subject: Identifying and preventing fraud [print this page] Identifying and preventing fraud Identifying and preventing fraud
Fraud is an intentional act involving deception, carried out by one or more individuals with a view to obtaining a personal gain.
In a corporate context, fraud can fall into one of two main categories:
Removal of funds or assets from a business includes:
(a) Theft of cash (b) Theft of stock (c) Payroll fraud
(d) Teeming and lading (e) Fictitious customers
(f) Collusion with customers (g) Bogus supply of goods or services
(h) Paying for goods not received (i) Misuse of pension funds or other assets
(j) Disposal of assets to employees
(k) Manipulation of bank reconciliations and cash book
Intentional misrepresentation of the financial position of the business is often caused by a desire to overstate or understate profits:
(a) Over-valuation of stock (b) Bad debt policy may not be enforced
(c) Fictitious sales (d) Manipulation of year end events
(e) Understating expenses (f) Manipulation of depreciation figures
Internal Fraud, which is fraud committed by one or more employees of the entity, and
External Fraud, which is fraud committed by someone outside the entity, such as a hacker into a computer system.
Fraud might be committed by an individual acting on his or her own. Alternatively, fraud might be committed by two or more people acting together: this is called collusion.
Fraud is different from error. Errors are unintentional mistakes. Fraud, on the other hand, is deliberate/ intentional. It is also a criminal activity.
Potential for fraud / Prerequisite of fraud:
(a) Dishonesty
(b) Motivation
(c) Opportunity
TEEMING AND LADING.
A common form of internal fraud is teeming and lading.With this type of fraud, an employee sets up a personal bank account, normally using a false business name, which is very similar to the name of the business that he works for.
He might receive a payment from a customer, say for $200, and pay this money into his own personal bank account. This missing money' will be detected unless the fraudster hides what he has done. So when a payment is received from another customer for about $200, he records this as the payment from the first customer.
This means that the payment by the second customer is missing', and to cover this missing money, the fraudster will record another payment from a third customer as the payment by the second customer.
This process can go on indefinitely, often with increasing sums being diverted into the fraudster's personal bank account as he gains in confidence.
Another form of teeming and lading applies to suppliers, where a fraudster diverts payments to suppliers into his own personal bank account, and hides the missing payments by reporting subsequent payments to another supplier as payment to the first supplier.
Circumstances where fraud is more likely
The senior executive managers are dominant and domineering, and are not sufficiently monitored by independent non-executive directors. This increases the risk of financial reporting fraud.
Remuneration for management is based on profit performance.
There are high rates of staff turnover in jobs that perform an important control function
Employees in the purchasing or stores department have been in their jobs for a very long time.
There is not enough segregation of duties, so that internal checks are weak or non-existent.
Key staff work very long hours, often on their own in the office at the beginning or end of the day; and they do not delegate work and do not take holidays.
Internal controls are weak or not applied. For example, passwords to computer systems are not changed frequently or access to sensitive areas is not restricted to authorised personnel.
The consequences of fraud
Fraud is carried out with the intention of making a personal gain
Fraud with the intention of committing theft, both internal and external fraud, results in financial losses for the employer. Money or other assets are taken by the fraudster. For example, if a hacker gains entry to the bank account of an individual with an on-line bank account, and takes money from the account, the bank will usually be held liable for the loss.
False accounting fraud might result in losses for the employer (due to the payment of bonuses that are not properly deserved) or for investors (who might be persuaded to buy shares in the company at a price that is not justified by the real' profit).
Detection of fraud
Responsibility for detecting and prevent fraud
Directors responsibilities include:
(a) Ensuring controls are appropriate (b) Ensuring financial information is reliable.
The directors and senior management are responsible for preventing fraud as well as detecting it when it occurs. Fraud prevention measures should consist of a combination of: internal controls and developing a culture of fraud awareness and a culture of control.
Internal controls for preventing fraud are often the same as the controls for preventing errors:
individuals should be screened' before they are taken on as employees
all employees should be given training (including refresher' training from time to time) in anti-fraud policies and whistle-blowing procedures
senior management should ensure that other managers and employees remain fully aware of the need to apply controls to prevent errors and fraud
fraud risks should be identified (as part of the regular review of financial risks)
and suitable controls for preventing fraud should be designed and implemented.
Whistle-blowing policy
An entity should have a policy to encourage whistle-blowing. Whistle-blowing is the reporting by an employee of suspicious activities by one or more other employees that cannot be reported through normal reporting lines. For example:
a subordinate might wish to report a suspicion of fraudulent activity against his boss
when someone reports suspicions of fraud by a colleague to his boss, the boss might refuse to believe the allegation and do nothing about it.
When an entity has a whistle-blowing policy, it provides a procedure for any employee to report suspicions of fraud or illegal activity to a senior person or a committee of senior individuals. The allegations should then be investigated.
There have been some notorious examples of whistle-blowing. Suspicions reported by an individual in the accounts department of US corporation Enron (Sharon Watkins) eventually led to the discovery of fraud by senior management, which in turn led to the collapse of the company in 2002.
However, in practice there have been problems with whistle-blowing procedures.
Some reports of suspicious activities by another person might be malicious and deliberately untruthful
If a whistle-blower's claims are dismissed, the whistle-blower might be exposed to victimisation by the individual or individuals against whom he made the allegation. Or example, if a subordinate reports suspicions of fraud by his boss, which are dismissed, the boss might get his revenge' by refusing to recommend the subordinate for any annual bonus or career promotion
