Updated June 2023
Business owners face challenges that come in a variety of forms – from internal strategy to staffing issues and from competitive climate to external market trends. It’s a never-ending list. One challenge that companies hope they never have to deal with is fraud. Unfortunately, business fraud is more common than many business owners imagine.
Fraud can be referred to as a deception deliberately practiced in order to secure unfair or unlawful gain. It can be in different sizes and shapes, ranging from a small employee theft of $100 to a sophisticated embezzlement scam resulting in hundreds of thousands of dollars in loss. Business fraud can be in various forms; however, they often fall into two main types: Misappropriation of Assets & Fraudulent Financial Reporting.
Misappropriation of Assets
This type of fraud is the most common type and is what people think of when they hear that a business has experienced internal fraud. It is defined as the theft of an organisation’s assets. The following are examples of this type of fraud:
- Consumer fraud
- Cash larceny
- Invoicing fraud
- Non-cash misappropriation
- Expense reimbursement
Consumer fraud occurs when you suffer a financial loss involving deceptive, unfair, or false business practices. Identity theft is a common example of this, whereby someone may assume your identity, open credit cards, bank accounts, and charge purchases. This may also include forgery of cheques.
Cash larceny is the theft of cash that has already been accounted for in the organisation’s books. It is a form of embezzlement limited to operations involving the original receipt of cash.
Invoicing Fraud is a billing scheme related to an individual submitting false invoices that the company makes payment on. Whilst the payment is legitimate, the payee is fraudulent. The two most common methods are:
- Using a dormant company, which then issues false invoices.
- Or by double paying the legitimate vendor.
This can be achieved through the diversion of funds into an alternative account, or even by creating false suppliers. Internal controls are extremely important in reducing the risk of being exposed to this. Some examples of internal controls that should be in place are:
- Splitting or rotating duties in high risk areas of accounts payable and payroll.
- Regular and thorough reconciliation of Accounts Payable and Payroll.
- Proper approval processes for purchase orders, invoices and on-line payments.
- Review of master files to ensure changes to supplier/employee details are legitimate.
Non-Cash Misappropriation occurs when a person takes company goods or any other physical assets and uses them for his personal benefits. Also, known as “shrinkage”, this type of fraud commonly affects businesses involved in the selling of products and merchandise.
Discovering non-cash misappropriation can be difficult, especially in organisations with large inventory. However, with proper controls, such as the following, risk, can be reduced.
- Rotating roles
- Regular Stock counts
- Proper employee vetting and reference checks
Expense Reimbursement fraudulent activities occur through false or inflated claims for reimbursement of work related costs. For example; when an employee attends a conference and needs to spend out-of-pocket expenses on things like accommodation or car rental. These costs are usually supported with receipts and invoices. An employee can exaggerate or submit false invoices/receipts, which the business subsequently pays.
An employee can exaggerate or submit false invoices/receipts, which the business subsequently pays. Identifying fraudulent expense reimbursement can be tricky. Often you must rely on your “Gut Feel” as to whether expected mileage, dinner tabs seem reasonable. Care must be taken in asking questions as you don’t wish to offend or falsely accuse an employee.
Fraudulent Financial Reporting
This type of fraud, being less frequent, tends to be far more costly to a business. Fraudulent financial reporting is basically misrepresentation in the financial statements. Financial statements are used by external parties, such as banks and investors, but, are also internally used for planning, forecasting and budgetary purposes. If the numbers in the financial statements are incorrect, it could easily cause an organisation’s financial infrastructure to crumble or even lead to a loss in the “external parties’ confidence.
Examples of this type of fraud include: Misrepresentation of assets, misrepresentation of revenue & misrepresentation of liabilities.
Given the frequency and extent of fraud in businesses, knowing what to look for is the key to any preventative effort. While many of these schemes often deduct only a small amount of money from the total assets of the business, these continual small amounts can lead to serious losses. Therefore, knowledge is the first step to prevention. Having an extensive system of checks and balances in place in your organisation, can lead to a considerable saving of assets, prevention of fraud and huge reduction in headaches for Business.
For more information on the above, or other audit related matters please contact our Davidsons Audit Team on 03 5221 6399 or email us at firstname.lastname@example.org.
Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article.