Organizational Fraud Red Flags to Watch Out for
November 24, 2022
The Association of Certified Fraud Examiners (ACFE) latest Report to the Nations states, “occupational fraud is very likely the most costly and most common form of financial crime in the world.”
As businesses have become increasingly complex, the role of the accountant has evolved to include being on the lookout for potential areas of fraud and abuse. This is because accounting records can provide a wealth of information about a company's operations, and any discrepancies can be an early warning sign of fraud.
Robin Bristow is a CPA and Certified Fraud Examiner who is part of the team at Clark Robinson, a member of the Integrated Advisory Community. Bristow has been conducting fraud examination work for almost two decades and has repeatedly witnessed first-hand the toll that organizational fraud can take.
“5% of gross revenue is lost every year on average to fraud. Beyond the financial cost, there is huge potential for loss of reputation if word gets out – which can make it hard to hire good talent. It’s also a very personal thing, especially for smaller companies who tend to know their employees pretty well – it hurts to be stolen from.”
Types of Organizational Fraud
The ACFE has identified three categories of organizational fraud - asset misappropriation, corruption, and financial statement fraud.
Asset misappropriation is the most common type of fraud; 86% of cases fall under this category. On the flip side, they tend to be on the lower side, loss-wise, with an average loss of US$100,000.
Asset misappropriation includes theft of cash, inventory, or any organizational assets. Asset misappropriation crimes include the following:
- Cash larceny
- Billing schemes
- Payroll schemes
- Expense reimbursement schemes
- Cheque and payment tampering
- Register disbursements
- Asset requisitions and transfers
Billing schemes are the most common type of asset misappropriation and present the greatest risk.
Corruption is often done in tandem with asset misappropriation in 32% of cases, or stand-alone corruption represents 12% of organizational fraud cases. Bribery, conflicts of interest, illegal gratuities, and economic extortion are all types of corruption. The average corruption fraud lasts one year.
Financial Statement Fraud
Financial statement fraud involves falsifying balances sheets, income statements or any financial statements to mislead about the financial health of an organization. This is the least common type of organization fraud, with only 9% of fraud cases reported, but by far the costliest with the average hit coming in at almost $600,000.
Common Organizational Fraud Red Flags
The bad news? A typical fraud cases lasts 12 months before detection, and causes a loss of over $8,000 per month, on average. The good news? 85% of these fraudsters displayed behavioural red flags that an organization and their accounting team could likely pick up on.
“Employees who are living well beyond their means is a huge red flag,” Bristow points out. “If you have an employee who is making $48,000 annually and yet they are driving a new Maserati, that could be worth further exploring. It could absolutely be legitimate, perhaps they got an inheritance. Or it could be a signal that they are fraudulently obtaining money.”
Another warning sign is sudden changes in financial reporting, such as an increase in credit card expenses or unexplained withdrawals from bank accounts. In some cases, employees may try to conceal fraud by making changes to financial records or creating false invoices.
“I knew of one case where an AR clerk didn’t take holidays for three years,” Bristow shares. “The reason being that she was stealing money using receivables and has been doing so for that entire three years. The owner insisted on her taking some time off, and within a week the individual who was providing job coverage had figured out what was going on. If someone is unwilling to share their job or take time off, that should raise alarm bells.”
Other suspicious activity may include employees making personal use of company funds, excessive entertainment or travel expenses, unusual patterns in vendor payments, or unexplained discrepancies in inventory levels. Does an employee have a particularly close relationship with a vendor or client? If so, that might warrant a deeper look.
How to Proceed if Fraud is Suspected
“The first thing is to be very strict with the confidentiality,” Bristow cautions. “You can open yourself up to a defamation suit if not. Only include those individuals in the loop who absolutely need to know.”
The next step is to secure legal advice, and to do so as soon as possible.
“Understand what your rights are. How do you secure evidence? Can, or should, you terminate the employee? Do you have a policy on company emails that allows you unfettered access? A lawyer can help clarify what your next legal steps are.”
And finally, assume that you are going to end up in court, so every piece of correspondence needs to be held to that judicial level of review.
“Carefully set about securing what potential evidence you can - paperwork, quotes, contracts,” Bristow advises. “But do so discreetly, as you don’t want to make it known that you are conducting an investigation.”
Organizational fraud can be a scary and daunting prospect. One of the best ways for organizations to fraud-proof themselves is by leaning on their trusted advisor, their accountant, to truly understand their operations and to pick up on discrepancies that might otherwise be missed.
In particular, those accountants who make up the Integrated Advisory Community are best positioned to protect their clients. With the support of a team of best-in-class specialists, they are able to truly enhance the client experience.
A member of WealthCo’s Integrated Advisory Community, Robin Bristow is a CPA with Clark Robinson, as well as the Practice Lead in fraud investigation services. A Certified Fraud Examiner, Robin has almost two decades of experience in helping clients deal with the challenges of fraud investigations, and well as working with them to establish fraud prevention programs.
The Integrated Advisory Community consists of a network of progressive CPA firms, along with best-in-class professional advisors, service, and product specialists, who work together to deliver an elevated and holistic client experience. One that optimizes both their personal and professional lives with an integrated financial strategy designed to help clients reach their goals.