By Daniel Keaton, Senior Manager
A common oversight made amongst many business owners and managers is fraud risk assessment. The Association of Certified Fraud Examiners states that a typical organization loses around 5% of annual revenue to fraud with much of it being attributed to internal fraud. It is imperative that business owners and management understand the different types of internal fraud as well as know the steps they should take to prevent such fraud.
Internal fraud is defined as “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the organization’s resources or assets.” There are three categories of internal fraud: asset misappropriation, corruption, and financial statement fraud.
Asset misappropriation occurs when people who are entrusted with the assets of an organization steal the assets. The asset most susceptible to theft is cash, however, assets such as inventory may be subject to theft as well.
Corruption is a scheme in which an employee misuses his or her authority in a way that violates his or her duty to the employer in order to gain personal benefit. Fraud involving corruption commonly involves areas pertaining to conflicts of interests and bribery, such as purchasing/sale schemes and kickbacks.
Financial statement fraud involves the intentional overstatement or understatement of net worth/net income on the organization’s financial statements. Financial statement fraud can also include omitting material information in the organization’s financial reports such as missing footnotes.
According to a 2016 Global Fraud Study by the Association of Certified Fraud Examiners (ACFE), the median loss from a single case of occupational fraud was $150,000. The median loss suffered by small organizations (those with fewer than 100 employees) was the same as that incurred by the largest organizations (those with more than 10,000 employees). However, this type of loss is likely to have a much greater impact on smaller organizations.
The study found that asset misappropriation was by far the most common form of occupational fraud accounting for 83% of cases. Although asset misappropriation is the most common type of fraud, it causes the smallest median loss of $125,000, whereas financial statement fraud, which occurs in less than 10% of cases, causes a dramatically higher median loss of $975,000. Interestingly, the study also found that organizations that lacked anti-fraud controls suffered greater median losses – as high as two times as much in some cases.
According to the study, the most common way that internal fraud is initially detected is by tips. While the study reported that tips were the most common means that fraud was initially detected, only around 60% of companies in the study reported actually having a fraud tip hotline in place. A fraud tip line is a great way to provide employees with a means to report any suspicions or accusations of fraud.
The second and third most common ways fraud is initially detected is by having both an internal audit function and management review function, respectively. While it may be difficult for small organizations to implement an internal audit function, all organizations should have a management review and monitor internal controls put in place to reduce fraud risks. Detecting and preventing internal fraud is difficult for companies of all sizes but by knowing how fraud happens and having the right systems in place, you can help protect your organization’s assets. As always, speak with your accountant for more information about internal fraud prevention.
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