My earlier publication titled “Fraud Detection and Prevention in Financial Reporting – Is it the Auditors Responsibility?” which was published in this same paper on September 13, 2017, sought to discuss on whose responsibility is it for fraud detection and prevention in financial reporting, however, this publication focuses on dealing with fraud detection and prevention in the workplace.
In today’s environment, companies of all sizes need to consider the risk of fraud and take proactive measures to help mitigate the risks that they face and Small businesses often suffer disproportionate fraud losses, as the “median loss” suffered by organizations with fewer than 100 employees was $190,000 per (fraud) scheme, says James P. Martin, managing director for Cendrowski Corporate Advisors LLC.
Fraud is defined by the Association of Certified Fraud Examiners as any intentional or deliberate act to deprive another of property or money by guile, deception, or other unfair means; and is expressed in forms such as corruption, cash asset misappropriation, non-cash asset misappropriation, fraudulent financial statements and fraudulent actions by third parties. Refer to earlier publication for more details.
It was also established that fraud involves the motivation to commit fraud and a perceived opportunity to do so and as such a perceived opportunity for fraudulent activities may exist when an individual believes internal control could be circumvented because of an individual’s position of trust or has knowledge of specific weaknesses in the internal control system. Three variables thus fuel fraud in every organisation – pressures, opportunity and rationalization.
Organisation processes such as procurement, payment, recording, receipts etc. are all exposed to fraudulent activities as fraud is a no respecter of persons – from bottom to top, all employees risk being fraudulent.
Some Indicators for Existence of Potential Fraud in Business – Detection
There is no specific rule, checklist or manual for fraud detection, however, options such internal audit, external audit, financial report analysis, surprise audits, anonymous information/tips, and data mining or forensic audits, especially if targeted at fraud detection is highly recommended. other indicators are:
Display of Unusual Behaviour – display of unusual behaviour and attitude is often associated with perpetrators of fraud. Most fraudsters hardly take their leave or vacation (even when sick) with the fear that when they vacate their desk, the new person may unravel their deals and are also unlikely to assign work even with overloaded with work.
Unresolved Items in Reconciliations – the purpose of reconciliations is to identity and resolve issues, if any, however, items that stay unresolved for so long in reconciliations could be indicative of fraud/theft.
Excessive Voids – frequent and excessive voiding of invoices could give an indication that goods may have been sold but payment is diverted for use by perpetrators hence subsequent cancellation of sales slip or invoices to cover up the theft.
Missing Documents – eventhough documents may be misplaced at one point in time, frequent disposal or unusual disappearance of documents like deposit slips, receipt or cheque books could also give a potential case of fraud.
Excessive Credit Memos – just like excessive voids, this technique is also used to cover the theft of cash because an ‘unwarranted or unsubstantiated’ credit memo could easily be written out to a customer, and cash taken to make total cash balance.
Frequent and unreasonable adjustments to debtors and creditors balance – where customer payments are misappropriated, adjustments could be made to debtors’ balance to cover the shortage whiles perpetrators can use a forged billing scheme convert cash for personal use and just use adjustments to make the creditors balance.
Duplicate Payments – not all duplicate payments are considered errors because they could equally be converted to use by perpetrators. This is usually a ‘cartel’ thing by group of employees and/or a third party, which is carefully planned and executed especially where there are weak controls for payment processing.
Inventory Shortages – normal operating shortages over time could easily be explained where proper inventory records exist, however, frequent and excessive decline in inventory could give a red flag for fraud, theft or misappropriation.
Increased Scrap – the frequent or excessive increase in amount of scrap could indicate a scheme to steal and resell materials or items especially in the manufacturing sector because such activities are carried with less scrutiny than normal inventory.
Some Adverse Effects of Fraud on Business – Adverse Implications
The Association of Certified Fraud Examiners’ (ACFE) “2012 Report to the Nation” is one study that describes the losses that an entity may experience because of fraud and it indicates that a typical organization loses approximately 5 percent of its annual revenue to fraudulent acts. Some identified adverse effects of fraud are:
- financial loss
- reduced credibility of financial reports
- reduced confidence by the public (i.e. external stakeholders)
- shattered company culture and employee morale (such as mistrust, loss of key staff etc)
- increased audit cost
- threaten the survival of business
- loss of potential funding or investors
Some Possible Ways to Minimise or Eliminate Fraud in Business – Prevention
The fraud cases studied in the ACFE 2014 Report revealed that the fraudulent activities studied lasted an average of 18 months before being detected and you can imagine the type of loss a company could suffer with an employee committing fraud for a year and a half. Cecilia Locati in the Journal of Accountancy suggested some tips to help companies decrease the presence of fraud. These include:
Segregation of duties – the lack of segregation of duties makes it easy for one individual to have complete control over a process, such as procurement. Implementing segregation of duties will disperse the responsibilities over more than one individual.
Reviews and approvals – it is important that the review process for invoice payments is thorough and complete in order for a reviewer to determine the legitimacy of the invoice and the vendor.
Vendor selection – the vendor selection process should include a bidding procedure and a due-diligence process to determine that the vendor is genuine and that the company is getting a quote that is reasonable based on other vendors in the market. Additionally, after the vendor is selected it should go to a second party for final review and approval.
Automated controls – companies should implement automated controls to go along with manual processes which are more prone to errors and fraud. Automated controls include processes in areas such as payment and other systems that cannot be overwritten by a manual control.
Consistent vendor monitoring – it is recommended that an individual other than the one maintaining a relationship with the vendor monitors vendor’s performance over time, to ensure expectations are being met and maintained regarding service and performance. This will help to eliminate the likelihood that fraudulent or fake vendors will be used in business.
Budget reviews – reviewing the budget to actual numbers will help a company to detect any outliers from expectations, along with reviewing financial ratios to determine any numbers that are not consistent with expectations.
Anonymous reporting of fraud availability – according to the ACFE 2014 Report, most occupational fraud (over 40%) is detected because of a tip. While most tips come from employees of the organization, other important sources of tips are customers, vendors, competitors and acquaintances of the fraudster. Companies should thus implement formal and structured processes for reporting suspected fraud. This can be done through the use of an anonymous hotline or other systems for employees to use at their convenience.
Know Your Employees – it is prudent for management to be involved with their employees and take time to get to know them because fraud perpetrators often display behavioural traits that can indicate the intention to commit fraud and thus observing and listening to employees can help you identify potential fraud risk. This can also reveal internal issues that need to be addressed such as an employee who feels a lack of appreciation from management or anger at their boss which could lead him or her to commit fraud as a way of revenge.
Implement Internal Controls – management must implement strong internal controls to safeguard company’s assets, ensure the integrity of its accounting records, and deter and detect fraud and theft and a typical example is segregation of duties which can reduce the risk of fraud from occurring.
Live the Corporate Culture – it is believed that a positive work environment can prevent employee fraud and theft hence the need for a clear organizational structure, written policies and procedures and fair employment practices. An open-door policy can also provide a great fraud prevention system as it gives employees open lines of communication with management. Directors and management should lead by example and hold every employee accountable for their actions, regardless of position.
As Corné Mouton, a Forensic Services Partner with Mazars will say fraud is unavoidable, and for those in business, it is an occupational hazard. The costs and long-term effects of fraud are many because organisations that are victims of fraud not only bear the cost of the fraud itself but also the costs of investigating the fraud, of clearing up the problem and of ensuring there is no reoccurrence.
Another must read: Facing the Reality of Fraud in your Business (Part 1)
Fraud is on the rise and it is therefore necessary to fight against fraudulent activities and financial misconduct. Fighting it through education, prevention, detection and, ultimately, the prosecution and punishment of fraudsters should be seriously considered by every organisation’s management team and it should be incorporated into the organisation’s strategy.
About the Author
The author is a Financial Reporting/Analysis, Audit and Tax professional, a Consultant at Danisa Consult (Accounting, Audit & Tax) and a Facilitator for accounting, tax and audit at Global Institute of Resource Development (GiRD), a capacity development and training institution. A member of the Institute of Chartered Accountant, Ghana; Chartered Institute of Taxation, Ghana; Association of International Accountants, UK; International Association of Accounting Professionals, UK; Association of Certified Fraud Examiners, US; Southern African Institute of Business Accountants, SA.
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