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An Ounce of Fraud Prevention
September 18, 2009
When the economy worsens, the risks of fraud increase. As employees experience difficult economic times – layoffs, hour reductions, personal financial burdens, uncertainties about the future - some look to their employers’ assets to relieve their financial problems. Often, the only barrier to a good employee making a disastrous mistake is the certainty that he or she will be caught. Employers can protect both their employees and their assets by creating and enforcing good checks and balances that increase the belief that thefts will be detected and prosecuted.
The first step should be to promote an ethical and honest tone throughout the organization. Many employers develop written ethical standards and provide them to employees. Additionally, employees at all levels should be made aware of the penalties for violating the company’s ethical expectations. Research indicates that organizations with well-communicated and enforced ethical standards experience less fraud overall.
Companies should conduct background checks on all employees to ensure that those hired meet the high standards established. Unfortunately, studies have found that as many as 60% of applicants lie on their application and 5% of applicants fail to disclose a felony record. Background checks are relatively inexpensive, costing approximately $75 per applicant.
Organizations have also found it useful to establish an anonymous method for employees, vendors and customers to report fraud, illegal acts and harassment. Such hotlines can cost as little as $1 per employee per year. Approximately 28% of frauds are detected as a direct result of employee tips and anonymous reporting methods increase the likelihood of employees reporting suspicious activity. Another 10% of frauds are detected as a result of reports from customers and vendors.
An annual independent check-up increases employees’ perception of the likelihood of detection of schemes. Although audits are not designed to detect fraud, about 12% of frauds are detected by outside independent auditors. Additionally, independent outside auditors can perform a review of an organization’s internal controls and suggest practical, cost-effective improvements.
Internally, sometimes small changes can reap large rewards in the prevention department. For example, bank statements should be received, opened and reviewed by someone outside the accounting department. One of the most common “accidental” ways fraud is discovered is by an owner unexpectedly opening a bank statement containing checks illegally written an employee. When banks do not return cancelled checks or copies, someone without other access to check preparation should review the electronic check copies on-line and investigate any unusual vendors or unexpected payments to accounting personnel.
Requiring all accounting personnel to take vacations of at least a week and rotating their duties to other employees during that time is another effective fraud deterrent. Many fraud schemes require constant monitoring to avoid detection. Employers often describe uncovered fraudsters as “super workers” – “She was always here – early in the morning, after everyone else left, even on weekends. She said she could get more done when no one else was around.”
A recent fraud at a Canadian winery perpetrated by a trusted internal accountant exemplifies the vital importance of internal controls. After a year-end financial review conducted in the employee’s absence discovered the fraud, a subsequent forensic audit revealed that this individual had embezzled more than $7.4 million from her employer over an 11-year-period.
The employee told court officials her “employers were partially to blame for their losses because they had not monitored her accounting practices closely enough.”
There are numerous other steps that organizations can take to enhance their internal controls. The American Institute of Certified Public Accountants has articles and checklists on its website (AICPA.org) to assist organizations in evaluating and improving their checks and balances.
Employee fraud is expensive and increasing. Estimates of annual losses range from 4% to 6% of gross national revenues and studies show that two thirds of companies experience a fraud loss in any two-year period. Smaller companies and non-profit organizations are particularly at risk. The average individual fraud loss in businesses with revenues under $50 million is $225,000. Plus, fraud is one of the leading causes of new business’ failure. Since fraud deterrence is always easier and more efficient than fraud detection, consider improving your company’s checks and balances as one step toward increasing your profitability.
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