Has your business been victimized by fraud? If not, it very likely will be. If you answered yes, you already know it could very well happen again. In a study done by international accounting firm, Pricewaterhouse Coopers, 38 percent of all US firms suffered economic loss as a result of fraud in 2016 alone, and that of course is just what was detected. Most fraud goes undetected for three to five years. The following provides some insight on internal fraud and what you can do to detect and hopefully prevent it from happening to your business.
The two most common types of internal fraud are asset misappropriation/corruption, and financial statement/accounting fraud. The former is most often perpetrated by middle management and trusted supervisors, while the latter is typically directed by senior management and ownership. Asset misappropriation/corruption accounts for approximately 90 percent of all reported frauds with a median loss per occurrence of $125,000, with financial statement/ accounting frauds making up the remaining 10 percent and a median loss of $975,000 according to a 2016 study done by the Association of Certified Fraud Examiners (ACFE).
Asset misappropriation includes check/cash theft, inventory theft, expense account fraud, payroll fraud, procurement fraud and vendor fraud, among many others. Here are some steps you can take:
General Tips to prevent fraud
- Perform thorough background and reference checks.
- Implement strong internal controls, separation of duties, and enforce with management oversight and approval of all disbursements. As an example, separate expense approval from check writing, check signing and especially bank account reconciliation.
- Rotate the duties of employees.
- Require two weeks of contiguous vacation.
Fraud from vendors can include scams such as billing schemes and price fixing. To avoid this, insure you have strong checks and balances on approval of payments to vendors. You should also reconcile your inventory receipt log to vendor payments regularly. Performing background checks and due diligence on new vendors can help prevent fraud as well. Finally, conduct random audits of vendor files.
Embezzlement, accounts payable fraud and accounts receivable fraud are some of the more common accounting fraud schemes. For companies with a limited accounting staff, which makes segregation of duties difficult, consider retaining an outside bookkeeper/accountant periodically to review. You should also require approval of all new account set-ups.
To avoid payroll fraud, require management approval of all timesheets and overtime. You should also require all master-file changes for amount, name, address, etc. to be approved by management. In addition, do not allow payroll employees to modify the master file. Consider using an outside payroll service.
Corruption is perhaps the most significant and costly challenge for small business. Collusion with another party is most often a required characteristic. Bribes or kickbacks paid for favored treatment to an outsider for contract benefits, unauthorized discounts or payment of phony invoices are all common and frequently difficult to detect.
Some procedures you might consider, in addition to those listed in this article, are:
Emphasize the culture of your company. Insure you have a well understood code of ethics and have management set the example in all ways.
Consider providing an anonymous employee ‘hot-line’. The majority of frauds are discovered through tips.
Small firms experience a much higher frequency of fraud than do larger firms. The primary reasons for this are generally the size of the management team that can conduct oversight, and the inability to adequately segregate duties and responsibilities of the employees. Fraud requires unsupervised autonomy or collusion. It is also generally a person of high trust.
While it is not possible to protect your company completely, by designing and implementing strong operating protocol and internal controls and maintaining aggressive oversight with a strong ethical culture you can limit your exposure. Finally, talk to outside accountants. They can help you design and strengthen your procedures and controls. Many have generic programs that can be modified to your company.
Mark A. Bailey, CPA/ABV/CEIV/CFF is the managing partner of Excelsis Accounting.