The "Five-Step Approach to Fraud Detection" is a strategy I use to detect fraud in any area and a template I provide to company executives and managers when helping them establish control systems design to detect frauds in their day-to-day operations. This is the third in a series of articles in which I will demonstrate how to apply this strategy to your own environment.
Step one halts most people because if they have no idea what can go wrong in their area, the rest of the strategy collapses. This continues a series of articles in which I will walk through some very common and dangerous frauds that affect all organizations, regardless of industry, to help you understand how to apply the strategy to create an environment hostile to fraud.
Suppose an employee or vendor offers your employees a kickback to enlist their participation in embezzlement? In this article, I want to focus on the concept of collusion—involvement by two or more perpetrators in a fraud. This risk intimidates auditors, finance and accounting managers, and risk professionals; their opinion in collusion enables a circumvention of controls established to prevent a particular fraud, thus rendering collusive frauds difficult to detect.
In one particular embezzlement, for example, the husband was a trucker for the company, his wife an accountant. Warehouse and inventory operations were properly segregated from accounting, but the two were able to violate the company's controls when the husband stole goods from the truck because the wife was able to book false sales, then subsequently write them off as uncollectible to cover the inventory shortages.
If multiple people can thus circumvent a control structure, how are we as managers and officers supposed to prevent such a fraud? The answer is by committing yourself to seeking the symptoms of the fraud.
Whether I am performing a tactical review of an area or discussing fraud-prevention strategy with executives, I always begin with a "What Can Go Wrong" list, in which I brainstorm potential perpetrators and fraud acts. Considering the risk of certain collusive frauds, here are a few good examples of what can go wrong.
Examples of What Can Go Wrong
A supervisor approaches several hourly student laborers: if the students record extra overtime on their timesheets that they did not work, the supervisor will approve those hours and not alert anyone. She'll do this as long as the students split the extra overtime money with her. Fourteen people (including the supervisor) become involved in stealing over $250,000.
Two operations employees of a construction company determine a method for overbilling indirect costs (such as rent, insurance) to their customers on multimillion dollar projects. Those two employees are able to siphon the extra billings into their personal bank accounts while allowing their company to collect on the legitimate charges. The company's chief financial officer (CFO) detects the fraud by his company's employees; however, he agrees to join in the fraud for a cut of the proceeds. The total amount of the overbillings is $36 million.
The procurement director agrees to share with a vendor the prices their competitors are bidding for the business. After the vendor wins the business from their low bid, they agree to provide a kickback to the procurement director.
Three employees of a pipeline company, including an accounting clerk, a terminal operator, and a terminal supervisor, conspire with two employees of a trucking vendor to steal 1.5 million gallons of fuel. They sold the fuel to unsuspecting fuel service station owners. The accounting clerk destroyed bills of lading and fabricated the numbers on the location's fuel variance report provided to headquarters.
Typically, my What Can Go Wrong documents for a particular area will list at least two or three dozen frauds stated in a single sentence or two. In the cases such as those above, we are dealing with multiple perpetrators, so list them all.
This is how we avoid the problem of collusion, by listing symptoms of the frauds regardless of the number of people participating. Symptoms are what these frauds would look like in the books and records. Here is a short list derived from the frauds listed above—you are likely to come up with many more.
Student employees are absent from the workplace during overtime hours.
Departmental labor expenses are over budget.
Overtime hours are strange, odd, or curious (30 hours of overtime posted during Thanksgiving week when offices were closed, or a full-time student recording 80-hour workweeks).
Indirect charges on a construction project exceed a reasonable percentage (e.g., >25 percent) of total billings.
Indirect charges are unsupported by adequate documentation, or the documentation appears to have been altered.
The bid winner/lowest bid is almost always the last bid received by Procurement, and the bid is almost always pennies lower than the second lowest bid.
Bid losers declined the procurement director's offers of favored status in exchange for some form of kickback.
Unexplained or "miscellaneous" losses in a particular division are higher than normal.
Service station owners complain their competitors are receiving below-market pricing on fuel.
Bills of lading are missing from the supporting documentation.
You will notice that I did not list a single control weakness. I did not say that duties were not properly segregated here, a signature was missing there. A control weakness is not a symptom of fraud. Just because a control is present does not mean a fraud is not occurring. Conversely, just because a control is absent does not mean a fraud is occurring. Just because someone smokes does not mean they have lung cancer, and just because they do not smoke does not mean their lungs are clear. A doctor must look for the symptoms.
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