5 Common Frauds & How to Prevent Them

This article was written by Kaitlin Accardi, CPA.

According to the Federal Trade Commission (FTC), the Consumer Sentinel Network received 2.4 million fraud reports in 2022, resulting in a consumer loss of nearly $8.8 billion.

One key way to protect yourself and your business from fraud is through awareness. Take a look at the below common frauds and how to prevent them.

1. Payroll Fraud: occurs when a person is inappropriately compensated for work or services they did not perform. Examples of payroll fraud include submitting false timesheets, issuing unauthorized rate increases or bonuses, or sending money to non-existent or duplicate employees.
   1. How: the most common reason that payroll fraud can occur is due to a lack of mitigating controls of the payroll process. When one employee is responsible for adding or modifying employees, updating pay rates, or inputting hours worked with little to no oversight, inappropriate changes or payments may be made.
   2. Signs: duplicate employee information in list of active employees, such as address or social security number, significant fluctuations in payroll expenses over pay periods, excess overtime hours logged, employees appearing to live beyond their means.
   3. Limiting risk: Segregating duties is the most impactful way to minimize payroll fraud. Increased oversight can be accomplished by comparing actual payroll to pre-approved payroll registers before submission, allowing for proper chain of approval for all employee changes made, such as pay increase and bonuses, regularly reviewing active employee lists and current pay rates, and implementing supervisor and management review of employee time sheets.
2. Asset misappropriation - cash: occurs when an employee steals directly from a company. This can include unauthorized withdrawals or transfer of funds to personal accounts, pocketing cash receipts, stealing from petty cash, and writing checks to fake vendors/payees.
   1. How: Opportunities for employees to misappropriate cash include an AR clerk who has access to cash receipts and authorization to issue credit memos, an AP clerk who has the ability to create new vendors/payees and is responsible to writing check payments, or an employee who has full access to banking accounts and also performs monthly bank reconciliations.
   2. Signs: frequent cash flow shortages, increase in credit memos issued, significant outstanding accounts receivables, unusual or new vendors, or differences in bank reconciliations.
   3. Limiting the risk: Segregation of duties and proper oversight of employees who have access to banking, record sales, accepts and deposits cash receipts, reconciles bank accounts, enters and approves new vendors, or vendor payments and approval are key. Additionally, regular review of AR aging and customer accounts, manual journal entries, or vendor lists should also be implemented.
3. Asset misappropriation - personal spending and inappropriate expense reimbursement: occurs when an employee uses company credit cards and/or funds for personal expenses or submits expense reimbursement requests for non-business related or spending beyond normal business policy.
   1. How: Every employee who has a company credit card is at risk of using the card for personal purchases. Common personal purchases that could be disguised as business expenses include dining, hotel stays, gas and other auto expenses, etc. Inappropriate expense reimbursement happens when an individual pays for expenses for their own benefit and is reimbursed by the company for them. This can include submitting receipts for additional travel expenses such as extending a hotel stay after a conference, extravagant accommodations and flight upgrades, treating friends or other nonemployee/associates to nights out.
   2. Signs: frequent or significant expense reimbursements that do not correlate with the individuals travel or work obligations, significant fluctuations or unexpected increases in expenses such as meals and entertainment, travel, or auto expenses, unusual payees noted that do not appear to be business related to or to the benefit of the company, unexplainable misses in budgets.
   3. Limit risks: Policies and procedures should call for proper review of credit card statements and receipt submissions before approval, regular bank reconciliation by person who does not have access to credit cards or banking, and management approval of bank reconciliation. Placing spending limits on credit cards, and holding employees accountable for submitting all receipts before the balance is paid minimizes exposure.
4. Corruption: may be any action taken by an employee that is not made for the benefit of the company.
   1. How: acts of corruption may include receiving bribes from suppliers, giving discounts to friends or relatives, using company property or benefits for personal use, hiring friends or relatives to perform work at increased rates.
   2. Signs: excessive or frequent invoices received from one vendor which may be for services that are not necessary or did not occur, frequent discounts issued to certain vendors or customers, or unusual fraternizing with vendors or contractors.
   3. Limit risks: Establish documented policies and procedures over conflicts of interest, vendor/contractor selection, and approval process for purchases and payment. Remember that having policies and procedures alone is not enough to prevent fraud, they must be regularly enforced to be effective.
5. Financial statement: occurs when an employee or group of employees working together manipulate financial records. Inflating assets, revenue, or net worth or minimizing the appearance of debt or expenses all are considered acts of financial statement fraud. Pressures to manipulate financial records often results of the need to obtain loans or better terms on loans, avoid defaulting on existing loan covenants, meet benchmarks or goals to qualify for bonuses or other incentives, improve results for investors and consumers.
   1. How: manipulating cut off of sales or expenses, overstating inventory, maintaining uncollectible receivables on the balance sheet, inappropriate or unusual journal entries
   2. Signs: Significant fluctuations or lack of movement in balance sheet or income statement line items year over year despite known market or industry trends, known events, etc., and unusual journal entries.
   3. Limit risk: Variance analysis, benchmarking, and regular review of financial statements and trends can help identify financial statement fraud. This review can be conducted by management, governance, or by investing in automated solutions for fraud monitoring. Be aware of creating compensation arrangements that may incentivize employees to commit fraud. As with all forms of fraud, segregation of duties and oversight of individuals with access to the general ledger are an organization’s first line of defense.

If you need further guidance or have any questions on this topic, we are here to help. Please do not hesitate to reach out to discuss your specific situation.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.