Occupational fraud is a concern for businesses, irrespective of their size, type, and industry. Though the majority of employees in every organization is loyal and works for the organization’s benefit, there could be some who commit fraud and cause financial loss besides tarnishing the business’ reputation.

To reduce such losses, employee fraud needs to be detected and prevented. Experts advise organizations to have a fraud prevention plan in place.

This article discusses various strategies that help employers detect and prevent fraud in their businesses.

What is Occupational Fraud?

According to Lofland & McNeal (2014), occupational fraud, often used interchangeably with employee fraud, occurs in small businesses where preventative measures to avoid fraud do not exist. It is found that unethical employee behavior is a significant factor that contributes to occupational fraud. Huge financial losses, legal costs, and ruined reputations caused by the fraud can, in the long run, lead to the downfall of the business.

As per the 2020 report by the Association of Certified Fraud Examiners (ACFE), a typical organization loses 5% of its annual revenue each year due to employee fraud. The study found that asset misappropriation (theft of cash, data, and property), corruption, and financial statement fraud schemes (deliberate misstatement, misrepresentation, or omission of financial statement data) are the most common frauds.

Types of Frauds

ACFE notes that there are three categories of occupational fraud at the highest level. They are:

• Asset misappropriation, the first category, involves an employee stealing or misusing the employing organization’s resources. It occurs in the vast majority of fraud schemes. Examples of asset misappropriation are stealing cash before or after it has been recorded, making false expense reimbursement claims, and/or taking non-cash assets of the organization.

• The next category, financial statement fraud schemes, in which the perpetrator intentionally causes a material misstatement or omission in the organization’s financial statements, are the least common but costliest category of occupational fraud. It can happen in the form of fictitious revenues, hidden liabilities, or inflated assets.

• The third category, corruption, happens when employees use their influence in business transactions for their benefit while violating their duty to the employer. It includes offenses such as bribery, conflicts of interest, and extortion. Corruption falls in the middle in terms of both frequency and financial damage.  

The Fraud Triangle

The fraud triangle is a model used by decision-makers in organizations to prevent and detect occupational fraud. It is employed to discover and avoid not only asset misappropriation or fraudulent financial statements, but deceitful acts committed by all fraudsters. Though there have been disputes about the effectiveness of the fraud triangle model, several auditors make use of it even today.

The fraud triangle framework put forth by Donald Cressey aims at explaining the rationale behind fraud and suggests three factors that apply to fraud perpetrators in general:

1. Pressure: An employee can be pressured or motivated to commit fraud due to a personal financial problem, such as a huge debt. At times, the pressure originates from problems at work.

2. Opportunity: The employee who plans to commit the fraud discovers a weakness of internal control and believes that no one will notice if they steal.

3. Rationalization: Rationalization is normally the excuse for committing fraud. Most often, fraudsters rationalize by telling themselves that they are only temporarily borrowing from the organization or that it is okay to steal.

In most cases, motive and rationalization are beyond the control of management. These factors are usually a result of outside influences, personal lives, and individual personalities. Opportunity is the one factor that management can control; thus, businesses need to focus on reducing the opportunities to commit fraud.

Who is responsible for preventing and detecting fraud?

Following the auditing standards, experts claim that the primary responsibility for the prevention and detection of fraud rests with the governing body and management. The responsibilities of the management include creating an environment where fraud is not tolerated, identifying risks of fraud, and taking proper actions to ensure that controls are in place to prevent and detect fraud.

The governing body is liable for ensuring that management is carrying out the tasks assigned to them concerning fraud risk and prevention, as well as understanding the situation to determine if management can overrule or influence the controls in place.

If an internal audit function can be established, some of management’s responsibilities can be delegated. Internal auditors are usually knowledgeable in evaluating the potential and probability of fraud, errors, or noncompliance and can review internal controls for effectiveness.

External auditors come into the picture when an internal audit function is not operational. Though the external auditors can assess fraud risk within an entity and perform procedures to address those risks, they are only responsible under the auditing standards for providing reasonable assurance that the financial statements are free from material misstatement, whether due to fraud or error. Owing to the complexity of most fraud schemes, it becomes hard for external auditors to detect misstatements resulting from fraud than misstatements resulting from errors.

It is thus evident that management and the governing body hold the lion’s share of the responsibility for fraud prevention and detection. Frauds can be detected by internal auditors and inspector generals or by dedicated departments within the organizations. Several organizations have departments devoted to information security and fraud detection. In rare cases, fraud detection happens by accident too. Identifying fraud risks and devising measures to lessen them is crucial in protecting both employees and the financial assets of businesses.

Fact: ACFE (2020) reports that less than 10% of frauds are detected by external auditors.

Fraud Prevention Strategies for Employers

Research by Davis and Harris (2020) identifies employee fraud as a threat to SMEs as fraud causes interruption of business operations, costs business owners additional time and resources to reverse the damage caused by fraud, and could tarnish business reputation. Here are a few ways that can help you minimize fraud occurrences by implementing different procedures and controls.

• ‍Understand Your Employees Thoroughly: Many a time, it could be an employee you least expect from that commits the crime. It becomes vital for the management to be involved with their employees and take time to get to know them since fraud perpetrators often exhibit behavioral traits that indicate the intention of commit fraud.  This can also reveal internal issues that need to be addressed.

• Provide Awareness and set up a Reporting System: ACFE notes that the best way to detect employee fraud is through tips, which is why implementing a whistleblower hotline is important. Empowering employees with the knowledge and awareness of fraud in the workplace is key to increasing employee tips. Communicating your fraud risk policy and its consequences to employees is a prevention method in itself. Knowing the company is watching and will take disciplinary action can hinder employees’ plans to commit fraud. Honest employees who are not tempted to commit fraud, if made aware of possible signs of fraud or theft, can be assets in the fight against fraud. Since many employees are hesitant to report incidents to their employers, make sure you set up an anonymous reporting system.

• Implement Internal Controls: Internal controls safeguard your company’s assets, ensure the integrity of its accounting records, and deter and detect fraud and theft. Experts suggest that segregation of duties is an important component of internal control that can reduce the risk of fraud from occurring.  Documentation is another internal control that can help reduce fraud. They include both automated and manual controls. If you do not have an internal control process or fraud prevention program, then you may seek the help of an expert to analyze the company’s policies and procedures, recommend appropriate programs and assist with implementation.

• Foster an open-door policy: Creating a positive work environment can prevent employee fraud and theft to a great extent. If your business has a clear organizational structure, documented policies and procedures, and fair employment practices, it can help you in averting employees turning to fraudsters. An open-door policy can offer a great fraud prevention system as it gives employees open lines of communication with management. Employers should lead by example and hold every employee accountable for their actions, regardless of their position in the organization.

• Monitor Vacation Balances: As employers, you could be impressed by the employees who haven’t missed a day of work in years. Though they may sound like loyal employees, it could be a sign that these employees are hiding something and are worried about leaving the office for the fear of their fraud getting detected. Therefore, it’s a good idea to rotate employees to various jobs within a company. This may help disclose fraudulent activity as it allows a second employee to double-check the activities of the first.

Summing Up

The cost of trying to prevent fraud is less expensive to a business than the cost of the fraud that gets committed. Several experts identify that companies should establish fundamental practices such as promoting a culture of honesty and high ethics, implementing anti-fraud processes and controls, and having an appropriate oversight process. The management’s proactive approach towards detecting and preventing fraud, coupled with vigorous internal controls will decrease the opportunities to commit fraud and instill an ethical culture within an organization.

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