Discovering fraud inside your business has to be one of the most painful, frustrating and challenging issues a businessperson ever has to face. Loss of funds, loss of trust and disruption of the normal flow of operations all come into play, no matter how much or how little the abuse.
There are three components of the fraud triangle: incentive, rationalization and opportunity. With few exceptions, people engage in fraud because they have a reason that’s related to either money or ego. And because most employees realize fraud is wrong, they convince themselves what they are doing is really not fraud–they rationalize their actions because they are either “deserving” or they are only “borrowing.” Incentives and rationalizations are outside your sphere of influence and, as such, cannot really be changed.
Your organization, however, can affect opportunity by instituting internal controls to help protect your assets and prevent loss exposure. Internal controls can range from the simple, such as locks on the doors and taking daily cash deposits to the bank, to the sublime with 24/7 video surveillance and retina scanning devices to access the inventory warehouse. Most businesses opt for something in-between because of personnel and monetary constraints.
Three of the best methods to reduce the potential for fraud are nearly free, or free.
The first simple and effective internal control is separation of duties: simply don’t let one individual have total control of all activities in a specific organizational function. Someone who has both an incentive to commit fraud and the ability to rationalize the action probably doesn’t want others to know what they’re doing. So, putting someone from another department in the job process, or reassigning duties within your organization, typically limits the opportunity to commit the fraud.
The second internal control is even easier than the first, since the only thing you need to do is to pay is attention by listening and observing. Simply listen to what people say, and look at what they do. New homes, new cars, new wardrobes, or exotic vacations with no change in an employee title, status or pay might be reasons to attempt to gather additional information. Other things to you need to watch for? Behaviors like consistently staying late at work, not taking vacations, lamenting financial difficulties, and avoiding company colleagues or get-togethers are all signals of rationalization.
The last easy and inexpensive internal control is making certain your staff understands the importance of whistle-blowing and is encouraged to speak up if they believe anything fiscally inappropriate is occurring in the organization. The Association of Certified Fraud Examiners (ACFE) has consistently shown that most frauds are found not by auditors (internal or external) but from tips by employees, customers and vendors. If a whistle-blower hotline is too expensive for your operation, you should make sure all your employees understand that “telling” is good and a variety of individuals (including internal auditors, if they exist) should be designated as those with whom issues can be shared confidentially.
Fraud surrounds us and, according to ACFE, costs the average U.S. business about seven percent of its annual revenue each year. When your business loses money to fraud, everyone loses. The prices of goods increase and the potential for job losses from business closures also rise. There are many industries where that seven percent is the difference between profit and loss for the year.
While fraud will never be eliminated in businesses, it can often be reduced through an “open” perspective. Open your activity loops: separate duties to prevent total control by a single individual. Open your eyes and ears: listen to what people say and watch what they do to garner clues about changed or changing circumstances. Open your mouth: vocalize the benefits of providing, and reward those who provide information about wrongdoing. Being more open will, in fact, help close the door on organizational fraud.
Cecily Raiborn, PhD, CPA, CMA is a retired Endowed Chair in Accounting for the McCoy School of Business at Texas State University-San Marcos
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