What happens when fraud happens?

robert-n-cantorMost small business owners don’t believe that fraud can happen to them. However, they are extremely vulnerable to occupational fraud.  Most of the time, believing in the honest of your employees is well founded, but not always.

This article concentrates on asset misappropriation, the most common type of occupational fraud, the other two being corruption and fraudulent statements.  Many workplace crimes are committed from the “inside” and involve the stealing of cash, inventory, equipment or committing payroll fraud.

When fraud is suspected, a trusted team of advisers needs to be assembled and should include someone from human resources, a labor attorney, and an outside financial expert. It is recommended that the financial expert be either a certified fraud examiner or a forensic accountant from an outside company rather than the internal accountant who is typically too close to the situation. A thorough financial investigation must ensue regardless of what the evidence initially shows and should only be communicated to the advisers and those on a “need to know” basis.

Role of the financial expert

The financial expert, will take a variety of steps to quantify the loss. The investigation will commence with an interview followed by the review of documents in the area(s) where the fraudulent activity is suspected starting from a period prior to when the suspicious activity was thought to have occurred. The financial expert has the technical knowledge necessary to perform effective investigations, and her advanced understanding of typical fraud schemes and data analysis techniques allows her to conduct examinations efficiently and strategically.

Signs of behavioral red flags displayed by any of the employees should be communicated to the expert. Examples of red flags are an employee living beyond his means, financial difficulties, family or addiction problems, and unusually close association with vendors/customers.

Fraudulent disbursements are extremely common types of fraud and include billing and payroll schemes, expense reimbursement and check tampering. When these occur, transactions in the detailed general ledger will be reviewed noting uncommon journal entries, excessive voids or credit memos, the appearance of common names on refunds, adjustments to receivables and payables, duplicate payments, and unusual employee expense reimbursements. Backup documentation for “strange” or “uncommon” transactions will be analyzed for fraudulent activity.

Besides the transactional analysis, the expert should review other company data such as a list of vendors, paying attention to those vendors whose payments were sent to a post office box. Then, a cross-check of vendor addresses to employee addresses should be conducted.

There are many types of payroll fraud. Ghost employee schemes are often uncovered when the expert attempts to physically match each employee with his or her name on the payroll register. Pay rate alteration is another type whereby an employee colludes with the payroll clerk who alters their rate of pay. This can be detected by matching the pay rate authorization to the payroll register.

The most common type, however, is the padding of time sheet hours by employees.  This occurs when the supervisors are known to make a cursory review of the time sheets instead of a more thorough review.

The expert will want to review the monthly bank reconciliations for all accounts for accuracy as well as for old reconciling items that still appear. Bank statements will also be reviewed for unauthorized transfers and copies of canceled checks for check tampering.  Another good indication of theft can be detected if the financial expert reviews the operating budget and compares the actual results to the budget. Large variances should be researched and explained.

Fraud detection

The average scheme continues for approximately 18 months prior to detection, and the most common means of detection is through tips from an employee, customer or others. All organizations should have a fraud hot line, which should be maintained by a third party so those who wish to remain anonymous can do so. The implementation of internal controls over a company’s assets is necessary.  Segregation of duties ensures that there is oversight and review to catch errors. It may help to prevent fraud that requires collusion amongst individuals.

Damages and recovery

When the expert believes that all areas of concern were addressed, he should memorialize the investigative process in a clear and concise document that concludes with a summary of findings.  Backup, comprising of detailed schedules, that depict damages as well as evidentiary proof of such findings should also be attached to the financial expert’s report. This report will be required in the recovery process.

Full financial recovery may be challenging, but it is imperative that the crime be reported regardless of the size of the loss. Remedies include reporting the incident to law enforcement, consideration of a criminal and civil action and the submission of a claim under a fidelity bond, assuming one is in place. All businesses should discuss the purchase of a crime insurance policy with their insurance agent to better protect entity assets.

Robert N. Cantor, CPA, CVA, CFE, is a manager with Hertzbach & Company, P.A.






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