Joe Epps 2013-12-05 06:01:14
Fraud Detection: A Forensic Accounting Perspective It is a news headline all too familiar. Investors defrauded out of millions by a wealthy financier. Accounting fraud committed at a multibillion dollar corporation by management. Employee embezzled hundreds of thousands from his company. While the magnitude of fraud involved in the cases that make headlines does not occur at all organizations, all organizations are at risk for fraud. A fraud detection analysis is a tool which can be used by organizations to minimize the potential for fraud to occur. The suggestions offered below will help identify important information to focus on when performing a fraud detection analysis: Identify Relevant Relationships Within the Data The median loss due to occupational fraud or employee theft is $175,000, with more than one quarter involving losses of at least $1 million. According to the Association of Certified Fraud Examiners 2008 Report to the Nation, approximately 88 percent of these frauds occur via asset misappropriation. Examples of asset misappropriations include skimming, falsifying expense reimbursements or billing, and payroll fraud. These potential fraud schemes can be directly linked to line items in the internal profit and loss statements. By analyzing relationships in the financial data, irregularities and potential fraud can be identified and further investigated. For example, third-party consultant or contractor costs per month or quarter could increase due to fictitious invoices. Increased travel expenses per employee could indicate an employee is falsifying expense reports. Payroll expenses per location could increase due to the creation of fictitious employees. As with most elements of income and expenses, there are multiple factors affecting their behavior. Any one comparison does not necessarily tell the full story, but by performing a few periodic tests on some high-risk areas, abnormalities can be identified and investigated. High-risk areas will vary by industry, some potential data relationships to monitor for fraudulent activity are: • Number or dollar amount of customer discounts per number or dollar amount of sales. • Sales per location, employee, hour or number of transactions. • Any expense line item as a percentage of sales; or other relevant factor. • Sales per number of transactions. Maintain Professional Skepticism Professional skepticism for a certified public accountant is defined by AICPA Practice Alert 98-2 as “an attitude that includes a questioning mind and working practices that encompass a critical assessment of…evidence.” Identifying potential fraud requires application of skepticism when looking at financial data. However, many accountants have no specific training in fraud investigation and as a result may be ineffective in applying skepticism for the purpose of uncovering potential fraud. Also, when an accountant sees essentially the same types of reports period after period, they may not notice changes that have gradually occurred and which could indicate potentially fraudulent activity. One procedure to address this situation is to consider bringing in an outside consultant to evaluate fraud detection procedures already in place and offer suggestions for new detection methods. Awareness of the potential for fraud is the key to detection. A Note for Small Businesses Many small businesses will not have the data capabilities, information availability or resources of larger businesses. However, the role of a financial analysis in these companies should not be discounted. According to the ACFE’s 2008 Report to the Nation, median losses due to occupational fraud at businesses with fewer than 100 employees were $200,000, which was higher than median losses in any other category. Although the scale of the fraud-prevention techniques may be smaller, the same methods described above apply to small businesses as well. In fact, the fraud-prevention may be more important since a significant loss due to internal fraud at a small company can be devastating. Small companies should also discuss employee dishonesty insurance coverage with their insurance agent. Most commercial insurance policies include little, if any, employee dishonesty coverage. Fraud prevention is an important issue for management and for anyone advising management. This would include outside accountants and the business attorney. By analyzing relevant relationships within financial data, brainstorming about areas of the business subject to fraud risk, and retaining a level of professional skepticism with financial information, finance professionals can provide a meaningful role in the prevention process. As the most trusted business adviser, the business attorney can play a key role in keeping management alert regarding potential fraud exposures. Joe Epps is a CPA and CFE with over 30 years of experience in forensic accounting. His litigation support experience includes contract disputes, antitrust, economic damages, fraud investigations, business valuation and intellectual property litigation. Joe is currently president of Epps Forensic Consulting and teaches a graduate course on forensic accounting at Arizona State University. For more information, please call (480) 595-0943 or visit www.eppsforensics.com
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