Apple Growth Partners

How to Identify Fraud in Your Company

By Bob Nemeth, CPA/ABV, CVA, CDFA, Certified Fraud Examiner

The Association of Certified Fraud Examiners (ACFE) estimates that fraud costs organizations worldwide nearly $4 trillion a year or five percent of the Gross World Product (GWP). The ACFE also reports that the median loss per case is $130,000. Usually, due to weaker internal controls, small businesses suffer even more as their median loss is $200,000 per fraud scheme. What if your company lost $200,000 to the hands of a fraudster?

Only the creativity of the deceiver limits fraud schemes.

There are three major types of fraud: asset misappropriation, corruption, and financial statement fraud.

Asset misappropriation occurs when an employee steals or misuses an organization’s resources. Corruption happens when an employee abuses their influence in a business transaction. Financial statement fraud transpires when there is an intentional misstatement of material information in a company’s financial statements.

According to the ACFE 2018 Report to the Nations, asset misappropriation occurred in 89% of the cases in the study. Corruption occurred in 38% of the cases and financial statement fraud occurred in only 10% of the fraud cases.

However, the financial impact of the major categories is completely reversed. The median loss for an asset misappropriation case is $114,000. The median loss for a corruption fraud is $250,000, and the median loss for a financial statement fraud is an astounding $800,000. Although financial statement frauds are much less common than other types of scams, their impact on the company is more severe.

Asset misappropriation schemes are endless. Plots often involve the theft of cash since it is the most liquid company asset. Other types of assets, such as computers or tools used in a manufacturing shop, can be stolen, but the fraudster must convert these items into actual cash at some point in the future. Fraudulent disbursements are also common. These schemes may include billing tactics where the company’s bookkeeper creates a fictitious invoice from a made-up company and then pays the invoice with their employer’s funds. Payment is then sent to a post office box and cashed by the fraudster.

In large organizations with many employees, as well as organizations with many seasonal employees, payroll can also be a target.  Bogus employees are created by someone in the payroll department, and payment is made to the “ghost” employee.  Payments are often sent to P.O. boxes or the personal bank account of the fraudster. Unapproved raises or bonuses can also occur. Fraudulent expense reports are common and often are not detected. If the reimbursements are small, the supporting details are often not scrutinized.

Corruption schemes can include such techniques as bribery, kickbacks, and illegal gratuities.  Although often associated with government agencies and foreign countries, it can occur in both public and private companies.

Financial statement fraud often makes headlines since the scams are so large companies can be forced to shut down, innocent people may lose their jobs, and retirement savings can be lost. Financial statement fraud can also occur in smaller, privately-owned companies as well. Financial statements may be manipulated so that larger bonuses are paid to company executives or the sales force. A company may create fictitious sales so that operating results look better to potential investors of company stock. Other times, financial statements are manipulated to meet bank loan covenants so that the company does not lose its line of credit or it’s not forced to accelerate the repayment of its bank debt due to poor credit risk.

Fraudsters can go to great lengths to cover-up their schemes. By understanding the techniques that fraudsters use to hide their arrangements, businesses can establish appropriate internal controls and be on the look-out for the warning signs that a fraud may have occurred.

Fraudsters can create counterfeit physical documents or alter otherwise legal, physical documents. Today’s high-quality printers allow a fraudster to create virtually identical company invoices or company checks. At times, tangible evidence of the fraud is destroyed.

To further conceal the crime, fraudsters can create fake transactions in the accounting system or alter legitimate transactions. This is often done by changing electronic files and creating bogus journal entries.

All companies are susceptible to fraud. However, owners can limit their risks by understanding common warning signs and placing internal controls in place. To start this process, Apple Growth Partners can help establish measures for prevention. Click here to request a free Fraud Risk Assessment.