EVALUATING THE EFFECTIVENESS OF FINANCIAL AUDITORS IN DETECTING FINANCIAL FRAUD IN INDONESIA’S RETAIL CORPORATIONS FINAL PROJECT By Marvelous Rafael Andrianto 19021027 Undergraduate Program School of Business and Management Institut Teknologi Bandung i EVALUATING THE EFFECTIVENESS OF FINANCIAL AUDITORS IN DETECTING FINANCIAL FRAUD IN INDONESIA’S RETAIL CORPORATIONS Marvelous Rafael Andrianto 19021027 Undergraduate Program School of Business and Management Institut Teknologi Bandung, 2024 Supervisor: Annisa Novieningtyas ABSTRACT This dissertation examines the effectiveness of financial auditors in detecting financial fraud within Indonesia’s retail corporations. The study will explore the methods of auditing whether it is traditional or advanced techniques. Thich includes the use of future auditing methods through AI in Indonesia itself. It evaluates the challenges auditors face due to the complexity of the retail industry since it is an industry which has high volume of transactions, fluctuating inventories and narrow profit margins. This research will be conducted in a qualitative and descriptive research method by comparing the SOP of an auditor to that of the auditee. Through this we can examine the key differences of both companies and pinpoint the flaws themselves. This study will be conducted through interviews with both auditors and auditee with a detailed analysis of their internal control and audit procedure. The findings highlight the critical role of an auditor which functions as an entity who maintains financial integrity and proposes improvements to enhance the accuracy and reliability of financial audits in the retail sector itself. Keywords: Financial Fraud; Retail Industry; Standard Operating Procedure; Auditing MENILAI EFEKTIVITAS AUDITOR KEUANGAN DALAM MENDITEKSI PENIPUAN KEUANGAN DI KORPORASI RITEL INDONESIA Marvelous Rafael Andrianto 19021027 Program Sarjana Sekolah Bisnis dan Manajemen Institut Teknologi Bandung, 2024 Pembimbing: Annisa Novieningtyas ABSTRAK Disertasi ini meneliti efektivitas auditor keuangan dalam mendeteksi penipuan keuangan di korporasi ritel di Indonesia. Studi ini akan mengeksplorasi metode audit, baik itu teknik tradisional maupun teknik lanjutan. Hal ini mencakup penggunaan metode audit masa depan melalui AI di Indonesia sendiri. Penelitian ini mengevaluasi tantangan yang dihadapi auditor karena kompleksitas industri ritel, mengingat industri ini memiliki volume transaksi yang tinggi, persediaan yang berfluktuasi, dan margin keuntungan yang sempit. Penelitian ini akan dilakukan dengan metode penelitian kualitatif dan deskriptif dengan membandingkan SOP auditor dengan SOP auditee. Melalui ini, kita dapat memeriksa perbedaan utama antara kedua perusahaan dan mengidentifikasi kelemahan mereka. Studi ini akan dilakukan melalui wawancara dengan auditor dan auditee serta analisis mendetail tentang pengendalian internal dan prosedur audit mereka. Temuan ini menyoroti peran penting auditor yang berfungsi sebagai entitas yang menjaga integritas keuangan dan mengusulkan perbaikan untuk meningkatkan akurasi dan keandalan audit keuangan di sektor ritel itu sendiri. Keywords: Penipuan Keuangan; Industri Ritel; Prosedur Operasional Standar; Audit Abstract 2 1.1Background 5 1.2ProblemStatement 6 1.3ResearchQuestions 7 1.4Researchobjective 8 2.1TheFraudDiamondModel 9 2.1.1OriginofFraudDiamondModel 9 2.1.2Theadditionalfactor 10 2.2TheFraudPentagonModel 10 2.3ComplexityofFraud 11 2.3.1Frameworks 11 2.3.2Typesoffrauds 12 2.4ImplementationofAIandmachinelearning 12 2.4.1NaiveBayesMethod 13 2.4.2ArtificialNeuralNetworkMethod 13 2.4.3SupportVectorMachineMethod 13 2.5ErrorsinInternalAuditing 14 2.5.1CommissionErrors 14 2.5.2OmissionErrors 14 2.5.3PrincipleErrors 14 2.5.4DuplicationErrors 14 2.5.5CompensationErrors 15 2.6Regulatoryissues 15 2.6.1InternationalAuditingregulations 15 2.6.2NationalAuditingStandards 16 2.6.3IndonesianAccountingStandards 17 2.7InternalControlsandRiskManagement 18 2.7.1RolesofInternalControl 18 2.7.2RolesofRiskmanagement 19 2.8ExternalAuditorExpertiseandQualifications 20 3.1Datacollection 21 3.2DataAnalysis 22 3.3TheAssessment 22 4.1Findings 23 4.1.1DatatakenfromPWCstandardoperatingprocedure 23 4.1.2DatatakenfromAksesmu 26 4.1.3Datatakenfromfinancialprocess 31 4.1.4Thetoolstheyusedintheiraudit 32 4.1.5DatatakenfromAksesmupastincident 33 4.1.6Datatakenfrominterview 33 4.2.1Discussion 35 4.2.2ComparingPWCSOPwithAksesmu 37 5.1Conclusion 40 5.2Recommendation 41 5.3Citations 42 5.4Appendices 43 ChapterI Introduction 1.1Background Inthelate20thcenturyIndonesiaexperiencedatransitionintheeconomywherethey previouslywereanagriculture-basedeconomytoamorediverseone.Thisparticularshift hasbeenfundamentalinpropellingIndonesia’seconomytobecomeoneofthemost promisingemergingeconomiesintheworld.Indonesia’sresilientgrowthintheeconomy sincethenhasmadeitoneofthebestcountriestoinvestinduetothehighceilingforgrowth. WithIndonesiabeingthe4thlargestcountrybypopulationintheworld,the24thlargest tradinggoodspartnerandthe7thlargesteconomybypurchasingpower,therelianceofthe country’seconomytowardslargecorporationsbothinternationalanddomestichasplayeda criticalroletotechnologicaldevelopment,jobcreation,exportsandespeciallytheGDP. BigcorporationshaveapivotalroleinIndonesia'seconomy,theseentitiescontribute39.5% tothecountry'sGDPin2019,equivalenttoIDR15,833.9trillion.Giventheirsignificant impact,theseentitiesoftenrequiresubstantialfundingtosustainandexpandtheiroperations. Thisneedforcapitaldrivesthemtoseekinvestmentfromexternalsources.However, investorstypicallyfavorcompaniesthatdemonstratestrongfinancialprofitability,acriterion thatmanyofthesecorporationsseekinginvestmentmaynotmeet.Thisiswhythese companiesareconstantlybeingmonitoredforaccountingviolationssuchasfraudor embezzlementbyCenterforFinancialTransactionReportsandAnalysis(PPATK) Thereareavarietyofaccountingviolationssuchasmisrepresentationoffinancialreports whichisdoneby41%ofcompanies.Fortunately,securityfraud(atypeoffinancialfraud)is doneby10%ofalllargecorporationsonaverage,witha95%confidenceintervalbetween7 and14%(Dyck,A.,Morse,A.&Zingales,L.,2023).Thisiswhyfinancialauditorsareat theforefrontinensuringintegrityastheyaretheoneswhopreventthemfromcommitting financialcrimeorembezzlement.Theyareresponsibleforassessingthefinancialstatements ofacompanywithprecision,identificationoffraudorerrors,ensureadherencetolegal standardsandallowstakeholderstobefurnishedwithdependablefinancialinformation. Forthesecondyearrunning,thePCAOBnoted,thereweremoreauditfaultsin202240%of auditshadflaws,comparedto34%and29%in2021and2020,respectively.Thisrisebegs thequestionofwhethernecessaryauditingstandardsarebeingfollowedanddemands internalreformsinauditcompanies. Theanalysissuggeststhatorganizationsmaybefindingitdifficulttomaintainconsistent complianceincertainareasbecausethesedeficienciesaretypicallyrecurringproblems.The proceduresusedbyauditingfirmsforauditexecutionandqualitycontrolneedtobegreatly improved.ThePublicCompanyAccountingOversightBoard(PCAOB)warnedthatit anticipatedalargerrateoffailureswithrelationtoparticularnoncomplianceissues. ThedegreeofoutsidecontrolishighlightedbythePCAOB'srecommendationthataudit firmsresolveissuespromptlyandkeepinvestorobligations.ThePCAOBisoneofthe regulatorybodiesthatmonitorstherulesandlegislationthatareessentialtofinancial reportingintegrity. Auditcommitteeparticipationinobservingcompliancewithauditfirmrequirementsislinked withinternalcontrolprocedures.Onegoalofinternalcontrol,whichentailspoliciesand practicesputinplaceinsidecompanies,isaccuracyoffinancialreports.Employingaudit committees,whichcanconsistofindependentboardmembers,isonewaythatbusinesses mayimprovetheirinternalcontrolsystem.Theaccuracyoffinancialreportingiseventually improvedbythiscooperativeeffortsinceitpreservestheauditingstandardandincreases accountability. 1.2ProblemStatement IntheadvancementofIndonesia’seconomylargecorporations’rolehasbeencrucialin drivingthenation’sgrowth.However,thisprogressisoftenovershadowedbyfinancialfraud casesinIndonesiasuchasthehugecorruptioncasebyWaskitaKaryawhichcausesthemto beonthevergeofbankruptcy.Theamountofmoneywhichwasconsideredasfabricated transactionsamountedtoanoutstandingRp2.5Trillion.Thissignificantlosshighlightsthe vulnerabilitiesincorporategovernanceamongbigcorporationsaswellasraisesconcernsin regardstotheeffectivenessoftheauditorsbehindthem. Therearemanymethodswhereacompanycancommitfinancialfraudsuchastaxevasions, payrollfraud,revenuerecognitionfraud,etc.Thesemethodscanbeincorporatedintothe company’srevenuestreamandexpensesespeciallytheaccountcodeswithbigvalues.People oftenlookawayatslightdecimalroundoffsorerrorssincetheydonotthinkitwouldmatter thatmuchhowever,thesesmalldecimalerrorscouldmeanmuchmoreifitisdifferentiating anaccountworthRp1billion.Thisiswhyfinancialfraudtendstohappenintherevenue streamduetoitusuallybeingtheaccountwiththehighestvalueThisitselfposesarealthreat towardsthetransparencyaswellasreliabilityofcorporatefinancialreporting.This jeopardizesshareholdervalueandmaycreatearippleeffectwhichtriggersthewrong perceptionofthecompanyinthemarketandleadtobigconsequences. Duetothesehugeconsequencesinternalorexternalauditorshaveahugeresponsibilityin maintainingthetruefinancialhealthofthecompany.Auditorsareatthefrontlineensuring theaccuracyandintegrityoffinancialstatements.Theintricacyoffinancialdealings, combinedwiththecreativetacticsusedtohidefraudulentacts,considerablyheightensthe difficultiesauditorsencounter.Thisisabiggerproblemintheretailindustryduetoitbeing oneofthemorecomplicatedtypesofindustries.Theretailsectorpresentsuniqueobstacles foraccountants,strictlybecauseofitsoperationalandfinancialcomplexities.Handlingthe largeandfluctuatinginventorycommoninretailsettingsrequiressophisticatedaccounting methodsforprecisecostmonitoringandshrinkagemanagement.Additionally,retailers handleasubstantialnumberoftransactions,makingthetrackingofsalesandreconciliationof transactionsmorechallenging.Giventhenarrowprofitmarginstypicaloftheindustry, accuratecostcontrolandmarginanalysisarevitalforsustainingprofitability.Their responsibilityextendsbeyondpinpointingirregularitiesinfinancialstatementstograspingthe subtletiesofdiversefraudulentschemes,suchastaxevasion,payrollfraud,andespecially, fraudrelatedtotherecognitionofrevenue. Addressingthechallengesposedbytheseactivities,acollaborativeeffortamongstauditors, corporationsandtheauthoritiesareneeded.Thecorporations’transparencyisoftheutmost importancetotheauditorsandthatbeingsaid,theeffectivenessoftheseentitiesarecrucial. Howeverdespitethebestefforts,errorsareinevitablewhichiswhytomitigatetheseerrors weneedtodeterminethekeyfactorstoinitiatethebestapproachtofacethesechallenges. ThereasonwhyIchoseAksesmuisbecauseAksesmuisacompanywhoprovidesproducts toretailSMEswhichisahugemarket.ResearchbyYCPSolidiancesaidthatIndonesiahas 62millionSMEsand98%ofthemaremicro-enterprises,theyhold67%oftheworkforceand contribute40%ofIndonesia’sGDPin2022.OutofthoseSMEsIndonesianChamberof CommerceandIndustryreportedthat28%ofitisretailandtheykeeponrisingeachyear. Thismeansthemarketforretailishugeandhasyettoreachitspeakpotential.Aksesmu servestheGeneralTrade(GT)market,whichstillhasa70%marketsharethatisnotyet reached,unlikeAlfamart,whichservestheModernTrademarketwitha30%market share(ACNielsen).ThuscreatingtheurgencytowhichareportonAksesmushouldbe conducted.ThiswillcreateahugeshiftonthefuturemarketofIndonesiahencemakinga hugeimpactontheeconomyandretailindustryitself. 1.3ResearchQuestions 1.Howdoauditorsdetectfinancialfraudintherevenuestreamofretailcompanies. 2.Whatarethekeychallengesindetectingfinancialfraud. 1.4Researchobjective Theprimaryobjectiveofthisstudyistodwellintothevariousmechanismsemployedto uncoverfinancialfraudoccurringinsidetherevenuechannelsoftheretailbusinessin Indonesia.Thisinvestigationaimsnotonlytocomprehendtheeffectivenessofthese mechanismsthoroughlyandhighlighttheenhancementswhichcanbemade.Bydoingso,the researchseekstoprovideacomprehensiveunderstandingofthecurrentstateofthedetection offraudwithinthesecompanies,assessingtheirstrengthsandweaknesses,andproposing valuableinsightsforimprovingtheseprocesses.Thisin-depthanalysiswillincludeareview ofbothtraditionalandinnovativefrauddetectionmethodologies,theirapplicationinthe Indonesianretailsector,andtheroleoftechnologicaladvancementsinimprovingthe accuracyandefficiencyofthesefrauddetectionefforts.Thehypothesisitselfwouldbethat bothtraditionalandinnovativemethodsshouldbeusedtogetapreciseaudit. ChapterII LiteratureReview 2.1TheFraudDiamondModel 2.1.1OriginofFraudDiamondModel InitiallyDonaldCresseydevelopedtheFraudTriangleTheory,thetheorywas developedin1950toexplorethereasonswhypeoplecommitembezzlementandthe factorswecandiveintotofindthesepeoplewithinthecompany.Cresseydeveloped3 factorswhichmayabandonethicsandviolatethecompany’strust.Thosefactors beingpressureisnon-shareable,theopportunitytodoembezzlementand rationalizationitself.Withthatbeingsaid,employeeswhocommitfraudduetoa specificreason,havetheabilitytodosowithzerochanceofgettingcaughtaswellas thejustificationtodosowillmoreoftenthannotcommitthecrime.Despitethatthe theoryitselfwasnotperfectandcanbeexploredfurther. Cressey'stheoryinterestinglyexplainswhyseeminglyhonestindividualscommit embezzlementbuthasitslimitations,particularlywhenappliedbeyondtheoriginal study.Theanalytic-inductionmethodinwhichheemployedishighlybeneficialfor theexplanationregardingthedatabutlackspredictivecapability.Theabsenceof conventionalhypothesistestingmighthavecontributedtofindingswhicharebiased towardswhatCresseybelieved.Furthermore,Cresseydidnotinvestigatethepast historyperindividualaswellasafocusgroup.Instead,heusedtheindividual’s non-violatingactitself. ThefirstintroductionofthismodelwasdonebyDavidT.WolfandDanaR. Hermansonintheirpaper,alongsidethethefactorsfirstfoundbyCresseytheyadd capabilityassomethingtofactorintodetecttheactorswhichcommitembezzlement. Thisitselfisthesituationwhereapersonhasthequalities,abilities,andskills necessarytocommitdeception.Atthispoint,theconartistunderstoodtherewasa particularpossibilityforfraudandhadtheresourcestomakeithappen.Position, intelligence,ego,coercion,dishonesty,andstressaretheauxiliarycomponentsof capability(WolfeandHermanson,2004). Overtime,concealedfraudisexpectedtoincreaseitscostandvolume.Inorderto proactivelymitigatetheriskfactorsandpreventfraud,anti-graftauthoritiesrequirea thoroughunderstandingofthebasicfundamentalswhichleadstothefraudulent activity.Theunderlyingcausesoftrustviolationsareone'sappraisalofthedanger involvedandthedesiretoprofitfromthecircumstance(WolfandHermanson,2004). 2.1.2Theadditionalfactor Aspreviouslymentionedbeforethereisanadditionalfactorinthedevelopedtheory whichiscapability.Capabilityisanimportantfactorwhichweneedtoanalyzedeeper sinceitisinitiallythecrucialpartoftheactofcommittingfinancialfraud.Notevery personwiththedesire,chances,andjustificationcanenactfraudwithouttheproper skillset.Thisunderlinesthecrucialroleofindividualabilitiesinbothexecutingand hidingfraudulentacts,particularlyincomplexorextendedfraudscenarios(Albert ,WilliamandWernz,1995). TakenbytheunderstandingsofAbdullahiandMansorhe(2015),thefactorof capabilitycanbederivedinto3mainsubfactorswhicharefunction,Intelligenceand egoaswellascoercion,deceitandstress.Functionistheroleorpositionan individualholdsinanorganizationcansignificantlyimpacttheirabilitytocommit fraud.High-rankingpositionsoftenhavelessoversightandthereforeprovidemore opportunitiestoengageinfraudulentactivities,especiallyincompanieslacking sufficientchecksandbalances.Asignificantportionoffraudcasesinvolvetop executiveswhoexploittheirpositionstobreachorganizationaltrust. Mostfraudperpetratorsarecharacterizedbyintelligence,creativity,andanin-depth understandingofinternalcontrolsandvulnerabilities.Theseindividualsoftenhave significantegos,markedbynarcissismandoverconfidence,leadingthemtobelieve theywillnotbecaughtorcaneasilymanagethesituationifdiscovered.This overconfidencecandistorttheirriskassessment,causingthemtounderestimatethe risksinvolvedintheirfraudulentactions. Successfulpeoplewhodidfraudoftenusecoercivebehaviortocompelothersto participateinorignorefraudulentactivities.Theymaycreateanatmosphereoffear ratherthanrespect,bypassingtheusualchecksandbalances.Effectivelyingand deceitarecrucialformaintainingtheirschemeswithoutdetection.Additionally,the abilitytomanagestressisvital,asongoingfraudulentactivitiescanbehighly demandingandstressful. 2.2TheFraudPentagonModel TheFraudPentagonModelisanextensionfromtheprevious2modelsthislatest modelexplainsfurtherpastboththeories.Thistheoryaddsanadditionalfactorinto theoriginalmodelbyDonaldCresseyaswellasWolfeandHermanson’sadditional factor.ThismodeldevelopedbyCrowein2011becauseheexaminedthatboth previousmodelswerelimited,hefoundthattheactorcommittingthesefraudsneeda certaintypeofarrogancewhichisneededtomakeonebelievethattherulesand regulationsinacompanydonotapplytoone’sself. TheFraudPentagonModelbuildsontheFraudTrianglebyaddingtothetraditional twocomponentsoffraud,whichare"capability"and"arrogance,"andincreasesthe elaborationoffrauddynamics.Thisoverallapproachassistsorganizationsin developingnuancedanti-fraudmeasuresthatarecustom-madetoindividualrisks (Crowe,2011). Inacorporateenvironment,thismodelcanbeappliedtobuildamoreresilient strategyforthesensitivenuancesoffraud,whichwouldassistincreatinganevenand morefortifieddefensemechanismagainstunethicalbehaviors(Wolfe&Hermanson, 2004). Anorganizationalclimatethatemphasizesethicswilllowerfraudulentproclivity. Therefore,notonlyindividualfactorsbutalsoorganizationalclimatefactorsareas necessaryasindividualfactorsforthepreventionoffraud(Ramos,2003). 2.3ComplexityofFraud 2.3.1Frameworks Thereareseveralframeworksofthedetectionoffraudsuchasthetriangle,diamond aswellaspentagontheory.Thesetheoriesdwellintotheunderstandingofthehuman psychologybehindfraudwithdetail.However,thereismoretofrauddetection besidesthepsychologyitself.TheGovernmentAccountabilityOfficehascomeup withaconceptualframeworkthatseekstofurtherhelpmanagersincurbingfraudas wellasfacilitatingintegritypreservationwithingovernmentprograms.Thisleadsto controllingactivitiesmorespecificallyrelatingtopreventionthatmayprevent,detect, orrespondtofraud.