Identifying Fraud Risk

July 2013       Download PDF      Print

Fraud can cause significant financial damage to companies of all sizes. Many small- and medium-sized businesses are particularly vulnerable to fraudulent activity because they often lack the infrastructure or resources to effectively deter such behavior. Every business owner should take an active approach towards fraud prevention and understand their own fraud risk.

You can start fighting fraudulent behavior in your organization by first identifying whether certain weaknesses exist in your company's internal processes and controls. The statements below are examples of specific weaknesses or "red flags" that, if applicable to your company, represent substantial fraud risk:

No background checks are performed on new employees

A job applicant may falsify information about his or her criminal record or professional background. Dishonest employees are more likely to commit fraud.

The same person handling incoming cash receipts also records transactions

When an employee who handles cash payments also records transactions, there may be an opportunity for the employee to misappropriate a customer's cash payment and post adjustments to the accounting system to conceal their actions. The employee could also potentially perpetrate a "lapping scheme" in which they apply a different customer's cash payment to the one they previously misappropriated.

Inventory and supplies are not counted on a regularly scheduled basis

If an effective perpetual inventory system is not in place, and inventory levels are not checked on a regular basis, you are allowing individuals the opportunity to steal inventory and supplies.

Itemized receipts aren't required for reimbursement of employee expenses

Employees could easily overstate their expenses with little fear of being caught.

The owner doesn't review original bank statements

By neglecting to regularly review the company's original bank statements and cleared checks, you may be allowing a key employee or manager to manipulate a bank statement to conceal fraudulent activity they commit for personal financial gain. For example, cleared checks should be reviewed for the following:

  • Unusual payees
  • Potential forged marker signatures
  • Dual endorsements
  • Employee endorsements

There are many more ways a typical business can be exposed to fraud. One way to gain a better understanding of your own company's fraud risk and the factors that increase that risk is to perform a self-assessment.

The American Institute of Certified Public Accountants (AICPA) and the Association of Certified Fraud Examiners (ACFE) both recommend that business owners conduct fraud risk assessments on their own companies. Performing a self-assessment will help you identify and manage your company's fraud risks, potentially saving you from lost revenues and costly legal fees.

Related Tools

  • Consider using the AICPA's Fraud Risk Self-Assessment to identify areas where your company is susceptible to fraud.

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