Common Fraud Schemes That Cost Your Company Big
Fraud is more common in business than one might think. Each year our firm uncovers instances of fraud and theft in the businesses we work with, both large and small. In mid-size companies, it can be difficult to create rigid internal controls where there is a clear separation of duties. Fewer accounting and administration means fewer checks and balances, such that a single employee can easily craft a way to steal money from the company. Here are some of the methods that we use and some helpful advice to ensure your company is safe.
Most common fraud: False Expense Reports
A $35M wholesale distribution business had a number of remote sales executives across the country. The same person who collected the monthly expense reports was also responsible for the reimbursements through payroll and entering the expenses into their accounting system. This accounting person created false expense reports and reimbursed themselves for the fake expenses. The total cost to the company was over $250K over four years. It was shrewdly orchestrated as the perpetrator never recorded the same amount twice. She would push more to her paycheck during the 4th quarter busy season, and very little during slow months to reduce the opportunity for detection. She would also spread the fake expenses over multiple accounts such as air travel, mileage reimbursement, meals, and client gifts. The company had a process where the sales manager approved the monthly expense reports before they were submitted to accounting and payroll for reimbursement, and then input into the accounting system. The challenge here was that after the manager’s approval, one person controlled all remaining access points to the accounting and payroll entries. Also, they didn’t have a measure in place to compare the expense reports submitted against what was actually paid out. This type of fraud is what we see the most frequently. A business, no matter how small, simply must separate the approval and payment of expenses to two or more people, or their inviting potential fraud.
2nd Most Common Fraud: False Employees Receiving Paychecks
A manufacturing company with over 300 employees had the same person input new employees into ADP, manage the payroll process, and run payroll. This person was in a position to very easily create fake employees. The scheme started out with one fake employee and the payroll was paid by ACH into the bank account of the payroll manager’s significant other. Over time they added several more fake employees. They were eventually caught when the company was downsizing their payroll during the great recession and management began to review the employee lists. The company had a process where new hires and terminations were approved by a manager and the approval was sent to payroll. The challenge here, again, was that one person covered all access points to payroll. Also, there was no tertiary process to confirm if the number of new hires matched the number of active employees.
3rd Most Common Fraud: Fake Vendors
A $25MM electrical manufacturing business with a tremendous number of vendors fell victim to this fraud. In this instance, the controller had the authority to set up new vendors in the system and to sign checks. The employee had been at the company for many years, and was given check signing authority to speed up processes when the business owner was traveling. He had gained a lot of trust and was considered a family friend. In his expanded role, the controller was able to create fake vendors, enter invoices, and then pay those invoices to a bank account that he controlled.
4th Most Common: False Checks/Manipulation of Balance Sheet Accounts.
My last example is less common than the three prior, but without controls or checks it can create a bigger risk. In this case, the accountant was able to write checks to himself, with the checks being coded to various balance sheet accounts that the management team never reviewed in detail - accounts like retained earnings and expense account accrual. Many CEOs focus primarily on the income statements and key balance sheet accounts such as cash, accounts receivable, inventory, accounts payable, and the bank line of credit. In order to avoid this type of fraud CEOs must scrutinize these accounts on the balance sheet and ask for specifics about what costs are being applied to every line item. While this type of fraud is less common it’s often the easiest to cover up.
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If CEOs suspect fraud or are unsure about certain financial transactions, they should seek advice from legal and financial professionals. Implementing a comprehensive code of conduct and ethics, coupled with ongoing employee training, fosters awareness of the importance of honest financial reporting. Proactive risk assessments, i.e. third-party auditors, and continuous monitoring of financial transactions can help identify potential areas of vulnerability. By promoting a culture of integrity, accountability, and transparency, organizations can significantly reduce the risk of fraud in their financial statements.
Understandably, CEOs can be embarrassed when they learn their company has been the victim of fraud, and instead of prosecuting they’ll choose to cover it up. In fact, in none of the examples cited were there charges filed against the perpetrators of the fraud. At Turning Point, we strongly disagree with those decisions and encourage prosecution. If no action is taken, guilty employees are free to take another job and continue their cycle of deception. You will be doing your company, CEO, and many others a huge favor when you prosecute this rampant crime.
