Key Takeaways
- Estimated losses related to occupational fraud exceed one trillion dollars annually.
- The three primary types of occupational fraud are asset misappropriation, corruption, and financial statement fraud.
- The number one red flag for occupational fraud is living beyond one’s means.
- Occupational fraud may be prevented and/or detected through a strong “tone at the top,” effective internal controls, and fraud awareness training.
What is Occupational Fraud
A common definition of fraud is any wrongful or criminal deception intended to result in loss to a victim and financial or personal gain to a perpetrator. The fraud triangle is a model that was developed by criminologist Dr. Donald Cressey in the 1950’s and it is still relevant today. It serves as a helpful tool to understand, prevent, and detect fraudulent activity. The fraud triangle includes three elements that illustrate the motivation to commit fraud:
- Pressure: Pressure may include financial or personal problems as well as external expectations and performance demands.
- Opportunity: Opportunity explains the circumstances that enable fraud or hinder its detection.
- Rationalization: Rationalization provides justification for the fraud.
We will explore each element of the fraud triangle throughout the sections below; specifically, the “Occupational Fraud Red Flags” section includes aspects of pressure and the “Preventing and Detecting Occupational Fraud” section provides tips for minimizing opportunity.
Occupational fraud, also known as insider fraud, is a subset of fraud that involves someone, such as an employee, manager, executive, or, in the case of a nonprofit organization, a volunteer, misusing his/her position, resulting in a loss to the organization and personal gain to the individual. At its core, occupational fraud is a breach of trust. According to the Association of Certified Fraud Examiners (ACFE), occupational fraud is very likely the largest and most costly financial crime in the world, with estimated annual losses in the trillions of dollars.
Types of Occupational Fraud
Occupational fraud can be broken down into three major categories: asset misappropriation; corruption, and financial statement fraud. Asset misappropriation is the most common type of occupational fraud and the least costly. Conversely, financial statement fraud is the least common and most costly type of occupational fraud.
Asset misappropriation is frequently synonymous with embezzlement. Common asset misappropriation schemes include billing schemes, payroll schemes, check and payment tampering, theft of cash, and theft of inventory and other assets. Asset misappropriation also includes the fraudulent use of corporate credit cards and fraudulent reimbursements.
Corruption often involves conflicts of interest, particularly collusion with vendors or customers. Corruption schemes include bribery, kickbacks, and economic extortion.
Financial statement fraud is typically perpetrated by owners and executives and is often committed in association with other types of fraud. Financial statement fraud schemes include overstating or understating net worth or net income through timing differences, improper valuations, and improper disclosures. Financial statement fraud is often motivated by intense pressure, whether internal pressure for a particular status or accomplishment or external pressure to achieve certain metrics or results.
Occupational Fraud Red Flags
Recognizing occupational fraud red flags is essential because the longer a fraud scheme goes undetected, the greater the loss. Equally important, however, is remembering that the presence of one or more red flags does not guarantee fraud is occurring; it simply indicates that more analysis is required. According to the ACFE, the number one red flag since the ACFE began compiling occupational fraud statistics in 2008 is living beyond one’s means. Fraudsters typically exhibit a lifestyle that is beyond their income level and the change in lifestyle may appear suddenly.
Other red flags for occupational fraud include:
- Control issues – unwillingness to share duties or take vacations
- Unusually close relationship with a vendor or customer
- Irritability, suspiciousness, defensiveness
- Bullying, intimidation
- “Wheeler-dealer” attitude
- Family problems, financial problems, addictions
- Complaints about inadequate pay and/or lack of authority
- Excessive pressure to meet targets, goals, metrics
Preventing and Detecting Occupational Fraud
There is no system of fraud prevention and detection that reduces the risk of fraud to zero. However, there are practical steps a business, church, school, or nonprofit can take to mitigate and detect potential fraud. Fraud prevention begins with a strong tone at the top. “Tone at the top” refers to an organization’s ethical climate that is established by its leadership. A strong tone at the top relies upon leadership’s commitment to being honest, acting with integrity, and leading by a positive example.
Fraud awareness training is a simple, cost-effective component of an organization’s anti-fraud strategy. According to the ACFE, victim organizations that did not provide fraud awareness training lost nearly twice as much as those that provided training. Additionally, tips are twice as likely to come from employees who received fraud awareness training than from those who did not. Annual fraud awareness training presented to employees, managers, executives, and volunteers by a Certified Fraud Examiner (CFE) or other fraud expert lays an excellent foundation for fraud prevention and detection.
Other effective components of an organization’s anti-fraud strategy include:
- Up-to-date policies and procedures
- A meaningful Code of Conduct
- A strong internal control framework
- A clearly defined process for reporting suspicions and tips
More than half of the cases reported in the ACFE’s 2024 Report to the Nations involved a lack of adequate internal controls or an override of existing controls. An effective internal control environment may include account reconciliations, segregation of duties, and management review.
Small organizations face unique challenges relative to internal controls, particularly around segregation of duties. Consider hiring an expert consultant, such as a forensic accountant, to perform an internal control assessment and make suggestions for strengthening your internal controls.
What if You Suspect Fraud
If you suspect fraud, it is often best to consult with an attorney first. Then consider hiring a forensic accountant to help you make sense of your financial data. Forensic accountants possess the knowledge and tools to identify and analyze relevant documents and summarize the results in easily understood charts, reports, and oral testimony. Forensic accountants understand the discovery process and can assist with document management, formulating questions, and follow-up requests. They are also invaluable in legal disputes, where their findings can help quantify damages and resolve conflicts through settlements or court decisions.
Summary
Occupational fraud is a costly breach of trust that may have devastating outcomes. Occupational fraud schemes include asset misappropriation, corruption, and financial statement fraud. An organization can protect itself by understanding common red flags, providing annual fraud awareness training, and maintaining a robust system of internal controls. An expert, such as a forensic accountant or CFE, is an excellent resource for any organization seeking to protect itself from the devastation of occupational fraud.
References
Occupational Fraud 2024: A Report to the Nations; Association of Certified Fraud Examiners; https://legacy.acfe.com/report-to-the-nations/2024/
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This article was written by Joan O’Dowd, CPA/CFF, CFE, MBA. Joan is a former FBI forensic accountant and the owner of Fathom Forensic Accounting LLC, a CPA firm in the Atlanta area that focuses exclusively on forensic accounting. Joan specializes in fraud investigation and prevention. Her services include providing fraud awareness training and conducting internal control assessments and fraud investigations. Joan is a Certified Public Accountant (CPA), Certified in Financial Forensics (CFF), and a Certified Fraud Examiner (CFE). To connect with Joan, send an email to joan@fathomforensic.com.
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Massey and Company CPA is a boutique tax and accounting firm serving individuals and small businesses in Atlanta, Chicago and throughout the country. Our services include tax return preparation, tax planning for businesses and individuals, estates and trusts, IRS tax problem resolution, IRS audits, sales taxes, small business accounting, and bookkeeping clean up services. To connect with Massey and Company CPA, send an email to gary.massey@masseyandcompanyCPA.com.
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