October 19, 2009

The statistics are sobering. Imagine simply throwing away seven percent of your organization's annual revenue. According to a recent study conducted by the Association of Certified Fraud Examiners, that's the impact of occupational fraud on U.S. organizations―including public and private businesses, not-for-profit organizations and governmental entitiesorganizations. It translates to approximately $994 billion.

Perhaps surprisingly, fraud losses tend to be more significant for smaller businesses than for larger organizations. The median loss for all organizations in the study was $175,000―but for those with fewer than 100 employees, it was $200,000. Unfortunately, many of these frauds continued for years―typically two years―before they were uncovered. 

Fortunately, the study also had good news to report: anti-fraud controls have a measurable impact on fraud losses. Given the magnitude of the problem, and the fact that smaller businesses are disproportionately affected, it is important that all business owners and executives have a general understanding of the nature of occupational fraud, as well as the steps they can take to prevent or mitigate fraud in their organizations. 

Instances of Occupational Fraud
As defined by the Association of Certified Fraud Examiners (ACFE), occupational fraud refers to "the use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets." 

According to a recent ACFE study of occupational fraud in the U.S., such fraud can be analyzed in terms of three broad categories:

  Asset misappropriation, where the perpetrator steals or misuses business resources―for example, theft of money or inventory, and the use of false invoices or payroll records. In the ACFE study, this category was both the most common and least expensive category of fraud. It represented nearly 90 percent of the instances of fraud in the study, with a median loss amount of $150,000.

  Corruption, where the perpetrator uses inappropriate influence with respect to certain business transactions for personal gain―for example, conflicts of interest, bribery, kickbacks, contract manipulation and extortion. This category was the second-most common and second-most costly of the three types of fraud. The study found corruption was present in approximately 27 percent of the cases, with a median loss amount of $375,000.

  Financial statement fraud, where the perpetrator omits or inaccurately represents the organization's financial reports―for example, stock manipulation, hiding liabilities and reporting nonexistent revenues. This category was both the least common and the most expensive type of fraud. Representing slightly more than 10 percent of the cases of fraud in the study, the median loss was $2,000,000.   

Fortunately for U.S. organizations, anti-fraud programs have proven effective in detecting and preventing occupational fraud.

Detecting Occupational Fraud
The single most effective action you can take to detect fraud in your organization is to implement a simple hotline or reporting program, including an anonymous option. In studies repeated over a number of years, tips or complaints from co-workers, clients/customers, vendors/suppliers, and other affected persons were the means for identifying nearly half of all uncovered frauds. Of these, co-workers/employees accounted for more than 60 percent of such tips.

Internal controls are another important, although less significant mechanism for uncovering fraud. Internal audits and accidental discovery are even less likely to detect occupational fraud. Finally, fraud uncovered as a result of an external audit is relatively rare as an external audit is not designed to detect fraud.

Statistically, fraud is most often committed by people in the accounting department or senior management, and the perpetrators are likely to be first-time offenders. Typically, the perpetrator acts alone. Common warning signals include an employee under extreme pressure to perform, an employee living beyond his or her means, and an employee with significant personal financial challenges. 

Preventing Occupational Fraud
Across the board, the most important factor in reducing the incidence of occupational fraud is a strong program of internal controls. In fact, these controls are much more important in preventing fraud than in detecting fraud.

Although specific internal controls can vary from organization to organization, they generally include the following: 

  segregation of duties and functional responsibilities, including separation of the invoice initiation process from checking signing and separation of bookkeeping and bank reconciliation tasks

  mandatory vacations, and job rotation where appropriate

  written policies and procedures, including those for authorizing and approving transactions

  documentation of business processes and controls

  implementation of a risk-assessment and management program

  management review of internal controls

  independent audit committee, for audited organizations

Other significant anti-fraud measures include implementation of an organizational code of ethics, ongoing anti-fraud education programs for management and employees, thorough hiring procedures that include comprehensive background investigations, management certifications of financial statements (most common for public companies), external audits, rewards for whistleblowers, and regularly conducted surprise audits.

For More Information:
The American Institute of CPAs―in conjunction with The Institute of Internal Auditors and the Association of Certified Fraud Examiners―has published Managing the Business Risk of Fraud: A Practical Guide to assist businesses in establishing effective fraud risk management programs.

The Association of Certified Fraud Examiners has developed the ACFE Fraud Prevention Check-Up, a simple, free questionnaire designed to help you proactively identify and manage your business' fraud risks.   

The Association of Certified Fraud Examiners has released a study of occupational fraud entitled 2008 Report to the Nation on Occupational Fraud & Abuse.    

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