Occupational Fraud: How to Identify and Prevent It

Jason Thompson

By: Jason Thompson - Partner, Sponsel CPA Group

Categories: Business Ethics, Cybersecurity

You may think you know what "fraud" means, but for a business owner/manager it is especially important to understand how to find and prevent fraud in their operations. Let's look at types of occupational fraud, learn who commits it and why.

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Most people believe that occupational fraud involves a complex conspiracy with lots of moving parts and layers deception. Our experience, however, indicates that, in most cases, if basic safeguards had been in place and utilized, the occupational fraud could have easily been prevented.

First, let's talk about common types of fraud involving asset misappropriation (a fancy word for theft).

Skimming in its simplest form is theft of money before it is reported by the company, such as not reporting or under-reporting a sale.

Larceny is also theft of funds. The primary difference between skimming and larceny is that while skimming happens “off the books” (before cash is reported by the company) larceny happens when funds “on the books” are stolen.

Fraudulent disbursement schemes include check tampering, register disbursement, billing, expense reimbursement and payroll schemes. A common example is an employee's use of a company-issued credit card for personal transactions. Without appropriate internal controls, expense reimbursement schemes can be difficult to detect.

Knowing who commits fraud can be helpful in designing internal controls to reduce the opportunity for fraud in your business. Based on data from the Association of Certified Fraud Examiners, occupational fraud is most often committed by perpetrators with the following characteristics:

Gender – Males account for approximately two-thirds of occupational fraud cases.

Age –54 percent of the perpetrators were between ages 31 and 45.

Education –54 percent of perpetrators have a college degree or above.

Position within the Company – Occupational fraud is committed most frequently by the rank-and-file employees of a company. While this level of authority constitutes the most frequent level of perpetrator, fraud at the owner/executive level of authority is approximately six times more costly than that of other employees.

Tenure with the Company – The longer an employee works for a company, the more trust they can build with supervisors and co-workers. They also gain a better understanding of the company and its transactions. These factors contribute to employees with tenure of between one and five years being the most frequent perpetrators of occupational fraud.

Department at the Company – Employees in the accounting department generated the highest number of occupational fraud cases, followed closely by operations and sales.

Prior Criminal Background/Employment History – Approximately 87 percent of cases in which information about prior criminal background was available indicated the perpetrator had not been previously convicted of a fraud-related offense. Of the cases with employment history available, 84 percent showed the perpetrator had no prior termination/punishment for occupational fraud.

Keep in mind that just because an employee falls into one or more of these demographic patterns doesn't mean they will commit occupational fraud; these are merely the common traits found among perpetrators.

Now let's talk about why occupational fraud occurs. Dr. Donald R. Cressey developed a hypothesis known as the “Fraud Triangle,” a model for explaining the factors that cause someone to commit fraud. The factors are Pressure, Opportunity and Rationalization.

Pressure is an incentive or reason for doing something. Pressure can be internal or external to the company. Internal pressures include perceived lack of appreciation, the perception of being under-compensated, being mistreated by a supervisor/boss/owner, etc. External pressures include addictions, unexpected financial difficulty, health concerns, family financial pressures, etc. In the context of occupational fraud, the pressure ultimately causes a financial problem for the employee that they are forced to search for ways to solve.

Opportunity is any chance for advancement. Opportunities exist for employees when they have both access to an asset and access to the company records regarding that asset. For instance, when an employee has both the ability to authorize and record a cash disbursement.

Opportunities can be minimized with well-designed internal controls. Therefore, a review of your company's processes, combined with periodic oversight and inquiry, will help in identifying opportunities and ways to eliminate them. Segregation of duties and authorization, along with avoiding conflicts of interest, are also strong preventive tools.

Rationalization is often considered the trigger for fraud to occur. Rationalization is the justification of the fraud as the solution to the pressure.

The existence of all three fraud triangle factors in a particular instance causes the chances of fraud to skyrocket. Don't get caught holding the triangle -- know your critical employees, design and implement effective internal controls and watch for changes in employees attitudes, habits and activities.

Jason Thompson is partner, director of valuation and litigation services Sponsel CPA Group.

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