Small Businesses More Susceptible to Fraud

Journal of Accountancy, gives an account of the 2004 Report to the Nation on Occupational Fraud and Abuse, by the Association of Certified Fraud Examiners.  Businesses with fewer than 100 employees were the targets of nearly 50 percent of the frauds.  These companies less frequently have adequate internal controls, hotlines, or outside audits.

The study estimates fraud at 6 percent of revenues annually. This translates to an incredible $660 billion.

Audits are good ways, but not the best, to discover fraud. Audits can also be effective at preventing fraud. 

Asset theft and corruption are more common than financial statement manipulation.  Asset theft includes improper payments, skimming, theft of merchandise, and payroll padding. Corruption includes bribes and conflicts of interest. Skimming refers to cash stolen before being booked. Larceny is cash stolen after being booked. 

Improper payments, however, are the most widespread and the most costly. These most often involve payments for goods or services never received, overstated invoice amounts, or personal expenses. Employees can be opportunistic in identifying and capitalizing on internal control deficiencies that expose the company to these practices. For example, if a company allows payments to vendors based on fax copies of invoices, unscrupulous employees can easily set up phony vendors and submit fax copies of altered original bills.

Tampering with checks is common, including writing checks in erasable ink and changing the payees and/or amounts after they are signed. Overstated or fraudulent expense reimbursements are a frequent stratagem. Adding fictitious employees to the payroll is easy to do when the same person controls the bank accounts and the books of account.

Discovery of Fraud

Most frauds are discovered by tips, often anonymous. In recognition of this, Sarbanes-Oxley (Section 302) requires public companies to set up procedures to encourage anonymous tips or whistle-blowing. These systems have had by far the greatest impact on decreasing fraud according to the study. When these systems are open to customers, suppliers, and others, they are even more successful. Despite these results, only one-third of the companies in the study employed such systems.

More than 50 percent of the frauds perpetrated by management were discovered through tips while only 6 percent were discovered through good internal controls. Management can supersede controls.

For more, see Journal of Accountancy, December 2004 http://www.aicpa.org/pubs/jofa/dec2004/wells.htm