Calculating Fraud Loss: What am I Forgetting?

Fraud is like a box of chocolates. Okay, maybe not, but believe me when I say that workplace fraud comes in a variety of forms. Most of the time, identifying fraud is a difficult task for any manager, owner or accountant. However, determining the true loss can, at times, be very challenging…even tricky.

In many fraud litigation cases, the loss extends beyond the actual dollar amount appropriated and results in additional economic damages. This type of calculation will help identify the opportunity costs incurred and answer the “but for” questions that arise when a business falls victim to theft or fraud. For the purposes of this article, let’s put economic damages aside and focus on the big question on everyone’s mind after a fraud has been discovered: “How much did they take?”

Depending on the type of scheme perpetrated, various elements should be considered. When conducting a fraud examination, I usually ask myself if any of the following four factors apply:

Taxes

No, I am not referring to income tax. The sneaky devils that typically come into play here are payroll taxes and sales tax. For example, a few years ago we examined a fraud scheme where the perpetrator gave themselves unauthorized pay increases and fictitious overtime hours. In calculating the theft amount, it is common to calculate the loss as the gross amount overpaid to the individual. Unfortunately, the company who paid the wages also incurred additional, and unnecessary, employer paid payroll taxes. That’s 6.2% of the gross wages for social security and 1.45% for Medicare. This additional 7.65% is a loss that can be easily overlooked.

Sales tax may also be overlooked when dealing with unauthorized purchases schemes. A common example involves a perpetrator who orders additional items through a vendor that is routinely used by the business. For instance, let’s imagine that a company buys equipment and supplies from the same vendor each month.

Let’s also imagine an employee was purchasing additional supplies and equipment for personal use. Looking through the invoices, there may be 50 items purchased, but only five of those items were fraudulent. In these instances, the portion of sales tax applied to those items may be overlooked. These are costs that otherwise would not have been incurred. This brings me to my next point.

Shipping Costs

Using the last example, shipping costs associated with any fraudulent purchases may also be neglected. Depending on the size, weight and frequency of the products fraudulently purchased, shipping costs may account for a significant portion of the loss amount.

Benefits

Benefits may be another factor to consider and are often overlooked when dealing with payroll-related schemes. Going back to my first example, when a perpetrator fraudulently inflates wages they may also receive additional benefits tied to those wages. In the case we examined, the perpetrator was receiving retirement benefits as a percentage of their wages. When they gave themselves unauthorized raises, they also received additional contributions to their retirement fund. These amounts, in addition to employer-paid payroll taxes, were included in the fraud loss suffered by the company.

Fees

Fees can be tricky as most businesses have recurring fees that can easily go unnoticed. Fraudulent disbursement schemes are typically where fees need to be addressed. Here are some examples:

  • Misuse of a company credit card resulting in additional finance charges, cash back fees or over-limit fees incurred by the organization.
  • Fraudulent check or debit card payments by a perpetrator resulting in non-sufficient funds (NSF) fees or overdraft fees.
  • Transfer fees incurred as a result of fraudulent or unauthorized transfers from company bank accounts.

No matter how cut and dry a fraud scheme may seem, all costs associated with the activity should be considered. If you or your business has been the victim of fraud, consult with a professional fraud examiner. There could be more damage than you think.

Fraud: Current Trends and Information

Trillions of dollars of revenue worldwide is lost due to fraud. According to the Association of Certified Fraud Examiners 2016 Report to the Nations on Occupational Fraud and Abuse, 5 percent of annual revenues are lost to fraud–that is $3.7 trillion worldwide. While the median loss was $150,000, 23 percent of cases involved losses of greater than $1 million. Typically, smaller organizations suffer the larger losses. It is important to be aware of the current trends in fraud so your company can avoid occupational fraud and abuse.

In 83 percent of fraud cases, the fraud involved asset misappropriation. Most frequently victimized were private companies and those in the banking and financial services industry. While employees were typically the perpetrators, owners and executives were the ones who generated the largest fraud losses. The primary weakness in many of these cases was lack of internal controls.

An example of poor controls in a small business can be seen in an actual fraud examination performed by Eide Bailly. The bookkeeper for a tile company was responsible for daily tasks including collecting sales receipts, completing deposit slips and making deposits. After a period of time, the bookkeeper began to remove checks and hid them in her desk. Later, when the daily sales included an amount of cash that matched one or several of the checks which had been set aside, the bookkeeper exchanged the cash for checks and made the daily deposit. No one in the company was aware the cash was missing until it was discovered revenue numbers would not reconcile. By the end of the scheme, the business lost more than $150,000.

Some simple controls could have prevented this scheme. Businesses should consider:

  • Using a hotline
    One way to stay on top of fraud cases is through the utilization of a hotline. More than a third—39.1 percent—of fraud cases were detected by a tip line, and in 51.5 percent of cases, employees were the source of the tip. Organizations with a hotline are 50 percent quicker at detecting fraud. Hotlines are beneficial for both the employer and the employee due to ease and anonymity.
  • Establishing preventative controls
    Preventive controls include deterring or preventing unauthorized transactions, requiring proper authorization, and instilling physical safeguards such as locks, keys and passwords. Another important preventative control is segregation of duties. Proper segregation of duties is imperative because when one person controls multiple phases of a transaction, the opportunity for fraud increases significantly. Nearly two-thirds of all frauds are committed by one person acting alone. By involving at least one other person, the risk of fraud can be greatly reduced. For example, having a second individual involved in documenting and verifying vendors can impact someone’s ability to introduce a false vendor into the company’s A/P process. One person documents the vendor’s information and a second individual then vets the vendors’ information prior to entering it into the company’s A/P system. This simple control can keep someone from submitting false invoices for services never rendered or requested. In one of our previous examinations, an A/P clerk used this specific scheme to embezzle $170,000.
  • Establishing detective controls
    Detective controls include independent checks to ensure that transactions have proper authority and are recorded correctly. For example, rotating job duties, a mandatory vacation requirement, and surprise audits are effective detective controls. Assuring adequate documentation and records are maintained is also an important detective control. Procedures should be implemented to ensure these detective controls are in place.

With appropriate measures in place, you can successfully decrease the risk of fraud in your workplace. While most frauds are uncovered by accident, it is important to remember to not overlook the most obvious signs. If you suspect fraudulent activity, employ the skills of a forensic accountant for detection and investigation.

See something? Say something.

The Sarbanes-Oxley Act requires publicly traded companies to provide a confidential way for employees to report fraudulent and wrongful behavior. Although it is a requirement, we still recommended that all organizations implement some sort of anonymous hotline reporting for any wrongdoing.

The Association of Certified Fraud Examiners 2014 Report to the Nations states that tips were the most common detection method for organizations with and without hotlines, but the benefit was much more pronounced in organizations with them.

Tip Blog

Hotline Advantages

  • Reduce the possibility of inappropriate or illegal company actions
  • Confidential way for employees to present issues to management and lessens the potential for retaliation
  • Increase the likelihood of early detection
  • Allows for more information to be provided than other communication methods
  • Having adequate controls that seek out fraud, rather than relying on external or passive detection methods, can dramatically reduce the cost and duration of schemes

 

Fraud Facts

Fraud Facts

Eide Bailly’s Forensic Accounting team provides services in preventing, detecting and investigating fraudulent behavior and financial crimes. Our services include fraud detection and investigation, internal controls examinations, fraud awareness training, employee background checks and hotline reporting.