This article originally appeared in the February 2016 issue of Smart Business Philadelphia magazine.
Many privately-owned businesses continue to experience losses from fraudulent activity. Typically, these crimes are committed by employees who are in a position of trust, usually within the accounting department. Individuals that are trusted by business owners often have the greatest opportunity to commit fraud.
Trust, combined with a poor internal control environment and a lack of segregation of duties, can be a recipe for employee fraud. This is not to say that all trusted employees are fraudsters. It just means that the existence of trust is the first ingredient in an employee fraud scheme.
What are the elements that contribute to the risk of employee fraud?
There are three elements that contribute to the risk of employee fraud (also known as the "fraud triangle"): (1) Pressure or incentive-the employee may be experiencing personal financial distress, substance abuse, or gambling addiction; (2) Opportunity-the employee has access to assets that allow the individual to believe the fraud can be committed and successfully concealed; (3) Rationalizations-the perpetrator justifies the fraud due to a perceived injustice (i.e. "I deserve this because I did not get a bonus").
What are some common myths about fraud?
The first common myth is that, 'Fraud won't happen in my company because there are no criminals that work here.' However, most employees that commit fraud have never been convicted of any crimes or punished by a previous employer. It's also easy to think that most fraud is committed by new or short-term employees. However, most fraud is committed by long-term employees that have been with the company for over 10 years and have an established comfort level with the owners or senior management. The third myth is, 'My controller would never steal because he or she is a good person, hardworking, and trustworthy.' Actually, fraudsters are typically those who are in a position of trust who have access to assets susceptible to a risk of fraud.
What are some signs that a trusted employee may be committing fraud?
Some red flags include employees living well above their financial means (expensive new cars, luxurious vacations, etc.), individuals with financial distress or pressure in their personal lives, a disgruntled employee that complains about his or her compensation and worth to the organization, an employee that refuses to take time off or vacation, sloppy accounting records, vague explanations for large or unusual expenditures, and unexplained decreases in company cash flow or profitability.
What are the costs to a company and business owner of employee fraud?
Obviously, there are financial losses if assets are misappropriated. Statistics show that incidents of employee fraud could cost thousands of dollars and that typical annual losses could average almost 5 percent of revenues. Many companies are unsuccessful recovering the financial losses. Besides financial losses, fraud can also damage a company's reputation, relationships with customers and other business partners, and have a negative impact on employee morale.
How do companies reduce the risk of employee fraud?
A comprehensive fraud risk assessment should be conducted to protect the company from losses due to fraud. Identify potential risk areas, assess the likelihood and significance of fraud occurrences, and develop a response to identified risks. You also need to assess the internal control environment, including preventive controls (designed to prevent fraud from occurring) and detective controls (designed to enable timely detective of fraud). The culture of the organization and "tone at the top" by the owners, senior management, and a board of directors responsible for corporate governance should play an important role through the establishment of policies against fraudulent behavior. Lastly, safeguarding of company assets and tightening of internal controls with proper segregation of duties would also be a deterrent against fraudulent activity.
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