Forensic accountants have seen a recent increase in the number of employee-fraud allegations. Financial crimes at work are becoming more prevalent, and they affect all businesses, small and large. When fraud is uncovered, sometimes business owners ask, “Why didn’t my auditors discover it?”
Despite being a common question, it is generally erroneous. According to an article by Ralph Summerford in “Fraud Magazine,” an auditor’s job is to test the risk of and identify material misstatements due to fraud; it is a forensic accountant’s job to resolve fraud. Unless an auditor has been engaged to specifically perform a fraud examination, resolving fraud isn’t the primary goal of a general audit.
That isn’t to say that an auditor cannot identify fraud. The American Institute of Certified Public Accountants has set standards that require auditors to consider the risks of fraud when auditing financial statements. These standards say that auditors should make a qualitative analysis of their findings to determine whether looking further into the risk is warranted. Depending on their best judgment, auditors may or may not conduct additional or different audit procedures to address identified risks.
Here is the inherent problem: while auditors are qualified in assessing risks, they are not specifically trained to detect subtle indicators of fraud. In fact, most auditors have never encountered a fraud scheme.
Organizations can help their auditors uncover fraud by self-identifying red flags, or risk areas, where in-house crime could occur. An organization can make this assessment through the lens of Donald Cressey’s fraud triangle – the basis fraud examiners use to detect and deter fraud. The theory states that even the most trustworthy individual is capable of committing fraud as long as three elements are present: financial pressure, opportunity and rationalization.
The first element of the fraud triangle is financial pressure. This is a factor that motivates a person to commit a crime. If someone has a financial need he or she can’t meet, it could lead to consideration of a fraud scheme.
This leg of the fraud triangle is the one that organizations can control the least. Only by knowing your team members on a personal level can you identify their financial pressures. Red flags may include divorce, medical expenses, drug or alcohol issues, or personal debt.
If an employee is weighing the possibility of stealing, suitable circumstances must exist that would allow him or her to carry out the plan. This brings us to our second piece: opportunity. This is when individuals identify a way they can abuse their position to solve their financial pressure without detection.
There are numerous potential opportunities in any organization. Some include using a company credit card for personal use, manipulating expense reimbursements through payroll or manipulating deposit slips when making a cash deposit.
The final side of the fraud triangle is rationalization. Most people are honest, so those considering a crime need to justify their decision to themselves.
Rationalizations to embark on fraud could include being underpaid, having a plan to pay it back or believing they have a dishonest employer.
Involving your auditor
If you are concerned about the potential for fraud in your organization, consider how the fraud triangle applies to those on your team, and offer any insight you gain to your auditor. Providing red flags upfront points your auditor to specific areas of risk.
If fraud is being committed, your auditor is much more likely to discover it with your insight. If fraud has not been committed, your auditor can help you identify preventive measures to proactively alleviate each of the three elements.
If your company does not require an audit, reach out to a qualified forensic accountant to help you assess your company’s risks of fraud and to perform testing.
By taking the time to assess and prepare for risk, your organization can decrease fraud, save money and maintain your well-earned reputation.
(Editor’s note: This column has been edited/corrected from its original post.)
Adriann Reed is a senior manager with Brown Schultz Sheridan & Fritz in East Pennsboro Township, Cumberland County. She specializes in forensic accounting, litigation support and collaborative practice services, and is a member of the Pennsylvania Institute of CPAs.