8 Tips for Preventing Internal Fraud

What is Internal Fraud?

Internal or corporate fraud is the deliberate misuse or misapplication of a company’s resources or assets by an employee for their own personal gain. Put simply, internal fraud occurs when an employee, manager, or executive commits fraud against their employer. This is as opposed to external fraud in which customers, vendors or other parties commit fraud against a company.

Some examples of internal fraud include:

• Skimming: A form of theft where the offender steals money before it is registered in the accounting system. A common skimming method involves an employee collecting payment from a customer for the sale of a product and then retaining the money for themself without actually registering the sale.
• Theft: Money or stock is stolen by the offender that is already registered in the accounting system, often by stealing money from the cash register immediately after processing sales transactions.
• Invoice Fraud: The offender draws up fraudulent invoices and processes them in the supplier system, for example using company credit or debit cards for personal use.
• Wage Fraud: Similar to invoice fraud, the offender forges invoices, this time to force the company to pay a salary to third parties that they may be an accomplice with. 
• Expense Fraud: For this form of fraud, the offender manipulates expense claims to be reimbursed for non-commercial expenditure. 

According to the Australian Institute of Criminology, internal fraud resulted in a loss of $2.7 million to Australian businesses in 2018-19, which includes stolen stock, cash, and damaged business reputation. More concerning is the fact that much fraud still goes undetected and unreported each year. 

However, there are many ways that managers can prevent internal fraud from occurring within their businesses, and deter employees from engaging in this form of fraud in the future.

Tips

1) Develop Clear Policies

It is important to establish clear and easy to understand policies to keep rules from becoming arbitrary and ensure that all employees are conscious of what the company expects of them. These policies should cover areas such as:

• Serving or processing transactions for friends or family
• Personal purchases and transactions
• Personal use of company equipment like telephones, computers and printers

The reason for having these policies is twofold. Firstly, those who intend to commit internal fraud will be deterred knowing that management is aware of this fraud and has enacted clear policies to prevent it. Secondly, honest employees who will not commit internal fraud will become familiar with the possible signs of fraud and will be more likely to report it. These employees will also gain more clarity on what constitutes fraud so they can avoid accidentally committing it.

2) Have Clear Transaction Procedures

For similar reasons as above, companies should have clear procedures for dealing with transactions as this is often where internal fraud occurs. These procedures can include petty cash limits, keeping registers closed unless they are in use and the provision of receipts to acknowledge transactions.

Companies should also segregate the processes of purchasing, receipting and paying, and have two people conduct daily banking if possible. The segregation of duties is an essential element of preventing internal fraud as it ensures that no employee has the ability to perpetrate and conceal errors or fraud during their normal course of duties. Additionally, employees will also be able to provide checks and balances on one another. 

3) Implement Strong Supervision of Staff

Employees are less likely to commit fraud if they know that they are being watched by management. When an employee is able to perform duties without supervision or authorisation from a higher up, there is a risk that they will act in their own self-interests. Some points to consider when implementing supervision include:

• Supervise employee compliance with procedures
• Regularly review cash shortages and investigate instances where an explanation is unsatisfactory
• Have supervisors consistently check receipts and documentation
• Look into suspicious transactions
• Review of personnel

4) Set up a Reporting System

Although supervisors may catch employees engaging in fraud by looking into suspicious activities, an important source of detecting fraud are the employees themselves. Although employees are often hesitant to report incidents to their employers, this can be overcome by setting up an anonymous reporting system. Other sources also include customers, vendors and competitors. 

The Association of Certified Fraud Examiners reports that 40% of occupational fraud is detected because of a tip, the most of any other source. Consequently, businesses must ensure that they have appropriate reporting systems in place. 

The most common formal reporting mechanisms used by whistleblowers that businesses should consider implementing are:

• Telephone hotline
• Email
• Web-based/Online Form
• Mailed Letter/Form

Reporting systems will act as an effective deterrent against employees who would engage in fraud but are afraid of being reported by their fellow employees.

5) Perform Accounting Reconciliations

Fraud is often successful when it is well concealed. A way of combating this issue is performing regular accounting reconciliations and catching irregularities that may point to a case of fraud. Again, potential perpetrators of fraud will be deterred from committing fraud if they know that the accounts are being frequently looked over. 

The accounting reconciliations that business should undertake at least on a monthly basis include:

• Bank reconciliations (for all accounts)
• Accounts receivable reconciliations (both month to month and general ledger to sub-ledger)
• Accounts payable reconciliations (both month to month and general ledger to sub-ledger

Not only will performing accounting reconciliations give an indication of potential fraud, it will also have the added benefit of helping managers make decisions and ensure the accuracy of the accounting records.

6) Establish Strong Human Resource Procedures

One of the best ways to prevent a problem is to stop it from the source. For fraud, this means hiring the right people and training them. 

Businesses can implement procedures such as:

• Check references and perform background checks. This includes employment, credit and criminal history. 
• Have formal, specific job descriptions. A red flag for fraud is when employees perform duties outside their job description.
• Appropriately train employees. Not only will employees learn what constitutes fraud, they will also be able to recognise and report any suspicious behavior.
• Implement an equitable remuneration system. Some employees may engage in fraud if they feel their remuneration is inadequate.

7) Constantly Monitor Your Assets

Although quite a simple measure, constantly monitoring your physical assets is a crucial step to prevent employees from engaging in stealing. Businesses should also have stringent control over their intangible assets, such as their knowledge and information. 

Examples of measures that businesses can put in place include:

• Conducting regular stocktakes
• Restricting physical access to only those who require it to perform their job function
• Locking doors, desks and filing cabinets
• Implementing electronic surveillance systems
• Using employee IDs and passwords

These measures are the most visible to potential offenders of fraud and are therefore the strongest deterrent. While these measures do not necessarily entirely eliminate the risk of fraud, reducing the potential offender’s access to these assets will reduce the likelihood of fraud occurring.

8) Get Expert Help

Sometimes the numbers still won’t add up, even after implementing all of the above fraud prevention recommendations. If that is the case, then it may be worthwhile hiring a professional auditor to have a look at the company’s books. 

A Certified Practising Accounting (CPA) or Certified Fraud Examiner (CFE) can perform an extensive review of the company’s accounts and control processes, without having any personal relationship with the company to cloud their judgement. They can help with fraud detection and prosecution if necessary. 

These auditors will also ensure the books comply with government regulation, add credibility to the financial statements after their review, and point out key processes that may need improvement. However, a key factor to consider is the steep cost of hiring these auditors.

Conclusion

Employee fraud can take on many forms, but all of them represent a detriment to the business. It should be the priority of all businesses to implement procedures that prevent and deter internal fraud to prevent further losses. Not only will this have a substantial financial benefit, it will also promote a healthy company culture, with new employees learning the correct way of doing their job, that minimises errors and promotes good communication throughout the organisation.