By: Lena Combs, CPA, CGMA , RRP, Partner And Brenna Agamaite, CPA, Manager
In 2018, the Association of Certified Fraud Examiners (“ACFE”) published the 10th edition of its Global Study on Occupational Fraud and Abuse entitled Report to the Nations, examining both the prevalence and extent of occupational fraud (fraud by employees). The study examined 2,690 reported cases of fraud from 125 countries across 23 industry categories that were investigated between January 2016 and October 2017. The study estimates that the typical organization loses 5% of its revenues to fraud each year and that the median loss caused by the occupational fraud cases in the study was $130,000. While 55% resulted in losses of less than $200,000, more than 20% of these cases caused losses of at least $1 million. Resort managers and operators should be aware of the possibility of fraud, types of fraud and methods of reducing the incidence of occupational fraud.
Types of Fraud Reported
Among the various kinds of fraud that organizations might be faced with, occupational fraud is likely the largest and most prevalent threat. Occupational Fraud is best understood when broken down into three major categories:
⦁ Asset Misappropriation
⦁ Financial Statement Fraud
What is most important is that each of these three categories requires the participation and cooperation of employees and/or representatives within the company or organization. It should not be surprising that these types of fraud are more likely to be discovered because of a tip than by any other method. Establishing a whistleblower policy and hotline can be a first step in providing a venue for the types of detection that can uncover incidents of fraud in an organization.
The most common and often most difficult type of fraud to identify, representing 89% of the cases studied, is asset misappropriation, which carries a median loss of $114,000. This category of fraud includes nine major types of theft: skimming, cash larceny, billing schemes, payroll schemes, expense reimbursement schemes, check tampering, cash register disbursements, theft and misuse of other assets. The actual mechanics of how these frauds were perpetrated can be both illuminating and frightening, but the more sobering facts are that these types of fraud usually go on for extended periods of time before being detected and stopped. In the 2018 study, payroll fraud accounted for a median loss of $63,000 and had a median duration of a staggering 30 months. Cash register fraud had a median loss of $29,000 and a median duration of 12 months. Acts of fraud in this category can range from impulsive actions, like voiding a sale and pocketing the cash, to much more deliberate and organized efforts like setting up false vendors or ghost employees.
The next most common type of fraud is corruption where 38% of the Global Study cases involved some form of corruption (please note the totals add up to more than 100% because multiple fraud schemes often occur together). Corruption schemes, including invoice kickbacks and bribery, resulted in a median loss of $250,000. Nearly 70% of corruption cases were perpetrated by someone in a position of authority. Top red flags in corruption cases are people who appear to be living beyond their means, who are unusually close with vendors or customers, who show signs of financial difficulties or boast a “wheeler-dealer” attitude.
The least common and most costly category of fraud is financial statement fraud. This type of fraud includes fictitious revenues, misstated liabilities and expenses and improper asset valuations. Given the level of access these types of fraud require, they are fortunately the least common representing only 10% of the Global Study cases. However, given the level of access and sophistication of perpetrators of this type of fraud, the median loss was an overwhelming $800,000.
Prevention and Detection
An act of fraud typically involves not only the commission of the scheme itself but also efforts to conceal the crime. Understanding the methods used to cover fraud can help organizations better design prevention mechanisms and detect the warning signs of fraud. The top eight concealment methods used include: creating fraudulent physical documents (55%), altering existing physical documents (48%), creating fraudulent transactions in the accounting system (42%), altering existing transactions in the accounting system (34%), altering existing electronic documents or files (31%), destroying physical documents (30%), creating fraudulent electronic documents or files (29%) and creating fraudulent journal entries (27%). Again, take note that the percentages add up to more than 100% because most frauds involve more than one type of concealment method. It is also worth noting that manager-level fraudsters are more likely to alter evidence while owners/executives are more likely to create or delete evidence.
Since tips are the most common detection method, it is important to understand where those tips come from. In all fraud cases studied, a tip from an insider accounted for 53% of initial detections, while 32% of tips came from people outside the organization ranging from customers to vendors to competitors. The active cultivation of tips and complaints, such as the promotion of fraud hotlines, is often geared primarily toward employees, however this data suggests organizations should consider promoting reporting mechanisms to outside parties. It is also important to note that 14% of tips came from an anonymous source. The presence of a hotline or other reporting mechanism also affects how organizations detect fraud and the outcome of the case. For instance, 63% of victim organizations had hotlines and fraud losses were 50% smaller than those without hotlines.
Given the scope of fraud and the potential for loss, how can organizations protect themselves and reduce the likelihood of fraud? The results of the 2018 Global Study suggest that the most effective method is establishing a companywide code of conduct, which contributed to a 56% reduction in median losses sustained from fraud. Other methods include: proactive data monitoring and analysis, surprise audits, external audit of internal controls over financial reporting, management review, hotline, anti-fraud policy, an internal audit department, management certification of financial statements, fraud training for employees, formal fraud risk assessments, employee support programs, fraud training for managers and executives, dedicated fraud department or team, external audit of financial statements, job rotation and mandatory vacations, independent audit committee and rewards for whistleblowers. No single measure will eliminate fraud, but a combination these efforts can reduce the opportunity, rationalization and motive that make fraud increasingly prevalent.
Fighting Fraud Pays Off
The most encouraging statistic is that companies that had one or more of these anti-fraud measures in place experienced a significant reduction in the duration of fraud. A comparison of companies that had proactive data monitoring and analysis compared to companies that did not showed a 58% reduction in the duration of reported fraud from 24 months (no proactive data monitoring and analysis) to 10 months (companies with proactive data monitoring and analysis). Similar reductions in fraud duration were reported for surprise audits (reduction of 54% from 24 months to 11 months), and having an internal audit department (50% reduction from 24 months to 12 months).
Occupational fraud is widespread, from large multi-national corporations to governmental units to small local businesses to not-for-profits. Fighting fraud takes a concerted effort across the organization and to be effective requires the implementation of multiple fraud reduction strategies. Company owners, managers and board members should consider whether their organizations have taken the appropriate steps to detect and reduce incidents of fraud.
ABOUT WITHUMSMITH+BROWN, PC (WITHUM)
Withum provides clients in the hospitality, vacation ownership and other industries with assurance, accounting, tax compliance and advisory services. For further information about Withum and the services they provide to the industry, contact Lena Combs (LCombs@withum.com) at (407) 849 1569 or visit www.withum.com.