As a small business owner, you might be well versed in fraud prevention. However, many employers fail to realize that fraud can happen anywhere and be carried out by anyone – including their own workers.
It's not uncommon for business employees to engage in accounting fraud. Employee accounting fraud occurs when an employee manipulates a business's financial records with the intent to steal from an employer. In many cases, the employee who commits accounting fraud has access to the employer's financial data with very little oversight. While lack of oversight is one of the most common business accounting mistakes, it certainly isn't the only source of employee accounting fraud.
No matter how close your team might be or how careful you are when recruiting, you should always be prepared for the possibility of employee accounting fraud. Here are four employee fraud-prevention tips for employers.
1. Begin with your hiring process.
Each time you hire a new employee, you're taking a risk. While a successful hiring process is necessary for every business, you can take steps to minimize the threat of future accounting fraud, such as conducting background checks on candidates.
"A background check for an employee can provide important insight into an individual's past behavior and potentially be an indicator of future actions," said David Thomas, CEO of Evident, a data security platform. "However, a background check is just the first step. Validating that an employee or applicant is who they say they are, with the appropriate documents, has the credentials and education they claim to have on their resume, and meets any regulatory requirements needed for their role are also invaluable identity verifications that can minimize the risk of fraud."
Background checks are not foolproof, and they don't always provide you with the most recent or relevant applicant information. For instance, Ken Stalcup, CPA and senior director at Houlihan Valuation Advisors, had a recent investigation involving an accountant who committed financial fraud. Stalcup's client ran a background check on the accountant before hiring them, and it came back clean. However, the accountant had just committed financial fraud in another state, and the background check didn't detect it. The company lost about $400,000 to the fraud.
"In my experience, [background checks] won't be very effective," Stalcup said. "It may weed out a few obviously bad prospects with an extensive, documented bad history, but background checks will not guarantee a fraud-free environment."
Moral of the story? It doesn't hurt to have an employee background screening system in place. However, don't rely on it as your sole means of fraud prevention.
2. Minimize employees' access to information.
"In any business, there are a number of ways for fraud to occur," Thomas said. "One of the biggest opportunities to prevent fraud, especially by employees, is to implement clear processes and controls across the company."
Thomas advised minimizing the amount of exposure and access employees have to information. This includes internal numbers and customer data.
You can get this level of information control by delegating access among the entire team rather than giving it all to one trusted person. Stalcup said that if only one person is responsible for all the accounting information, there won't be any effective internal controls to prevent fraud.
"Generally, the best way to prevent fraud is to establish good internal accounting controls," Stalcup said. "That means no one person has the ability to initiate, approve and record a transaction."
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3. Get help.
If you are suspicious of fraud, act quickly – but not on your own. Don't approach the suspect with empty accusations that could potentially violate the employee's rights. Make sure this employee is actually committing fraud and hire legal help. Be very cautious when gathering details, as falsely accusing an employee of fraud may end with a major lawsuit.
"You need to build a rock-solid case if you can," Stalcup said. "Then, once you have collected enough information, you can confront the employee with the help of an attorney and the HR department. It's likely you will have one opportunity to talk to the employee before they quit or lawyer up, so you have to be ready."
From there, you can decide what course you want to take and how it will affect you and your business going forward. Many employers turn to certified fraud examiners (CFEs) to assist in the process. According to Stalcup, who is a CFE, "CFEs are typically hired after the attorney and client realize there is a loss and want to take additional steps to recover or prosecute. Typically, the client and a lawyer will discuss the nature of the fraud. If the client has insurance covering fraud losses, the insurance company might want a CFE to quantify the loss. If the client wants to prosecute the employee, they may have to persuade the prosecutor to file charges based on evidence from a CFE."
However, Stalcup added, many clients often "recover nothing and will not hire a CFE or disclose the situation. They will just fire the employee and move on."
4. Establish the consequences.
How a small business responds to employee accounting fraud usually depends heavily on the circumstances of the fraud and the monetary loss incurred. It's also a good idea to consider how long it will take the business to recover from the incident. Depending on the value of assets lost due to the employee's activity, fraud can be extremely costly, even for large companies.
To decide the best way to handle employee accounting fraud within your business, be sure to figure out details like the extent of the activity and how the fraud was conducted. Employers often choose to resolve more passive forms of employee accounting fraud by terminating the person responsible, even if they have to fire a long-term employee. Extensive fraud, however, might best be handled through legal action following termination.
Generally, a loss of less than $500 typically ends in termination, while a loss of more than $100,000 can lead to hefty fines for the fraudster and even jail time of up to eight years.
Regardless of the loss amount, of course, the employee responsible will suffer significant damage to their professional reputation.
Types of employee accounting fraud
There are several types of employee accounting fraud. Understanding these fraud categories can help you avoid falling victim to them.
These are the most common types of employee accounting fraud:
- Asset misappropriation
- Payroll fraud
Asset misappropriation is usually the first thing that comes to mind when you think of employee accounting fraud. One type of asset misappropriation is using company resources for purposes other than their true intention.
This could mean taking your family on a business trip and having the company pick up the tab, using the company car and fuel card to run personal errands, or taking home company supplies.
Taking money from the company before it enters the accounting system is also asset misappropriation. This includes overcharging customers and pocketing the difference, fake billing schemes and fake expenses.
Usually, employees involved in this type of fraud steal small amounts of the employer's assets consistently, hoping the employer won't notice the missing assets because they've been taken in such small increments.
This type of fraud – also known as embezzlement – most often involves the misuse of money. Depending on how small the stolen amounts are, it can be challenging to notice this type of fraud when it begins.
Corruption is the second most common type of employee fraud. While this isn't always directly related to accounting fraud, this fraud type still hurts a business's bottom line.
Corruption often involves someone in a position of authority and includes bribery, product substitutions and kickbacks.
One typical example of corruption is when an employee offers discounts on products or services to bribe an external source. In another scenario, a manager might agree to take on a contractor to provide cleaning services to the business in exchange for free cleaning services in their home.
While most people associate corruption with public figures, it should not be ignored as a costly potential risk within a small business.
Payroll fraud occurs in more than one-fourth of businesses. On a small scale, payroll fraud includes clocking in and leaving work or forging a timesheet to include more hours. On a larger scale, ghost employee schemes are common. In these schemes, employees are on the books and getting paid, but they don't exist. Instead, the money goes to the person who set up the ghost employee account.
Other examples of payroll fraud include buddy punching, which happens when an employee has a co-worker clock in for them when absent. Another example, which could easily go unnoticed, is when an employee requests a paycheck advance and never pays the advance back.
Sammi Caramela contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.