Small business, big losses: audits and hotlines stack up as the best crime busters in a new ACFE study.Occupational fraud has become--at least so far--the crime of the 21st century. It is a widespread phenomenon that affects practically every organization. The frauds in the 2004 Report to the Nation on Occupational Fraud and Abuse, from the Association of Certified Fraud Examiners Established in 1988 the Association of Certified Fraud Examiners is the professional organization that governs professional fraud examiners. Its activities include producing fraud information, tools and training. , caused over $761 million in total losses, with a disproportionate percentage committed against small businesses--almost half of the frauds in the study took place in businesses with fewer than 100 employees. Not surprisingly such businesses are less likely to be audited or employ antifraud measures than the larger ones. Several broad conclusions can be drawn from the 2004 report. First, though the losses have been stable over the years, the Years, The the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109] See : Time fact that in one year alone they are approaching $660 billion is cause for concern. Dishonest executives and employees are plying Plying, in textile manufacture, is the activity of twisting, intermingling, or otherwise intimately combining two or more fibers or yarns into a combined yarn or fiber. Plying Yarns essentially the same schemes with the same results. Second, although large financial statement frauds receive the most attention, they are relatively uncommon compared to asset misappropriations and corruption. Third, small businesses remain the most vulnerable to occupational fraud because of three factors: They are the least likely to have an audit, a hotline or adequate internal controls. Fourth, audits--both internal and external--although excellent prevention devices are not the most effective means of detecting frauds. Fifth, hotlines and other reporting mechanisms are a vital part of any organization's prevention efforts but should go beyond employees to vendors and customers, too. Finally, occupational fraud cannot be eliminated but organizations that use both hotlines and auditors can greatly reduce these costly crimes. Occupational fraud schemes can be as simple as pilferage pilferage n. a crime of theft of little things, usually from shipments or baggage. (See: theft) of company supplies or as complex as sophisticated financial statement frauds. This article summarizes some of the key findings of certified fraud examiners Certified Fraud Examiner (CFE) is a designation awarded by The Association of Certified Fraud Examiners (ACFE). The ACFE is a 41,000 member-based global association dedicated to providing anti-fraud education and training. (CFEs) in cases they investigated. Internal and external auditors The examples and perspective in this article or section may not represent a worldwide view of the subject. Please [ improve this article] or discuss the issue on the talk page. and CPAs advising small business clients will learn of the most effective antifraud measures. MEASURING THE COST OF FRAUD Determining the true cost of occupational fraud is an impossible task. Because fraud is a crime based on concealment, organizations often do not know when they are being victimized. Many frauds never are detected or are caught only after they have gone on for several years. Many of those are never reported or prosecuted. In fact, there is no agency or organization that is specifically charged with gathering comprehensive fraud-related information. All of these factors combine to make any estimate of the total cost of occupational fraud just that--an estimate. The study asked CFEs to give their best estimate of the percentage of revenues a typical organization in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. loses in a year as a result of occupational fraud. The median response was 6%, the same result obtained from previous studies. This is a staggering figure. If multiplied by the U.S. gross domestic product, which for 2004 will total over $11 trillion, it would translate into $660 billion in annual fraud losses (see exhibit 1, at right). VICTIMIZED ORGANIZATIONS The victims of occupational fraud are the organizations that employ the fraud perpetrators and suffer losses as a result of these crimes. Exhibit 2, at right, shows the distribution of frauds in the ACFE ACFE Association of Certified Fraud Examiners ACFE Adult, Community and Further Education (Department of Education, Victoria, Australia) ACFE American College of Forensic Examiners survey, based on the type of organization that was victimized. Approximately 46% of the occupational frauds in our study were committed in small businesses (defined as organizations with fewer than 100 employees). The impact of occupational fraud on small businesses was much greater than on larger companies (see exhibit 3, at right). Part of the reason for the larger losses is that small businesses are the least likely to be audited. As noted in the 2002 report, the audit appears to be a powerful deterrent to occupational fraud. HOW OCCUPATIONAL FRAUD IS COMMITTED A major goal of the study was to gain a better understanding of how fraud is committed and the types of schemes that tend to produce the largest losses. We classified each fraud according to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. the methods used by the perpetrator A term commonly used by law enforcement officers to designate a person who actually commits a crime. . Breaking down occupational frauds into distinct categories also helps CPAs better understand the common characteristics, which in turn assists in the development of better antifraud tools. There are three major categories of occupational fraud to consider: Asset misappropriations. These schemes involve the theft or misuse of an organization's assets by such means as skimming Skimming An electronic method of capturing a victim's personal information used by identity thieves. The skimmer is a small device that scans a credit card and stores the information contained in the magnetic strip. revenues, stealing inventory or committing payroll fraud. Corruption. Fraudsters wrongfully wrong·ful adj. 1. Wrong; unjust: wrongful criticism. 2. Unlawful: wrongful death. use their influence in business transactions to procure To cause something to happen; to find and obtain something or someone. Procure refers to commencing a proceeding; bringing about a result; persuading, inducing, or causing a person to do a particular act; obtaining possession or control over an item; or making a person some benefit for themselves or another person. One of the most common is accepting kickbacks or engaging in conflicts of interest. Fraudulent financial statements. These generally involve falsification falsification /fal·si·fi·ca·tion/ (fawl?si-fi-ka´shun) lying. retrospective falsification unconscious distortion of past experiences to conform to present emotional needs. of an organization's financial statements by overstating revenues or understating liabilities or expenses. While asset misappropriations were by far the most common of the three categories, occurring in over 90% of the cases, they also had the lowest median loss, at $93,000. Conversely con·verse 1 intr.v. con·versed, con·vers·ing, con·vers·es 1. To engage in a spoken exchange of thoughts, ideas, or feelings; talk. See Synonyms at speak. 2. , fraudulent financial statements were the least common (7.9%) but had the highest median loss at $1,000,000. (See exhibits 4 and 5, page 44.) CASH MISAPPROPRIATIONS Of the cases in the study, 87% involved some form of cash misappropriation misappropriation n. the intentional, illegal use of the property or funds of another person for one's own use or other unauthorized purpose, particularly by a public official, a trustee of a trust, an executor or administrator of a dead person's estate, or by any . Cash frauds fall into one of three categories: Fraudulent disbursements. A perpetrator causes his organization to disburse dis·burse tr.v. dis·bursed, dis·burs·ing, dis·burs·es To pay out, as from a fund; expend. See Synonyms at spend. [Obsolete French desbourser, from Old French desborser funds through some trick or device, such as submitting false invoices or forging company checks. Skimming. Cash is stolen from an organization before it is recorded on the organization's books and records. Cash larceny larceny, in law, the unlawful taking and carrying away of the property of another, with intent to deprive the owner of its use or to appropriate it to the use of the perpetrator or of someone else. . Cash is stolen from an organization after it has been recorded on the organization's books and records. Approximately three-fourths of the cash frauds in the study involved some form of fraudulent disbursement DISBURSEMENT. Literally, to take money out of a purse. Figuratively, to pay out money; to expend money; and sometimes it signifies to advance money. 2. , making this the most common category by far. Schemes that involved a fraudulent disbursement also had the highest median loss, at $125,000. (See exhibit 6, at right.) FRAUDULENT DISBURSEMENTS Just over half of the fraudulent disbursement cases in our study involved billing fraud, making this the most common type. Among these cases the highest median loss occurred in schemes involving check tampering tampering The adulteration of a thing. See Drug tampering. . (See exhibit 7, page 45.) The schemes included the following: Billing. A fraudster fraudster Noun a person who commits a fraud; swindler causes the victimized organization to issue a payment by submitting invoices for fictitious Based upon a fabrication or pretense. A fictitious name is an assumed name that differs from an individual's actual name. A fictitious action is a lawsuit brought not for the adjudication of an actual controversy between the parties but merely for the purpose of goods or services, inflated invoices, or invoices for personal purchases. Example: When a secretary for a public company interceded on behalf of an unpaid legitimate supplier and the accounts-payable department could not locate the original invoice, it nonetheless agreed to pay the vendor based on a fax copy. Seizing on this basic internal control deficiency, the secretary and two nonemployee accomplices set up three phony companies, submitting fax copies of doctored original invoices for "consulting fees." The fraud was discovered when a manager questioned a huge variation in the budget--but not until four years and $1.7 million later. Payroll. An employee causes the victim organization to issue a payment by making false claims for compensation. Example: A controller for a small nonprofit organization Nonprofit Organization An association that is given tax-free status. Donations to a non-profit organization are often tax deductible as well. Notes: Examples of non-profit organizations are charities, hospitals and schools. , believing she should be earning twice her salary, added a "ghost" employee to the payroll. Since she managed both the bank accounts and the books--a serious internal control deficiency--that was easy enough to do. Every pay period, she wrote a paycheck to the nonexistent non·ex·is·tence n. 1. The condition of not existing. 2. Something that does not exist. non ghost, but thanks to the company's direct payroll deposit policy, the money actually went straight to her bank account. The bank evidently never noticed the discrepancy. During a surprise audit of the payroll account, the controller mysteriously left town. It didn't take the auditors long to figure out why when they matched the direct deposits and uncovered the scheme, which had cost the nonprofit A corporation or an association that conducts business for the benefit of the general public without shareholders and without a profit motive. Nonprofits are also called not-for-profit corporations. Nonprofit corporations are created according to state law. $208,000 over three years. Expense reimbursements. An employee enters a claim for reimbursement Reimbursement Payment made to someone for out-of-pocket expenses has incurred. of fictitious or inflated business expenses. Check tampering. The perpetrator converts an organization's funds by forging, altering or stealing a check. Example: The administrative assistant to a CEO (1) (Chief Executive Officer) The highest individual in command of an organization. Typically the president of the company, the CEO reports to the Chairman of the Board. of a privately held company privately held company A firm whose shares are held within a relatively small circle of owners and are not traded publicly. knew her boss's habits all too well. Each week, right before lunch, she presented him with a stack of checks, which he quickly signed. He didn't notice the checks were prepared in erasable e·ras·a·ble adj. 1. Capable of being erased: erasable ink. 2. Capable of producing something that can be erased: an erasable pen. ink. The administrative assistant--who also acted as the company's bookkeeper--would change the payee The person who is to receive the stated amount of money on a check, bill, or note. payee n. the one named on a check or promissory note to receive payment. PAYEE. The person in whose favor a bill of exchange is made payable. on the checks, deposit the funds to her own bank account and post the checks to various company expenses in order to conceal the fraud. When the checks were returned in the bank statement, the assistant would change the name back to the payee to whom the payment was originally directed. In her haste, however, she altered checks meant to pay the boss's personal expenses. In the end, the boss's appetite cost him a half-million dollars. Register disbursements. An employee makes false entries on a cash register to conceal the fraudulent removal of currency. Example: A crafty service station attendant discovered a flaw in the cash register system; it could put a sale on hold until the transaction was completed. Simply depressing the "hold" button for a few extra seconds made the transaction disappear altogether. So when a customer bought gasoline gasoline or petrol, light, volatile mixture of hydrocarbons for use in the internal-combustion engine and as an organic solvent, obtained primarily by fractional distillation and "cracking" of petroleum, but also obtained from natural gas, by , the clerk would erase the sale and pocket the proceeds. Company auditors finally noticed a large disparity dis·par·i·ty n. pl. dis·par·i·ties 1. The condition or fact of being unequal, as in age, rank, or degree; difference: "narrow the economic disparities among regions and industries" when they compared fuel inventory to sales. After exhausting all other possibilities (including leaks in the fuel storage tanks), they installed surveillance cameras over the cash registers and caught the fraudster on tape. This simple scheme cost the company $132,000. DETECTING FRAUD As in the 2002 study, the most common means of detection--by a wide margin--was through tips (see exhibit 8, above). Recognizing the value of encouraging tips, section 301 of the Sarbanes-Oxley Act See SOX. requires audit committees of publicly traded companies publicly traded company A company whose shares of common stock are held by the public and are available for purchase by investors. The shares of publicly traded firms are bought and sold on the organized exchanges or in the over-the-counter market. to establish procedures for "the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters." Respondents were asked what, if any, antifraud measures they had in place at the time the frauds occurred. They listed anonymous reporting mechanisms (typically hotlines), internal audit or fraud examination departments and external audits. Exhibit 9, at right, shows the percentage of victimized organizations that had implemented these mechanisms. HOTLINES WORK To test the effectiveness of each antifraud control, the study measured the median loss for organizations with controls against those without them. The figures showed that anonymous reporting mechanisms had the greatest impact on reducing fraud losses. Organizations that did not have reporting mechanisms suffered median losses that were more than twice as high as organizations with them. (See exhibit 10, at right.) This was consistent with the findings of the 2002 report. This result is also consistent with the data the ACFE gathered showing the most common way for frauds to be discovered is through tips. Obviously, hotlines and other reporting mechanisms are designed to facilitate tips on wrongdoing wrong·do·er n. One who does wrong, especially morally or ethically. wrong  do . The fact that tips were the most common
means leading to detection--combined with the fact that organizations
that had reporting mechanisms showed the greatest reduction in fraud
losses--indicates this is an extremely valuable antifraud resource. The
effectiveness of these reporting mechanisms is significantly higher when
they are made available to customers, vendors and other third
parties--not just employees. Organizations that rushed to implement
employee hotlines to comply with Sarbanes-Oxley might profit from adding
these valuable additional sources of information.Curiously, anonymous reporting mechanisms were the least common antifraud measure of the three we tested for; only slightly more than one-third of victim organizations in our study had established anonymous reporting structures at the time they were victimized. THE WAGES OF CRIME Generally speaking, the position perpetrators held in an organization and their annual income tended to be the most significant factors in the size of losses in a fraud scheme. As the employees' level of authority rose, so did fraud losses. In just under 5% of the cases in the ACFE study, the perpetrator earned more than $200,000 a year--but, in those cases, median losses exceeded $1 million (see exhibit 11, page 47). OBSERVATIONS In many respects, the ACFE's 2004 report supported its findings of 2002: Small businesses still were disproportionately affected by occupational frauds, asset misappropriations still accounted for approximately 90% of reported cases and the vast majority of perpetrators were still first-time offenders. As in 2002 occupational frauds still were much more likely to be detected by a tip than through an internal or external audit; and anonymous reporting mechanisms such as hotlines still exhibited the greatest impact on occupational fraud losses. But the 2004 report also presents new information about occupational fraud that is especially critical in the post Sarbanes-Oxley world. For example, the ACFE found that over half of all frauds committed by owner/executives were detected through a tip, which was much higher than the rate for fraud in general. By comparison, only 6% of these cases were caught through internal controls. Obviously, this was because owners and executives often were able to override An arrangement whereby commissions are made by sales managers based upon the sales made by their subordinate sales representatives. A term found in an agreement between a real estate agent and a property owner whereby the agent keeps the right to receive a commission for the sale of controls to commit fraud. Given the fact that schemes by owner/executives now must be disclosed to audit committees regardless of whether they are material, and that these schemes tend to be the most costly, the study offers strong support for Sarbanes-Oxley's requirement for the establishment of anonymous reporting mechanisms. The 2004 report also looked more deeply into the ways in which small businesses were affected by occupational fraud. The ACFE found one-third of the small business cases involved a billing scheme, and one-third involved check tampering--two forms of fraudulent disbursements that typically succeed when there is a lack of control over the company checkbook. This suggests that if there is one critical area where small businesses should focus their antifraud efforts and resources, it is in establishing solid controls--including a strong separation of duties--over the check-cutting and payables functions. The ACFE also found that very few small businesses in the study--only 31%--had any form of internal audit or fraud examination department. But among that group, it was the internal audit department that detected half of the frauds. This suggests that internal auditors Internal auditor An employee of a company who analyzes the company's accounting records to that the company is following and complying with all regulations. can have a significant impact in detecting occupational fraud and minimizing losses in small businesses.
Exhibit 1: Total Occupational Fraud Losses
Year Billions of dollars
2004 660
2002 600
1996 400
Note: Table made from bar graph.
Exhibit 2: Type of Organization Victimized
Organization type
(Median loss) Percentage of cases
Private company
($123,000) 41.8%
Public company
($100,000) 30.3%
Government
(%37,500) 15.8%
Not-for-profit
($100,000) 12.2%
Note: Table made from bar graph.
Exhibit 3: Median Loss Based on Size of Organization
Median loss
Number of employees 2004 2002
<100 $98,000 $127,500
100-999 $78,5000 $135,000
1,000-9,999 $87,500 $53,000
10,000+ $105,500 $97,000
Note: Table made from bar graph.
Exhibit 4: Methods of Fraud--All Occupational Frauds
Category (Percentage of cases) Median loss
Fraudulent statements
(7.9%) $1,000,000
Corruption
(30.1%) $250,000
Asset misappropriations
(92.7%) $93,000
Note: Table made from bar graph.
Note: The percentages exceed 100% due to multiple schemes in more
than one category.
Exhibit 5: Breakdown of Asset Misappropriations
Asset targeted (Media loss) Percentage of cases
Cash
($98,000) 93.4%
Noncash
($100,000) 22.1%
Note: Table made from bar graph.
Note: The percentages exceed 100% due to multiple schemes in more
than one category.
Exhibit 6: Breakdown of Cash Misappropriations
Category (Median loss) Percentage of cases
Fraudulent
disbursement
($125,000) 74.1%
Skimming
($85,000) 28.2%
Cash larceny
($80,000) 23.9%
Note: Table made from bar graph.
Note: The percentages exceed 100% due to multiple schemes in more
than one category.
Exhibit 7: Breakdown of Fraudulent Disbursements
Category (Median loss) Percentage of cases
Billing
($140,000) 52.1%
Check tampering
($155,000) 31.3%
Expense
reimbursement
($92,000) 22.1%
Payroll
($90,000) 19.6%
Register
disbursement
($18,000) 4.3%
Note: Table made from bar graph.
Note: The percentages exceed 100% due to multiple schemes in more
than one category.
Exhibit 8: Initial Detection of Occupational Frauds
Percentage
of cases
Detection method 2004 2002
Tip 39.6% 43.0%
Internal audit 23.8% 18.6%
By accident 21.3% 18.8%
Internal controls 18.4% 15.4%
External Audit 10.9% 11.5%
Notified by police 0.9% 1.7%
Note: Table made from bar graph.
Note: The percentages exceed 100% because some respondents identified
more than one method.
Exhibit 9: Frequency of Antifraud Measures
Percentage of
victims with
measure in
place
Antifraud measures 2004 2002
External audit 74.7% 73.0%
Internal audit 57.2% 57.7%
Anonymous
Hotline 36.8% 35.2%
Note: Table made from bar graph.
Note: Some respondents had more than one measure in place.
Exhibit 10: Median Loss Based on Whether Organization
Had a Hotline
Survey Year Hotline No hotline
2004 $56,500 $135,500
2002 $77,500 $150,500
Note: Table made from bar graph.
Exhibit 11: Median Loss Based on Perpetrator's Annual Income
Income (Percentage of cases) Median Loss
<$50,000
(51.2%) $47,000
$50,000-$99,000
(28.5% $135,500
$100,000-$149,000
(11.2%) $429,000
$150,000-$199,999
(4.4%) $200,000
$200,000-$499,999
(3.6%) $1,000,000
$500,000+
(1.1%) $2,010,000
Note: Table made from bar graph.
RESOURCES AICPA AICPA See American Institute of Certified Public Accountants (AICPA). Resources Books * CPA's Handbook of Fraud and Commercial Crime Prevention (# 56504JA). * Financial Reporting Fraud: A Practical Guide to Detection and Internal Control (# 029879JA). * Fraud Detection in a GAAS See gallium arsenide. Audit (# 006615JA). CPE (Customer Premises Equipment) Communications equipment that resides on the customer's premises. CPE - Customer Premises Equipment * Introduction to Fraud Examination and Criminal Behavior (# 730275JA). * Identifying Fraudulent Financial Transactions (# 730244JA). * Finding the Truth: Effective Techniques for Interview and Communication (# 730164JA). For more information, to register or to place an order, go to www, cpa2biz biz n. Informal Business. biz Noun Informal business Noun 1. .com or call the Institute at 888-777-7077. AICPA antifraud initiatives Antifraud and Corporate Responsibility Resource Center, www.aicpa.org/antifraud. * SAS (1) (SAS Institute Inc., Cary, NC, www.sas.com) A software company that specializes in data warehousing and decision support software based on the SAS System. Founded in 1976, SAS is one of the world's largest privately held software companies. See SAS System. no. 99 information. * Management Antifraud Programs and Controls (SAS no. 99 exhibit). * Fraud Specialist Competency COMPETENCY, evidence. The legal fitness or ability of a witness to be heard on the trial of a cause. This term is also applied to written or other evidence which may be legally given on such trial, as, depositions, letters, account-books, and the like. 2. Model. * Free corporate fraud prevention training and CPE. * Academia outreach and assistance. * Other antifraud activities. JOSEPH T. WELLS, CPA, CFE CFE Conventional Forces in Europe (treaty) CFE Cash Flow to Equity (finance/accounting) CFE Comisión Federal de Electricidad (México) CFE Certified Fraud Examiner , is founder and chairman of the Association of Certified Fraud Examiners and professor of fraud examination at the University of Texas at Austin “University of Texas” redirects here. For other system schools, see University of Texas System. The University of Texas at Austin (often referred to as The University of Texas, UT Austin, UT, or Texas . Mr. Wells won the Lawler Award for the best JofA article in 2000 and 2002 and has been inducted into the Journal of Accountancy Hall of Fame. His e-mail address See Internet address. e-mail address - electronic mail address is joe@cfenet.com. |
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