Litigation + Valuation Perspectives

Demystifying Valuation, Economic Damages + Forensic Accounting

Is Your Company Vulnerable to Fraud? Part 1

Evaluate your business’ vulnerability with this simple checklist

The opportunity for fraud in your business may be greater than you think.  It may be quite easy to pull off and it may come from one of your most trusted staff.  How does your company measure up in controlling the potential for fraud and what can you do about it?

How easy is it for your employees to commit fraud against your company?  You may be surprised at how vulnerable the assets of your business are to theft by your staff.

What is fraud?

Fraud is a very broad term.  According to the Collins English Dictionary 10th Edition, fraud can be defined as: “deceit, trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage”.  In the broadest sense, a fraud is an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent.

In business, occupational fraud and abuse includes asset misappropriation, false statements, false overtime, petty theft and pilferage, use of company property for personal benefit, and payroll and sick time abuse.

There are three categories of fraud: a) corruption (e.g., bribery, conflicts of interest, economic extortion and illegal gratuities), b) asset misappropriations (e.g., cash, fraudulent disbursements, expense reimbursements, payroll, bogus invoices, claims and loans), and c) fraudulent statements (e.g., financial).

Employee fraud generally is found in the second category: misappropriation of assets.  The likely culprits could be anyone from managers down to accounting and bookkeeping personnel or warehouse staff.

CausesResearchers have concluded the most common reason employees commit fraud has little to do with opportunity but more to do with motivation – the more dissatisfied the employee, the more likely he or she was to engage in criminal behavior. A study conducted by sociologists, Richard Hollinger and John Clark, describes the phenomenon as “wages in kind.”  According to the study, all of us have a sense of our own worth; if we believe we are not being fairly treated or adequately compensated, statistically we are at much higher risk of trying to balance the scales.

 

Another theory promulgated over 60 years ago by criminologist, Donald R. Cressey, asserts that employees commit fraud simply to satisfy their financial obligations.  Mr. Cressey observed two other factors that had to be present for employees to commit fraud. They must perceive an opportunity to commit and conceal their crimes, and be able to rationalize their actions as something other than criminal activity.

You may least expect a trusted employee to engage in theft from your company.  However, statistics reveal that when a significant embezzlement or theft is discovered, it is usually a situation where the employee is a trusted person who has been with the company for an extended period of time.  Moreover, the employee typically has an exemplary work record, is dedicated and is considered to be a “company person.”  After all, if the employee did not have the implicit trust of the employer the embezzlement or theft might not occur.  A breakdown in internal control of a company’s assets can create a situation where the dishonest employee can manipulate the system.

Companies unwittingly assist the fraud process

Typically, the employer is extremely busy and does not have time to get involved in the accounting department.  Also, smaller companies usually lack numerical depth in their accounting department, which precludes the implementation of strong internal control procedures.  When you combine the aforesaid factors with the employer’s implicit trust in the employee, the situation can prove to be very dangerous.

What are your business’ red flags?

How susceptible is your business to fraud?  Answer the questions in my next blog post to find out.  A few negative responses may not be serious in some asset handling functions.  On the other hand, just one negative answer in another area may be a huge red flag of impending trouble.

Summary

Businesses aren’t always as secure against employee fraud as their owners may believe.  Use the Fraud Indicator checklist to help correct internal control problems.  Owners must be ever vigilant about potential employee theft.  Fraud can happen…and, it can occur by the most trusted employees.

Don Bays, CPA/ABV, CVA, CFF