Unscheduled Audits Can Catch Fraud in the Act

Scheduled audits are recommended for privately owned businesses and nonprofits, and they’re required of all public companies. However, because regular audits give cheating employees time to hide their crimes, the experts conducting them typically don’t find occupational fraud schemes. That’s why companies also need unscheduled fraud audits.

Experts conducting unscheduled audits can use a number of different accounting procedures to detect malfeasance. Regardless of the techniques used, the goal is the same: to catch perpetrators red-handed.

Looking for irregularities

forensic accounting

To understand how surprise audits work, consider this fictional example. A client suspects that his company’s CFO is falsifying financial statements. Because large financial statement frauds revolve around inventory, sales and accounts receivable, an outside expert focuses on these areas.

When the expert detects an irregularity, she interviews the suspect and other staff members and takes a more detailed look at the company’s historical financial statements for unusual trends. Eventually, she finds evidence of fraud, which the company uses to help terminate the employee and as evidence in court.

Element of surprise

Catching employees off guard is critical. Say a company has multiple inventory locations, and employees know when and where auditors will conduct test counts. They can easily conceal shortages at locations not scheduled for a count that day. But if auditors show up without notice, employees don’t have a chance to shift inventory around.

Surprise fraud audits are just as useful in uncovering lower-level theft, such as cash skimming.   Experts can uncover long-running schemes if the guilty parties don’t have time to shred, alter or hide records and other evidence.

The types of surprises auditors use vary — for example, when they start work or how they conduct the audit. If auditors usually start their visits counting cash, a fraud perpetrator is likely to know this. Thus, it may be possible to trip up the thief by starting with receivables.

In fact, surprise audits can both detect and deter fraud. Numerous studies have found that people who perpetrate fraud believe the risk of getting caught is minimal. Seeing other employees taken unawares may discourage potential thieves.

Fraud-busting techniques

The AICPA’s Statement on Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit, recommends that experts conduct surprise audits on test areas, locations and accounts that would otherwise not receive scrutiny. Based on the company’s internal controls and other standard procedures, experts can design tests that employees won’t predict or expect. Surprise audits also may include high-tech sampling and computer data analysis techniques. For example, specialized software can examine as many as 1,000 invoices quickly and in detail, including invoice numbers and to whom payments were made.

By isolating suspicious cases, auditors can shine a spotlight on schemes where, for example, someone submits phony invoices to the company’s accounting department, which then sends payment to a post office box. A technology-aided surprise audit also can help uncover suspicious duplicate invoice amounts and invoice numbers.

Testing internal controls

Regularly scheduled audits aren’t enough if companies want to prevent financially damaging fraud schemes. Surprise audits, on the other hand, enable organizations to test the effectiveness of their internal controls and determine whether activities and transactions comply with antifraud policies.

For more information on employee fraud and abuse issues, call our forensic accounting team at 716.847.2651 or contact us here.