Forensic Accounting (Handout 2) OCCUPATIONAL FRAUDS

Feb 2014- June 2014

Occupational Frauds Elements and Divisions of Occupational Frauds How do Occupational frauds happen?-How to prevent Occupational Frauds Questions We E!ercises Previous ACFE research has identified three primary categories of occupational fraud used by individuals to defraud their employers:

Occupational Frauds

Asset %isappropriatio n

Corruption

Schemes

Financial Statement Fraud Schemes

Financial statement fraud is the most costly form of occupational fraud causin! a median loss of more than "# million$ "sset misappropriations are those schemes in which the perpetrator steals or misuses an organizations resources. hese frauds include schemes such as s!imming cash receipts" falsifying e#pense reports and forging company chec!s. #orruption schemes involve the employees use of his or her influence in business transactions in a way that violates his or her duty to the employer for the purpose of obtaining a benefit for him$ or herself or someone else. E#amples of corruption schemes include bribery" e#tortion and a conflict of interest. Financial statement fraud schemes are those involving the intentional misstatement or omission of material information in the organizations financial reports. Common methods of fraudulent financial statement manipulation include recording fictitious revenues" concealing liabilities or e#penses and artificially inflating reported assets. Asset misappropriations are by far both the most fre%uent and the least costly form of occupational fraud. &n the other end of the spectrum are cases involving financial statement fraud. hese schemes were present in less than '( of the cases" but caused a median loss of more than )* million. Corruption schemes fell in the middle category in both respects and causing a median loss of )+',",,,.

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Forensic Accounting (Handout 2) Asset %isappropriation Su&'Schemes

Feb 2014- June 2014

-ith nearly .,( of occupational frauds involving some form of asset misappropriation" it is instructional to further delineate the methods used by employees to embezzle organizational assets. Nine su& cate!ories of asset misappropriation argeting cash/ these frauds account for appro#imately 0'( of all asset

misappropriations. 1!imming and cash larceny 2 involve pilfering incoming cash receipts" such as sales revenues and accounts receivable collections. 3illing" e#pense reimbursement. Chec! tampering. Payroll and fraudulent register disbursement schemes 2 involve fraudulent

disbursements of cash. Eighth form of cash misappropriation targets cash the organization has on hand" such as petty cash funds or cash in a vault. he final sub$category of asset misappropriations covers the theft or misuse of non$ cash assets" including inventory" supplies" fi#ed assets" investments" intellectual property and proprietary information. Duration of Fraud Schemes 4n addition to e#amining the monetary cost of the fraud cases the time period from when the fraud first occurred to when it was discovered 2 for all cases it too! on average 50 months. 6ot surprisingly" cases involving financial statement fraud 2 the most costly form of fraud 2 lasted the longest" with a median duration of +7 months. Fraudulent register disbursements" on the other hand" were not only the least costly form of fraud" but also tended to be detected the soonest.

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Forensic Accounting (Handout 2) D(T(CTION OF FRAUD SC)(%(S

Feb 2014- June 2014

&ne of the principal goals is to identify how past frauds were detected so that organizations can apply that !nowledge to their future anti$fraud efforts. ips were by far the most common detection method in our study" catching nearly three times as many frauds as any other form of detection. ips have been far and away the most common means of detection. 8anagement review and internal audit were the second and third most common forms of detection" uncovering 5'( and 5*( of frauds" respectively. 4t is also noteworthy that 55( of frauds were detected through channels that lie completely outside of the traditional anti$ fraud control structure: accident" police notification and confession. 4n other words" 55( of the time" the victim organization either had to stumble onto the fraud or be notified of it by a third party in order to detect it. *Frauds are much more li+ely to &e detected &y tips than &y any other method$, %ethods of Fraud in Small -usinesses 3ecause the challenges faced by small businesses in combating occupational fraud are numerous and uni%ue" it is helpful to !now the types of frauds that are most prevalent within these organizations. 1uch observations may help small businesses target their limited resources to those areas that pose the greatest ris!. &f course" the specific ris!s faced by any organization are largely dependent on its particular industry" operating environment" processes" culture and many other factors. 6onetheless" e#amining which fraud schemes are most commonly perpetrated at small companies can aid us in better understanding the fraud issues faced by these businesses. 3illing Chec! ampering Corruption 1!imming E#pense 9eimbursements 6on$Cash Cash on :and Payroll ;arceny Financial 1tatement Fraud

Anti'Fraud Controls at Small -usinesses Enacting hotlines would go a long way in helping small$business owners protect their assets from dishonest employees. Importance of Controls in Detectin! or Limitin! Fraud 6ot all controls are effective against all frauds. 8ost control mechanisms are more li!ely to detect or deter some fraud schemes than others. ;i!ewise" some perpetrators are more

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Forensic Accounting (Handout 2)

Feb 2014- June 2014

adept than others at circumventing particular controls" and some controls are more susceptible to being overridden than others. Control .ea+nesses That Contri&uted to Fraud A lac! of internal controls" such as segregation of duties" 8ore than 0,( of the frauds are committed by individuals in si# departments: accounting" operations" sales" e#ecutive<upper management" customer service and purchasing. -ea!ness in the system of 4nternal Control.: 4f the internal control is very wea!" there is every chance that fraudulent activities would ta!e place. 1o" the internal chec! and internal audit mechanisms need to be strengthened. &therwise" it would be difficult to unearth the fraud committed by the people. 4ndependent and domineering individuals: Although there could be many individuals or whistle blowers" sometimes if the boss or manager is a dominating individual" people will not come forward to give the message regarding the fraud. -ea!ness in management abilities of senior officers: he tope management and

senior officials should be !nowledgeable enough to detect the frauds. 4f they do not give sufficient attention to deviations" there will be many cases of fraud. Poor maintenance of records in file storage areas: 8aintenance of up$to$date records is an essential pre$re%uisite for any organization. &therwise" people would commit frauds and steal the files as well thus destroying the evidence from the office. ;ac! of effective internal audit Poor staff morale and high staff turnover 4ncomplete or missing documentation =nusual relationship between the employee and the client :igh levels of personal indebtedness by employee Accounts that are force balanced and which have high volume of activity >ecisions made by one dominant individual

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Forensic Accounting (Handout 2) CE& with lac! of honesty and integrity ;oans or sales out of turn Fre%uent deviations from policies" procedures or

Feb 2014- June 2014

common

practices$lots

of

e#ceptions. Perpetrator/s Position0 here is a strong correlation between the perpetrators

position of authority and the losses caused by fraud. he median loss in owner<e#ecutive frauds was more than three times the loss caused by managers" and more than nine times higher than losses in employee fraud cases. o some e#tent" the higher losses caused by males are attributable to the fact that they tended to occupy higher positions of authority within the victim organizations. here were an e%ual number of male and female fraudsters at the employee level" but the manager and owner<e#ecutive levels 2 which tend to cause higher losses 2 were dominated by males. From the 1ie2point of Perpetrator or Fraudster0 3$ Unusually hi!h personal de&ts0 people with heavy financial problems are more li!ely to commit occupational fraud. 4$ Li1in! &eyond one/s means or -i! spenders: 3ig spenders: Employees who seem to be spending outside of their means probably are. &ne cause of this could be fraud. 5$ E#cessive gambling habits. #$ Alcohol Problems. 6$ >rug addiction and related problems. 7$ Feeling of being underpaid. 8$ Feeling of insufficient recognition for ?ob performance. 9$ Poor credit rating. :$ Consistent rationalization of poor performance. 3;$-heeler$>ealer attitude.

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Forensic Accounting (Handout 2) 33$4ntellectual challenge to beat the system. 34$Criminal record. 35$6ot ta!ing vacations of more than two or three days. 3#$A department that lac!s competent personnel.

Feb 2014- June 2014

36$A department that does not enforce proper procedures for authorization of transactions. 37$6o separation of duties between the accounting functions. 38$4nade%uate attention to details and rules: people who ignore rules and regulations set a bad e#ample and can trigger fraud throughout the company. 39$Placing too much trust in !ey employees. 3:$Pay levels not commensurate with the level of responsibility assigned. 4;$Failure to discipline violators of company policy. 43$6ot ade%uately chec!ing bac!ground before employment. 44$Customer complaints. 45$-ea! corporate culture and ethics. 4#$-ea! leadership 46$>ominant top management 47$=nprofessional audit reporting 48$=nusually rapid growth<profitability 49$=nusual balance sheet changes or trends 4:$:ighly comple# business arrangements 5;$;ac! of planning<hiring and organizational policies

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Forensic Accounting (Handout 2) Perpetrator/s Tenure0

Feb 2014- June 2014

enure may have an effect on occupational fraud rates and losses hey also may ac%uire higher

because individuals who wor! for an organization for a longer period of time tends to engender more trust from their co$wor!ers and superiors. levels of authority" and they tend to develop a better understanding of the organizations internal practices and procedures" which can help them design frauds that will evade internal controls. *Losses tend to rise as the perpetrators/ tenure increased$, Perpetrator/s (ducation Le1el0 Education level may also affect fraud rates and losses" because more highly educated individuals tend to have greater levels of responsibility and perhaps greater technical ability to design sophisticated fraud schemes. ACFE study +,5, shows that fifty$two percent of all perpetrators had a college or postgraduate degree" which was up slightly from ACFEs +,,0 findings. ;osses rose in correlation with increased education levels. Accountin! Department0 he most common schemes committed by fraudsters in the

accounting department were chec! tampering and billing fraud" each of which occurred in over @,( of cases. Accounting personnel are much more li!ely than other employees to commit chec! tampering and payroll fraud" but less li!ely to engage in corruption or steal non$cash assets. Sales Department0 he most common frauds in the sales department were corruption and theft of non$cash assets. Fraudsters in the sales department were somewhat more li!ely than others to steal non$cash assets. (<ecuti1e or Upper %ana!ement0 -hen fraud occurred in the e#ecutive suite" nearly half of the cases involved corruption. 3illing fraud A*5(B and e#pense reimbursement schemes A@,(B were also very common. All three of these schemes occurred with much more fre%uency among e#ecutives than other employees. Financial statement fraud schemes were also much more common among e#ecutives and upper management. Customer Ser1ice Department0 Corruption was the most common form of fraud among customer service employees but compared to the distribution for all cases" we see that corruption was actually much less li!ely to occur in customer service than elsewhere. Conversely" s!imming" theft of cash on hand and fraudulent register disbursements were more li!ely to occur in customer service than in other areas of the organization. Purchasin! Department0 he vast ma?ority of frauds in the purchasing department involved corruption and billing schemes also occurred at a very high rate. 3oth of these schemes were more li!ely to occur in the purchasing department than in any other area of

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Forensic Accounting (Handout 2)

Feb 2014- June 2014

the organization" which is not surprising because the purchasing function often lends itself to bribery" overbilling and bid rigging schemes" which are among the most costly forms of occupational fraud. -eha1ioral Red Fla!s Displayed &y Perpetrators0 -hile a fraud is ongoing" the perpetrator often displays certain behaviors or characteristics that might indicate he or she has a heightened ris! of committing fraud. &n their own" these behavioral red flags do not prove an individual is engaged in a fraud" but they should raise warning signals to the individuals co$wor!ers and managers" as well as the organizations anti$fraud staff. -hen these red flags e#ist alongside other indicators of misconduct" this can be a strong clue that something is wrong. As discussed earlier in this report" occupational frauds often last for months or years before they are caught" so the ability to detect frauds as early as possible can have a big effect in limiting losses. Red Fla!s -ased on Perpetrator/s Position0 he behavioral indicators that a fraud

perpetrator displays can vary depending on a number of factors.Among employee$level fraudsters" the most common behavioral red flag was financial difficulties" which was present in nearly half of all employee fraud cases. 3ecause employee$level fraudsters generally have lower incomes than managers or owners<e#ecutives" we would e#pect their motivation for committing fraud to more often be based on an immediate" pressing financial need" which e#plains why this red flag shows up so often. -hile financial difficulty was still fre%uently cited in cases involving managers and owners<e#ecutives" it occurred much less often. Conversely" owners<e#ecutives and managers were much more li!ely than employees to display control issues" to have unusually close associations with vendors or customers or to e#hibit a Cwheeler$dealerD attitude. Each of these red flags tends to reflect the authority level of owners<e#ecutives and managers" who are in a better position than employees to influence organizational decision$ma!ing" arrange deals with outside parties and e#ert their control over the direction or tone of the organization. Red Fla!s -ased on Scheme Type0 >ifferent forms of occupational fraud result from different factors and circumstances" which we would e#pect to show up in the fraudsters behavior. 4ndividuals who engaged in financial statement frauds were much more li!ely than other perpetrators to e#hibit control issues or to be under e#cessive pressure to perform within their organization. 8eanwhile" living beyond ones means and e#periencing financial difficulties were not as common among financial statement fraudsters as others. his ma!es sense" because while asset misappropriations and corruption schemes are almost always committed to enrich the fraudster" in many financial statement schemes" other factors 2

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Forensic Accounting (Handout 2)

Feb 2014- June 2014

such as meeting earnings forecasts or hitting budget targets 2 may be as much of a motivator as personal financial gain. An unusually close association with a vendor or customer was noted as a red flag in corruption cases" which is not surprising given that most corruption frauds involve bribery or some !ind of illicit benefit. A Cwheeler$dealerD attitude was also more common in corruption cases than in other forms of fraud" and *+( of all corruption perpetrators were identified as living beyond their means. Among those who misappropriated assets" living beyond ones means and financial difficulties were the two most common red flags. )o2 to pre1ent Occupational Frauds= here are certain ways and means to prevent &ccupational Frauds. below: 3$ Create and maintain a culture of honesty and high ethics. 1et the tone at the top by setting achievable goals and e#pressing Ezero toleranceE for unethical behavior. Also" train employees regularly regarding the companyFs values and code of conduct. 4$ :ave strong system controls. 4dentify ways to increase security in your computer" record !eeping and payment systems. 5$ Pay attention to the warning signs on the boo!s. Create internal mechanisms that alert you to potential transgressions. #$ 9eport irregularities. Create a system for employees to anonymously report illegal or unethical actions they have witnessed or suspect. 6$ Conduct Fraud Audit 7$ Conduct 1ystems Audit 8$ Ensure tight internal controls 9$ ips from employees hey are discussed

:$ Customers and vendor information 3;$4nvolve as many persons in a process. AFor e#ample" the person cutting chec!s should be different from the one approving invoices" and the person approving invoices should not be the one issuing purchase orders or chec!ing in shipments. he more people involved" the less chance there is for fraud. 4n

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Forensic Accounting (Handout 2)

Feb 2014- June 2014

small businesses" where it might be difficult to segregate duties" one tool would be having the ban! statement sent to the owners home to allow independent comparison to the records.B >uestions 5. Analyze the causes of occupational frauds. >iscuss the ways and means to eliminate them from wor! place. +. E#plain the significance and role of an 4nternal Auditor in chec!ing G&ccupational Frauds. @. >iscuss the preventive measures that could be ta!en to avoid corruption and asset misappropriation in a wor! place. 1uggest how we can inculcate honesty and integrity among employees.

.(- (?(RCIS(S

#. ;og on to http:<<www.so#law.com<introduction.htm

9ead the different sections from @,+ to 0,+ and discuss the significance of these provisions with your classmates.

2. Hisit http:<<www.eidebailly.com<services<forensic<
Clic! on the pdf documents related to Fraud chec!" managing fraud" steps to prevent employee frauds and discuss what you have learnt with your friends.

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