OCCUPATIONAL FRAUD HOW BAD IS IT? Gregory S Kollmeyer, CPA, CFE, MAcc Elliott, Robinson and Company, LLP WHAT IS FRAUD?

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1 OCCUPATIONAL FRAUD Gregory S Kollmeyer, CPA, CFE, MAcc Elliott, Robinson and Company, LLP WHAT IS FRAUD? FRAUD IS CRIMINAL DECEPTION INTENDED TO FINANCIALLY BENEFIT THE DECEIVER. OCCUPATIONAL FRAUD HAS FOUR KEY ELEMENTS: Its clandestine Violates the perpetrators fiduciary duties Committed for purpose of financial benefit Costs the employing organization HOW BAD IS IT? According to the 2006 Report to the Nation: On average, organizations lose 5% of their annual revenues to fraud. The median loss in the study was $159,000, with nine cases losing $1 billion or higher. The median length of time the schemes lasted was 18 months 1

2 DETECTING IT CONFIDENTIAL HOTLINES More likely to be detected by tip than by any other means. 44% of the million dollar frauds in the study were detected by tips. ANTI-FRAUD CONTROLS hotlines were key cut median loss in half. Also surprise audits and anti-fraud training reduced losses WHO LOSES THE MOST? Small businesses (fewer than 100 employees) suffered the highest median loss of $190,000 per scheme. This was higher than the median loss in large organizations. Why would that be? WHO IS DOING IT? Accounting department or upper management 30% of frauds studied committed by employees in accounting, 20% by upper level management, 14% by sales department. 2

3 The Perpetrators Tenure Employees with 10 years or more tenure caused median losses of $263,000 Employees with less than 10 years tenure caused median losses of $45,000 Trust Paradoxical but the more trust you place in an employee in the form of autonomy and authority, the greater the OPPORTUNITY for that employee to commit fraud HOW IS IT DONE? ASSET MISAPPROPRIATION CORRUPTION FRAUDULENT STATEMENTS 3

4 HOW OCCUPATIONAL FRAUD IS COMMITTED Asset misappropriations occurred in 90% of the cases studied Financial statement fraud was the least common but had the highest median loss of $2 million. 3 The sum of percentages in this table exceeds 100% because several cases involved schemes that fell into more than one category. WHY IS IT DONE? Opportunity + Motive = Fraud Opportunity Lack of or perceived lack of ethics in entity and owners/management Trust placed in key employees Poor internal controls Motive/Rationalization Everybody does it Borrowing will pay back Not likely to get caught Need for cash 4

5 WHAT ASSETS ARE TAKEN? Over 90% of cases had assets stolen. Of those cases cash is king.88% of the assets stolen were cash and only 12% non-cash (ie( inventory, equipment, proprietary information) HOW IS CASH TAKEN? There are eight common methods by which fraudsters steal cash: Incoming cash schemes Skimming Larceny Outgoing cash schemes Billing schemes Payroll schemes Expense reimbursements Check tampering Wire transfers Register disbursement DETECTION AND PREVENTION CASH SCHEMES 5

6 CASH SKIMMING Skimming generally involves off-book sales or services that are never recorded in the books and the employee pockets the money. Symptoms of cash skimming Cash sales different than normal patterns Cash deposits different than normal patterns Inventory discrepancies Unusual cash over/short Currency receipts decrease while credit card, checks remain the same Declining gross profit Prevention and detection of cash skimming Use spotters and surveillance Analytical procedures Compare inventory Analyze gross profit Use/reconciliation of sequential sales tickets Overall sense of ethical culture from top management 6

7 CASH LACERNY Cash larceny is stealing on the book sales/revenues Stealing daily deposits Less cash schemes Voids and return schemes Theft of cash on hand Symptoms of cash larceny Cash sales or deposits differ from normal or expected patterns Inventory discrepancies Lack of segregation of duties Missing deposit slips Missing sales invoices Unusual journal entries Analyze voids, inspect and account for returned merchandise, compare to original sale Prevention and detection of cash larceny Compare bank deposits to cash receipts records Review journal entries Review bank reconciliations Review accounts receivable aging Send statements Overall corporate climate of ethical behavior 7

8 BILLING SCHEMES Billing schemes are schemes in which a person causes his/her employer to issue a payment by submitting invoices for fictitious goods or services, inflated invoices or invoices for personal purchases Symptoms of billing fraud Higher than usual costs Excess goods/services Copies of documents rather than originals Unusual vendors added Unusual changes in behavior or lifestyle of potential suspects Unusual endorsements one checks, vendors with alternate addresses Prevention and detection of billing schemes Review vendor lists Confirm with third parties Review personnel files Review contracts/bids Perform background checks of employees and vendors 8

9 Expense Reimbursement Schemes Any scheme in which an employee makes a claim for reimbursement of fictitious or inflated business expenses Symptoms of expense reimbursement fraud Unusual or unexpected fluctuation patterns. Unusual amounts of travel and entertainment to one particular employee Prevention and detection of expense reimbursement fraud Vouch and trace all receipts Corporate culture of ethics Require original receipts Require detail credit card receipts, not just totals. 9

10 Check Tampering Check tampering is any scheme in which a person forges or alters a check on an organization s s bank account, or steals a check the organization has legitimately issued to another payee Symptoms of check tampering Unusual payees (cash) Unusual endorsements Missing cancelled checks Lack of segregation of duties Stale checks on bank reconciliations Unlimited access to checks or check printing machines Prevention and detection of check tampering Control blank check stock Review personnel files and background checks Review returned checks, reconcile promptly Corporate culture of ethics 10

11 Payroll Schemes A payroll fraud involves an employee causing his or her employer to issue a payment by making false claims for compensation. This can happen by overstating hours worked or by adding ghost employees to the payroll. Symptoms of payroll frauds Unusual fluctuations in payroll expense Employees with PO Box addresses Missing paychecks Poor internal control of payroll function Prevention and detection of payroll frauds Review payroll registers regularly Review personnel files Keep track of unused check stock Segregation of duties 11

12 Wire Transfer Fraud A scheme in which the perpetrator steals employer funds by fraudulent wire transfers Prevention is easier very close attention to bank account and reconciliation with proper segregation of duties Register Disbursement Fraud Schemes in which an employee makes false entries on a cash register to conceal the fraudulent removal of cash such as false voids or paid outs. Prevention and detection involves monitoring the volume of these items and frequency by employee Accounts Receivable Fraud Accounts receivable fraud usually involves manipulating accounts receivable and sales to steal cash or other assets Common schemes are: Lapping of receivables Credits, discounts, and other write-offs Collection agency schemes 12

13 Lapping schemes A classic receivables fraud. It involves stealing a customers payment on account and concealing it by applying subsequent payments from other customers to the first customers account. Symptoms of lapping schemes Customer complaints about statements Different dates between deposits and customer payments No annual vacations by people with access to cash and related records Unexplained accounts receivable aging Prevention and detection of lapping schemes Send periodic confirmations to your customers. Review journal entries Require mandatory vacations Cross train employees 13

14 Credits and write off schemes Similar to lapping in that customer payments are stolen Rather than replace with subsequent payments, credits are posted to customers account. Symptoms of credit schemes Customer complaints Confirmations from customers with variances Volume of bad debts or credit memos Preventing and detecting credit schemes Send periodic confirmations to customers Periodically review journal entries to accounts receivable Inspect credit memos Review excessive bad debts 14

15 Collection agency schemes These schemes can involve an outside organization by themselves or with an employee of your organization. Collection agencies collect old receivables but remit only a portion of their collections. Can involve collusion with inside personnel who have access to credit memos for customers. Symptoms of collection agency fraud Unusual proportion of write-offs by a collection agency Unusually low collection rate by collection agency Customer complaints/variances in confirmations sent to them Preventing and detecting collection agency schemes Send confirmations to customers periodically Periodically rotate collection agencies 15

16 SUMMARY Fraud is very expensive Management attitude towards fraud is very critical in prevention Do fraud checkups/review internal controls Be cognizant of your business/surroundings Have open communication between employees/management 16