May 03, 2018
Author: , CPA, CVA, CFE

Ok. Lets get it right out in front. Fraud happens! It is a serious problem for all organizations, whether they are corporations, limited liability companies, partnerships, and even non-profits. Regardless of the line of business, the fact is that employees (and non-employees also) commit fraud.

Most fraud is ongoing; once it starts it does not stop by itself, and as it continues, it grows. Very few thefts occur for the first time in large amounts. However, after the fraudster realizes how easy it is to take $100, the next week its $200, then $500, etc. By the time it is caught, each individual occurrence can be in the thousands of dollars or more. Many are surprised to find out that most fraud is perpetrated by well-educated males in senior executive positions (61%), and is affected by conditions within the organization, beginning at the top, and filtering down.

Many business owners will contend that there are sufficient internal controls in place to deter, or even eliminate, fraudulent actions. But, as experience has shown, internal controls do not entirely prevent fraud. Also, last year’s internal controls may no longer be as effective as when they were developed. Businesses change, and as they do more/different employees are hired for old and newly created positions. Rarely are internal controls considered in these circumstances.

Some statistics to ponder:

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• Certified Fraud Examiners estimate the annual business fraud loss to be in the neighborhood of $652 billion.
• The average loss in a small business is $190,000
• The average loss in large companies is $97,000
• In more than 37% of the fraud cases discovered, the fraudster had been employed was employed for more than 10 years by the organization
• Personal problems with debts, gambling and drugs were recognized in many of the situations uncovered by investigation
• While some frauds involved theft of inventory or other tangible assets, cash was targeted in more than 90% of the schemes

Fraud generally does not occur in a vacuum; many times it happens within an environment that, while maybe not overtly, is a breeding ground for this type of behavior. Many of the frauds we have investigated were perpetrated in offices where the managers/owners were very busy with their daily routines and did not pay appropriate attention to areas which, when left unguarded, presented opportunity for fraud.

While some of the warning signs of fraud listed below may seem like common sense, they are meaningless unless someone is paying attention. Frauds in small business tend to be unsophisticated, and on the surface, begging to be discovered. But when no one is looking, they go on, sometimes for years, before detection. Here are some common warning signs of fraud:

• An employee who is living beyond his/her means
• Sub-ledgers which do not reconcile with the general ledger
• Excessive write-offs of accounts receivable
• Unexplained cash discrepancies
• Complaints from customers about billing or amounts owed
• Complaints from vendors about payment
• Rise in “soft” costs (i.e. advertising, consulting, etc.)
• Voided, destroyed or missing checks
• An employee who never takes a vacation

The above warning signs are not intended to alert the reader that a fraud is definitely taking place. Rather, these guidelines are simply indications that if any one or more of the events are exhibited, someone should take another look at the processes of the company that allow these events to occur.

Below are some common methods of committing fraud:

Skimming
This type of fraud occurs when cash is taken out of the system PRIOR to its recordation. A typical example of this type of fraud is sales which are not rung into the register and find their way into the cashier’s pocket. Skimming can also take place when receipt records are falsified or bank deposits are tampered with.

Larceny
This type of fraud occurs AFTER the cash has been recorded in the accounting system. Many larcenies are committed by bookkeepers, or others who have access to the bookkeeping/accounting records of the organization, and also to the cash/checks received. Check tampering and fraudulent vendor schemes also fall into this class.

Expense Account Schemes
We generally see four different methods for misappropriation of funds when dealing with expense accounts. First, it is not unusual for legitimate receipts to be submitted, although they are for non-business expenses (dinner with a friend). 

Second, it is not unusual for a fraudster to inflate expenses where receipts are not expected to be required, i.e. taxi cab receipts, or to alter the receipts prior to submission for reimbursement.

Next, fictitious expenses can be sometimes found on expense reports. In this case, a false receipt or other proof of the expense is presented. It is very easy to create a receipt for an expenditure that never occurred.

Also, multiple submissions for the same expense is not an uncommon method to perpetrate a fraud against an employer. In this method, an expense, possibly an airline ticket and hotel bill, are resubmitted two or three months after the original submission. Since many employees incur multiple out of town trips each month, the submission is not unusual, and only a keen memory will be able to ferret out this scheme.

Fraudulent Disbursements
This fraud generated a median loss to companies of $75,000, based on the 2006 Report to the Nation on Occupational Fraud and Abuse, issued by the Association of Certified Fraud Examiners. Generally these disbursements take the form of nonexistent employees or vendors. These losses can be difficult to detect, especially in large companies with hundreds or thousands of employees, and many vendors.

Fraud is an ever present threat to every organization’s balance sheet, and even its continued existence. However, not enough companies pay the appropriate amount of attention to this peril. While recognizing it is impossible to provide any assurance that the information contained in this article will prevent fraud in your company, here are a few tips to help you prevent fraud in your organization:

• Develop a written code of ethics
• Lead by example
• Establish reasonable expectations of all employees
• Treat employees well
• Restrict access to bank accounts
• Make sure bank reconciliations are performed regularly
• Secure inventory and supplies
• Provide a mechanism for reporting fraud
• Have a Fraud Assessment conducted by a qualified fraud examiner

KAWG&F has several Certified Fraud Examiners on our staff to assist you with the development of controls to detect and prevent fraud in your organization. Contact Joel Charkatz, CPA, CVA, CFE at 410-307-6400 or via email at [email protected].