A lot of business stories over the years have focused on financial crimes as we discussed in an article previous to this. Lying, cheating, and stealing have been done by corporate executives and others to line their own pockets with shareholders’ money. Whether one is talking of major fraud or small-time embezzlement, the perpetrators are often very clever and able to cover their tracks. Thus, audit committees should be very alert to the “fraud triangle”—a combination of three factors that should lead them to wrongdoers.
But first, let us define fraud. Fraud is an act intended to deceive through false pretences for the purpose of inducing another party with something of value to part with it for the benefit, of or to the detriment of the organization, by persons inside or outside the organization. Some examples of fraud are stealing money or merchandise, cheating on expense accounts, falsely claiming overtime, taking kickbacks or bribes from suppliers or customers, and providing false company information to creditors or government regulatory bodies. Some fraud schemes include asset misappropriation; bribery and corruption; credit-card fraud; theft of intellectual property; insurance fraud; tax fraud; consumer and Internet fraud; contract and procurement fraud; and many others.
The detection of fraud is an important function of a company’s audit committee, which must be alert to three major points that lead to fraudster activity. These are: motive, opportunity and rationalization or self-justification, which may be considered as the fraud triangle.
Motive usually stems from some kind of pressure or perceived pressure, which is typically economic, such as the need for funds to pay for any of the following: educational tuition, hospital bills, child support, addictions to such vices as gambling or drugs, illicit affairs, or unaffordable high lifestyle.
Opportunity comes into play when internal controls are weak, and the fraudster is confident that he will not be discovered. For example: nobody counts inventory or checks deviations from specifications, so losses are not known, the petty cash box is left unattended, laptops and other digital gadgets, such as cameras, are left out in the open, and offices are unlocked, people are given authority, but their work is not supervised or reviewed, and too much trust and responsibility are placed in one employee, and there is no separation of duties.
Rationalization or self-justification occurs with such excuses as: I’m just borrowing, it’s temporary and will pay it back when I get over this financial difficulty; I need it more than they do, and they will never miss it; everyone else is doing it; no one will get hurt; it’s for a good cause; I deserve it because I have been treated unfairly—the company owes me. No fraudster really believes that he has committed a crime, and he will set things right eventually, or he deserves a bonus or promotion of which he has been unfairly deprived.
The fraud triangle is aggravated for example by instances like an employee that is caught isn’t prosecuted, just fired; supervisors set a bad example by bringing supplies home, borrowing company equipment for personal use; padding their expense reimbursements, not paying for personal long-distance calls, etc.; monthly or regular financial reports are not reviewed by managers; and there is no internal-audit function.
Internal controls, particularly accounting controls, are the first line of defence in detecting and preventing fraud. However, it is difficult to detect or prevent fraud when two or more employees collude, not necessarily just senior level officials, but midlevel or lower-level employees may perpetuate fraud to achieve company growth objectives, advancement or recognition, or to conceal failures or mistakes.
The following are briefly some tips to detect fraud, including potential warning signals: analyze the integrity of management; have a reliable accounting department and internal-control system; audit committee should obtain independent auditors who are knowledgeable about the company; analyze the trends and practices in the industry as compared to the trends and practices in the company; and material fraud is often exposed by analysis of changes in financial information, account balances and significant financial ratios between different accounting periods.
Definitely, fraud is a major concern of all companies. It is suggested that fraud examinations usually require a cooperative effort among many disciplines. A fraud team might consist of the following members: fraud specialist; auditors; security personnel; human-resource personnel; management representative; outside consultants or private investigators; and legal counsel.
merci.suleik@gmail.com