Fraud In The Workplace

Morgan DennisMarch 14, 2012

The Auditor’s Role• “Expectation Gap”

– Public assumes that the purpose of the audit is to catch fraud.• Statement on Auditing Standards 99 (AICPA Accounting Standards Bd)

– “The auditor has responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. “

• So, the auditors are there to prepare a report on whether the financial statements are fairly presented. While they have an obligation to investigate suspected frauds uncovered during their review, it is not their primary objective.

How Much Fraud Is There?• Association of Certified Fraud Examiners (ACFE) Annual

Report (www.acfe.org)• 1,843 cases surveyed Jan08-Dec09 (40% outside US)• Average loss 5% of annual revenue• Median Loss $160k, 25% > $1m– Financial Statement Fraud $4.1m, Corruption $280k,

Asset Misappropriation $135k– Asset misappropriation cases most common 90%,

Corruption 22%, Financial Statement Fraud 4% (Overlap because many cases involve more than one)

SOURCE: 2010 ACFE Annual Fraud Report

Who Commits Fraud?

• Employees 42% (median loss $80k)

• Managers 41% (median loss $200k)

• Executives 17% (median loss ($723k)

SOURCE: 2010 ACFE Annual Fraud Report

Who Commits Fraud? (cont.)

– Men 57% » The median $ loss is 2.5x women

– 40% have between 1-5 years seniority» The longer they have worked there, the bigger

the average theft– 50% between ages 31-45

» Losses sharply increase with age

SOURCE: 2010 ACFE Annual Fraud Report

– Accounting 22%– Sales 14%– Upper Management 14%– Purchasing 6%– IT 3%– HR 1.3%– Internal Audit 0.2%

SOURCE: 2010 ACFE Annual Fraud Report

Who Commits Fraud? (cont.)

• 87% had no previous criminal record

• 83% had never been punished or terminated from earlier job

SOURCE: 2010 ACFE Annual Fraud Report

Who Commits Fraud? (cont.)

How Did They Do It?

• Missing/Weak Internal Controls (37.8%)• Override of Good Internal Controls (19.2%)• Lack of Management Review (17.9%)• Poor “Tone at the Top” (8.4%)• Incompetent Oversight (6.9%)• No Independent Oversight (5.6%)• All others (4.2%)

SOURCE: 2010 ACFE Annual Fraud Report

Management Thinks Fraud is Detected By?

• External Audit – 76%• Internal Audit 69%• Fraud Training-Managers 42%• Fraud Training-Employees-40%• Job Rotation/Mandatory Vacations-15%

SOURCE: 2010 ACFE Annual Fraud Report

Fraud Actually Detected By?

• Fraud Tip Line (40.2%)• Management (15.4%)• Internal Audit (13.9%)• Accident (8.3%)• Account Reconciliations (6.1%)• Document Review (5.2%)• External Audit (4.6%)

SOURCE: 2010 ACFE Annual Fraud Report

Warning Signs

• Living beyond means (43%)• Financial difficulties (36%)• Control issues (23%)• Close with vendors/customers (22%)• “Wheeler-Dealer” style (19%)• Divorce/Family Issues (18%)• Addictions (12%)• Never takes vacations (10%)• Frequent complaints about pay/promotions (5%)

SOURCE: 2010 ACFE Annual Fraud Report

The “Fraud Triangle”

Opportunity

Motive/Pressure

Rationalization

Three Steps to Fraud• Commit-Take the money, create the false vendor,

etc.–Perception of effective internal controls is best

way to stop this.• Conceal-Alter records to make detection difficult–Effective internal controls make hiding the fraud

more difficult• Convert-Alter the form of what has been taken into

something useful to the fraudster–Conversion can be internal (check for cash) or

external (ebay?)

Types of Fraud

• Theft of Assets (generally cash, but could be equipment/inventory)–Most common, but lower in total amount

• Improper Expenditures (fake vendors, “ghost” employees)– Less common, but generally much larger

• Financial Statement

Cash Receipts Frauds• Is all money getting to bank when it should, and

are all adjustments valid?– Skimming/Underreporting (before entering system)– Outright theft of cash (receipts already recorded in

accounting system)• What are the ways money comes in? – Mail, credit cards, wire, cash receipts at the counter,

etc?– Do you know all your sources of revenues?

Detecting Cash Receipts Fraud

• Missing Records• Gaps in numeric sequence of documents• Inventory shortages• Lower revenues in specific locations/times• Lower revenues by specific employees• Sloppy record keeping• “Markers”

Preventing Cash Receipts Fraud• Segregation of duties

– Handlers of cash should never be able to adjust accounts• Enforced vacations• Separate tills• Use receipts that are difficult to alter (prenumbered, Z-Tapes,etc)

– Always give receipts• Daily deposit of ALL funds

– Even if you don’t know why you got it, accounting can figure it out later

– Daily reconciliation of deposit to CR records– Composition of deposits (Does check/cash composition match what

the bank received?)

Asset Misappropriation Frauds• Are you getting the benefit of all your

purchases?– Small and attractive items– Theft of inventory– Borrowing of equipment– Disposal of “Surplus” or “Damaged” equipment

Preventing Misappropriation Frauds• Internal Controls– Separate approval of purchases– Separate approval of writeoffs, surplus, scrap– Policy prohibiting personal use of district assets– Tagging the assets– Physical control over inventory/equipment (locked

room)– Periodic inventory count

• Fraud Hotline (SAO and to Agency)

Disbursement Frauds• Do you know where your money is going?• False Billing Fraud– Fake invoices/Fake Vendors

• Most commonly these are for services, not goods– Pay & Return Scheme (Real vendors asked to return

“overpayment” which is intercepted)– Kickback schemes (Vendor actually participates in

fraud)– Mileage & Travel expenses

Detecting Disbursement Frauds

• Review vendor totals & investigate unexplained increases

• Review vendor addresses & compare to employee addresses

• Search Internet for phone numbers on invoices & compare to employee records

• Review clearing information on backs of checks

Preventing Disbursement Frauds– Separate person authorizing payment– Original invoice supports expenditure• Documentation supports vouchers• Person who actually knows is the person who

approves it• Duplicate payments?• Do warrants from the county agree to the warrant

register?– Different person making the comparison

• Control of the mailing of the warrants– Different person mails the payments after they

are prepared

Payroll Frauds• Are you paying the right people?– “Ghost” employees.

• Are you paying the right people the wrong amount?– Padding of timesheets– Unapproved Raises

• Leave records?– Effectively a raise, since the employee has more

vacation as a result

Preventing Payroll Frauds

• Internal Controls– Reconciliation of the pay disbursements to the pay

records– Who creates and maintains the payroll/records?– Who approves the timesheets?• Can the fraudster alter them after approval?

– Who hands out the checks?

Financial Statement Frauds

• Not just Bernie Madoff. Can take place in the public sector as well– Bond covenants– Grant requirements

• Types of Frauds– Concealment of expenditures or liabilities– Improper disclosures– Related parties

Questions? (For You to Ask Your Staff)

• How does our system work?– How would you explain it to an outsider?

• How would you improve it? Strengthen the controls?

• How could you break it?• If someone was dishonest, how could they

conceal theft in our system?

Resources

• State Auditor’s Office –www.sao.wa.gov– Fraud Hotline - 1-866-902-3900

• Washington State Society of CPAs – WSCPA.Org• Association of Certified Fraud Examiners –

ACFE.Org

Questions (for me)?