Do you want to know how to detect occupational fraud? Are you concerned that bribery and corruption could be a problem in your organization or for your clients?
Greg Kyte is a comedian and CPA and Caleb Newquist is Editor-at-Large at Gusto, and the founding editor of Going Concern The duo discussed important findings from the Association of Certified Fraud Examiners and what they might mean for your career.
How big of a hazard is occupational fraud?
If you think fraud only occurs on a mass scale in high-profile companies, think again. Fraud is much more prevalent than most people realize. Businesses of any size and in any industry must take steps to protect their assets. The first step is awareness and education.
To begin with, you should have a clear understanding of what occupational fraud is. This type of fraud isn’t committed by customers, clients, or anyone outside your organization. It’s committed by employees.
“It’s a gigantic problem, but … it’s not [like] the big media stories that we always hear [about]. Your Enrons, your Bernie Madoffs, [and] those kinds of [fraud stories that] make a huge splash in the media, and they do account for huge losses. … [The ACFE] estimates that the typical organization loses 5% of its revenue to fraud. … They’re not saying every organization loses 5% to fraud, but they estimate that on average companies are losing 5% of their revenue to fraud.”– Greg Kyte
While it may seem counterintuitive, it’s the smaller businesses rather than the larger companies that are more vulnerable to fraud. Why is that? Small businesses tend to have fewer staff members available to both implement and track internal controls.
Internal controls are the official processes that safeguard against internal fraud. One type of internal control is a system that prohibits one individual from having sole responsibility for approving, recording, and executing a financial transaction. Simple separation of duties like reconciliations of bank accounts by a second team member, or transaction approval for transactions over a specified dollar amount by someone outside the accounting department are also effective measures to prevent fraud. However, they require adequate staff and resources.
Does your firm recommend safeguards against fraud? What measures have your clients taken?
Types of occupational fraud
Asset misappropriation is the most common type of fraud and accounts for 71.4% of all cases. It involves stealing assets from a company, whether it’s cash, cash equivalents, or other assets that will impact the finances of the organization.
Asset misappropriation results in a median loss of $100,000 and can occur in a variety of ways. Employees may steal assets through payroll scams, fake expense reports, fake businesses or employees, cash larceny, stealing inventory, or taking raw materials.
Opportunities for fraud occur throughout all stages of business operations. This is why strong protective measures must be in place for all processes, from payroll to cash transactions to invoicing.
This type of fraud encompasses bribery, illegal kickbacks, and bid-rigging. Corruption accounts for 11.8% of occupational fraud cases and has a median loss of $200,000. Bribery is pretty straightforward—an individual asks for a favor in exchange for money or some other perk. It’s a quid-pro-quo situation that deals with a specific outcome.
Bribery differs from an illegal gratuity or kickback because those are less about a specific outcome and more about developing favoritism. An individual paying a kickback is attempting to influence a person to provide support in the future. They’re not asking for something yet; they’re asking for the other person to keep them in mind. It’s basically saying, “Remember me when you need to.”
Bid rigging is the act of manipulating the bidding process and pre-determining the winner. Most often, multiple companies work together covertly to avoid having to compete with each other. This undermines the bidding process, resulting in prices that are higher than they’d be in the free market. Companies may do this by taking turns submitting the lowest bid, intentionally submitting bids that are likely to lose, or avoiding bidding at all.
Financial statement fraud
Caleb and Greg called this the nerdiest type of fraud because it requires a particular skill set to pull off. It accounts for 16.8% of all cases. While it’s uncommon, it has a median loss of $954,000. This means that those who do pull it off are stealing huge sums of money.
Financial statement fraud occurs when a corporation or business misrepresents its profitability by manipulating financial statements. This could include creating fake statements, misreporting revenue, or leaving obligations and liabilities out of a company balance sheet. In doing so, they cause massive damage to their investors, creditors, and the accounting firms they work with.
Signs of occupational fraud
Just as it’s essential to familiarize yourself with occupational fraud, you should know how to spot it. While every case is different, there are a few red flags to be aware of when it comes to employee behavior.
- Living beyond their means: An individual has a high amount of debt or spends more than they can really afford.
- Financial difficulties
- An unusually close association with a vendor, client, or customer
- Control issues: An individual wants to have sole ownership of a process and won’t let anyone else participate.
- Unwilling to share duties: May indicate that a person has something to hide.
- Suspiciousness or defensiveness
- Unwillingness to take a vacation: May indicate that a person is afraid to let other people look at their work.
- Mental health issues
- Addiction issues
- Social isolation
- Family problems
When looking at behavioral red flags, consider how many of them a person exhibits. Greg and Caleb were quick to point out that exhibiting any one or more of these traits doesn’t necessarily mean someone is likely to commit fraud. Many people struggle with financial problems, family disputes, mental health challenges, and social isolation. These factors alone are unlikely to lead to or correlate with illegal activities.
Before you consider any other red flags, assess the level of accessibility the person in question has to the relevant information, as well as their ability to commit fraud. If someone has a low level of accessibility to the components they’d need for a fraudulent act, it’s unlikely that they committed it.
“The opportunity for fraud is a key factor. … Accessibility … is why accountants are so commonly the perpetrators. … There’s a confluence of circumstances that increase the likelihood of fraud, so that’s what I think people have to keep in mind.”– Caleb Newquist
Learn more about occupational fraud
Illegal activity within a company is much more common than you might believe. While you don’t want to be paranoid, make sure you have measures in place to prevent insider theft. You also need to understand fraud so that you can identify when something is amiss in your client’s records. Studies show that companies are losing an average of 5% of revenue due to occupational fraud. It’s worth taking it seriously.
There are three main types of insider theft you should be aware of. Asset misappropriation occurs when an employee steals assets from their employers, whether through payroll processes, stealing raw materials, or simply stealing cash. Corruption encompasses bribery and illegal kickbacks that a person may use to gain inappropriate influence and power. Financial statement fraud is the most sophisticated type of all. It involves falsifying or manipulating financial records to appear more profitable than they are.
People who are more prone to fraud may exhibit a number of characteristics you should be aware of. Be alert to traits such as suspiciousness, defensiveness, and control issues. Financial difficulties and family problems can also indicate a problem, but be sensitive to the fact that almost everyone experiences those from time to time.
Gusto’s mission is to create a world that empowers a better life. We’re here to help you navigate even the most complex issues accountants face today. Don’t forget to check out our next two articles based on the same webinar, “A Fraud Case Study: NC Firefighter Embezzlement” and “A Fraud Case Study: $8.5 Million Stolen from ING.”
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