This is the second installment in my four-part series on fraud. In the first installment I presented the Fraud Triangle. All three elements must be present for fraud to occur: pressure, opportunity and rationalization.
In this installment I cover Internal Fraud. That is, fraud committed by employees rather than outsiders. Fraud committed by outsiders, External Fraud, will be the subject of the third and final installment in about two weeks.
Internal Fraud
The 2010 Report to the Nations on Occupational Fraud and Abuse found that almost 90% of all frauds were “asset misappropriation.” And the most common asset that is “misappropriated” is cash. No surprise here. But theft can also mean stealing inventory, fixed assets or other assets. The average loss from an asset misappropriation was $160,000.
There are a lot of ways to steal cash. The most obvious is pilfering actual money. There is the phony vendor scam. Starbucks fell prey to this a few years ago. A purchasing agent set up a dummy company and then directed payments to this company. I have firsthand experience with an employee who hired family members (with different last names) as contractors and then authorized payment to these “contractors” that was excessive or for work never performed.
Another way employees steal is by writing checks to themselves and then covering the fraud in the accounting records. That’s why segregation of duties is a standard part of internal controls. For example, the party signing the checks should be different from the person reconciling the bank account and different from the person authorizing payment. Of course, sometimes in small companies there just aren’t enough employees to segregate the duties sufficiently. In that case, the owner should consider signing every check themselves. Even then, how do you know you’re signing every check? Forgery is easy and banks don’t check signatures.
I heard of one fraud in which the trusted accountant diverted the payroll taxes to themselves. This meant the accounting records looked accurate and the bank account reconciled. The problem was that the employees’ withholding and social security taxes were not being remitted to the government. They were be remitted to the accountant! Eventually, the IRS came calling but by that time the amount was sizeable and penalties and interest were added to the amount due. And these taxes, called trust fund amounts, cannot be discharged in bankruptcy and are the personal responsibility of owners and officers of the company.
In this case, the accountant had all the elements of the classic fraud triangle. She was under financial pressure. She had the opportunity because the owner gave her full responsibility for the accounting function and didn’t check her work. And she rationalized the theft because of a family situation. Other types of payroll frauds include “ghost” employees, falsified pay rates and padded hours.
I’ve even heard of employees who budget for fraud! In this case, a department head budgeted for capital equipment. Then the equipment was purchased from a fake company set up by the employee. The invoice was approved, within the budget, and paid. Of course, the equipment never was delivered by the phony vendor. But they were on budget!
No comments yet.