The Role of Internal Controls for Detecting and Eliminating Employee Fraud and Abuse
While this is only a general estimate based on the Certified Fraud Examiners (CFEs) that participated in the study, if that 5% loss estimate were applied to the United States Gross Domestic Product for 2017 (about $19 trillion), total fraud loss to US companies would be around $950 Billion.
The Impact of Poorly Designed Internal Controls on Preventing Corporate Fraud
Whether you’re a small company or large organization, every entity can be susceptible to fraud or employee theft. When internal controls are poorly designed, or not operating effectively, employee theft can occur and remain undetected.
Typically, fraud begins as an undetected incidental error. But if undiscovered, perpetrators may be emboldened to commit the fraud again, usually on an even larger scale. It’s likely that they’ll continue until they are eventually caught, whether it be by their own mistake or by someone within the organization.
In fact, the worse the control environment, the longer the fraud will continue.
According to the ACFE, the median duration of a fraud scheme is 16 months.
Read this blog post from the Freed Maxick Risk Consulting Team: Giving Cheating Employees Time to Hide Their Crimes
Internal Controls are the Best Way to Prevent and Deter Workplace Fraud
If you believe that the facts or circumstances point to the existence of fraud in your organization, you may want to consider conducting an independent fraud examination; consisting of specific procedures that are necessary for determining whether fraud has taken place and how it occurred, or for the existence of red flags indicating that a fraud is at hand.
If a fraud has occurred, the examination can also determine who was responsible and provide an estimate on the scope and size of the theft. It will also help determine if the issue is the result of an honest mistake, or if there was intent to defraud.
One of the most important characteristics of a corporate fraud examination is to determine if existing internal controls failed or were circumvented. Then, new controls for preventing similar attempts and protecting against future losses can be developed and implemented. Often employees that steal from one area of the company may steal from other areas as well.
One of the most important yet frequently ignored controls is the development and enforcement of proper segregation of duties and oversight. Certain activities should not be performed by the same person or even by the same department in order to prevent embezzlement and its coverup. Even your most trusted employee can become susceptible to pressures in their personal lives leading them to commit fraud, so it’s important to remove as many opportunities and install as many protections as necessary to deter theft.
Unfortunately, many companies and organizations learn too late that an issue with segregation of duties can be catastrophic. You should understand where your company is at greater risk or exposure to employee fraud and begin an evaluation and revamp at those points.
Moving Forward Once Fraud is Suspected or Confirmed
Weak internal controls don’t necessarily mean that fraud is occurring in your company or organization right now, but it does mean that you are at risk as an environment in which fraud can be perpetrated exists.
Conversely, having strong internal controls does not preclude fraud from occurring. If fraud is suspected, or has been uncovered in your organization, you need the ability to investigate what happened, what is needed to correct it, and if necessary, referral of the matter to law enforcement.
Freed Maxick Can Help Detect and Prevent Corporate Fraud
Freed Maxick has team of Fraud Resolution Experts that are here to help.
If you have concerns about a suspected or confirmed occurrence of fraud for or against your organization, contact one of fraud specialists here, call us at 716.362.6244, or email Richard.Graesser@FreedMaxick.com to discuss the fraud resolution services that we offer.
We are able to assist with conducting a fraud examination, implementing internal controls to prevent fraud, or independently assess the design and operating effectiveness of the current control environment.
We will work discretely and confidentially with you and your organization to mitigate the effects occupational fraud has on your organization.
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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.
Author: Mike Boeheim
Protect Your ABL’s Assets by Helping Your Clients Recognize and Stop Internet Fraud
As people flock to the Web to make purchases, they risk being snared by Internet fraud. Asset based lenders need to be aware of the latest scams that could affect your customers and impair debt service.
Popular Fraud Tactics
As you can imagine, cybercrime can take many forms, such as credit and debit card fraud, mobile phone transaction fraud, pay-per-click (PPC) scams, and, of course, identity theft.
Fraudsters can get very creative when “trolling” the Internet for opportunities. For instance, some might use malware to collect credit card information from unsecured merchant websites. PPC fraudsters also cause unsuspecting merchants to incur charges every time customers click on their ads. Then they redirect the customers to their website, thereby “stealing” the sale.
Help Your Clients Stop Internet Fraud
Determine whether your clients are taking appropriate steps to protect themselves against Internet fraud. Ask whether they’re analyzing transactions and identifying which are at a higher risk for cybercrime. Some examples of online order form red flags include customers who use drop shipment forwarding addresses, or post office boxes and payments split between multiple debit and credit cards. All of these can signal the use of stolen cards.
According to a survey by technology provider FIS’s ClearCommerce®, an e-payment processing and fraud prevention service;
other warning signs you need to be aware of include differences between billing and shipping addresses, the country of the billing and IP address, or the area code and the billing ZIP code. International shipping addresses — especially those in former Eastern Bloc countries or the Middle East may be suspect, Of course, just the existence of a red flag doesn’t mean that fraud has taken place. But it does mean that borrowers should take a closer look at the potentially high-risk order before processing it.
Asset Based Lenders Need to do Due Diligence too
As part of your due diligence, ask your clients whether they’ve taken steps to secure their IT against fraud. Transaction screening software can take a lot of the guesswork out of identifying these high-risk transactions. Another security measure you should pass along to your clients is to couple automated address verification services with card security code systems. This will not only verify the cardholder’s address, but also crosscheck the security code on the back of the card.
All borrowers should employ and maintain encryption codes, antivirus software, firewalls, and operating system and browser updates. By taking these measures, the client will be protected on the merchant side, as well as when ordering for its own materials, downloading, or sharing information with any supply chain partners.
Don’t go it alone
Of course, maintaining secure, efficient computer systems can be quite daunting and way outside the bailiwick of most entrepreneurs. So, if one of your borrowers simply can’t afford a dedicated IT professional, a CPA can help them tackle the cybercrime prevention tasks mentioned above on an as-needed basis.
Freed Maxick’ s Asset Based Lending Team works with dozens of asset based lenders across the country. We can assist you in evaluating the integrity of your customers’ collateral by performing pre-loan surveys and rotational collateral monitoring field examinations.
Freed Maxick also provide specialized forensic accounting services.
If you or your clients need assistance in fraud detection, prevention or remediation, contact us, or call me directly at 716-847-2651.
Best Practices in the Prevention and Detection of Borrower Fraud!
Mike Boeheim, CIA, CFE and Director at Freed Maxick ABL Services will take part in the upcoming Fraud Awareness Workshop presented by the CFA on April 17th-19th.
The event is a three-day program presenting best practices in the prevention and detection of borrower fraud while also recommending fraud prevention procedures for a variety of ABL disciplines. Reinforcing each learning point through numerous case studies, the goal of the program is for participants to understand their roles in mitigating the risk of fraud within their organizations.
This is a must attend for any staff member seeking to minimize their institutions' fraud risk.
Wednesday, April 17: 8:30 a.m. - 5:00 p.m.
Thursday, April 18: 8:30 a.m. - 5:00 p.m.
Friday, April 19: 8:30 a.m. - 1:00 p.m.
Continental breakfast will be served each day beginning at 8:30 a.m. The program will begin at 9:00 a.m. Lunch will also be provided each day.
Program Level: Intermediate
April 17 - 19, 2013
Event Start Time: 8:30 a.m.
Troutman Sanders, LLP
The Chrysler Building
405 Lexington Avenue
New York, NY 10174
To gain more insight into fraud and Asset Based Lending issues, check out related blog posts on our "Summing it Up" blog. You can also get a free copy of the keynote presentation delivered at the Commercial Finance Association Fraud Awareness Program Workshop.
We’re pleased to offer a complimentary copy of this valuable resource.
11 common fraud schemes
Critical management pressure points that lead to fraud
6 red flags that every asset based lender needs to be on the lookout
Recognizing irregularities in source documents, accounts payables and financial statements
9 common inventory fraud schemes and deterrents
For information about our ABL Services team and related services,
check us out on the web.
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.
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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.