Are You Prepared For Accounting Fraud?

How To Deal With Accounting Fraud

A man holding a sign with the word fraud on it, reminding you to watch out for accounting fraud
Photo by Tima Miroschnichenko

Accounting fraud can be a serious problem when it happens. It can cause businesses to go bankrupt if they don’t deal with it properly. How do you deal with accounting fraud, though? I spoke with Stapley Accounting, an accounting firm in Cache Valley, Utah, to get some details.

What Is Accounting Fraud?

Accounting fraud is when a company, or a company’s employee lies about a company’s financial situation. This is usually done by forging false records to cover tracks and is most often done to steal money. Sometimes accounting fraud is committed to fool investors into putting more money into a company that is actually failing. Other times, it’s committed by employees to steal from the company for personal gain. Generally, there are signs that fraud is being committed before it’s proven.

Signs You Should Watch For

1. Managers performing clerical duties. These duties are far beneath a manager’s pay level and if they are doing them, it might be because they are trying to hide their fraudulent activities.

2. Staff claiming records need to be rewritten. Usually frauds will claim “neatness” as justification, saying the record must be cleaned up or made neater. In truth, the records should have been made neat before being submitted, so be suspicious of these claims.

3. Vendors without physical addresses. Vendors need a place to store their goods, so if a vendor does not provide a physical address, the vendor probably doesn’t exist. It’s a good idea to verify the address provided, too; some frauds will give physical addresses to hide this, but the addresses go to personal homes, other businesses, or sometimes vacant lots or docks.

money in a bag
Photo by Tima Miroshnichenko

4. Missing documents, or excessive photocopied documents. Frauds often photocopy documents to create double billing, so do not accept a photocopied document at face value, especially if the original would be expected.

5. Employees that are always early and always stay late, or who never take vacations. While staying early and late now and then might be a sign of a loyal employee, doing so all the time is suspicious. They may be doing so in order to forge documents, or doctor records. This is especially likely if the employee has custody over assets like cash, or inventory.

6.Staff with gambling or drug/alcohol habits, or lifestyles beyond their income. If an employee has a known habit for gambling or alcoholism/drug abuse, or some other expensive lifestyle choice, but their pay rate does not justify those habits, that’s definitely a warning sign that they’re getting more money than they should. They might just be stealing it from you.

7. Erratic inventory errors. Mistakes happen, but when they happen all the time, something’s fishy. Either your accountant isn’t very good at their job, or those mistakes are being used to disguise and misdirect attention from their fraudulent activities.

8. People behaving differently around their peers, or display abrupt mood swings or other changes in emotional behavior. They might just be nervous about someone finding out what they’re doing. It could be something personal, but then again, it might not be.

How To Prevent Fraud

1. Have a Plan For Dealing With Fraud

First thing to realize is that it’s rare that you’ll immediately catch on to fraud when it starts. It may take a few weeks to notice, so have a plan for how to deal with it. According to Frank Abagnale, one of the world’s foremost authorities on fraud, taking matters to court rarely works out as well as you’d think. Defendants can cut deals that may get them off the hook, leaving you on it instead. He recommends having plans in place ahead of time. Some of his suggestions include using 1099 forms, which make theft taxable income for the fraud and let you write it off on your taxes. This allows you to send the IRS after frauds instead of the courts – and even The Joker doesn’t fool with the IRS.

You can also set up programs with your bank like Positive Pay Protection for checks, which are one of the most commonly forged documents. In these programs, you run all checks by your bank before you send them out, so the bank has a record of how much money should be spent and where. If someone forges a check, it won’t match the records with your bank, so they won’t authorize the transaction. You should also scan all your transaction documents and include a copy as a standard policy. Look for other programs that look to give you ways to deal with fraud as well. Don’t wait for it to happen before you act.

2. Open Bank Statements Yourself

Never have someone else open your bank statements. Your bank statements will show all the monetary transactions before anyone has a chance to enter them into records. If you let someone else open them, they have a chance to tamper with them. This way, you know everything up front.

3. Don’t Let Your Bookkeeper or Accountant Reconcile Your Bank Account

While your bookkeeper needs to see the records to do their job, never let that person also be the one who reconciles actual payments from the bank. That makes it too easy to make fraudulent transactions that you might not ever see.

4. Close Prior Accounting Periods

A common tactic frauds use to hide their tracks is place their actions into previous accounting periods. Nobody will be looking for them there because it’s in the past, where nothing new should ever happen. You can avoid this by closing accounting periods after you have your confirmed financial statement. Once closed, the records become much harder to alter after the fact.

5. Control and Monitor Access To Your System

Everybody uses computers for accounting these days. Computers make tracking easier if you use the tools at your disposal. First, make sure every employee who has access to your system has a username personal to them. That way, any time someone accesses the system, it will log who does what. If you just let your accountants log in as Administrator, you have no idea which person it was, making fraud easier to get away with.

The second part is to restrict access of users to only the things they do. Do not allow any single person other than yourself to have access to everything. This will prevent employees from being able to make all the changes needed to cover their tracks.

getting to know your employees
Photo by Christina Morillo

6. Know Your Employees

You’ll note that a lot of signs of accounting fraud happen to come from changes in behavior in your employees. You can’t spot changes in behavior if you don’t know what their normal behavior is, though. Getting to know your employees familiarizes yourself with their actions, so you’ll be able to spot any suspicious changes.

Getting to know them also builds rapport. If you know your employees and get along with them, that personal relationship makes stealing from you harder. You’re not just a faceless silhouette in an office window, you’re a person and that will get them thinking about how stealing from you hurts you as a person. While genuine sociopaths won’t care about this, it’s hard for most people to steal from people they know and have good relationships with.

If your business is big enough, you may not be able to get to know everyone. In this case, you should encourage your managers to do the same. The more anonymous the company leadership is, the easier it will be for employees to justify fraud to themselves.

Protect Yourself From Accounting Fraud

Accounting fraud is fairly easy to deal with when you’re equipped with the right tools. If you develop a plan for dealing with fraud when it happens and know the signs to watch for, you should be able to catch it before it does serious damage to your business. This requires you to pay attention and know what’s normal behavior for your employees. With these six steps, you’ll prevent most fraud with little trouble.