Abstract illustration of audit report verification with a magnifier. Image credit to Mohamed Hassan
External auditors may not actively look for fraud, and might not even find it. According to a 2020 report, they discover only 4% of occupational fraud. To help prevent accounting fraud in your company, there are certain steps you can take.
Table of Contents
Introduction: What is Accounting Fraud?
Accounting fraud creates a false appearance of a corporation’s financial health by deliberately manipulating financial statements. It can involve an accountant, an employee, or even the organization itself. This way, they mislead shareholders, lenders and investors.
An organization can falsify its financial statements by:
Not recording expenses
Misstating liabilities and assets
Overstating its revenue
Regardless of size, industry, location or type, accounting fraud is a challenge faced by organizations around the globe.
However, small business owners usually cannot hire enough employees for ideal separation of duties. Hence, there are not enough internal controls for fraud prevention.
Furthermore, small businesses often are reluctant to report cases of internal fraud. Since the fraudster could be a family member or someone from the owner’s social circle, some instances of fraud are swept under the carpet or forgiven.
Another reason for lack of reporting is not wanting to get the police involved and taking the case to court. Commonly, the fraudster is just fired.
The Cost of Accounting Fraud
Fraud is considered an “unnecessary” cost, since many time it can be prevented. A report published in 2021 by the University of Portsmouth asserts that losses are usually in the range of 3–10%, with an average of 6.4% (possibly higher).
Having said that, there is always more research to be done, and every organization should determine what their own accounting fraud costs are likely to amount to.
The Covid-19 pandemic has not made matters easier. According to Accounting Today, the pandemic might be giving more opportunities for financial fraud, with notable increases in fraud incidences. Investigating and preventing fraud also became more challenging.
Common Fraud Risk Factors
There are some factors that will make accounting fraud more likely. Such risk factors include, though are not limited to:
High employee turnover: If there is a high level of employee turnover, especially among the management team, there may be lowered attention to controls due to weakened institutional memory of how transactions are processed.
No internal audit: Without an internal audit, it is harder to spot and correct inappropriate transactions.
Dissatisfaction with company: If your workforce is unhappy or dissatisfied with your company, they will be less likely to check transactions properly and more likely to engage in fraud. Hence, it is suggested to avoid eliminating bonuses, voiding promotions, reducing benefits, and so on, if possible.
Cash on hand: If there is a large amount of cash on hand or in bank accounts, there can be a high risk of accounting fraud.
No separation of duties: If multiple employees are involved in the various phases of a transaction, the risk of fraud declines sharply. Therefore, avoid poorly defined job descriptions and approval processes.
Full time off: If you require your employees to take their full allocated time off, this deters them from hiding ongoing fraud.
No documentation: While documentation is not a guarantee against fraud, it does make it less likely and easier to correct. Employees feel more assured of not being caught when there are no digital or physical transaction records.
Complex transactions: If the nature of your organization’s business involves complex transactions, particularly involving estimates, it is easier for employees to manipulate transaction results.
Individual dominance: If a single person dominates management decisions, especially when the board of directors is weak, this person is more likely to engage in fraud.
Steps to Prevent Accounting Fraud
Review Key Controls
Review your key controls, such as bank reconciliations, journal entries and reconciling items. It is recommended that the person performing the review documents what they are looking at and how they are resolving questions.
Bank reconciliation is the simplest of these to tackle. The bank statement itself should be periodically reviewed for atypical or peculiar disbursements or receipts.
Review cancelled check images to make sure that the signatures are appropriate and match as the company should expect (such as who is meant to be signing).
Review the sequence of wire numbers or checks against records of payments issued. This can also yield unusual results that indicate fraud.
It is recommended that bank reconciliation is done by an individual who does not have the capability to sign checks or issue electronic payments. You can also hire a bank reconciliation service.
Ideally, the reviewer should initial the reconciliation and the bank statement. This will indicate the completion of the review.
Receive the Bank Statement Yourself
Business owners, especially of small businesses, should receive the unopened bank statements and review them before giving it to the accounting team.
Close Prior Accounting Periods
Periods should be closed after financial statements are produced. This will lower the risk of obfuscating fraudulent transactions from previous years.
Attach Scanned Images to Each Transaction
Often, fraud will occur from tampering with checks. To discourage fraud, scan the bill and link it to the relevant accounting transaction.
Your Bookkeeper Should Not Reconcile the Bank Account
This will allow the bookkeeper to hide fraud. It is generally a good idea to outsource bank reconciliation services.
Usernames for Each User
Instead of having one “Administrator” account that everyone uses, set up individual accounts for each employee. This way, it will be easier to know who made which entry, and when, thus making fraud detection simpler
Restricted User Access
The following duties should be separated:
Custodial responsibility for assets in every transaction
Encourage a Culture of Ethical Practices
A strong ethical culture in your workplace can lead to lowered risk of fraud.
This should be combined with better corporate transparency and incentives for executives to act in the best interests of shareholders
Watch out for retaliation for reporting fraud. This usually flows from the top down.
Fraud Management: The Fraud Response Plan
It is a good idea to develop a Fraud Response Plan in advance, in case fraudulent activity does occur later in. The plan should be flexible and contain some structure and a list of resources for reference.
Here are some general tips for the plan:
Try to keep your initial response low-key and contact your legal counsel for advice on your next steps. They will probably recommend you secure any useful documents or evidence, such as invoices and CCTV footage.
Your lawyer might recommend a fraud examiner or financial investigator to help the investigation.
You should review your insurance contract and contact the insurer right after you talk with your lawyer, as most insurance policies need a notification within a specific time frame.
Do not immediately terminate any employees you suspect. Instead, ask your lawyer about the matter. A safe move would be to prevent the suspected employees from removing or touching anything in their work area, except personal items.
It is also a good idea to inform everyone at your company that there is a fraud policy and that all tips given in good faith will be considered seriously.
Any of these steps can be changed to fit your company’s needs and situation. It is recommended that you engage your lawyer to review the response plan and make any necessary modifications.
While the news tends to focus on high-profile incidents of fraud involving public companies, fraud can hit any company regardless of size, nature or industry. Note that the median loss for private companies ($164,000) is higher than those of either public companies ($117,000), government entities ($118,000) or not-for-profits ($75,000).
The consequences of accounting fraud can be severe. In the infamous Enron case, the company’s share price collapsed, it declared bankruptcy, and criminal charges were brought against several of its top executives – some were sent to prison. The scandal also ended up crippling accounting company Arthur Andersen LLP, which had managed Enron’s books.
However, as long as fraud prevention is taken seriously by your company, the likelihood of such a scenario is low. To help prevent accounting fraud, it is recommended to hire a trustworthy company like NextGen that can provide reconciliation solutions. Whether you need bank reconciliation or credit card reconciliation, we’ve got you covered.
Get your daily bank and credit card reconciliations and prove your books. Contact us now!