Manufacturing Articles
Flagging Fraud can be a Lifesaver
Author: Mark Chow, Matthew Lem
Date: October 2010
Publication: Canadian PLANT
In economic downturns, every manufacturer should be mindful of the potential for fraud. Occurrences of employee or occupational fraud tend to rise during such financially difficult times. And, when a company is struggling financially, fraud can prove to be the fatal blow. In fact, insolvency practitioners are now seeing exactly this result – many of today’s corporate insolvencies were accelerated by fraudulent activities. While the Association of Certified Fraud Examiners estimates the average organization loses 5% of revenue to fraud and abuse, the highest losses occur within organizations with less than 1001 employees – and tough economic times escalate these losses.
If you want to focus on fraud prevention, begin with your company’s standard codes of conduct. Ensure that every employee know these. At the same time, management needs to demonstrate ethical leadership and foster an environment of integrity, free from fraud.
Ethical leadership alone, however, will not stop fraud, so it is important that manufacturers are alert to “red flags” that could be indicators of fraudulent activity. Understanding what drives employees to commit “occupational fraud” may therefore be helpful; generally, it’s a combination of three factors:
- the opportunity to commit fraud, typically due to weaknesses in an organization’s controls;
- pressure from an employee’s personal life, such as debt, divorce, gambling, drugs – or work pressures such as unrealistic performance goals; and
- rationalization or justification of the fraud, such as: “I’m just borrowing; I’ll pay this money back,” “I deserve more” or “everybody does it.”
Sadly, it’s often the people an organization trusts most that tend to commit this type of crime. Good people can do bad things – especially when times are tough. A trusted employee may be experiencing personal financial pressures. At the same time, the employer may be downsizing or cost cutting, which can deflate employee morale and weaken internal controls. This is an ideal environment for fraud to thrive.
Moreover, fraud can be difficult to spot because it can arise in many different forms.
- Stealing (cash, inventory, supplies, equipment, data, etc.)
- Forgery (cheques, signatures on purchase orders, etc.)
- Lapping (diverting cash from customer accounts)
- Kiting (drawing against balances credited to uncollected cheques)
- Cheque tampering
- Taking cash receipts intended for deposit
- Recording fictitious transactions
- Falsifying timesheets for higher pay
- Creating fictitious employees and collecting their pay
- Collecting pay cheques of employees who no longer work for the company
- Establishing dummy companies and placing false orders
- Fabricating/duplicating/overclaiming expense account items
- Issuing false receipts and skimming payments from customers’ accounts
- Taking bribes or kickbacks from vendors
- Falsely billing for products or services and collecting the cash
- Taking cheques that are payable to suppliers
- Falsifying financial statements
Typically, employee fraud begins with small transactions, which become larger and more frequent when the crime is not discovered. Thus it’s important to prevent or limit fraud before losses accumulate to the point where they may become detrimental to the health of the company. Following are some red flags that can alert you to the potential existence of occupational fraud in your organization.
Employees
Lifestyle improvements (e.g. more expensive vehicle, home, clothes)
Behavioral changes (may be a result of stress or addictions)
Personal debt troubles
Refusal to take vacation or sick leave
Payroll
High overtime claims
Unusual increases in hourly rates
Missing or duplicate social security numbers
Employees without payroll deductions
Accounts Receivable
Bank deposit and posting discrepancies
Slow reconciliation of bank accounts
Disproportionate or unsupported cash transactions
High volume of discounts, returns, voids, credit notes issued
The appearance of unauthorized bank accounts or new activity in dormant accounts
Non-payment notices
Frequent expense items, supplies, or reimbursements claimed by an employee
Large number of account write-offs
High employee turnover
Purchasing
Increase in purchasing inventory without corresponding sales increase
Atypical inventory shrinkage
Invoices unaccompanied by shipping documents
Growing volume of complaints about products
Large number of purchases from new vendors
Payments made to vendors that are not on approved vendor list
Purchases do not follow regular procedures or have unusual payment terms
Vendor address is a post office box or an employee’s address
Unfortunately, in many cases of fraud, red flags like these are present, but are either not recognized or not acted upon. Thus in order to prevent losses from soaring, it is vital to actively look for fraud flags and, when present, to immediately investigate. And, even when no flags are apparent, keep in mind that 85% of companies surveyed in a recent global fraud report were affected by at least one fraud in the past three years.2 Thus for any organization, implementing proactive fraud prevention measures protects the bottom line. In fact, they can be a life saver.
Does your company have effective fraud prevention measures in place?
- Is ongoing anti-fraud training provided to all employees?
This includes what constitutes fraud; the costs of fraud to the company and everyone in it (lost profits, adverse publicity, job loss, decreased morale and productivity); how to communicate concerns about wrongdoing; where to seek advice; clear communication of zero-tolerance policy for fraud.
- Is there an effective fraud reporting mechanism in place?
This includes an anonymous reporting channel, (such as a third-party hotline) and clear communication that reports of suspicious activity will be promptly and thoroughly investigated.
- Are proactive measures taken and publicized to employees to increase their awareness of the potential for detection?
These include actively seeking possible fraudulent conduct; performing scheduled and surprise fraud audits; using auditing software to detect fraud and communicating this throughout the organization
- Is the management climate/tone at the top one of honesty and integrity?
This includes realistic performance goals; fraud prevention goals integrated into manager performance measures; a process for oversight of fraud risks by those charged with governance; and questions in employee surveys asking the extent to which they believe management acts with honesty and integrity.
- Are fraud risk assessments performed to proactively identify and mitigate the company’s vulnerabilities to internal and external fraud?
- Are strong anti-fraud controls in place and operating effectively?
These include proper separation of duties; use of authorizations; physical safeguards; job rotations; mandatory vacations.
- Does the internal audit department (if one exists) have adequate resources and authority to operate effectively and without undue influence from senior management?
- Does the hiring policy include (where law permits): past employment verification; criminal and civil background checks; credit checks; drug screening; education verification; references check?
- Are employee support programs in place to assist employees struggling with addictions, mental/emotional health, family or financial problems?
- Is there an open-door policy in place that allows employees to speak freely about pressures, providing management with an opportunity to alleviate such pressures before they become acute?
- Are anonymous surveys conducted to assess employee morale?
Excerpted from the 2010 Report to the Nations on Occupational Fraud and Abuse, Association of Certified Fraud Examiners
Mark Chow, CA, CIRP, CFE, CMC, trustee in bankruptcy, is a senior vice-president and Matthew Lem, CIRP, trustee in bankruptcy, is a vice-president of the Financial Recovery Services Group of BDO Canada Limited. You can reach Mark in the Toronto office at (416) 369-3129, MChow@BDO.ca and Matthew in the Markham office at (905) 946-5431, MLem@bdo.ca.
