Employee fraud is a very real risk and MFR's David Ahola, Internal Audit Principal, sheds light on the motivation and risk factors behind employee fraud.  David is a CPA, CIA and CFE, and has spoken to groups on the topic of employee fraud.  David can be reached at 713.622.1120 or dahola@mfrpc.com.

How and Why Does Employee Fraud Occur?

The Association of Certified Fraud Examiners estimates that employee fraud accounts for nearly $1 trillion in losses each year. Workers may commit a variety of crimes, ranging from misappropriation of assets to stealing supplies. There’s no guaranteed way to stop your employees from committing fraud, but you can slow them down.

According to David Ahola, CPA, CIA, CFE, a principal with MFR’s Internal Audit practice, employees who commit fraud aren’t your typical criminals. Many perpetrators of fraud are trusted employees, who, for whatever reason, choose to embezzle funds or otherwise commit fraud because they’ve either gotten into financial trouble (especially true in tough economic times) or they see a window of opportunity and the temptation is too hard to resist.  “Three conditions must be present for fraud to occur – opportunity, pressure and rationalization.”

Some employees justify their actions by convincing themselves that they’re just “borrowing” the funds or even that the company owes it to them. Others are motivated by a desire to live a more extravagant lifestyle. “Behavioral red flags include employees living way beyond their means or experiencing financial difficulty.”

At-Risk Functions

A variety of company functions are particularly vulnerable to fraud:

Accounts Payable        
Employees may forge checks to themselves, accept kickbacks from vendors, pay personal bills with company funds, or create and pay bills to fictitious suppliers.

Accounts Receivable    
Workers may grant fake credits or take fraudulent write-offs for bad debts or simply collect written off balances.

Cash Management        
Employees may steal cash on hand, divert cash receipts or alter bank deposits.

Payroll 
Workers might pay nonexistent employees, pad time records, falsify salaries or commit withholding fraud.

Inventory and Fixed-Asset Management
Workers might steal company assets; divert and sell shipments; or use job materials, tools or other assets for non-job-related purposes.

In each of the aforementioned scenarios, the employee simply pockets the money and keeps his or her fingers crossed that no one will find out. But if you work with your accountant to create effective internal controls, you’ll be able to locate the areas in which fraud is being committed.

Real-Life Example

If you think it can’t happen to your organization, think again. The recent case of Houston-based oilfield services company is a very real example of how this can happen in a successful business. The recent court ruling indicated that about $15 million was embezzled.

A 12-year accounting employee at the company, the defendant, and relatives working under the defendant, carried out a fraud scheme through hundreds of checks over several years.

In the late spring of 2009, the company was involved in restructuring leases on numerous copying machines for its business. During this restructuring, a certain copy machine could not be accounted for or located immediately. The company learned that said copy machine leased to them was not located at its facility, but was in fact located at facilities owned and operated by the defendant’s son. Shortly after this discovery the company undertook an investigation into the accounts payable that had been managed by the defendant.

After extensive forensic examination of the accounting records, telephone records and the accounting systems, the company discovered that the defendants had engaged in multiple and various schemes to embezzle millions of dollars.  The former employee/defendant, and the other defendants employed by the company, utilized various methods to access funds to which they were not entitled.

Generally, the schemes were variations of a primary scheme in which those parties who were employed in the company’s accounts payable department would draft checks to various entities with which they had some affiliation and/or were not entitled to the funds. These checks were supported, at the time they were signed by the authorized signatory, by fraudulent back up invoices or general invoices of the company’s legitimate creditors with similar names to the defendants’ entities. This fraud was carried out over a number of years and involved hundreds of checks. These checks were then negotiated and/or deposited at banks into accounts controlled by the defendants.

Protect Yourself

MFR can help you protect your organization from fraudulent activity.  Our team of Certified Internal Auditors, Certified Fraud Examiners, and Certified Public Accountants can also show you how to monitor bookkeeping records, invoices, bank statements, payments, journal entries, financial reports and other documents so you can catch subtle changes before too much money has been siphoned off. MFR also can perform scheduled and surprise audits to identify potentially dangerous gaps in your controls and procedures. 

Contact us to learn more.