Accounting fraud comes in many forms. Some fraud is quite complex and can last for decades, as we recently discovered with the Olympus accounting scandal. When executive management and even board members are in collusion it is very difficult to detect this kind of fraud.
But there are other kinds of fraud that can cost a company significant amounts of money or resources over time, and much of this fraud is not necessarily sophisticated or engaged in by top decision-makers.
The most common type of fraud involves improper accounting for revenue and assets, such as cash, inventory, and fixed assets. Typical situations involve the theft of money or merchandise and covering it up with bogus accounting transactions. It can range from petty cash abuse to writing off expensive assets or inventory as having been destroyed, when in fact it was resold off the books for individual or corporate profit. Improper revenue recognition and overstating assets are also examples of financial reporting fraud.
One of the largest areas of abuse involves employee expense reports. When an employee expenses something that violates company policy or rules, it can be considered fraudulent activity. For example, purchasing tires for a personal motorcycle but listing them as tires for a company car on an expense report is considered fraud. This example may sound unusual but the types of abuse that exist are as creative as the individuals concocting them.
Another type of fraud includes bribery and corruption. These activities include providing illegal or unauthorized incentives to elicit desired behaviors or outcomes for the benefit of the individual or company. The Foreign Corrupt Practices Act specifically includes information on internal controls and defines the requirements as well as the penalties for violating those rules. Bribery and corruption may sound like abstract concepts to many accountants but when people in your purchasing organization are being provided with gifts and trips, or abnormally large discounts, this can amount to violations under your own company internal controls.
So how can you tell if fraud potentially exists in your organization? Some basic guidelines include the following:
- Does the company have internal controls (procedures) around activities that require the approval of cash receipts and/or payments? Are these procedures regularly followed and is there evidence to determine that they were followed correctly?
- Do material or significant financial transactions have stated thresholds for approval and do the appropriate personnel always review and approve them?
- Are employees who review company expenses/payments aware of and properly trained on the limits allowed per company policy?
- Is the access to financial systems limited to appropriate personnel and is it enforced? As people move through jobs in an organization it is not uncommon for access privileges to remain intact even when they should be modified.
These are just a few examples of ways to think about the opportunity for fraud to occur. Fraud is always a surprise when discovered, but seems evident in hindsight. However, the damage has already been done so the optimal approach is to ensure effective controls are in place and working to mitigate the chances of financial loss.