(P) Managing risks – fraud prevention and recognition

Dumitru Martin

by Daniela Bularda, Certified Internal Auditor, Certification in Risk Management Assurance

Many organizations can go through periods of business failures or declines. Sometimes such periods can be caused by economic conditions, but there are also lots of cases where fraud is simply the key factor.

There are many definitions for the word fraud, but all of them have two elements in common: fraud is an illegal, criminal act. The Institute of Internal Auditors defines fraud as any illegal act characterized by deceit, concealment, or violation of trust. These acts are independent of violence or physical force threats. Frauds are perpetrated by parties and organizations to obtain money, property, or services, in order to avoid payment or loss of services, or to secure personal or business advantage.

Fraud not only takes place at all levels of the organization, but it is usually those who have the power that are most likely to commit fraud. No matter how comprehensive the organization’s code of ethics is, no matter how many rules and policies are implemented, fraud exists and it is committed because three conditions exist (the fraud triangle): situational pressure, opportunity and rationalization.

A situational pressure means that an individual may have been experiencing personal problems which may could motivate him to act dishonestly. Examples in this category include: encountering heavy financial losses, living beyond one’s means, high personal debt. In these cases, the perpetrator feels that fraud is the only way out to overcome this situation.

Opportunity is the condition which allows a person to commit fraud, to conceal it and convert the theft into personal gain.  Examples of opportunities include: numerous adjusting entries at year-end,  unusual, large, complex transactions; rapid turnover of key employees, inadequate staffing, fixed assets which are small in size, easy to sell or lacking observable identification of ownership, inadequate segregation of duties or independent checks, etc.

Fraud concealment often takes more time and effort, but usually leaves behind more evidence than the actual theft. When an asset was stolen or overstated, the only way to balance the accounting records is to increase the other assets’ value or to decrease liabilities. Except the situation in which the perpetrator finds a method to keep the accounting records in balance, the financial statement misrepresentation can be discovered. Stealing cash requires only a few seconds, whereas modifying records to hide the theft is usually more challenging and time consuming.

Rationalization: takes place when a person considers their actions as being rational. Rationalization can take the form of a justification of one’s actions (“I only took what they owed me”), an attitude (“rules do not apply to me, I occupy a very important position of trust. I am above the rules”), or a lack of personal integrity (“having what I want is more important than being honest”). The employee resorts to fraud because he believes that he was treated unfairly, or he may feel that his contribution to the organization is not sufficiently appreciated.

The fraud risk can be reduced through a combination of prevention, deterrence and detection measures. Organizations have to adopt anti-fraud policies, should train employees on fraud awareness, and implement strong internal controls.

As per ACFE, in 2014  the most effective methods used for  preventing and detecting possible fraud schemes  were  represented by an implemented  hotline system and by internal audit reviews. Together, these two instruments were able to detect 66% of the total fraud schemes.

How can fraud be detected:

  • Hotline
  • Internal audit
  • Management review
  • Account reconciliation
  • By accident
  • Surveillance/Monitoring
  • Document examination
  • External audit
  • Notified by Law Enforcement

Although internal auditors play an important role in fraud detection and prevention, managers have the primary responsibility for fraud detection.

As it can be easily seen in the above list, internal auditors are a valuable resource within an organization.

On the other hand, they help managers build and implement an adequate system of internal controls, review the already implemented fraud prevention controls, and – during regularly internal audit reviews – they are the first who identify the fraud red flags. Moreover, when a fraud is reported inside the organization, internal auditors are generally the first resource called to conduct an investigation to determine the extent of the reported fraud.

Rödl & Partner Romania, through its specialized team of auditors, has the necessary competence to carry out investigations in order to identify and eliminate these threats.

Rödl & Partner is active at 102 wholly-owned locations in 46 countries. The integrated firm for audit, legal, management and tax consulting owes its dynamic success to over three thousand entrepreneurial-minded partners and colleagues. In close collaboration with our clients, we develop information for well-founded economic, tax, legal and IT decisions that we implement together – both nationally and internationally.

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