At long last, the U.S. economy seems to be recovering from the effects of the recession. But at least one major financial risk remains — corporate fraud. The good news is: A fraud expert can help investors and companies minimize losses from fraudulent conduct by simply scrutinizing a business’s financial statements.
Corporate fraud often is concealed when a business intentionally misrepresents material information in its financial reports. These misrepresentations may result from overly aggressive estimates of figures, the misapplication of accounting principles and material omissions. For instance, financial statements may conceal expenses or liabilities or report fictitious revenues in order to make a business appear more profitable than it really is.
In order to cover fraud, a perpetrator often conceals or omits information that can damage or improperly change the bottom-line results appearing in financial statements. Such omissions might include:
- Liabilities such as loan covenants or contingency liabilities.
- Significant events that are likely to affect future statements, such as potential lawsuits, impending product obsolescence and new competition.
- Accounting changes that materially affect financial statements and are subject to disclosure rules, such as methods of accounting for depreciation, revenue recognition or accruals.
Perpetrators also might engage in fraudulent manipulation, particularly in the areas of revenues, reserves, expenses and one-time charges. A falsified financial statement can improperly value sales transactions (by, for example, inflating the per unit price), recognize sales prematurely or report phantom sales that never occurred. On the other hand, expenses can be manipulated by simply delaying their recognition — whether to match expenses with their corresponding revenue or to avoid reporting a loss. Another scheme is to improperly capitalize expenses so they appear on the business’s balance sheet rather than on its income statement.
In many cases, fraudulent financial statements may show reserves that have been calculated using bad-faith estimates. For instance, a fraudster can justify a smaller amount of reserves simply by underestimating the percentage of uncollectible receivables. One-time charges, such as a charge for research and development costs for a specific product, or a write-off of goodwill, can further distort financial statement figures and help hide fraudulent activity.
Unusual trends and relationships
When fraud is suspected, a CPA can examine complex financial statements and uncover manipulation that might not be apparent to the untrained eye. A fraud expert typically begins by reviewing suspicious statements for unusual trends and relationships. Any leads are then followed by more intensive forensic accounting work. This may include analysis of journal entries, specific transactions, work papers and supporting documentation — going far beyond a standard annual audit.
Moreover, a CPA may employ several types of analyses. For instance, a vertical analysis compares the proportion of every financial statement item — or groups of items — to a total within a single year that can be measured against industry norms. A horizontal analysis compares current data with data from prior years in order to detect patterns and trends. And a financial ratio analysis can calculate ratios from the current year’s data and then compare those with previous years’ ratios for the business, comparable companies and the relevant industry. Of course, the expert must have tremendous experience in the subject industry and be able to recognize any noncompliance with Generally Accepted Accounting Principles.
Noncompliance is a huge red flag for financial statement fraud. The Association of Certified Fraud Examiners (ACFE) has identified several behavioral red flags, including executives who exhibit a cavalier attitude toward internal controls, live beyond their means, have excessive organizational pressure to perform, and are unwilling to share duties or information with colleagues.
The ACFE has estimated that the median loss in financial statement fraud schemes is around $1 million. But there are other damages as well, such as the public relations damage that rogue executives who manipulate the numbers can cause. A qualified CPA can help limit your clients’ losses by finding critical omissions and manipulations.
Skimmer fraud is a global epidemic – are you stepping up to the plate and helping your borrowers?
Skimmer fraud costs businesses billions of dollars annually in the United States, according to a report released in February by the Association of Chartered Certified Accountants USA (ACCA) and Pace University.
The average loss per skimmer scam was around $50,000 in 2011 — up from some $30,000 in 2010. Unfortunately, this trend isn’t showing any signs of stopping.
Skimmer scams can damage a business’s reputation, compromise its ability to service debt and generate financial losses. Even though it’s most common among restaurants and retailers, skimmer fraud is a risk for any business that takes electronic payments.
What is “Skimmer Fraud”?
“Skimmers” are electronic devices that are used to read and store electronic data. They can be installed directly on ATMs, gas station pumps and point-of-sale terminals to extract data from magnetic stripes on payment cards. Some schemes even use small cameras to simultaneously record personal identification numbers (PINs).
After skimming the electronic data, thieves will usually clone payment cards. The phony cards might be used to purchase high-end goods that can sell quite easily on the black market or online marketplaces.
U.S. is Vulnerable to These Threats
Skimmer fraud has become a global epidemic, which is often perpetrated by Eastern European crime rings. Unfortunately, the United States is especially vulnerable to these threats. Why? For one thing, it has more ATMs than any other nation, and U.S. credit cards don’t contain global chips, which makes them easier to skim and clone.
Restaurants in the United States also typically swipe customers’ cards away from the table, which creates an opportunity for dishonest restaurant staff to skim a patron’s electronic data using handheld devices. In other countries, however, payment cards are swiped at the table, never leaving diners’ sight.
While skimmers have been around for years, today’s devices are smaller, they have more memory and they incorporate advanced encryption methods that can make them harder to detect. Some skimmers even use wireless technology. In January, 13 people were indicted for operating a skimmer fraud ring. They stole upwards of $2 million using Bluetooth-enabled skimmers at gas stations.
How to Prevent or Mitigate Skimmer Scams
There are several ways you can protect your borrowers from skimmer scams. Here are just a few:
- Inspect card readers for tampering and using skimmer detection cards.
- Install surveillance cameras to record activity at ATMs, gas stations and ticket kiosks.
- Prohibit cashiers from leaving their registers or terminals.
- Require employees to swipe payment cards in customers’ plain view.
- Equip point-of-sale terminals with anti-skimming devices.
U.S. retailers are also validating transactions using ZIP codes, driver’s licenses or PINs. What does the future hold? Look for biometric data — such as fingerprints or irises — to authenticate transactions.
Keep Abreast of Skimmer Fraud
If you want more information on the ACCA’s report, look for “skimmer fraud” on the association’s website (http://www.accaglobal.com). In addition, work our forensic accounting team. We can provide additional information on prevention and detection.
Freed Maxick’s Asset Based Lending Team works with dozens of asset based lenders across the country. We can help you reduce the risk of lending or assist your clients with our business advisory, audit, fraud detection and prevention, and tax services.
For more information about our business advisory, audit, and other accounting services contact us here, or call us at 716-847-2651.
Report Sheds Light on Fraud Perpetrators
Author: Adrienne Schreier
In its 2012 Report to the Nations on Occupational Fraud and Abuse, the Association of Certified Fraud Examiners (ACFE) estimates that the typical organization loses 5% of its revenues to occupational fraud every year. The median loss in the ACFE’s survey of almost 1,400 fraud cases was $140,000, and more than 20% of these cases resulted in losses of at least $1 million.
The numbers are alarming, as few companies can afford such losses. Perhaps more surprising are the ACFE’s findings related to fraud perpetrators. The employees behind such costly schemes aren’t your average criminals.
Tone at the top
Although it’s easy to place the blame for occupational fraud on lower-level employees, research tells another story: 42% of the perpetrators in the ACFE survey were nonmanagement, but 38% were managers and 18% were owners or executives.
And, in fact, the higher the thief’s position in the company, the more costly the fraud. Owners and executives were responsible for losses that were approximately three times higher than managers instigated. For their part, managers rang up losses about three times higher than regular employees caused. The ACFE attributes such statistics to the fact that those with more authority have greater access to their company’s assets. They’re also in a better position to override internal controls. Not surprisingly, the study also finds that the amount of fraud losses increases with perpetrators’ tenure and education — which typically are associated with higher positions and greater trust.
Other notable findings
Certain departments provide greater opportunities for fraud. Accounting, operations, sales, executive / upper management, customer service and purchasing areas together accounted for 77% of all cases.
Another important finding is that most occupational thieves aren’t career criminals. Of the 860 cases in the ACFE study (where information was available), only 6% involved a perpetrator who had previously been convicted of a fraud-related offense. And of 695 cases with information on the perpetrator’s employment history, 84% of them had never been punished or terminated by an employer for fraud.
Most fraud perpetrators turn to theft because they’re experiencing some type of pressure — at work, in their personal lives or both. The pressure could be financial — stemming from debt, addiction, gambling losses, poor investments, medical bills, divorce, or “keeping up with the Joneses.” Or pressure may come from supervisors with unreasonable performance goals or from company shareholders with high earnings expectations.
Frequently, occupational thieves are motivated by anger and dissatisfaction with their manager or the company’s leadership. Their anger may be fueled by a perception that management’s own ethics and integrity are lacking. In rare cases, perpetrators draw personal satisfaction from outsmarting their boss or the system.
The ACFE report makes several recommendations to employers that want to prevent fraud:
Set up fraud reporting mechanisms. Typically, this means a confidential tipline accessible to both internal and external sources. As in previous surveys, the ACFE report found that such tiplines were one of the most effective methods of catching occupational thieves.
Provide targeted fraud-awareness training. At a minimum, a qualified fraud expert should explain to employees and managers the actions that constitute fraud, how fraud harms everyone in the organization and how employees can safely voice their suspicions. ACFE research shows that organizations with antifraud training programs experience lower losses and schemes of shorter duration than those without.
Educate on the characteristics and behavior of fraud perpetrators. It’s important that managers and employees be able to spot red flags — and know how to report them.
No program can prevent all fraud, but following these tips should help you reduce its incidence in your organization. When you know how to detect fraud schemes, you can stop them quickly and thereby reduce overall losses. In addition, potential perpetrators may be more hesitant to steal if they know that management and co-workers are on the lookout for fraud and have the means to report it.
Don’t go it alone
A little knowledge about fraud can go a long way, but companies can get themselves in trouble by acting too hastily on mere suspicions. Encourage your clients to retain fraud experts who have experience performing thorough and comprehensive investigations.
If you have any questions about fraud perpetrators or any other issue, give us a call at 716.847.2651, or you may contact us here.
Earlier we published a blog post about about that discussed not losing your business to occupational fraud. Check it out here.
Freed Maxick has worked with hundreds of high tech companies and startups. Please call us to talk with one of our CPAs or business advisors on fraud detection and prevention for your high tech company. Call us at 716.847.2651, or contact us here.