Question

7 Simple Steps to Corporate Fraud Prevention: A Case Study

Evidence of internal theft shines a bright light in the rear-view mirror. Posted by Chris Hamilton on September 6th, 2012

The shock when a victim discovers that a trusted employee – and even a friend – has stolen from him or her is absolute. It’s a feeling of betrayal and violation that strikes fear in some, grief in others and anger in most.

In my experience, it is almost always accompanied by a sense that the victim should have known it was going on. The evidence of theft sheds a bright light in the rear-view mirror. Patterns and circumstances take on a clarity that contemporaneous experience obscured. Sometimes the clarity was there but for a variety of reasons it was ignored.

A Case Study

The internal fraud was revealed, he felt stupid for allowing it to happen and the lesson cost him several hundred thousands of dollars in uninsured losses.

A victim uncovered theft when his bookkeeper unexpectedly missed a few days of work and he opened a bank statement. The simple act of thumbing through cancelled checks from one month’s bank statement prompted a phone call to his attorney who directed him to a forensic accountant. The internal fraud was revealed, he felt stupid for allowing it to happen and the lesson cost him several hundred thousands of dollars in uninsured losses.

The forensic accountant uncovered evidence of a simple but effective embezzlement scheme. The bookkeeper had set up vendors that were very similar to existing real vendors. For example, if the real vendor was ABC Service Company then a fake vendor was established called ABC Service Co. The bookkeeper set up bank accounts for the fake vendors. That was the hard part. The rest was easy. The business owner signed hundreds of checks to the fake vendors thinking the checks went to legitimate business activity.

Since that worked so well, the bookkeeper began forging checks to pay the vendors, personal expenses, and provide cash gifts to family and friends. And, since all that worked without detection by the business owner, the bookkeeper took an unauthorized increase in salary.

It was bold. It was also easily discovered and should have been easily prevented. The bookkeeper was quickly arrested and has spent time in jail.

Fraud Prevention 101

The following are fraud prevention steps that were ignored and could have prevented the theft:

1. Know your employee. In this particular case the business owner recounted that he knew the prior employer of the bookkeeper well. He was aware that the bookkeeper had left the prior employer on less than positive terms but figured it was none of his business and hired the bookkeeper because of knowledge of the industry. A phone call to the prior employer/friend after the embezzlement was discovered revealed that the bookkeeper was probably stealing from the current employer to pay off a judgment obtained by the prior employer to recover embezzled funds.
2. Do a background check. Embezzlers tend to be repeat offenders. This is an obvious follow-up to the prior point. A simple background check is not expensive, is easy to do and, in this case, would have prevented a bad hiring decision. It would have confirmed the ill-at-ease feeling the employer had at the time of hiring.
3. Open your own mail. Let the bookkeeper do the bookkeeping. You cannot abdicate other important (and seemingly unimportant) functions because the clerk is always around and does his or her job well. Vendor communications, bank statements, and bills from vendors and suppliers are important sources of information.
4. Separate functions and duties. Many small business owners are so busy that they tend to overlook common sense when assigning work. In this case a bookkeeper was eventually given the responsibility for answering the phones, opening all the mail, writing checks, making deposits, preparing invoices, reconciling the bank statements, and preparing the financial reporting provided to the business owner and his outside tax preparer. As noted above, simply opening the mail would have prevented some of the problems – or would have caught it a lot earlier.
5. Don’t accept bad answers to good questions. When the forensic accountant arrived on the scene, the business owner requested a report showing payments to all vendors. The bookkeeper had previously argued that it was difficult to put such a report together, would take a long time, and would not be correct. The accountant produced the report in about 90 seconds. The business owner was shocked – and the point was made. His bookkeeper, for a long time, had prevented him from seeing the very report that exposed the whole scheme.
6. Force vacations. Nobody else had access to the bookkeepers work for more than two years. Any other eyes on the accounting records would have exposed everything.
7. Acknowledge your instinct. If the lifestyle of the employee exceeds what you know about their legitimate compensation there is good reason to look harder. If the bookkeeper can’t produce simple reports from “the books” they are keeping there is a problem. If you feel like you are working for the bookkeeper rather than them working for you, something is wrong. If it feels like the business is doing better than ever but there isn’t any cash find out why.

All of the steps above were recognized by the business owner in this case: “I knew something wasn’t right. I should have known this was happening.” That is never good after the fact.

Please let us know whether you agree or disagree with the article below

Answer 1

ANS:

Dear student,

Above mentioned case study not mentioned all the steps to prevent frauds that,s why i am disagree with the article.

Small and mid-sized businesses are more vulnerable to fraud than larger organizations, and the effects can be more damaging. The types of fraud that businesses need to be aware of generally fall into three categories: Theft, financial statement fraud and asset misuse. Theft, or misappropriation of assets, makes up the majority of fraudulent activity, according to the Association of Certified Fraud Examiners.These thefts, either by directly stealing cash, claiming bogus expenses or taking other property, are usually done by employees. This is a tough fact for many small business owners, who often consider their employees as friends and even members of an extended work family. The other primary types of fraud involve financial statement reporting and general corruption, such as kickbacks or other schemes in which the employee benefits personally by violating their responsibility to the employer.

The reason small and mid-sized businesses face a greater risk from fraud is due to many factors, including employees performing many functions across the organization, the close relationships between staff that leads to less scrutiny, few formal oversight procedures, less expertise on financial matters, and the large impact on cash flow that even a comparably small fraud event can have on the fiscal health of the business.

Therefore, i would like to provide you detailed steps to preventing frauds, it’s vital that small businesses take steps to deter fraud, and to detect it as soon as possible:

1.    Segregate Accounting Duties.

Because of their size, many small businesses have one person that always handles bookkeeping functions such as client receivables, processing client payments, paying invoices, managing petty cash and recording these functions in their accounting system. This makes it easy for cases of fraud to go unnoticed. Businesses should have at least two persons handling these functions interchangeably, keep the handling of cash and accounting functions totally separate, or have the functions performed through a virtual CFO relationship with an accounting firm.

2.    Know Your Employees.

While every business strives to hire honest employees, having a formal hiring routine, even at a small business, can help prevent fraud. Background checks should be performed for all staff handling cash or managing payments (and bank account information) from customers. As the employee’s level of interaction with finances increases, so too should the scrutiny paid to their past, and present, situations.

Although it may seem counterintuitive, employees committing fraud are often found to be the most endeared by their coworkers, because the person will go out of their way to help and gain trust, often working longer hours and rarely taking time off. This results in them handling several duties, and with less oversight. Likewise, employees facing sudden financial challenges in their personal lives may succumb to temptations. Requiring staff to take their vacations can help expose fraud, if it is occurring, and also can help relive overworked honest employees.

3.    Maintain Internal Controls.

Even small businesses need to create and maintain internal controls that can prevent or detect fraud. This includes restricting access to financial account data, inventory access, establishing multi-person sign-off on expense reimbursements, overtime, all check writing functions, and other accounting or payroll functions, and performing an overview of audit logs to ensure the integrity of the books.

4.    Scrutinize Business Bank Accounts.

With online banking options, it’s easy to view account activity and statements whenever is convenient, and business management should do this frequently to make sure that paper-based statements in the office have not been manipulated. The key items to look for are missing or out-of-order checks, unknown payment recipients, and checks that were signed over to a third party instead of deposited in a business account. Simply letting staff know that reviewing check activity is part of the accounting review process can help prevent fraud.

5.    Audit the Books Regularly.

Businesses should routinely audit areas that deal in cash, refunds, product returns, inventory management, and accounting functions. Additionally, occasional non-scheduled audits can also help detect fraud in high risk, critical business areas.

6.    Train Employees To Prevent Fraud.

Employees in fraud-prone areas of the business should know the warning signs of fraud, prevention skills and how to report suspicious behavior or actions by coworkers and customers. Establishing an anonymous reporting system or process can also set their mind at ease about letting their bosses know about a fellow coworker. The management, including owners of small businesses, should create a code of ethics that makes it clear that unethical behavior will not be tolerated.

7.    Protect Credit Card Information.

Credit card fraud is in the headlines so often that some people may have become numbed by the news. But businesses of all sizes, even the smallest home-based endeavor, should start by firmly separating business and personal accounts. Mingling of business funds with personal finances is not only prone to very costly errors, but can expose the individual to lost funds on both sides if the credit card information is breached. Separating accounts also makes tracking business expenses much easier. Businesses should also be wary of who they provide their credit card information to, and should use secure, online bill payment services when possible, eliminating the potential for check fraud or theft.

8.    Know Your Business Partners.

Before getting into a business relationship with another business, or individual, that requires some level of trust – such as sending them an invoice after they’ve received a product or service – make sure you at least know the basics. Knowing their physical address is a major deterrent to fraud, as is having alternate contact methods and persons, and references. Even a simple web search of a company should provide enough information as to whether they are really in business, and for how long. Additional resources that can provide background information include the Better Business Bureau and your local, state or provincial government commerce department.

9.    Check Into Every Case.

If you’ve set up fraud prevent steps and reporting procedures, but you don’t follow through by looking into reports or suspicions, then you’re defeating your own security. In order to reinforce the business’ policy of no tolerance for unethical behavior, each case should be looked at, regardless of size.

10.   Get Expert Help.

If a business has implemented fraud prevention steps and the numbers still aren’t adding up, or when there are larger legal implications, in may be prudent to hire a professional accountant to come in and perform a more extensive review and audit of the business’ books and control processes. CPAs and Certified Fraud Examiners can provide extensive help in fraud detection and prosecution, if necessary.

Every business can refer above provided steps to identify and resolve fraud activities, i tried to cover all details in case any query kindly let us know.