Mitigating Occupational Fraud (Jerry Spratt Commentary)

by Jerry Spratt  on Monday, Sep. 16, 2013 12:00 am  

Jerry Spratt

Opportunity, incentive and rationalization are the three elements of the fraud triangle that are present in most occupational frauds. The failure of organizations to implement policies and procedures to mitigate the fraud triangle elements is a significant contributing factor to the occurrence of occupational fraud.

For the Association of Certified Fraud Examiners’ 2012 Report to the Nations, survey participants estimated typical fraud losses to be 5 percent of revenue, which translates to potential worldwide fraud loss of more than $3.5 trillion annually.

Occupational fraud mitigation begins with effective organizational governance. According to the Committee on Sponsoring Organization’s reports, those in governance — board of directors, proprietors and partners, etc. — play a significant role in establishing effective internal controls that deter fraud. Effective governance involves:

  • Independent oversight over management's establishment of effective internal controls;
  • Accurate accounting;
  • A proper tone ethics and integrity at the top;
  • A system designed to employ competent employees;
  • A risk-assessment system designed to identify fraud risks;
  • A system designed to communicate to employees their roles in accurate financial reporting; and
  • Monitoring that ensures all of the above systems operate as intended and that employees are held accountable.

Opportunity risks for fraud include failure to properly segregate significant accounting functions. Revenue functions that should be segregated are approval of customers and sales, billing, accounts receivable recording, opening the mail, receipting, cash receipt journal recording, depositing and bank reconciliation. Disbursement functions that should be segregated are approval of vendors and purchase orders, recording of accounts payable, verification of receipt of goods, approval of disbursements, payments, cash disbursement journal recording and bank reconciliation.

Larger organizations have enough employees to segregate these functions, but smaller organizations do not. In those cases, independent oversight should be established by assigning an employee not involved in transaction processing to oversee the accounting functions assigned to one employee. If one employee opens the mail, receipts, prepares deposits and posts the cash receipts journal, the oversight employee should add receipts and compare them to the deposits and the cash receipt journal postings. An easy control is direct delivery or electronic access of the bank statement to an oversight person who looks for unauthorized checks or transfers to employees or vendors and who tests for reasonableness of cash flows and balances.

Company growth and downsizing can both contribute to opportunity risk. Layoffs and excessive turnover can leave fewer employees to segregate accounting duties, while growth results in re-assignment of personnel and internal controls. Incompetent employees increase opportunity risk because they may not properly execute their assigned internal control duties. Organizations with assets susceptible to theft — i.e., assets that are valuable, not individually identifiable and easily concealable and convertible into cash — have increased opportunity risk.

Fraud incentive risks include high competition with declining financial results, unrealistic or inconsistent performance expectations and bonus targets, and employees with personal financial difficulties, adverse relationships and addictions.

These risks can be mitigated by increasing oversight of financial reporting, establishing reasonable performance and bonus targets, offering financial family planning, identifying and correcting adverse relationships and surprise drug testing.

Fraud rationalization risks include lack of equal opportunity hiring practices and adequate employee training, unfair or noncompetitive wages, nepotism, dictatorial management practices, known employee fraud without consequences and unjustified unequal treatment of employees.

Rationalization risks are mitigated by fair compensation practices, equitable personnel treatment and policies, swift punishment of fraudulent activity and establishment of a proper tone at the top of ethics and integrity.

Jerry E. Spratt, a CPA and certified fraud examiner, owns Spratt Financial Forensics Inc. of Maumelle. Email him at SprattJE@SWBell.net.

 

 

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