How to Prevent and Detect Fraud in Your Organization


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Ernie Paszkiewicz, CPA, presented "How to Prevent and Detect Fraud in Your Organization" at Gross Mendelsohn's Baltimore office.

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How to Prevent and Detect Fraud in Your Organization

  1. 1. How To Prevent & Detect Fraud In Your Organization Ernie Paszkiewicz, CPA
  2. 2. Fraud in audit and accounting jargon • COSO is the acronym for the Committee of Sponsoring Organizations of the Treadway Commission • They issued the report called “Internal Control-Integrated Framework” in 1992 and expect to issue update in 1st quarter of 2013
  3. 3. COSO report • States that the objectives of an internal control system are to ensure: – Efficient and effective operations – Accurate financial reporting – Compliance with laws and regulations
  4. 4. Other A&A jargon • Sarbanes-Oxley AKA SOX and SAR-BOX (can tell you good stories about Sen. Sarbanes and some of his comments) • SAS 99 • Inherent risk • Control risk • Combined risk
  5. 5. The good news is that we are not talking about any of the jargon today.
  6. 6. Real world fraud discussion • Basically there are two or three types of frauds depending on who you listen to – Misappropriation of assets (theft) – Financial statement fraud (mostly big guys) – Bribery and corruption
  7. 7. Most should be concerned about misappropriation or theft • Financial audits are designed to detect fraud = FALLACY • Commonly referred to as the “expectation gap” • Seems to have been around a long time, just like frauds have been around forever • Opt for review or compilation with some agreed upon procedures instead of audit if possible
  8. 8. Extent of fraud / theft • U.S. Chamber of Commerce estimates theft by employees costs American companies $20-$40 billion each year • Employee theft 15 times more likely than nonemployee theft • 75% of thefts go unnoticed and unreported
  9. 9. Extent of fraud / theft • Another chamber survey says: – Rule of thumb is a company loses 1-2% of its sales to crime, mostly committed by or in collusion with employees – 78% of 126 “prosecuted” cases of employee fraud involved simple theft of cash, checks inventory or other property
  10. 10. Extent of fraud / theft – 60% of prosecuted cases and 97% of frauds reported by CPAs involved cash – Frauds involving noncash assets, while less frequent, often produced larger losses
  11. 11. Extent of fraud / theft – Cash frauds by responsibility area • Accounting / finance 70% • Teller / customer service 9% • Marketing / sales 6% • Purchasing 3% • DP 2% • Manufacturing / production 2% • Shipping / receiving 1% • Other 7%
  12. 12. Extent of fraud / theft • Cash fraud by level of responsibility – Part owner 3% – Management 19% – Supervisor 22% – Clerk / bookkeeper 56%
  13. 13. Extent of fraud / theft • Average fraud scheme runs less than two years • Left unchecked it grows in amount and frequency • It often involves a trusted employee
  14. 14. What should you do? • Don’t go back and think everyone is stealing; be aware that not everyone is dishonest, but neither is everyone completely honest • Blame the accountant: “I trust you, but my accountant says I have to do things this way.” • Blame your insurance person: “If we do this we will get a discount on our insurance.”
  15. 15. What should you do? • Blame the lottery: “I trust you, but if you hit the lottery tomorrow and retire I need good procedures in place for the next person since I won’t know them like I know you.” • Brainstorm what could happen and figure out how to plug the holes
  16. 16. The infamous fraud triangle
  17. 17. Prevention vs. detection • Cost benefit of prevention – Prevention attacks the opportunity side of the fraud triangle – Sometimes it’s cheaper to let the little things through, rather than hiring another person for absolute segregation of duties
  18. 18. Examples of preventative controls • Having security guards in lobbies • Keeping high dollar inventory or equipment in secured areas • Keeping unissued and cancelled checks under lock and key
  19. 19. Examples of preventative controls • Removing excess cash from registers and keeping in time lock controlled safes • Checking account arrangements where checks are preapproved or they don’t clear • Use camera monitoring systems including fake cameras
  20. 20. Examples of detection controls • Reviewing cancelled checks and bank statements for alterations or forgeries • Periodic test counts of inventory and comparing to perpetual systems • Surprise cash counts • Tagging inventory with theft alarm tags
  21. 21. Common theft schemes • Dipping into cash registers / funds • Fake employees on payroll • Extra pays to real employees • Issuing phony refunds • Issuing phony receivable credits
  22. 22. Common theft schemes • Kickbacks • Forging checks / check washing / creating fake checks • Lapping • Check kiting
  23. 23. Common theft schemes • Inventory and supply thefts • Equipment thefts (computers and peripherals) • Fictitious vendors
  24. 24. Cash controls • Have bank statements sent to owner’s house to review first before they are opened at the office • Implement segregation of incompatible duties as much as you can • Bond employees who handle cash
  25. 25. Cash controls • Do background checks when hiring (not only a cash control area) • Limit check signing authority • Review supporting documents when signing checks, then give to someone other than the person who prepared them to mail
  26. 26. Cash controls • Never pre-sign checks even if they need two signatures • Check sequencing of pre-numbered checks
  27. 27. Cash controls • Avoid signature stamps or signing machines if possible; implement controls over stamp / machine key if you have to use them • Control and deposit receipts daily
  28. 28. Cash controls • Have independent reviews of payrolls for reasonableness • Review accounts receivable charge offs • Review credit card adjustments • Review all adjustments to bank reconciliation
  29. 29. Cash controls • Set check limits with bank to get a call re: any check over a certain dollar limit Any other ideas?
  30. 30. Some REAL LIFE stories • Trusted employee forging checks and paying her husband’s business • Bookkeeper steals from elderly and retired nuns • Man gets out of jail for embezzlement and friend hires him. He then steals from the “friend.”
  31. 31. Some REAL LIFE stories • Bookkeeper steals from company, gets fired but not prosecuted, goes to another company and starts all over • New CFO gets hired and writes payments to bank that look like payroll tax payments, but are really deposits into his own account
  32. 32. Some REAL LIFE stories • Company made all payroll tax payments, but still on the hook when payroll company steals the tax money • Employees take inventory and toss in dumpster during day and come back and get it at night
  33. 33. Some REAL LIFE stories • Petty cash limit is low but reimbursed frequently and portion is due to theft of a lot of small amounts • Credit / debit card skimmers used to get I.D. off cards (gas stations, restaurants, etc.)
  34. 34. Some REAL LIFE stories • Credit card switches – your card for someone else’s card • RFID scanning without touching your card
  35. 35. Other considerations • Consider internal audit if larger company; if smaller company, maybe hire someone part time for limited testing • Set up a finance committee • Put an accountant on your board • Have a board member review bank statements
  36. 36. CAAT – computer assisted audit techniques • IDEA • Active Data • Excel • ACL • Many others
  37. 37. CAAT uses • Search for duplicate addresses • Search for breaks in sequences • Search for duplicate vendors • Stratify $ range of payments and sort by vendor • Check invoice to shipping dates • Benford’s Law • Any data extraction and comparison you can think of
  38. 38. Questions? Ernie Paszkiewicz, CPA 410.685.5512
  39. 39. Download our fraud whitepaper.