Mechanisms to Prevent and Detect Fraud

Jason W. Olson

CPA, CFE

Eide Bailly

eidebailly.com

Topic: Accounting

 The median loss for businesses with this control was $64,000, while businesses without this control experienced a median loss of $164,000, according to the 2008 Report to the Nation on Occupational Fraud and Abuse, by the Association of Certified Fraud Examiners (ACFE). Although implementation of this control leads to a significant decrease in fraud losses, only 12.3 percent of respondents to the ACFE's survey had the control in place at the time the fraud occurred.

Only 25.5 percent of ACFE survey respondents had implemented another effective anti-fraud control, the use of surprise audits. In businesses that implemented this control, the median loss due to fraud dropped by 66.2 percent, from $207,000 to $70,000. Similar statistics exist for many other anti-fraud controls, indicating these controls can be a very effective tool in decreasing businesses' fraud losses.

Anti-fraud controls assist in preventing fraud and reducing the length of time a fraudulent act occurs without detection. Controls in place at a business increase the "perception of detection" for employees. When an employee recognizes that he/she will be forced to take vacation in the near future and another employee will be performing his/her job or that a surprise inventory count may uncover theft of assets, the employee is more likely not to commit fraud for fear of being caught. Increases in the perception of detection are also effective because employees are more likely to monitor the actions of their co-workers. This monitoring of co-workers by other co-workers caused by an elevated perception of detection can result in more anonymous tips regarding suspicious acts that could have otherwise gone undetected. Tips are the most common method of fraud detection in all types of businesses. An employee alerted to the suspicious actions of others may be more likely to report potential fraud, especially if permitted to do so anonymously. The use of a fraud hotline as an anti-fraud control may result in the detection and reporting of more fraud by employees.

Management should identify their high risk areas and which anti-fraud controls may be most effective to deter and detect fraudulent acts in their specific business and industry. The following basic questions provide a starting point to assess risk areas and identify controls which may be implemented to reduce the likelihood of fraud:

• What type of fraud is common in the industry?
• What type of relationships do my employees have with each other and management?
• What is the culture of the business?
• What controls is the business required to implement?

Once management has determined the anti-fraud controls that may be most effective for their business, the next step is to implement an anti-fraud policy. A successful anti-fraud policy should include the following items, at a minimum:

1.    Establish a compliance program. This program should be known throughout the business as an anti-fraud and ethical conduct program. To be effective, the program needs to be followed from the top-down and all employees need to be aware of its existence. Awareness can be created by including the compliance program information in the employee handbook and having employees attend annual training. The handbook should include a code of conduct section. Employees should review the handbook and sign a document each year acknowledging that they understand the program. 

2.    Require management and executives to participate in fraud training. A survey by the ACFE indicates that fraud training for managers and executives reduces the median loss of fraud by 55.9 percent. Awareness of what constitutes fraud and how to detect it will increase the perception of detection for management and other employees, as well as encourage the top-down attitude.

3.    Implement a fraud hotline. An ACFE survey indicates most frauds are known to someone in the defrauded organization and nearly 50 percent are revealed after a tip is received from someone with knowledge about the fraud.  Fraud hotlines make it easier for employees to report suspicions or knowledge of a fraud, especially when the alleged perpetrator is at a higher level in the organization than the reporting employee. 

4.    Conduct background checks. New hires may increase the fraud risk for a business. It is important to conduct background checks on potential new hires to identify individuals with past criminal histories and/or severe financial pressure. Hiring decisions should not be based on these factors alone, but they should be considered in the final hiring decision.

5.    Continuously increase the perception of detection. The perception of detection can be augmented through various means. Steps to increase employees' perception of detection include increasing surveillance, requiring mandatory vacations, performing fraud assessment interviews, utilizing surprise audits, implementing job employee support programs, providing fraud training for employees and offering rewards for reporting fraudulent activities.

The importance of implementing anti-fraud controls within a business cannot be stressed enough. It is imperative for management to employ anti-fraud controls that are appropriate for the particular business. Proactively implementing such controls through an anti-fraud policy before fraud occurs can potentially save businesses a significant amount of money. After all, the implementation of a job rotation and mandatory vacation policy could save your business $100,000 in losses, increase employees' perception of detection and be a tool to deter fraud in the future. Why not reduce the losses from fraudulent acts before they are committed, instead of waiting to learn a lesson the expensive way?