan To be considered as part of the calculation of sensitivity/public profile risk factor under Impact 32

33 Impact Fraud Risk Indicators Example (Continued) Risk Factor Reputation/ public profile Definitions Considers the reputation or public profile risks to the organization if a potential fraud was to occur within the area. Sensitivity/public profile was assigned using the following scale: Low risk to reputation/public profile L Moderate risk to reputation/public profile M High risk to reputation/public profile H Link to Riskbased Audit Plan To be considered as part of the calculation of sensitivity/public profile risk factor under Impact 33

34 Assessing the Potential for the Occurrence of Fraud Example Universe item: Management of Contracting Risk Factor Rating Rationale Probability of Occurrence L The probability of occurrence of fraud is low due results of recent audit completed in the area. Materiality M The materiality on the financial statements for potential frauds is low since less than $5 million are contracted each year. Reputation/Public Profile H There would be a high impact due to the nature of work within this area and public perception due to past contracting issues in government. Potential Frauds that may occur within this audit area: Using advance access to information/access to confidential information for economic gain; Contracting - Conflicts of Interest; Bribery and Illegal Gratuities 34

35 AUDIT ENGAGEMENT FRAUD RISK ASSESSMENT 35

36 Poll #5 During an audit engagement, your internal audit group assesses which of the following: a) Significant errors b) Fraud risks c) Non-compliance issues d) Do not know e) Does not apply 36

37 Audit Engagement Fraud Risk Assessment Disclaimer: Any examples used in this section of the presentation are fictional and are for illustration purposes only 37

38 Audit Engagement Fraud Risk Assessment (Continued) IIA standard 2210.A2 Internal auditors must consider the probability of significant errors, fraud, noncompliance, and other exposures when developing the engagement objectives. 38

39 Audit Engagement Fraud Risk Assessment (Continued) Potential Pitfalls: Risk assessment limited to fraud only Confusion over definition of terms, e.g. exposures Duplication of other risk assessment work by internal auditors Suggestions: Create a tool that encompasses significant error, other exposures and non-compliance issues Adopt a common definition of terms Define the purpose of fraud risk assessment and how it links to other risk assessment work 39

40 Audit Engagement Fraud Risk Assessment (Continued) Suggestion: The following are suggested questions for internal audit to answer when developing an audit engagement risk assessment tool: 1. Determine ultimate usage of assessment information e.g. link to another risk assessment, standalone assessment 2. Develop common definition of terms 3. Determine, if required, linkages to another risk assessment 40

41 Audit Engagement Fraud Risk Assessment - Example Step 1: Identify relevant past audit or management review Have any past internal/external audits or management reviews found significant errors or types of fraud, non-compliance or other exposures in the area/program/process being assessed? If yes, have the significant errors or types of fraud, noncompliance or other exposures been corrected or is there a management action plan in place to correct them? 41

42 Audit Engagement Fraud Risk Assessment - Example (Continued) Step 2: Identify and document potential schemes Based on the information available and the knowledge of the audit team, what significant errors or types of fraud, non-compliance or other exposures, if any, could occur in the area/program/process being assessed? For each one, answer the questions below: Who could perform the significant error/fraud/non-compliance or other exposure? Why could this occur? How could this occur? When could this occur? Where could this occur? What is the probability that this could occur? 42

43 QUESTIONS 43

44 Contact Information

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