Fraud Risk Assessment

Fraud risk assessment is often “done” once a year and then forgotten, which is exactly what examiners, auditors, and audit committees dislike. COSO’s expectation is narrower and more operational: fraud must be considered as part of assessing risks to achieving objectives, and the organization should do that explicitly, in a way that connects to real processes and controls (COSO IC-IF (2013)).

For a Compliance Officer, CCO, or GRC lead, the fast path is to treat the fraud risk assessment like a scenario-based overlay on your existing enterprise risk assessment (ERA) and internal control program. You are not trying to predict every bad act. You are trying to (1) identify plausible fraud schemes tied to your objectives, (2) measure inherent risk and control coverage, (3) decide what must change, and (4) prove you followed through.

This page gives requirement-level guidance you can operationalize quickly: who needs to participate, what artifacts to create, what controls and monitoring to expect, and where programs commonly fail (especially on management override and third-party-enabled fraud). It is written to help you walk into a steering committee meeting with a plan and walk out with accountable owners.

Regulatory text

COSO Principle 8 – Risk Assessment: “The organization considers the potential for fraud in assessing risks to the achievement of objectives.” (COSO IC-IF (2013))

What this requires you to do as an operator:

• Make fraud a named input to your risk assessment method, not an implied concept (COSO IC-IF (2013)).
• Evaluate fraud across the fraud “universe,” including fraudulent financial reporting, misappropriation of assets, and management override of controls (COSO IC-IF (2013)).
• Show how identified fraud risks affect objectives, and show what control activities and monitoring reduce those risks (COSO IC-IF (2013)).

Plain-English interpretation (what auditors mean by “fraud risk assessment requirement”)

You must be able to answer, with documentation:

1. Where could someone commit fraud here? Include internal actors, third parties, and customers where relevant.
2. How would they do it? Document realistic schemes (not just “fraud could occur”).
3. What makes it more likely? Incentives/pressure, opportunity, and rationalization are common lenses, but keep the output practical.
4. What stops it today? Map schemes to preventive and detective controls.
5. What did you change because of the assessment? If nothing changed, you need a defensible explanation (for example, strong control coverage and monitoring already in place).

Who it applies to (entity and operational context)

COSO is a framework, but the requirement applies broadly wherever COSO is used to structure internal controls, ICFR, SOX programs, or an enterprise controls environment (COSO IC-IF (2013)). In practice, this requirement applies to:

• The organization as a whole: leadership, finance, compliance, internal audit, and process owners who run revenue, procurement, payroll, inventory, treasury, and financial close.
• Operational contexts with elevated fraud exposure:
  • Cash handling, refunds, credits, incentives, rebates, and commissions.
  • High-volume payment flows (AP, expense, payroll).
  • Manual journal entries, estimates, reserves, and end-of-period adjustments.
  • Third-party relationships where a third party can submit invoices, receive payments, access systems, or influence reporting.
  • Programs with heavy manual exceptions or weak segregation of duties.

Ownership typically sits with risk/compliance or internal audit, but execution requires process owner participation. A fraud risk assessment run only by GRC without finance/operations input usually produces generic risks and weak control mapping.

What you actually need to do (step-by-step)

Use this sequence to operationalize Principle 8 in a way that produces audit-ready evidence (COSO IC-IF (2013)).

1) Define scope tied to objectives

• List the objectives you are assessing (financial reporting objectives, operational objectives, compliance objectives).
• Identify in-scope processes and systems that materially support those objectives (order-to-cash, procure-to-pay, record-to-report, etc.).
• Define boundaries: business units, geographies, products, key third parties.

Output artifact: Fraud Risk Assessment (FRA) scope statement, aligned to enterprise objectives.

2) Build a fraud scheme library (start practical, then expand)

Create a list of plausible schemes for each process. Keep them specific enough to test control coverage. Examples:

• Procure-to-pay: fictitious vendors/third parties, duplicate invoices, split purchases to bypass approvals, kickbacks, payment redirection via bank change fraud.
• Order-to-cash: improper revenue recognition, credit memo abuse, refund fraud, channel stuffing, side agreements not captured in systems.
• Payroll: ghost employees, timekeeping manipulation, unauthorized pay rate changes.
• Financial close: manual journal entry manipulation, reserve/estimate bias, reclassification to meet targets (management override focus).

Output artifact: Fraud scheme catalog with process mapping.

3) Identify fraud risk factors and “where opportunity exists”

For each scheme, record conditions that increase opportunity:

• Concentrated access (one person can create vendor + approve invoice + release payment).
• Manual workarounds, spreadsheet-based calculations, weak logging.
• Override-able approvals, broad admin access, shared credentials.
• Incentive compensation tied to targets without counter-balancing controls.

Output artifact: Fraud risk factor notes attached to each scheme.

4) Assess inherent risk, then control coverage

For each scheme:

• Score inherent likelihood/impact using your existing risk rating approach (keep consistent with your enterprise risk assessment).
• Identify controls that prevent/detect the scheme:
  • Preventive: segregation of duties, approval thresholds, system validations, vendor onboarding controls, bank account verification.
  • Detective: exception reports, journal entry analytics, 3-way match exceptions, duplicate payment reports, refund outlier review, access review results.
• Rate control design coverage (strong/partial/weak) and note whether controls are manual vs automated.

Output artifacts:

• FRA risk register (scheme → inherent risk → controls → residual risk).
• Control mapping matrix (scheme-by-control).

5) Explicitly address management override

COSO calls out management override as a core fraud consideration (COSO IC-IF (2013)). Make it a visible subsection, not a footnote:

• Identify where executives/managers can override controls (journal entries, credit approvals, manual pricing, access provisioning, policy exceptions).
• Document compensating controls: independent review, audit committee oversight, restricted access, logging and monitoring, post-override testing.

Output artifact: Management override assessment and control response.

6) Document response decisions and assign owners

For top fraud risks, record one of three outcomes:

• Accept (with rationale tied to low residual risk).
• Mitigate (list control improvements, due dates, owners).
• Avoid/Change process (stop the activity or redesign the workflow).

Tie each mitigation to a trackable action item in your GRC system. If you use Daydream, set up a workflow that links each fraud scheme to the control owner, testing cadence, and evidence request list so follow-through does not depend on email.

Output artifacts: Remediation plan, ownership log (RACI), tracked issues.

7) Integrate into monitoring and testing

A fraud risk assessment that does not change monitoring becomes shelfware. Update:

• Internal audit plan or compliance monitoring plan based on highest residual fraud risks.
• Control testing scripts to include fraud-specific assertions (for example, test bank change controls against fraud scenarios).
• Training content for high-risk roles (AP, payroll, finance close, sales ops).

Output artifacts: Updated monitoring plan, test plans, training assignments.

8) Refresh triggers (event-based refresh, not calendar-only)

Define triggers that require an FRA update:

• M&A, new product lines, new payment methods, ERP migrations.
• Control breakdowns, significant fraud allegations, hotline trends.
• Changes in incentive plans or significant org restructures.

Output artifact: FRA refresh criteria and documented refresh events.

Required evidence and artifacts to retain

Keep evidence that shows both analysis and execution:

Core documents

• FRA scope statement and methodology aligned to risk assessment practices (COSO IC-IF (2013)).
• Fraud scheme catalog and risk register (inherent and residual ratings).
• Management override assessment section (COSO IC-IF (2013)).
• Control mapping matrix (scheme ↔ controls ↔ owners).

Decisioning and governance

• Meeting minutes/attendees for workshops and approvals (Finance, Compliance, Internal Audit, key process owners).
• Sign-off by accountable executive (often CFO/Controller for ICFR contexts) and documented audit committee reporting where applicable.

Operational follow-through

• Remediation tickets with owners, evidence of completion, and validation testing.
• Monitoring reports and exception review evidence (who reviewed, what they did, outcomes).
• Access review outputs for sensitive roles tied to fraud scenarios.

Common exam/audit questions and hangups

Auditors and exam teams tend to focus on these:

1. “Show me where fraud is explicitly considered in your risk assessment.” They will not infer it from generic risk language (COSO IC-IF (2013)).
2. “How did you address management override?” Expect follow-ups on journal entries, estimates, access, and approval exceptions (COSO IC-IF (2013)).
3. “How do you know the controls you listed actually mitigate the scheme?” If you cannot map scheme → control → test → results, you will struggle.
4. “What changed as a result of the assessment?” Mature programs show updates to monitoring, control design, or audit plans.
5. “How did you include third parties?” Many fraud events ride through third-party invoices, refunds, agents, or outsourced processes.

Frequent implementation mistakes (and how to avoid them)

Mistake	Why it fails	Better approach
Treating FRA as a one-time workshop	Produces generic risks and no ownership	Convert top risks into tracked issues with control owners and due dates
Ignoring management override	Directly conflicts with COSO’s stated fraud focus (COSO IC-IF (2013))	Create a dedicated override section and test compensating controls
Listing controls without testing evidence	Auditors treat it as “paper controls”	Link each control to testing/monitoring results and exceptions handling
Over-scoping into an encyclopedic list	Teams stop maintaining it	Start with highest-risk processes and expand iteratively based on triggers
Forgetting third-party-enabled schemes	Real exposure sits in AP, refunds, outsourcing	Add third party touchpoints to process maps and include them in scenarios

Enforcement context and risk implications

No public enforcement cases were provided in the source catalog for this requirement. Practically, the risk is still concrete: if you cannot show that fraud risk was considered, your control environment can be assessed as ineffective under a COSO-aligned evaluation (COSO IC-IF (2013)). That can translate into audit findings, delayed closes, control remediation work, and governance escalation.

A practical 30/60/90-day execution plan

First 30 days (stand up and scope)

• Confirm scope, objectives, and in-scope processes.
• Identify stakeholders and schedule scheme workshops by process.
• Build the initial fraud scheme catalog and agree on a consistent scoring method.
• Draft the FRA template (risk register + control mapping + override section).

Days 31–60 (assess, map controls, decide)

• Run workshops, document schemes, and assign inherent risk ratings.
• Map current controls, identify gaps, and rate residual risk.
• Produce a management override assessment with clear compensating controls.
• Present top risks and recommended actions to leadership for decisioning.

Days 61–90 (operationalize and prove follow-through)

• Convert mitigations into tracked remediation items with owners and evidence requirements.
• Update monitoring/testing plans to reflect the highest residual fraud risks.
• Train high-risk control owners on fraud scenarios and evidence expectations.
• Establish refresh triggers and a governance cadence for updates and reporting.

Frequently Asked Questions

Do we need a separate fraud risk assessment if we already do an enterprise risk assessment?

You can embed fraud into the enterprise risk assessment, but it must be explicit and scenario-based, including management override considerations (COSO IC-IF (2013)). If your ERA cannot show that level of detail, create a fraud overlay that maps to the ERA.

How deep do we need to go on management override?

Deep enough to identify where overrides occur, who can perform them, and what compensating controls detect inappropriate overrides (COSO IC-IF (2013)). A single sentence that “management override is possible” will not hold up.

What is the minimum evidence an auditor will expect?

A documented risk register of fraud schemes, control mapping, and proof of governance and follow-through (meeting notes, sign-offs, remediation tracking). Testing or monitoring results tied to key controls reduces debate.

How do we handle third parties in the fraud risk assessment?

Map where third parties can initiate transactions, change payment details, access systems, or influence reporting. Add third-party-enabled schemes (invoice fraud, payment diversion, collusion) and map them to onboarding, due diligence, and payment controls.

Who should own the fraud risk assessment?

Accountability usually sits with the control environment owner (often Finance for ICFR) with execution run by Compliance/GRC or Internal Audit. Process owners must co-own scheme identification and control accuracy, or the output will be theoretical.

What if we identify fraud risks but can’t remediate quickly?

Document the decision, interim controls, and timelines as tracked issues with owners. Auditors generally distinguish between “known and managed” versus “known and ignored,” especially when monitoring is strengthened during the interim.