Combatting the Increased Risk of Embezzlement

The Association of Certified Fraud Examiners’ Report to the Nations reveals that on average companies lose 5% of their annual revenue to fraud with a median loss per case of $125,000 and an average loss per case of just over $1.5M.

The report further elaborates that more than half of businesses never recover any of the lost funds.

While only 20% of fraud is reportedly committed by business owners (compared to 41% by individual contributors and 35% by managers), the cost of owner-run fraud schemes cost their businesses 10 times more on average than fraud cases committed by lower-level employees.  

The average perpetrator of fraudulent crimes has been with the company for 1-5 years and engages in their fraudulent activity for 14 months before being detected. And small businesses typically carry a higher fraud risk than their larger counterparts with twice the rate of billing fraud and payroll fraud and four times the rate of check and payment tampering. 

No one wants to believe that fraud could be happening at their company, but these statistics tell the true story – fraud is far more widespread than many people think.

So, how does this kind of fraud occur and why is the risk of fraud higher this year than previous years? And most importantly, how do you identify fraud and what can you do to prevent it?  

---

Opportunity to Commit Fraud

​Patchwork Solutions
In an article on how the pandemic has increased demands on CFOs, Michael Cohn explains, “Labor models are changing, in part as a result of the pandemic, with 18 percent of the finance leaders surveyed saying their organizations are relying on managed services providers, while 29 percent are augmenting their staff to handle financial planning and analysis with greater speed and agility.” In some cases, this has resulted in a patchwork financial solution.
​
Using multiple providers or outsourcing some of your accounting activities while handling other activities in-house can lead to a situation where no one is responsible for oversight of the entire accounting operation, opening the door for fraud. It can also create confusion – allowing double work to unintentionally occur or routine checks to slip through the cracks, muddling your ability to detect fraud effectively.

Increased Responsibilities
With senior financial staff spending more of their time on adapting strategic planning, the business’s day-to-day financial operations have been increasingly handed off to accountants and lower-level finance staff. At the same time frequency of financial forecasting has created more work that has left accountants and bookkeepers to operate at hyper speed with less oversight. Combined, these factors provide more opportunity for financial fraud to occur, while also making financial personnel less likely to catch fraud occurring elsewhere in the organization.

Remote and Hybrid Work
Interviewing prospective employees, partners, or providers from afar may make it more difficult to screen their trustworthiness. Furthermore, with employees largely still at home, there is increased opportunity for fraud because employees are working alone instead of in a busy office with peers and management around. With less visibility and oversight areas of the company that were already ripe for fraud are even more vulnerable.

Additionally, with employees working remotely, there is less chance of noticing that an employee is living beyond their means (driving a luxury vehicle, taking lavish vacations, wearing designer clothes, and so on), which may indicate that they are engaged in fraudulent activity.

COVID-related Opportunities
John Hanson, managing director of BDO’s Forensic Accounting and Investigation practice, explains how the pandemic has contributed to the rise in fraud when he says,

Giving out tons of money in a relaxed manner – less guidelines, less requirements, less scrutiny over documents that are submitted (such as payroll lists, tax documents, and bank statements) coinciding with a rush to get money out… will make a proverbial tsunami of fraud over the next few years.

And this is largely just fraud related to government financial relief that he is commenting on, not even general embezzlement. With the preponderance of remote workers and pop-up companies offering to help companies obtain relief dollars, overall business fraud will likely hit record highs.
 
Signs of Fraud
With more opportunities for fraud to flourish, savvy companies have begun proactively scrutinizing their books. While some fraudulent schemes can be very sophisticated, the telltale signs of accounting fraud include:
​
Increasing Payments to New Vendors
Be suspicious of new vendors that have increasing payments recorded. When employees are stealing from a company, they usually start small to test out the scam and then slowly increase up until a point just below where it would raise suspicion. At that point, the payments flatten out and typically never cross a threshold where an approval or sign off would be required.

Vendors or Invoices with Employees’ Information
​Run a check to ensure that vendors or invoices do not contain contact information that matches employees’ information in the form of a phone number, email address, or physical address. Be wary also of any names that seem oddly close to employees’ names as well.

Sequential Vendor Invoicing
Your vendors should have other customers too, so their invoices should not be sequential. If the invoice you receive from a vendor one month is #2005 and the next month is #2006, that should raise suspicion. The invoices should also be progressively increasing (not randomly generated) because a real vendor will not issue invoice #2005 one month and #1125 the next month.

Invoices That Look Off
Sometimes you can tell if an invoice just looks wrong, like if it appears to be photocopied. Other times, however, you may have to dig a little deeper. Invoices that are not standardized from one month to another can be a red flag that fraud may be occurring, but that is not the only giveaway.

Invoices that are missing information like an email address, physical address, or website should be examined more closely. Similarly, invoices that include extra information, especially secure information or items that are not typically included (like full credit card numbers) should raise suspicion.

Invoices in clean, rounded numbers, like $500 or $1,000, may indicate that they are fraudulent, especially when vendors have multiple invoices for these types of amounts or duplicate payments against those invoices.
If the contact’s email address is from a free email provider instead of a company email address, that could be an indication that something is amiss, but it is not a surefire indication that something is wrong, especially if you work with a lot of microbusinesses.

Preventing Fraud
The reason that so many business owners are surprised to discover fraud occurring at their companies is because people mistakenly believe that only unscrupulous-looking, scary, shadowy characters can steal. But corporate fraud is not committed in a dark alley with a crowbar. It is most often committed by otherwise “good” people that find themselves in bad situations or end up giving in to the lure of temptation. Recognizing that can help put business owners on the offensive when it comes to preventing fraud.

John Hanson explains that understanding the fraud triangle helps to identify fraud but you still need to look for it. He reminds us that fraud is an activity that is meant to be concealed, so it will not be out in the open.

When it comes to fraud, best defense is a strong offense.

Understanding common fraud schemes is the best way to be on the lookout for those types of fraud. Remember, AP is one of the most common areas for fraud, but it is not the only area that can be affected. Fraud can occur across other areas of accounting, as well as sales and operations. Again, business owners must assume it could be happening in any area of any company right now because fraud is on the rise across the nation in the wake of COVID-19.

The Association of Certified Fraud Examiners’ 2020 report outlines the most effective ways to prevent fraud, which include:

• Implementing formal internal controls
• Developing an anti-fraud policy
• Requiring fraud awareness training
• Enumerating official reporting mechanisms
• Implementing an anonymous tip line

When it comes to preventing fraud the best thing you can do is to be skeptical – trust but verify. If something looks wrong, investigate it further. Always dig deeper to verify that it is legitimate and not hiding a case of fraud.
​
Do you need help implementing internal accounting control systems at your company? Let our experienced accountants clean up your financial practices to mitigate fraud risk regardless of what the next year holds in store.