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The Financial Cost of Occupational Fraud on Business

Occupational fraud is the use of one’s position to exploit, through misuse or misappropriation, an organization’s resources and assets for personal gain. Most people recognize and understand occupational fraud through more common terms such as embezzlement or corruption.  A recent survey by Association of Certified Fraud Examiners (“ACFE”) provides an insight into the potential cost and financial impact of occupational fraud on business.

The survey indicates the numerous schemes that potential perpetrators have at their disposal if they choose to exploit and attack an organization. However, these schemes can all be generally broken down and categorized into one of three categories – corruption, asset misappropriation and financial statement fraud. According to the ACFE’s 2016 Report to the Nations on Occupational Fraud and Abuse, of these three categories, asset misappropriation occurs at a higher rate (89% of fraud cases in 2018) as compared to those for corruption (38%) and financial statement fraud (10%).

Asset misappropriation occurs when those entrusted to hold and manage the assets of a business physically steal the asset or abuse the benefits of the asset for their own personal gain. Considering asset misappropriation is the overwhelming favorite route for the “typical” occupational fraudster, it is important to better understand some of the more common schemes that fraudsters may try to employ on your business and the effects that those schemes may have. As seen in the chart below, the largest and most common occupational fraud schemes include excessive billing, the theft of non-cash items and exaggerated and non-business related expense reimbursements.

What asset misappropriation schemes present the greatest risk?
 
© 2018 Association of Certified Fraud Examiners. All rights reserved.

Based on our review of the ACFE survey, we’ve noticed that although asset misappropriation occurs at a much higher rate than corruption or financial statement fraud that does not necessarily mean that it will have the largest monetary effect on the business. The survey indicates that the average loss due to asset misappropriation is $114,000.

Financial statement fraud is the deliberate misstatement or omission of company financial statement data with the intent of misleading the reader to believe the company is in a better financial position than it truly is. These instances tend to be much larger in terms of dollar amounts and much more complex in execution in comparison with those of corruption and asset misappropriation. Generally, with asset misappropriation and corruption, the fraudster prefers that the amounts be smaller so as not to raise any eyebrows, whereas with financial statement fraud the fraudster would need to grossly exaggerate the numbers to convince the reader that the company is financially sound and prosperous. For example, a $2,000 decrease in office expenses isn’t going to have the same impact on the reader of the financial statements that a $500,000 increase in revenue would have.

The survey also indicates that the three broad categories of fraud can overlap, intertwine and work together in any given circumstance. Often fraudsters will not limit themselves to using just one category of fraud schemes. If the opportunity presents itself and they believe they will not be found out, they will take advantage of utilizing the different categories of fraud schemes. In other cases, to successfully conceal their fraudulent activity, it may be necessary for fraudsters to employ several layers of fraud in order to cover their tracks. As a result, fraudsters will attempt to conceal their wrongdoing in a multitude of different ways. The most popular concealment schemes include creating fictitious documents or altering original physical documents, which is followed by the creation of fraudulent entries or alteration of original entries transactions in an organizations accounting system.

Noted below are the top types of schemes used by occupational fraudsters in various industries based on the ACFE survey.

Figure-16.jpg
 
 © 2018 Association of Certified Fraud Examiners. All rights reserved. 

As reported in the survey, the average median loss of financial statement fraud ($800,000 in 2018) accounts for over three times the monetary loss of corruption ($250,000) and seven times as much as asset misappropriation ($114,000). Important to note, however, is that instances of financial statement fraud tend to occur less frequently and, generally, it takes longer to uncover them. However, all the fraud schemes noted here can have a significant impact on business in terms of financial losses.

It is evident that regardless of the fraud scheme’s origin or category, the key to combatting occupational fraud is first to prevent it and, if it cannot be prevented, find it and find it fast.  The ACFE survey shows that if a scheme is uncovered early the losses, in terms of dollar amounts, are nominal in comparison. However, if the fraud continues after those two years, it generally becomes harder to uncover and the monetary losses begin to increase exponentially.

The chart below from the ACFE indicated the financial impact of the various fraud categories based on length of time till uncovered:

Figure-11.jpg
 
 © 2018 Association of Certified Fraud Examiners. All rights reserved.

In summary, occupational fraud continues to be a serious threat facing many business organizations.  It can have a significant impact on business profits, cash-flow as well as organizational reputation.  Therefore, it is vital for organizations to use preemptive planning in order to minimize the risk that their organization will be impacted.  This includes reviewing and testing current control systems as well as designing a plan of action to deal with a control breach and related uncovering of an occupational fraud scheme. Through proper planning and control testing, organizations can both minimize their fraud risk and adapt their controls to an ever changing fraud environment. So as fraudster’s schemes evolve with technological advances, organizations must to be ready to adapt to these changes and keep their controls and procedures up to date. The best defense to minimizing your risk to occupational fraud is being proactive rather than reactive.

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Hubert Klein is a Partner in the Financial Advisory Services Group with technical resources in various litigation actions. He has consulted in complex damages, business valuations and due diligence analysis.

Amy Fitzgerald is a Senior Associate in the Financial Advisory Services providing commercial litigation, financial investigations, intellectual property disputes, martial dissolutions, and business interruptions services.