Organizational Fraud Red Flags to Watch Out for
The Association of Certified Fraud Examiners (ACFE) in its latest Report to the Nations states, “occupational fraud is very likely the most costly and most common form of financial crime in the world.”
As businesses become increasingly complex, the role of accountants has evolved to include vigilance against potential areas of fraud and abuse. Accounting records provide a wealth of information about a company's operations, and discrepancies can be an early warning sign of fraud.
Robin Bristow, a CPA and Certified Fraud Examiner with Clark Robinson, part of the Integrated Advisory Community, has been conducting fraud examinations for almost two decades. He has witnessed firsthand the toll that organizational fraud can take.
“On average, 5% of gross revenue is lost to fraud each year. Beyond the financial cost, there is the potential for significant reputational damage, which can make it difficult to hire good talent. For smaller companies, it’s also very personal—it hurts to be stolen from.”
Types of Organizational Fraud
The ACFE identifies three categories of organizational fraud: asset misappropriation, corruption, and financial statement fraud.
Asset Misappropriation
Asset misappropriation is the most common type of fraud, accounting for 86% of cases. These crimes include:
Skimming
Cash larceny
Billing schemes
Payroll schemes
Expense reimbursement schemes
Cheque and payment tampering
Register disbursements
Asset requisitions and transfers
While common, asset misappropriation tends to result in lower losses, with an average of US$100,000. Billing schemes present the greatest risk within this category.
Corruption
Corruption accounts for 12% of organizational fraud cases but often occurs in tandem with asset misappropriation (32% of cases). Types of corruption include bribery, conflicts of interest, illegal gratuities, and economic extortion. The average duration of corruption fraud is one year.
Financial Statement Fraud
Financial statement fraud involves falsifying balance sheets, income statements, or other financial statements to mislead about the financial health of an organization. This is the least common type of organizational fraud, with only 9% of cases reported, but it is the costliest, averaging losses of nearly $600,000.
Common Organizational Fraud Red Flags
The bad news is that a typical fraud case lasts 12 months before detection, causing an average loss of over $8,000 per month. The good news is that 85% of fraudsters display behavioral red flags that can be detected by an organization and their accounting team.
“Employees living well beyond their means is a huge red flag,” Bristow points out. “If an employee making $48,000 annually is driving a new Maserati, that warrants further exploration. It could be legitimate, perhaps due to an inheritance, but it could also signal fraudulent activity.”
Other warning signs include sudden changes in financial reporting, such as increased credit card expenses or unexplained withdrawals. Employees may also attempt to conceal fraud by altering financial records or creating false invoices.
“I knew of a case where an accounts receivable clerk didn’t take holidays for three years,” Bristow shares. “She was stealing money using receivables. When the owner insisted she take time off, her replacement quickly discovered the fraud. If someone is unwilling to share their job or take time off, that should raise alarm bells.”
Other suspicious activities include personal use of company funds, excessive entertainment or travel expenses, unusual patterns in vendor payments, and unexplained discrepancies in inventory levels. Close relationships with vendors or clients might also warrant a deeper look.
How to Proceed if Fraud is Suspected
“The first step is to maintain strict confidentiality,” Bristow cautions. “You could open yourself up to a defamation suit if not. Only include those who absolutely need to know.”
Next, secure legal advice promptly.
“Understand your rights and how to secure evidence. Determine whether you should terminate the employee and if you have a policy that allows access to company emails. A lawyer can help clarify your next steps.”
Assume that you will end up in court, so all correspondence should be prepared for judicial review.
“Secure potential evidence discreetly—paperwork, quotes, contracts—without alerting the suspect,” Bristow advises.
Fraud Prevention: A Proactive Approach
Organizational fraud can be daunting, but proactive measures can help. Lean on your trusted advisor, your accountant, to understand your operations and detect discrepancies. Accountants within the Integrated Advisory Community are uniquely positioned to protect clients with the support of a team of best-in-class specialists.
Meet Robin Bristow
Robin Bristow is a CPA with Clark Robinson and the Practice Lead in fraud investigation services. As a Certified Fraud Examiner, Robin brings nearly two decades of experience in helping clients navigate fraud investigations and establish fraud prevention programs.
At WealthCo, we are committed to safeguarding your business. Contact us today to learn how we can help you protect your organization from fraud and enhance your financial security.
The Integrated Advisory Community consists of a network of progressive CPA firms, along with best-in-class professional advisors, service, and product specialists, who work together to deliver an elevated and holistic client experience. One that optimizes both their personal and professional lives with an integrated financial strategy designed to help clients reach their goals.