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Why Fraud Can Be So Hard to Detect


It’s a recurring nightmare for many business owners. Something happens, and you suddenly discover that one of your trusted employees has been cheating you. Even worse, the fraudulent activity has been going on for quite some time.

The reality is, fraud can be very hard to detect. Here’s why…

The Fraud: Overpaying for purchases
In this fraud the purchasing agent agrees to noncompetitive pricing, and then gets some type of kickback on every purchase, whether it’s cash, travel, or whatever. Even high-level employees can be on the take, such as a Controller or CFO responsible for professional services contracts.

• Why this is hard to detect: Quite often companies have complete faith in the person doing the purchasing. They do not require that this person gets competitive quotes on major areas of spending, or have somebody review those quotes.

The Fraud: Phantom employees
What typically happens in this type of fraud is that somebody adds fictitious employees to the payroll. For example, a supervisor in the field submits paperwork for someone who doesn’t exist, or for someone who exists but doesn’t actually work for the company. HR has no idea it’s a sham.

• Why this is hard to detect: Most companies will scrutinize time sheets, but will not go out and physically verify that these people were on site during the stated dates and times. This can be especially challenging for companies with labor that fluctuates based on the work load. It can be easy for someone to submit falsified time cards for real people who were not actually employed by the firm at the time.

The Fraud: False overtime claims
This type of fraud generally requires collusion between the employee and the supervisor who approves their time cards. Often the employees are legitimately on the job on the days stated on the time sheet, but are not actually working any overtime. The supervisor agrees to approve bogus overtime in return for a percentage of the extra pay.

• Why this is hard to detect: It is hard to detect a fraud that involves both the employee and the supervisor. To avoid this problem, a good control to put in place is a “labor budget.” Supervisors must keep labor costs within this budget, with additional costs requiring additional approvals.

The Fraud: Embezzlement
What I’ve seen in this area is that someone in accounting opens up a bank account for a fictitious vendor, sets that vendor up in the A/P system, and then cuts checks to them. While banking regulations make this harder than it used to be, it’s still possible. Another common embezzlement scheme is to collude with a vendor who provides bills and receives checks, but does not provide any actual goods or services.

• Why this is hard to detect: First, many companies do not have the necessary controls in place to prevent this type of problem, such as requiring the use of purchase orders, or requiring that multiple people approve new vendors. Second, once checks start regularly going out to a vendor, everyone becomes familiar with it. If a person can get away with the fraud for a few months, it’s easy to keep it going.

Need help getting appropriate checks and balances in place to help you avoid these scenarios? Give me a call. As an experienced CFO, establishing policies, procedures and controls is one of the many services I provide.

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