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Financial Oversight and Fraud

As you are most certainly aware, fraud and more importantly fraud prevention, has become a major concern of anyone charged with financial oversight. A key element of any organizations internal control environment is the development and implementation of controls and processes to assess the risk from fraud. In order to properly develop these controls it is important to have a solid understanding of what fraud is and how fraudsters think.

What is Fraud?

Fraud is defined as “any intentional or deliberate act to deprive another of property or money by guile, deception or other unfair means.” It is important to note that for something to be
considered fraud, it must be intentional– there is no such thing as accidental fraud. What this means is that the fraudsters had to develop a plan to commit fraud and circumvent any internal controls in place.

There are two main types of fraud:

  1. Misappropriation of assets – theft of company assets
    • Overwhelmingly most common
  2. Fraudulent financial reporting – misrepresentations in financial reports
    • Committed by top management
    • More common among publicly traded companies
What is Necessary to Commit Fraud?

Many years ago several academics who were studying fraud created the concept of the fraud triangle and determined that in order for fraud to be committed, all three elements of the fraud triangle have to be present.

Pressure – This leg of the triangle represents internal pressure that the fraudster may be experiencing. Most often these are financial pressures such as a gambling problem, drug addiction or medical bills. In recent years the downturn in the US economy has created a situation wherein people are struggling to pay their mortgages and other bills as a result of job losses. This may create an added pressure if a fraudster’s spouse or other family member has lost a job is struggling financially.

Rationalization – This leg represents that ability of the fraudster to rationalize his/her behavior, typically by claiming that they were entitled to any money they stole. A prime example of this occurs when an employee believes they are being underpaid or were passed over for a promotion. They will then use this belief to justify their fraud. This has also become more prevalent in recent years due to the downturn in the US economy. Another common rationalization is that the fraudster is stealing from a large, faceless entity and no one is really being hurt.

Opportunity – The final leg of the triangle represents the ability fraudster to actually commit the fraud. Looked at another way, this leg represents the gaps in the internal control structure. This is the one leg that can be effectively mitigated through internal controls and the overall environment that is created by the organization’s leaders.

By: Shawn H. Miller, CPA, CFE | Partner