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Does fraud follow economic cycles?

Does this sound like your business lately?  Sales volume is down.  Cash is tight. The company is losing money.  And just when you think things can’t possibly get any worse, you discover that one of your employees has committed fraud… Sadly, this scenario is all too common and begs the question of whether fraud is more likely to occur when the economy slows down.

Economy down, fraud up?

A survey conducted by Deloitte & Touche in late 2008 showed that 63% of the firm’s clients expected an increase in fraud related to the global financial crisis experienced in that year.  This would seem to indicate that, at a minimum, people expect more fraud to occur during an economic downturn.

However, it may be that fraud is simply more likely to be discovered during times of economic stress.  When business is good, people don’t tend to question anomalies as thoroughly and small frauds might even be dismissed in an effort to maintain focus on growth, not problems.  But when money is tight and management is kicking over every rock looking for profits, it’s much harder to conceal fraud and companies are willing to go after fraudsters to recover precious lost resources.

Public perception of fraud can also make it seem as though there’s an uptick in fraud in lean times.  During a downturn, most economic news coverage is negative.  Discovery of fraud certainly contributes to the tone of the times and is often a lead story during such periods of stress.  Additionally, improved fraud detection measures (think Sarbanes-Oxley) have helped increase the actual number of frauds detected, hence the appearance that more fraud is happening.

So what actually causes a person to commit fraud?

Fraud Triangle

fraud triangle

The Fraud Triangle, first set forth by Donald Cressy, describes three factors that are present in every situation of fraud:

  1. Pressure – the need for committing fraud (need for money, etc.)
  2. Rationalization – the mindset of the fraudster that justifies them to commit fraud
  3. Opportunity – the situation that enables fraud to occur (often when internal controls are weak or nonexistent).

In order to break the fraud triangle, an organization must remove one of the three elements of the triangle.

Pressure

Many things may contribute to the pressure to commit fraud during troubled economic times.

Any of these or a host of other factors could pressure a person into biting the hand that feeds them.

Rationalization

How does a person justify theft from their employer?

Particularly during a downturn, it’s not terribly difficult for a dishonest person to find a reason to steal.

Opportunity

Times of economic stress present many opportunities to commit fraud that might not be present during better times.

  • Less people doing more work = lack of oversight
  • Same level of supervision over more people
  • Middle managers (supervisors) are generally the first to be cut
  • Battlefield promotions of un- or under-experienced people

It’s important that companies realize the risks associated with cutting resources and take steps to ensure that internal controls aren’t compromised.

(Find out what the 7 Warning Signs of Fraud are!)

An Ounce of Prevention…

So what’s a company to do?  There are several fraud-prevention tactics that can be used, both in good times and in bad.

  • Review internal control policies/procedures
  • Get a handle on crucial resources
  • Monitor key metrics for anomalies

Most fraud prevention scenarios focus on removing opportunity by strengthening internal controls. While this is a great first-line defense against fraud, it’s also important that a company take stock of its resources (like cash) to establish a baseline from which to measure changes.

It’s hard for fraud to hide out when management is tracking key drivers.  Fraud will usually cause a blip in key metrics, but if those metrics aren’t being watched, the blip could slip by unnoticed.  Not sure what you should be tracking?  Check out our free KPI Discovery Cheatsheet below.

does fraud follow economic cycles

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does fraud follow economic cycles

Whether or not fraud actually follows economic trends is up for debate.  The good news is that there are steps that a company can take to minimize the likelihood and impact of fraud.

Leave us a comment with your fraud prevention tips below.

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7 Warning Signs of Fraud

warning signs of fraudUnfortunately, companies of all sizes can become victims of fraud. In fact, a study on fraud published by accounting firm KPMG International found “a very large increase in cases involving the exploitation of weak internal controls by fraudsters up from 49 percent in 2007 to 74 percent in 2011.” Thus, internal controls are a first line of defense and are important in any size organization. So, implement them to reduce the opportunity for fraud. Whatever the size company, there are some warning signs of fraud that are important to pay attention to.

7 Warning Signs of Fraud

1.  Is the person reconciling the bank statement also a check signer?

These are important duties to segregate. When combined, a person signing a fraudulent check can go on without being detected.

2.  Does your company have several bank accounts?

Multiple bank accounts make inappropriate movements of cash harder to detect. So, make sure you understand the business need for each bank account the company has and use as few accounts as possible.

3.  Do you have a budget to compare with your actual financial results on a monthly basis?

This is an important control in the detection of unauthorized transactions.

4.  Have you noticed a controlling personality or secretive behavior on the part of an employee?

This may be a sign that a person is being deceptive or needs to control people or the environment in order to conceal their activity.

(Have you ever heard of skimming fraud? It’s the most difficult fraud to detect.)

5.  Are there accounts on your financial statements that you do not understand?

Ask! If your question is not welcomed or answered to your satisfaction, then pay attention to this response.

6.  Financials that are not timely or closed on a monthly basis.

Lax or non-existent cut offs leave room for inappropriate entries in months long gone.

7.  Are employees related in your accounting department?

Part of a functioning internal controls system is the need for collusion in order to circumvent controls.

The Fraud Triangle

What is the motivation for an employee to steal?  The fraud triangle shows us 3 following conditions:

  • Pressure (motivation or intent to steal)
  • Rationalization (justification of dishonesty)
  • Opportunity (ability to carry out misappropriation of company assets.)

Well designed internal controls serve to mitigate the opportunity for fraud in your organization.

(Have you every wondered does fraud follow economic cycles?)

How to Reduce Fraud

What can you do to reduce the chance for fraud in your organization? First, remember that internal controls are necessary for all size organizations. Check out the following ideas that you will find helpful as you assess controls in your organization:

Live Ethics in Your Corporate Culture 

A culture of ethics starts at the top and you start by demonstrating it on a daily basis. We cannot emphasize this enough as it sets the bar for acceptable behavior in your organization.

Trust is Not a Control 

Trust is not a control, so design internal controls. Then put them in place for the position. Thus, they should not be for a particular employee, regardless of how trusted that employee is.

Pre-Employment Screening

Conduct pre-employment screening including background checks as appropriate.

Utilize Entire Team

If you do not have enough employees in accounting, then utilize others as part of your control system.

Have Different Signers

If your bank account reconciler is a signer, then find a different signer. Segregate the check cutting, signing and reconciling duties from each other.

Unbiased Reviewer

Have the company bank statements go unopened for review by someone in a management position who isn’t cutting or signing checks.

Choose Signers Carefully

Understand what authority signers have with company bank accounts and choose signers carefully. Add extra controls to your corporate bank accounts – an example is precluding any counter withdrawals so that all bank account withdrawals go through the check writing process.

Anonymous Alert System

Set up an anonymous way for your employees to alert you of any concerns/suspicions related to potential fraud within your company. Then take these alerts seriously.

Segregation of Duties & Controls

Segregation of duties and internal controls protect both your employees and the company.

If you want to reduce the fraud or detect fraud in your company, then check out our free Internal Analysis whitepaper. We have designed this whitepaper to assist your leadership decisions and create the roadmap for your company’s success!

warning signs of fraud
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The Fraud Triangle

See Also:
Accounting Fraud Prevention using QuickBooks
Audit Scope
Bankruptcy Chapter 11
How to Hire New Employees

Fraud Triangle Definition

Donald Cressey created the concept of the fraud triangle. The creation of the theory required Cressey to interview about 200 convicted embezzlers around the Midwest which he dubbed “trust violators.” The people that had entered the work place with no intention of stealing peaked his interest. After the interviews Cressey formed the following hypothesis:

Trusted Persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as trusted persons with their conceptions of themselves as users entrusted funds or property.

Cressey created the fraud triangle and the three fraud triangle components. These consist of all of the following:

The fraud triangle can best explain most all abuse unless the particular person entered the company with the intent of stealing in the first place.

Fraud Triangle Pressure

Pressure is the first leg of the fraud triangle. Define the pressure Cressey describes in his hypothesis as a non-shareable financial problem. These financial problems are usually personal to that person. But, they are too ashamed by the problem that they are unwilling to share with others. This is particularly disturbing when it is later understood that if the violator had talked about it others would have been willing to help.

(Have you ever wondered does fraud follow economic cycles?)

Fraud Triangle Opportunity

The second leg of the fraud triangle is an opportunity that exists within a company for fraud to take place. Opportunities usually occur from a lack of internal controls within a company. For example, the violator here feels that he/she can take advantage of the situation without getting caught. Of course, there has to be a certain level of technical skill to be able to define an opportunity which is why several violators find opportunities within their own job function.

(Discover the 7 warning signs of fraud!)

Fraud Triangle Rationalization

The third and final component of the fraud triangle is that of rationalization. Cressey found that many of the violators never felt that they were actually a criminal. This is because they had rationalized to themselves that the misdeed was ok. In fact, many of the violators Cressey interviewed felt that they were justified. Instead, the act was part of a general irresponsibility for which they were not completely accountable.

If you are dealing with fraud, then check out our free Internal Analysis whitepaper to help you solve the issues and prevent it from happening again.

fraud triangle
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Access your Exit Strategy Checklist Execution Plan in SCFO Lab. The step-by-step plan to put together your exit strategy and maximize the amount of value you get.
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