Accounting Fraud and Its Prevention

Fraud Triangle

Accounting fraud encompasses a known violation of financial policy and actions taken by a company, an individual or group of individuals. The fraudster would manipulate a company’s accounts in order to cover a theft or to provide a fake financial façade of the organization. People who are usually involved in accounting fraud usually hold positions where they have privileged access to the company’s financial records with little or no supervision.

Accounting fraud can be very contrasting to each other in their scope and damage. For instance, it could be a theft of few thousand dollars from a dishonest individual or it could be so immense in its degree where consumers might lose billions of dollars; such as the damage caused by scammer Bernie Madoff.

Accounting fraud, like any other occupational scam, can be played out at many different levels and in many different capacities.

Fund Embezzlement

Fund embezzlement is the most common type of accounting fraud. Here, people who are responsible to manage an organization’s funds misappropriate them for their own benefit. A study from 2016 indicates that 40% of fund embezzlements are done by the employees of accounting and finance department. While in the industrial sector, more fund embezzlements are done by the managers instead of the lower staff.

It has also been noted that employees with more control and access to a company’s assets are mostly responsible for embezzlement activities. Moreover, managers who have spent more time with an organization breach the company’s trust by misappropriating the funds.

Account Payable Fraud

These frauds are carried out through the accounts from where money is leaving the company. They are the most damaging accounting frauds because of two major reasons.

  • There is no easy way to tell whether the money’s outward flow is in the legitimate direction or it is getting consumed up by dishonest employees. There are hundreds and thousands of legitimate transactions on an account payable system of a company and a dishonest employee can squeeze in a few fake ones in between them.
  • Secondly, a single account payable fraud doesn’t involve an immense amount of money. Therefore, it stays off the radar in a routine audit.

From expense reimbursements to kickbacks, this type of accounting frauds can use many different titles. We will discuss these notorious accounting frauds in detail in a separate article.

Accounts Receivable Fraud

In contrast to AP frauds, account receivable frauds are done where money is making its way to a company. Accounts receivable frauds act as a double whammy for companies. Apart from losing money, they also have to suffer the damage of their reputation because this type of accounting fraud is usually carried out by the employees who exploit the trust of clients and use their name to misappropriate the funds.

Account receivable frauds are usually carried out in a more complex manner. Employees who are involved in such malevolent activities have done it before. They produce long and complex paper trails (fake ones of course) to confuse the auditors and other personnel responsible for investigations.

Moreover, they continue to carry out this accounting fraud by successfully balancing the account books. For instance, they apply made up discounts, subsidies and directs payments to the wrong accounts to balance the accounting books.

Prevention of Accounting Fraud

Companies lose billions of dollars every year in instances of accounting frauds. They can be prevented if rigorous practices are employed by organizations. Let’s have a discussion on some of the prevention and detection measures for an accounting fraud.

Firm Internal Control

All the accounting frauds are internal frauds. Therefore, having your accounting functions managed in a tightly controlled environment is a must. Don’t concentrate all the accounting responsibilities to a single employee, no matter how honest and tenured they are with your organization. We have discussed earlier how the most trusted employees often turn into culprits.

Having a horizontal hierarchy in the department overseeing the company’s finance will help in deterring any rogue employee to execute such malevolent plans.

Fragmentation of the Process of Setting up an Account

We have also discussed how many of the accounting frauds in both payable and receivable cases are instigated through setting up fake accounts to channel the embezzled money. It becomes easy because setting up an account and its approval is being overseen by the same system.

By separating the activity of setting up an account and its approval, companies can reduce the instances where an employee can create fake accounts on their own.

Random Audits

Most of the companies have scheduled annual audits. Employees managing the finances are well aware of the time and date this auditing routine. Employees involved in any fraudulent activity remove all the trails and loopholes of their fraud before the visit of an auditing team.

In order to detect any ongoing fraudulent activity, random auditing can help a lot. Get the random auditing of the records of both payable and receivable accounts. Setting up a routine of unexpected auditing visits can dissuade many ill-intentioned employees from committing any accounting frauds.

Rotation Policy

Rotation of staff between different departments is another measure which can also be used to prevent accounting frauds. By constantly changing people from one account to the other, you will not provide enough time to rogue employees to execute any malevolent activity.

Many times an accounting fraud is carried out after elaborate planning, which can take several months. By implementing rotation policy on the employees working in the department, an organization can preemptively incapacitate any fraudulent activity.

Painstakingly Match Revenue Growth with Cash Flow

At the end of the day, the money ripped off through accounting frauds belongs to the company. Therefore, a comprehensive analysis of revenue growth in accordance with cash flow can also show any discrepancies in the management of company’s accounts.

Aside from these measures, you can establish an anonymous hotline to encourage employees to report any anomaly that they have been witnessing in their surroundings. With the implementation of all these measures, a company can create an effective shield against all these different accounting frauds.

Posted On March 10, 2018