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Theft from the inside

When times are tough, manufacturers should be aware that employee or occupational fraud tends to rise.


March 29, 2011
by Mark Chow and Mathew Lem

When times are tough, manufacturers should be aware that employee or occupational fraud tends to rise. The Association of Certified Fraud Examiners estimates the average company loses 5% of its revenue to fraud and abuse, but the highest losses occur within organizations of less than 100 employees.

Fraud prevention begins with your company’s code of conduct. Foster an environment of integrity and watch for red flags.

Three combined factors drive occupational fraud: opportunity, typically due to weaknesses in an organization’s controls; pressure at home or work from debt issues, divorce, gambling or drugs; and rationalization (“I’ll pay this money back”).

Fraud is also difficult to spot because it comes in many different forms such as:
•Stealing (cash, inventory, supplies, equipment, data)
•Forgery (cheques, signatures on purchase orders)
•Lapping (diverting cash from customer accounts)
•Kiting (drawing against balances credited to uncollected cheques)
•Cheque tampering
•Taking cash receipts intended for deposit
•Recording fictitious transactions
•Falsifying timesheets for higher pay
•Creating fictitious employees and collecting their pay
•Collecting pay cheques of employees who no longer work for the company
•Creating dummy companies, placing false orders
•Fabricating/duplicating/overclaiming expense items
•Issuing false receipts and skimming payments from customers’ accounts
•Taking bribes or kickbacks from vendors
•Falsely billing for products or services
•Taking cheques that are payable to suppliers
•Falsifying financial statements

Typically, the trouble begins with small transactions that become larger and more frequent while the crime is undiscovered. Here are some of those red flags:

Employees. Lifestyle improvements (more expensive vehicle, home, clothes); behavioural changes (may be a result of stress or addictions); personal debt troubles; and a refusal to take vacation or sick leave.

Payroll. High overtime claims; unusual increases in hourly rates; missing or duplicate social security numbers; and employees without payroll deductions.

Accounts receivable. Bank deposit and posting discrepancies; slow reconciliation of bank accounts; disproportionate or unsupported cash transactions; high volume of discounts, returns, voids and credit notes issued; the appearance of unauthorized bank accounts or new activity in dormant accounts.

Non-payment notices. Frequent expense items, supplies, reimbursements and account write-offs; and high employee turnover.

Purchasing. Increased purchasing inventory without corresponding sales; atypical inventory shrinkage; invoices unaccompanied by shipping documents; growing volume of complaints about products; large number of purchases from new vendors; payments made to vendors that are not on an approved vendor list; purchases don’t follow regular procedures or have unusual payment terms; vendor address is a post office box or an employee’s address.

Even when no flags are apparent, keep in mind 85% of companies surveyed in a recent global fraud report were affected by at least one incident in the past three years. Implementing proactive fraud prevention measures protects the bottom line.

Mark Chow is a senior vice-president and Matthew Lem, a vice-president of the Financial Recovery Services Group of BDO Canada Ltd. (www.bdo.ca). E-mail mchow@bdo.ca or mlem@bdo.ca.

Comments? E-mail joe.terrett@plant.rogers.com.


Fraud prevention measures

  • Ongoing anti-fraud training for all employees. Cover what constitutes fraud; the costs (lost profits, adverse publicity, job loss, decreased morale and productivity); how to communicate concerns about wrongdoing; where to seek advice; and clearly communicate a zero-tolerance policy.
  • An effective fraud reporting mechanism. Set up an anonymous reporting channel (such as a third-party hotline) and clearly communicate that reports of suspicious activity will be promptly and thoroughly investigated.
  • Make employees aware of the likelihood of detection. Actively seek out possible fraudulent conduct; perform scheduled and surprise fraud audits; and use auditing software.
  • Ensure honesty and integrity at the top. This includes realistic performance goals; fraud prevention goals integrated into manager performance measures; a process for oversight of fraud risks by those charged with governance; and questions in employee surveys asking the extent to which they believe management acts with honesty and integrity.
  • Perform fraud risk assessments. Proactively identify and mitigate the company’s vulnerabilities to internal and external fraud.
  • Put strong anti-fraud controls in place. These include proper separation of duties; use of authorizations; physical safeguards; job rotations; and mandatory vacations.
  • Create an internal audit department. Ensure it has adequate resources with the authority to operate effectively without undue influence from senior management.
  • Make fraud prevention part of your hiring policy. Include (where law permits) past employment verification; criminal and civil background checks; credit checks; drug screening; education verification; and a references check.
  • Put employee support programs in place. Assist those who are struggling with addictions, mental/emotional health, family or financial problems.
  • Have an open-door policy. Employees should be able to speak freely about pressures, and management should help alleviate such pressures before they become acute.
  • Conduct anonymous surveys. Use them to assess employee morale.

Adapted from the 2010 Report to the Nations on Occupational Fraud and Abuse, Association of Certified Fraud Examiners.