Detecting and Preventing Occupational Fraud: Strategies Businesses Can Adopt

Published On
Aug 18, 2021
Read Time
4 Minutes
OnBlick Inc

Occupational fraud is a concern for businesses, irrespective of their size, type, and industry. Though the majority of employees in every organization is loyal and works for the organization’s benefit, there could be some who commit fraud and cause financial loss besides tarnishing the business’ reputation.

To reduce such losses, employee fraud needs to be detected and prevented. Experts advise organizations to have a fraud prevention plan in place.

This article discusses various strategies that help employers detect and prevent fraud in their businesses.

What is Occupational Fraud?

According to Lofland & McNeal (2014), occupational fraud, often used interchangeably with employee fraud, occurs in small businesses where preventative measures to avoid fraud do not exist. It is found that unethical employee behavior is a significant factor that contributes to occupational fraud. Huge financial losses, legal costs, and ruined reputations caused by the fraud can, in the long run, lead to the downfall of the business.

As per the 2020 report by the Association of Certified Fraud Examiners (ACFE), a typical organization loses 5% of its annual revenue each year due to employee fraud. The study found that asset misappropriation (theft of cash, data, and property), corruption, and financial statement fraud schemes (deliberate misstatement, misrepresentation, or omission of financial statement data) are the most common frauds.

Types of Frauds

ACFE notes that there are three categories of occupational fraud at the highest level. They are:

Asset misappropriation, the first category, involves an employee stealing or misusing the employing organization’s resources. It occurs in the vast majority of fraud schemes. Examples of asset misappropriation are stealing cash before or after it has been recorded, making false expense reimbursement claims, and/or taking non-cash assets of the organization.

• The next category, financial statement fraud schemes, in which the perpetrator intentionally causes a material misstatement or omission in the organization’s financial statements, are the least common but costliest category of occupational fraud. It can happen in the form of fictitious revenues, hidden liabilities, or inflated assets.

• The third category, corruption, happens when employees use their influence in business transactions for their benefit while violating their duty to the employer. It includes offenses such as bribery, conflicts of interest, and extortion. Corruption falls in the middle in terms of both frequency and financial damage.  

The Fraud Triangle

The fraud triangle is a model used by decision-makers in organizations to prevent and detect occupational fraud. It is employed to discover and avoid not only asset misappropriation or fraudulent financial statements, but deceitful acts committed by all fraudsters. Though there have been disputes about the effectiveness of the fraud triangle model, several auditors make use of it even today.

The fraud triangle framework put forth by Donald Cressey aims at explaining the rationale behind fraud and suggests three factors that apply to fraud perpetrators in general:

1. Pressure: An employee can be pressured or motivated to commit fraud due to a personal financial problem, such as a huge debt. At times, the pressure originates from problems at work.

2. Opportunity: The employee who plans to commit the fraud discovers a weakness of internal control and believes that no one will notice if they steal.

3. Rationalization: Rationalization is normally the excuse for committing fraud. Most often, fraudsters rationalize by telling themselves that they are only temporarily borrowing from the organization or that it is okay to steal.

In most cases, motive and rationalization are beyond the control of management. These factors are usually a result of outside influences, personal lives, and individual personalities. Opportunity is the one factor that management can control; thus, businesses need to focus on reducing the opportunities to commit fraud.

Who is responsible for preventing and detecting fraud?

Following the auditing standards, experts claim that the primary responsibility for the prevention and detection of fraud rests with the governing body and management. The responsibilities of the management include creating an environment where fraud is not tolerated, identifying risks of fraud, and taking proper actions to ensure that controls are in place to prevent and detect fraud.

The governing body is liable for ensuring that management is carrying out the tasks assigned to them concerning fraud risk and prevention, as well as understanding the situation to determine if management can overrule or influence the controls in place.

If an internal audit function can be established, some of management’s responsibilities can be delegated. Internal auditors are usually knowledgeable in evaluating the potential and probability of fraud, errors, or noncompliance and can review internal controls for effectiveness.

External auditors come into the picture when an internal audit function is not operational. Though the external auditors can assess fraud risk within an entity and perform procedures to address those risks, they are only responsible under the auditing standards for providing reasonable assurance that the financial statements are free from material misstatement, whether due to fraud or error. Owing to the complexity of most fraud schemes, it becomes hard for external auditors to detect misstatements resulting from fraud than misstatements resulting from errors.

It is thus evident that management and the governing body hold the lion’s share of the responsibility for fraud prevention and detection. Frauds can be detected by internal auditors and inspector generals or by dedicated departments within the organizations. Several organizations have departments devoted to information security and fraud detection. In rare cases, fraud detection happens by accident too. Identifying fraud risks and devising measures to lessen them is crucial in protecting both employees and the financial assets of businesses.

Fact: ACFE (2020) reports that less than 10% of frauds are detected by external auditors.

Fraud Prevention Strategies for Employers

Research by Davis and Harris (2020) identifies employee fraud as a threat to SMEs as fraud causes interruption of business operations, costs business owners additional time and resources to reverse the damage caused by fraud, and could tarnish business reputation. Here are a few ways that can help you minimize fraud occurrences by implementing different procedures and controls.

Summing Up

The cost of trying to prevent fraud is less expensive to a business than the cost of the fraud that gets committed. Several experts identify that companies should establish fundamental practices such as promoting a culture of honesty and high ethics, implementing anti-fraud processes and controls, and having an appropriate oversight process. The management’s proactive approach towards detecting and preventing fraud, coupled with vigorous internal controls will decrease the opportunities to commit fraud and instill an ethical culture within an organization.

Complete, Update and Retain Your Form I-9s Digitally

Know More