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 is Everywhere—Is Your Business Next?


“It can’t happen here.”

“My employees would never steal from me.”

“I would know if something was going on.”

These are just some of the mindsets that organizations have had before falling victim to fraud. The truth is that fraud is widespread and occurs in all industries and all sizes of organizations. The following chart from the Association of Certified Fraud Examiners’ (ACFE) most recent Report to the Nations reflects the frequency of fraud cases by industry. As you can see, the banking and financial services industry reported more cases of fraud than all other industries and was nearly double the next closest industry.

ERIC'S POST

 

According to the ACFE, as high as 60 percent of employees would steal from their employer if faced with enough pressure and the opportunity was available to them. With these alarming statistics, how is an organization supposed to protect itself? It starts with being aware that no organization is immune, knowing what fraud schemes are currently occurring in your industry and then ensuring your organization has the proper internal controls in place.

Common Schemes

The two most common fraud schemes in the banking and financial services industry are corruption and cash schemes. Understanding how these schemes are conducted will give you the inside knowledge on how to detect when one may be occurring or prevent them entirely.

Corruption schemes are carried out when an employee misuses his/her influence in a business transaction in order to gain a personal benefit, in an action that is in violation of the duty they owe their employer. An example would be a loan officer receiving a kickback payment from the customer in exchange for a favorable outcome on the loan. These can be difficult to detect as the “benefit” often will not run through the bank’s financials and is often paid in cash “under the table.” However, paying attention to close relationships between loan officers and specific borrowers, as well as understanding the employee’s lifestyle to see if they are living beyond the reach of their paycheck, will help detect these schemes.

Cash schemes are relatively simple and involve an employee’s theft of the bank’s cash. These can occur by an employee stealing money from the bank’s vault, ATM machines or in the account opening process for depository accounts. They are often concealed by lack of internal controls and with false documentation to balance out accounts. Surprise audits, job rotation and proper segregation of duties will help detect and prevent these schemes.

Internal Controls Necessary

The ACFE’s Report to the Nations outlines that the number one reason fraud occurs in an organization is due to lack of effective internal controls. To reduce the risk of fraud within your organization, take time to understand your vulnerabilities and implement the proper anti-fraud internal controls. As Ben Franklin once said, “An ounce of prevention is worth a pound of cure.”

 

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.