Fraud Awareness and the Small Business 2016

By Frank Stover, CPA/CFF/CGMA, CFE

Audit Manager at Atchley & Associates, LLP

The Association of Certified Fraud Examiners has released the biennial Report To The Nations on Occupational Fraud and Abuse, a 2016 Global Fraud Study.

For small business the fraud that owners will most often see committed against them or their company is “occupational fraud”.  The Association of Certified Fraud Examiners defines occupational fraud “as the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.”  Occupational fraud can manifest itself in many ways.  Nor is it limited by gender.

Based upon the statistics and information contained in the “Report to the Nations on Occupational Fraud and Abuse”, 2016 Global Fraud Study, approximately two thirds of the reported cases targeted privately and publicly held companies.  Private companies suffered median losses of $180,000. The median losses suffered by small organizations (those with less than 100 employees) was the same as those of the largest organizations, but the impact upon smaller organizations would be much greater.  The total losses caused by the cases studied exceeded $6.3 billion. It is estimated that fraud costs organizations 5% of revenues each year, applying this percentage to the Gross World Product of $74.16 trillion results in a potential total fraud loss worldwide of $3.7 trillion.  Constant vigilance to prevent fraudulent activity is something that small business owners must practice every day.

Generally, occupational fraud categorized as financial statement fraud, misappropriation of assets, or corruption.  Asset misappropriation was the most common form of fraud reported in more than 83% of the cases studied.  Financial statement fraud will typically involve falsification of an organization’s financial statements or some form of regulatory or financial report. Examples include overstating assets and revenues, or understating liabilities or expenses to achieve personal gain.  Misappropriation of assets is the theft or misuse of an organization’s assets, such as skimming revenues, stealing inventory or committing payroll fraud.  Corruption involves fraudsters wrongfully use their influence in a business transaction to procure some benefit for themselves or another person(s), contradicting their duty to their employer or the rights of another, for instance by accepting kickbacks or engaging in conflicts of interest.

94.5% of the cases studied involved the perpetrator making efforts to conceal their fraud by creating or altering physical documentation.

For Small businesses cash, inventory, payroll and misuse of organization assets are the most common areas of fraud occurrence.  Cash is the most often pilfered from small business but because of its nature and importance to small businesses it is usually discovered within one month.  Inventory fraud is usually not discovered until later because small organizations will be more focused on operation measures (for example, revenues run rates, billing cycle  and accounts receivable information) in the short term and inventory will not be counted or reconciled against purchases and jobs in progress until quarter or year end.  Payroll fraud is usually committed by persons who have some form of operational control and authorization such that they can add phantom employees to the payroll or in collusion with others falsified time records submitted to the payroll department, this type of fraud is most usually discovered when there is turnover in personnel, a “falling out” between conspirators, or some form of periodic management review and reconciliation of historical project costs against approved budgets.  Misuse of organization assets many times occurs when a service company employee uses their employer’s assets on the weekend and holidays to run another business on the side, discovery of this type of fraud will usually occur when a disgruntled customer of the employee’s side business complains regarding defective work or makes a warranty claim, control of physical access to company operating assets during no business hours and mileage logs reconciliations are several ways to prevent or detect such abuse.

The most common detection methods in the cases studied were tips (39.1%).  Organizations that had reporting hotlines were much more likely to detect fraud through tips.

There are fraud policies and controls which can assist small businesses in deterring bad behavior.  Some of these include having a clearly written and communicated fraud policy which describes how and who handles fraud matters and investigations within the organization, what actions the organization considers to constitute fraud, reporting procedures (anonymous tip lines, a designated official, etc.), and what consequences the organization will take for such activity and the dedication to follow through with those stated consequences.

Atchley & Associates, LLP is a group of dedicated professionals, which include Certified Fraud Examiners, who can review, assess and make recommendations regarding small business systems of internal controls to decrease the likelihood of fraud being committed.

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