We’ve recently seen an increase in the number of employee frauds that we been asked to investigate. Many times, the first question a victim of an employee fraud asks is, “How can I keep this from happening again?”
Often business owners have the misconception that they are not susceptible to fraud. They think they have strong internal controls in place and their employees are honest, loyal, and trustworthy. When it does occur, they feel hurt and violated.
Donald Cressey developed the concept of the fraud triangle in the 1950’s. This theory is still the basis upon which fraud examiners use to detect and deter fraud. His theory is that even a trustworthy person will commit fraud if three elements are present: financial pressure, opportunity, and rationalization.
Even in small businesses, there are preventative measures business owners can take to decrease their susceptibility to employee fraud by thinking about each element of the fraud triangle and relating it to their employees and business.
The first element of the fraud triangle is financial pressure. This is what motivates the crime. The employee has a financial need they can’t resolve by other means and, therefore, consider committing fraud.
Knowing your employees is the best way to know their financial pressures. To prevent this element of the fraud triangle, look out for red flags of financial pressures and try to address them with employees by other means. Some red flags to look for would be divorce, health issues, drug or alcohol problems, or personal debt.
The second element is the opportunity to commit fraud. The employee sees a way they can abuse their position within the business to solve their financial pressure without anyone finding out. They might use a company credit card for personal use, manipulate expense reimbursements through payroll, or manipulate the deposit slips when making a cash deposit. There are many opportunities that could exist.
Opportunity is the element business owners have the most control over through implementing preventative internal controls. However, it is more difficult to have preventative internal controls and segregation of duties in smaller businesses. The owner needs to be involved in the controls. This could include reviewing bank statements, having check signing abilities, reviewing payroll reports, or approving expense reimbursements.
The list of opportunities and controls is endless. Identifying risk areas and addressing them is an effective way to decrease opportunities for employee fraud.
The third element of the fraud triangle is rationalization. Most people are honest people and need to justify their decision to commit fraud. They might use rationalizations such as being underpaid, they planned to pay it back, or having a dishonest employer.
To alleviate this element of the fraud triangle, utilize a “tone at the top” approach to management and integrate that culture into your business. By creating an honest, open culture, it makes justifying committing fraud more difficult for an employee. While some small businesses can’t afford to give employees annual raises, there are nonmonetary ways to compensate employees such as providing lunch, recognizing achievements, and other small tokens of appreciation.
According to the Association of Certified Fraud Examiners’ Report to the Nations on Occupational Fraud and Abuse , private companies lose 5% of revenues to fraud each year. In 2014, the average loss was $154,000 for companies with less than 100 employees.
Every organization is susceptible to fraud. Being aware of the elements of the fraud triangle and implementing them into the risk management of your business is a great way to prevent fraud.
Please contact us if you would like more information on preventing fraud in your business.
ABOUT THE AUTHOR
Adriann H. Reed, CPA, CFE, CVA
Adriann is a Senior Manager with Brown Schultz Sheridan & Fritz and specializes in accounting and audits in various industries including contractors, distributors, healthcare providers, and employee benefit plans. As an Audit Manager, Adriann is involved in planning, performing, and supervising audits and reviews.