Occupational Fraud

When your most valuable assets, your employees, steal from you!

In my work I have the opportunity to visit a large number of companies in the portable storage industry as well as companies in peripheral industries and I often hear stories of fraud, embezzlement and theft by employees. I also find that not until a company has been defrauded do they start to think of how to implement controls and routines to prevent fraud and theft. The Association of Certified Fraud Examiners recently published a report from having studied over 1800 fraud cases during 2008 and 2009. While these incidents occurred a few years back the methods, issues and challenges are no different today. Here are some highlights of their findings.

• The estimated average loss from fraud is equivalent to 5% of a company’s revenue
• Small business is disproportionately victimized by occupational fraud
• Occupational fraud is mostly discovered by a tip rather than by the owners or auditors
• The median time between the start of a fraudulent activity and discovery is 18 months
• Anti-fraud controls are rarely implemented in small businesses
• Most fraud occurs in accounting, operations and sales departments
• Fraud perpetrators send out warning signals while engaging in illicit activities
• 85% of the fraud perpetrators are first time offenders

Occupational Fraud is defined as: the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organizations resources or assets. It is a very broad definition and the schemes range from petty thefts such as an employee pilferaging from the company’s supplies to very complex financial statement fraud. However, what is most important for an employer is that all frauds involve a violation of trust. It doesn’t matter if the fraud is a simple manipulation of a time sheet or outright theft of assets or money. The perpetrator has shown that he or she is no longer trustworthy.

Occupational fraud is divided in to three categories;

I – Corruption such as; Bribery, Illegal Gratuities, Purchasing and Sales schemes as well as Economic Extortion

II – Fraudulent Statements such as; Illegal Time Sheets, Fraudulent Resumes or Overstated Equipment Values

III – Asset Misappropriation is the largest category includes the foll0woing;

Category Description Examples % of incidents in small businesses
Schemes Involving Theft of Cash Receipts
Skimming Any scheme in which cash is stolen from an organization before it is recorded on the organization’s books An employee accepts payments from a customer and pockets the money instead of recording the sale 15%
Cash Larceny Any scheme in which cash is stolen from an organization after it has been recorded on the organization’s books An employee steals cash and checks from daily receipts before they can be deposited to the employers bank account 10%
Schemes Involving Fraudulent Disbursement of Cash
Billing Any scheme in which a person causes his employer to issue a payment by submitting invoices for fictitious goods or services, inflated invoices or invoices for personal purchases An employee creates a shell company or collaborates with a vendor and bills the employers for services and goods that are not delivered 19%
Check Tampering Any scheme in which a person steals his employer’s funds by intercepting, forging or altering a check drawn on the employer’s bank account An employee makes out company checks to himself or deposits checks issued to vendors to his own bank account 18%
Expense Reimbursement Any scheme in which an employee makes a claim for reimbursement of fictitious or inflated business expenses An employee files fraudulent expense report claiming personal travel or nonexistent expense etc. 11%

Pay Roll Any scheme in which an employee causes his employer to issue a payment by making false claims for compensation An employee claims over time for hours not worked
An employee adds ghost employees to the payroll and takes their payment 9%
Schemes involving Misappropriation of other Assets
Inventory Misappropriation Any scheme that involves incorrect accounting for inventories upon receipt or delivery of merchandise or, during inventory reconciliation An employee misstates a delivery receipt of merchandise and keeps some of the products for his own benefit 8%
Delivery Misappropriation Any scheme that involves delivery of merchandise that has correctly been accounted for as leaving the employers warehouse or similar An employee delivers less than what a customer has ordered and keeps the undelivered products 5%
Unauthorized use of tools and equipment Any scheme that involves use of an employer’s assets activities performed by an employee outside of his employment. An employee uses his employers tools and machines to repair his home or moonlights as an independent contractor 5%

Asset Misappropriation is by far the most common incidents of occupational fraud, close to 85%, however the least costly per incident. It is obvious that a large number of small incidents of different categories are difficult to monitor by the employers and therefore goes undetected. As you can see from the percentages for each of the different categories the majority of the incidents occur involves accounting department. The second most common fraud involves situations where the employee is trusted with having access to the employer’s assets at all times.

Another important component of occupational fraud is the perpetrator him or herself. The stereo type of the individual who commits occupational fraud in the accounting department is a person who has worked with the firm for a very long time, knows a lot about the owner’s personal economy and hardly ever takes a long leave from his or her work. The report found that 67% of the accounting fraud is committed by men and 33% by women. Both genders ranging in age between 30 and 50 years old at the time of the fraud is discovered. The losses take about 18 months to discover and they are, when discovered, in the range of $250,000 per incident for men and $100,000 for women. The amount of the loss is also related to the tenure of the employee which makes sense. If I am committing fraud and it goes undetected the longer my tenure the larger the amount involved. Furthermore perpetrators tend to increase the amounts by which they defraud their employers the longer they go undetected.

How to prevent Occupational Fraud in your company

• Set up a hot line that allows employees to anonymously report fraud, make comments and complaints to management. This allows employees to communicate without the fear of repercussions from their immediate superior who may be the perpetrator.
• Train your employees to look for fraud. It gives the organization a better understanding for the issue in itself and gives a potential perpetrator a reason to have second thoughts about crossing the line.
• Look for odd behavior. Employees that have strange reasons for why things are missing, books not balancing or related reports being late or out of date.
• Learn about your employees’ personal situation. When you see an employee with a standard of living at a higher level than one can expect given his or her salary it is worthwhile finding out how that is possible.
• Organize surprise audits using someone other than your regular CPA. To not make potential perpetrators suspicions present the audit it as an insurance or banking audit.
• Create job rotation programs so that there is no single employee that only understands his or her position.
• Establish routines for opening and date stamping of inbound mail.
• Establish policies and routines for signing of checks, authorization of outgoing payments and ordering of supplies that involves several individual that change occasionally.
• Have payments sent to a bank lock box or the company’s CPA firm.
• Establish frequent and random drug test programs for all employees in the company.

It is obvious that occupational fraud is a dilemma for all businesses. Therefore implement controls and routines with the purpose of preventing fraud. Don’t be afraid of talking about your concerns with your employees. It may lead to a potential perpetrator not crossing the line. Furthermore, don’t be afraid of talking to business colleagues about situations when you have been defrauded. It may help you resolve the problem or you may help someone else from ending up in your situation.