by Dan Mason

Created on: May 17, 2008   Last Updated: June 22, 2009

Fraud occurs when one knowingly makes significant misrepresentations of fact with the intent to cause harm to some other party. Generally speaking, fraud can fall into one of two categories: Embezzlement or Misappropriation. Embezzlement occurs when an employee takes money or property that has been entrusted to their care. Misappropriation involves scheming to take possession of assets, often including falsifying documents, lying, or exceeding policy.

There are red flags an employer can look for to help detect employee fraud. One of these signs is to simply observe an employee's demeanor. Often, the stress of carrying out fraud will lead to symptoms such as loss of sleep, inability to look managers in the eye, irritability, and becoming defensive easily. Managers must be careful, however, not to jump to conclusions if an employee is acting in any of these manners. The stress they are feeling may be completely unrelated to work, or any wrongful activity.

Professional auditors are trained to spot fraud warning signs. Some of the things auditors look for can also be noticed by keen management, or internal auditors. Gaps in accounting records, mismatched invoices/purchase orders, excessive scrap inventory, or payments being issued to companies that have no real address(only a PO Box), are just a few examples. Management can benefit greatly by educating themselves on audit procedures so that they can be aware of what is occurring within the organization.

When it comes to fraud prevention, a manager can also turn to the advice of an auditor. Auditors also receive training to recommend internal control practices aimed at preventing fraud. Some basic examples are in regards to custody of cash, payment policies, and segregation of duties. The cash on site should not be left unlocked, obviously, but it is also useful to arrange it so that no one person can gain access to cash alone; rather, set up the system so that at least two people must be present when cash is disbursed. In terms of payment policies, the same person printing the checks should not be the one signing them. Many banks actually require two signatures on checks over a certain amount; this also qualifies as an internal control measure. Finally, duties should be segregated to allow for substantial checks and balances at each step of the accounting process. For example, the person entering payroll should not also authorize the payroll checks.

No matter how strong a company's internal controls, it is impossible to remove the threat of fraud entirely. A manager must at some point have a certain amount of trust in his employees. But when internal controls fail, how does a manager catch fraud before it becomes out of control? A good start would be to regularly check accounts that are most susceptible to fraud; these include receivables, payables, inventory, and cash. By making routine checks, the manager will begin to notice patterns. Then, if fraud is to occur, the manager is more likely to notice an odd discrepancy. In addition to this, the manager should make unannounced checks, to try and catch fraudsters who know his routine, and plan their fraud accordingly. If a manager can learn to perform these few tasks effectively, he will be well on the way to drastically lowering the fraud risk in his organization.

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