The Risk Of Occupational Fraud In An Organization

Overview

In order to infer whether a company is well managed, we must understand the company’s business activities. It goes without saying that it’s through the scrutiny of Financial statements that we understand these business activities. These statements report on a company’s performance, financial condition and health. To achieve the best results using this information system entails making decisions and estimates based on data availed in the financial reports. It’s for this precise reason that financial reports must and should be fraud-free to represent the actual financial position of the company. “The most prevalent and largest threat among the various kinds of fraud that organizations are faced with is occupational fraud” (ACFE: Global fraud report (2018). ). This type of fraud is committed against the organization by its own managers, directors, or employees. It constitutes an attack against the organization from within, by the very people who were entrusted to protect its assets and resources. Since the tracking of data on occupational fraud cases in 1996 by the ACFE, thousands of cases where reviewed in which insiders collectively stole billions of dollars from their employers. However, those cases are few compared to the actual numbers on the ground.

There are multitudes corporations and organisations operating throughout the world and it’s a fair assessment to say that each and every one of them, to a certain extent is vulnerable to fraud committed by their employees. It should be made clear though, that most employees will never steal or abuse that trust, but the few who do may cause enormous damage. It is because of this risk that we are going to assess the motivating factors of this unspeakable act and how to mitigate them. What’s financial and Creative accounting? Peter D, John J, Robert F. and Mary M. (2015). infers in defining Financial accounting that its a field of accounting concerned with the summary, analysis and reporting of financial transactions pertaining to a business. This cuts across to preparation of financial statements available for public consumption. Stake holders interested in receiving such information for decision making purposes include but not limited Finance providers, business owners, employees, government agencies and regulators.

Creative accounting is using the flexibility within accounting to manage the measurement and presentation of the accounts so that they serve the interests of preparers (Bhasin, M. L. (2008). ). Financial fraud a number of scholars have broadly defined financial fraud as an intentional act of deception involving financial transactions for purpose of personal gain. Or according to Atrill, P. , & McLaney, E. (2011). its the deliberate misrepresentation of the financial conditions of an enterprise accomplished through the intentional misstatement or omission of amounts or disclosures in the financial statements to deceive financial statement users. Fraud is a crime, and is also a civil law violation. The Cost and Consequence of financial Fraud. While anti-fraud professionals are not the only ones who know just how devastating fraud can be to its victims in equal measure they are not the only ones who benefit from insight into the amount of damage that fraud causes. While regulators need it to determine where to focus their enforcement efforts, Investors, creditors need it to understand what’s at stake in terms of risks, resource-allocation related decision making, Fraud not only impacts organizations financially but operationally and psychologically. While the monetary loss as a result of fraud cannot be ignored, the full impact of fraud on organisations and markets is shocking.

In fact, losses to reputation, goodwill, and customer relations consequently burry the affected organisation into bankruptcy to points of no return. According to Bhasin, M. L. (2008). when fraudulent financial reporting occurs, the damage that results spreads with a ‘ripple’ effect and the victims may range from victims in close’proximity’ (the company’s stockholders and creditors) to the ‘furthest in proximity’ (those harmed when investor confidence in the stock market is shaken). Between these two extremes, others like: ‘employees’ who suffer job loss or diminished pension fund value; ‘depositors’ in financial institutions; the company’s ‘underwriters, auditors, attorneys, and insurers; and even honest ‘competitors’ whose reputations suffer by association.

According to ACFE: Global fraud report (2018). the total loss caused by fraud cases exceeded USD 7. 1 billion. While USD 7. 1 billion is an obscenely ridiculous figure it does not even come close to representing the total amount lost to fraud. The true global cost of fraud is likely to be 6 way higher, especially when factoring in the indirect costs, such as reputational harm and loss of business, Jobs and livelihoods during the aftermath of a scandal. As fraud can be instigated by employees within or outside an organization, it is important to have an effective fraud management framework in place to safeguard the organization’s assets and reputation (Bhasin, M. L. 2008). Hence early detection and prevention of fraudulent financial reporting must start with the entity that truthfully prepares financial reports. How is Financial Fraud Committed? Over the last two decades, even with tremendous technological development and numerous changes in the global business and regulatory environments, ACFE: Global fraud report 2018 research shows that occupational fraud falls into several time-tested categories.

Corruption.

• Payoffs and kickbacks

These are situations in which employees accept cash or other benefits in exchange for access to the company’s information or business to gain advantage or competitive advantage. Take an example Company Y wants to sell its products to Company Z. An employee in Company Z helps Company Y get in the door. Company Y prices its product a bit higher and gives the employee of Company Z that extra profit in the form of a kickback for helping it out. That un accounted for money is quickly taken by the employee who helped facilitate the access. A Kickbacks is paid after the “deal” is made, to say “thank you” for job well done. Technically, payoffs and kickbacks are a form of corruption or bribery. Asset misappropriation and misrepresentation.

• Overstated Assets

Asset accounts are manipulated to enhance a company’s balance sheet, especially to positively impact important ratios involving assets. At higher risk of overstatement are current assets such as accounts receivable. A good example is Companies that don’t always like to write down or reserve for outstanding balances that customers aren’t going to pay. Yet the accounting rules require these write-downs to be done when management is aware that an account is uncollectible.

• Understated Liabilities. The most common method of concealing liabilities or expenses is to simply fail or not to record them. Sizable monetary judgements against a company from a recent court decision might be 7 conveniently ignored. Vendor invoices might be thrown away rather than posted into the accounts payable system, thereby increasing reported earnings by the full amount of the invoices.
• Skimming of cash. Skimming consists of taking cash before it even enters the company’s accounting system. It’s not easy to uncover since it relies on evidence of information not yet recorded yet. It’s not complicated to execute, hence so common and popular option among those that commit fraud. Financial statement Fraud
• Inflated Revenue Manipulation of sales figures is the most common financial statement fraud. In most cases, It plays in the company’s interest to showcase higher as opposed to lower sales, so virtually every company runs the risk of overstating sales. This is mostly intended to create an impression that “all is well” especially for the gain of the financial report preparers.
• Institutionalized Misreporting Misreporting of Financial reports is done by managers of companies to help increase their value. The reason for this motivation is to project the company in the best light possible to entice investors or finance providers to review and invest. Take an example of Toshiba one of Japan’s oldest and most respected companies’ financial crisis of 2008, which imposed aggressive targets for revenue and profitability on its business units’ managers. When circumstances rendered those goals unachievable, managers altered the books to provide the illusion they had met their performance goals. This led to fraud investigations leading to findings released in a report in July 2015 followed by stiff penalties and prison sentences.

What Motivates Financial Fraud? Despite the risk of being caught and the possibility of imprisonment, people commit fraud for personal benefit, such as getting a bonus for meeting revenue goals. Attempts to falsify statements in annual reports to inflate the worth of the company is instigated by high level management. The easy answer as to why people commit fraud is that they do it out of greed, but there’s more to the fraud crime than just that. Mullins, J. Laurie. (2010). allude that people need certain motivations to be driven to steal from their company. Regardless of the motivation, financial statement fraud poses serious issues, 8 sanctions and penalties to shareholders and potential investors. The Fraud Triangle attempts to categorize factors that motivates employee to consider internal fraud into three: The Pressure to Commit Fraud Bad situations can lead to bad decisions. Difficult and stressful situations can lead employees into fraud as an easy way to eliminate their problems. Pressure can also be caused by people around us. Take an example a spouse, relative, or friend might push a person into fraudulent activity. unprecedented pressure on an employee can be drive them into illegal activities, such as stealing money or abusing other internal systems.

The Rationalization That Fraud is Okay Rationalization can come in multiple forms. Sometimes it’s a justification. An employee who hasn’t gotten a pay raise in 10 years may feel the company owes them, so the person commits fraud to try and get the money he or she feels is long overdue. In such situations, it comes naturally to employees to justify that by stealing small amounts isn’t all that bad. In all honesty and truth, it’s not only bad but illegal as well, but the person committing fraud may have him or herself convinced otherwise. The Moment of Opportunity for Fraud Opportunity for fraud as a factor is the biggest in The Fraud Triangle. Here employee find themselves committing fraud “just because” they’ve seen an opportunity to. This opportunity might be in terms of loopholes or weakness in the system, management or leadership. It’s important to note that even if a person is under pressure to commit fraud or has rationalized the idea to the point of no return, without an opportunity window, it’s nearly impossible to commit fraud. 9 How are Fraud Schemes Concealed?

According to Peter D, John J, Robert F. and Mary M. (2015) Fraud Concealment is a deliberate hiding, non-disclosure, or suppression of a material fact or circumstance (which one is legally or morally bound to reveal) with intent to deceive or defraud in a contractual arrangement. Actions of fraud typically involve more than the commission of the scheme itself, it also includes efforts to conceal the misdeeds. Understanding the methods fraudsters use to cover their crimes can help organizations better prepare prevention mechanisms and detect the warning signs of fraud. On-book Fraud. Principally, an On-book fraud is one that occurs within the confines of the business. Unreal or inexistent payments or activities are recorded, generally in a disguised manner, in the regular books and records of the company. Examples might include payments to a shady vendor generated by fictitious charges to travel, entertainment, or other miscellaneous accounts. altered or destroyed physical documents, altered or created fraudulent transactions in the accounting system Off-book Fraud. Off-book fraud normally occurs outside the accounting stream, and no audit trail is likely to exist.

Generally, for an Off-book fraud to occur, the company usually has unrecorded vendor transactions or significant cash sales to aid the fraud process. bribery and kickbacks are examples of Off-book fraud. How are Fraud Schemes detected? Atrill, P. , & McLaney, E. (2011). alludes that there are numerous proactive methods of detecting fraud other than fraud auditing. The moment fraud is suspected, it should be documented and investigated. Several investigations technique to curb the vice include; investigative audits interviews, record searches, surveillance (observation), and net worth analyses.

Proactive methods however include: Complaints and Tips Usually tips and complaints by customers, employees and others frequently lead to suspects in fraud schemes. Organisations should encourage an enabling environment and communication channels that lead to possible investigation. 10 Behavior Changes Fraud perpetrators time and again show personality changes as a result of the continuous pressure of committing fraud. Including a management and employees observation technique to follow up changes in behavior can lead to suspects.

Lifestyle Changes Fraud perpetrators rarely stash their loot or proceeds of their acts. Its natural Instead that they’ll frequently spend on lavish luxury items such as cars, homes, clothing and jewelry. Internal Control Weakness Internal control weaknesses are a major contributing factor to the opportunity to commit fraud. Weaknesses that usually aid or lead to fraud are fundamental in nature and some of them include; the failure to structurally segregate the functions of record keeping, authorization and custody over assets. The most common financial statement fraud red flags:

• Accounting anomalies, for example increasing revenues without a corresponding cash flow growth. Despite sales being much easier to manipulate than cash flow, the two should move more or less in tandem over time.
• The company maintains consistent sales and gross profit margins while its industry is facing pricing pressures. This might lead to suspicion of failure to recognize expenses or aggressive revenue recognition.
• A large buildup of fixed assets. An abrupt accumulation of fixed assets can flag the usage of operating expense capitalization, rather than expense recognition.
• Depreciation techniques and asset estimates useful life that do not correspond to those of the overall industry. This normally creates an overstated life of an asset hence decreasing the annual depreciation expense. Safe guards against Fraud schemes. It is critical to an organization to have a fraud prevention plan or framework in place. The fraud cases studied in the ACFE 2018 Report revealed that the fraudulent activities studied lasted an average of 18 months before being detected. Its inconceivable the magnitude of loss a company could suffer with an employee committing fraud for more than a year. Precisely because of this, there are ways fraud occurrence could be minimized through implementing different procedures 11 and controls.

Know Your Employees

When carefully observed fraud perpetrators often display behavioral traits that can imply intention to commit fraud. Surveillance in form of observing and listening can help identifying potential fraud risk. It is important for management to be involved with employees and take time to know them. This may also reveal internal issues that need to be addressed. For example, if an employee feels a lack of appreciation from the business owner, this could lead them to commit fraud as a way of revenge. Unfortunately, quite often it’s the employee you least expect that commits fraud crime. Its critical to engage and know your employees.

Make Employees Aware/Set Up Reporting System

Fraud risk policy including consequences associated with fraud should be common knowledge to all in the organisation. This is not only for awareness purposes only but also meant to be a deterrent to those planning to commit fraud. Honest employees who are not tempted to commit fraud will also be trained on possible signs of fraud or theft and rewarded for whistleblowing. Aware, trained and Empowerd employees are assets in the fight against fraud.

According to the ACFE 2018 Report, most occupational fraud (over 40%) is detected because of a tip. Implement Internal Controls These are plans implemented to safeguard a company’s assets, accounting records integrity, deter and detect fraud and theft. Role Segregation is an important internal control characteristic. Take an example, a retail store having one salesperson, one cash register employee, and one manager. One employee should be tasked with tallying the Cash and cheque register receipts while another prepares deposit slips. This would be an effective control mechanism to deal with discrepancies in the collections. Internal control processes should be consistently monitored and updated to ensure they are effective and relevant to technological and other advances. Monitor Vacation Balances. It might be miss construed to mean that employees who haven’t missed a day of work in years are the most “hard working and loyal” ones, yet it could be a sign that they have something to hide and are worried that someone will uncover “something” if they were out of the office for too long. Employee job rotations are also a good idea in various jobs within a company as it may uncover fraudulent activity of previous employees.

Hire Experts. Certified professionals such as; Certified Fraud Examiners and Certified Public Accountants who are Certified in Financial Forensics (CFF) can help establishing antifraud policies and procedures. Such professionals bring a wealth of skills with a wide range of services from complete internal control audits and forensic analysis to general and basic consultations. Live the Corporate Culture. An enabling work environment that rewards practice professional ethics can prevent employee fraud and theft. There should be a clear organizational structure, code of conduct and fair employment practices. An open-door policy gives employees open lines of communication with management hence indirectly deterring fraud. Regardless of position, business owners and senior management should lead by example and hold every employee accountable (Mullins, J. Laurie. 2010). Fraud Detection. In addition to prevention strategies, detection methods must be in place and make them visible to the employees. According to Managing the Business Risk of Fraud: A Practical Guide, published by Association of Certified Fraud Examiners (ACFE), the visibility of these controls acts as one of the best deterrents to fraudulent behavior. It is important to continuously monitor, document and update fraud detection strategies and individuals or teams responsible for each task to ensure they are effective.

Conclusion

Fraud is deception and those willing to commit fraud do not discriminate. This Vice happens in large and small companies across various industries and geographic locations. Financial statement fraud can result in huge financial loss, legal costs, and ruined reputations that can ultimately lead to the downfall of an organization. Having the proper plans in place significantly reduces fraudulent activities from occurring or cut losses if a fraud already occurred. Company code of conduct and policy awareness across the board is one of the best ways to deter fraudulent behavior. Following through with the policy guidelines and unreservedly enforcing the noted steps and consequences when someone is caught is crucial to preventing fraud. It’s a widely known fact that the cost of trying to prevent fraud is far less burdening to a business than the cost of the fraud that gets committed.