Forensic Accounting

Concept of Fraud
“Fraud” is any activity that relies on deception in order to achieve a gain.
Fraud becomes a crime when it is a “knowing misrepresentation of the truth or
concealment of a material fact to induce another to act to his or her detriment”. In
other words, if you lie in order to deprive a person or organization of their money or
property, you’re committing fraud.

Different Types of Fraud in Business

1. Asset Misappropriation
As the name suggests, asset misappropriation happens when an employee
takes or misuses company assets for their gain. This type of fraud can look like
simple theft or abuse of company goods or services. For instance, an employee uses
company equipment for their personal use even if they never actually steal it.

If the fraudster is clever, asset misappropriation can happen again and again until
proper controls, such as strong asset and inventory management, are put in place. A
company doesn’t have to be large to be a victim.

2. Forgery
Forgery often appears as falsified business or financial records. An employee
may create fake records over time and use them to steal funds. They may also falsify
official badges or identification to steal property or goods.

3. Inventory Theft
Stealing goods for resale or personal use is known as inventory theft.
Employees may accomplish this by changing inventory records or claiming to have
lost documentation and receipts.

4. Account Fraud
Scammers can also come from outside a company. Business account fraud
happens when a hacker gains access to bank accounts through malware, fraudulent
emails (also known as business email compromise) or other means. They may try to
make unauthorized purchases or transfers before account credentials are changed.

5. Payroll Fraud
Embezzlement of company funds using the company payroll is called payroll
fraud. An employee can steal funds by way of falsified time sheets, issuing
unauthorized bonuses, or paying fictitious or terminated employees. Companies can
even commit payroll fraud by misidentifying their employees to the IRS.

6. Cash Theft
Also known as skimming, cash theft can occur a few dollars at time. This
fraud is most common in a business that deals with a lot of customer payments in
cash, such as restaurants and food carts. In some cases, a business owner will skim
cash, since doing so reduces the reported profitability of the business, and therefore
its income tax liability.

7. Credit Card Scams

 Businesses that hand out company credit cards for incidentals must keep a
close eye on receipts and statements. An employee might be tempted to swipe their
company card for something not related to their job. If they successfully submit an
erroneous expense report, they may continue the practice.

8. Business Email Compromise

Business email compromise is a type of phishing scam in which fraudsters
try to hack, spoof or impersonate business email addresses. They may change one
letter or number in a familiar email address to make their scam appear legitimate.

Categories of Fraud
Unfortunately, fraud is so common that it can be categorized in countless
ways. But fundamentally, every type of fraud is either organizational or individual.
Let’s look at some key characteristics of each.
 Against individuals
This is when a single person is targeted by a fraudster — including
identity theft, phishing scams and “advance-fee” schemes. Perhaps one of
the most noteworthy and devastating individual frauds is the Ponzi
scheme. → (an investment fraud that pays existing investors with funds
collected from new investors)
 Internal organizational fraud
Sometimes called “occupational fraud,” this is when an employee,
manager or executive of an organization deceives the organization itself.
Think embezzlement, cheating on taxes, and lying to investors and
shareholders.
 External organizational fraud
This includes fraud committed against an organization from the
outside, such as vendors who lie about the work they did, demand bribes
from employees and rig costs. But customers sometimes defraud
organizations, such as when they submit bad checks or try to return knock-
off or stolen products. And increasingly, technology threatens organizations
with theft of intellectual property or customer information.

Fraud Triangle
The most widely accepted explanation
for why some people commit fraud is known as
the Fraud Triangle. The Fraud Triangle was
developed by Dr. Donald Cressey, a criminologist
whose research on embezzlers produced the
term “trust violators.”

The fraud triangle states that “individuals are

motivated to commit fraud when three elements come
together: (1) some kind of perceived pressure, (2) some perceived opportunity, and (3) some
way to rationalize the fraud as not being inconsistent with one’s values.”

Condition #1: Financial Pressure/Motivation

What one person feels is a valid justification might not be compelling to another.
There are as many different motivations for fraud as there are people in the world, but they
can be sorted into a few main categories:
 Sudden changes in circumstances: a partner’s job loss, a surprise medical bill.
 A sense of being wronged: being passed over for a promotion or denied a raise.
 Survival: inability to afford life-saving medicines or to put food on the table.
 Status pressure: feeling compelled to keep up with peers’ earning or spending.

Condition #2: Opportunity

Perhaps the easiest piece of the triangle for business owners to control is
opportunity. No matter how disgruntled or desperate your employees might feel, they can
only commit fraud if they’re given the chance to do so.
Here are a few examples of fraud opportunities:
 Lying about the number of hours worked, their sales numbers, or their productivity to
receive higher pay.
 Creating false invoices for products the company never purchased and pocketing the
money.
 Selling proprietary company information to competitors.

Condition # 3: Rationalization
The final piece of the fraud triangle is rationalization. Even when people have
motivation and opportunity, most will not choose to act unless they can justify to
themselves why their fraud is “okay.” Even those who could strike to break the law given the
right motivation usually wouldn’t be willing to do so if it meant they were harming someone
else. But when it comes to defrauding a company, many fraudsters can convince themselves
that theirs is a victimless crime.
Examples of common rationalizations that fraud committers use include:
1. “They treated me wrong”
An individual may be spiteful towards their manager or employer and believe that
committing fraud is a way of getting payback.
2. “Upper management is doing it as well”
A poor tone at the top may cause an individual to follow in the footsteps of those
higher in the corporate hierarchy.
3. “There is no other solution”
An individual may believe that they might lose everything (for example, losing a job)
unless they commit fraud.

Fraud Cases
 Enron Scandal
The Enron scandal was a series of events involving dubious accounting
practices that resulted in the 2001 bankruptcy of the energy, commodities, and
services company Enron Corporation and the subsequent dissolution of the
accounting firm Arthur Andersen.
Enron used special purpose entities to hide debt off of its balance sheet and
mark-to-market accounting to overstate revenue. In addition, it ignored internal
advisement against these practices knowing that its publicly disclosed financial
position was incorrect.
 Ponzi scheme
Ponzi schemes are named after Charles Ponzi. a con artist offers investments
that promise very high returns with little or no risk to their victims. The returns are
said to originate from a business or a secret idea run by the con artist. In reality,
the business does not exist or the idea does not work in the way it is described.
Ponzi promised investors a 50% return within a few months for what he
 claimed was an investment in international mail coupons. Ponzi used funds from
new investors to pay fake “returns” to earlier investors.
 ZZZZ Best
It is a carpet-cleaning company set up in 1982 by 16-year-old Barry Minkow.
ZZZZ Best was a company set up as a front for a Ponzi scheme. Its founder engaged
in a range of criminal acts including insurance scams and check kiting. Minkow and
his business associate Tom Padgett set up a fake company called Interstate Appraisal
to defraud financial institutions out of millions.
 Theranos
Theranos was a healthcare startup that claimed to revolutionize the blood-
testing industry. However, the aggressive claims by CEO Elizabeth Holmes were later
found to be fraudulent, and the company was actually fabricating results to deceive
both investors and patients.
Theranos claimed to have developed blood tests that required only small
amounts of blood and devices that could quickly perform the tests. Based largely on
those claims, Theranos reportedly raised roughly $724 million of capital from
venture capitalists and private investors.

How Can Businesses Protect Themselves from Fraud?

Educate and Empower
Educate employees about signs of fraud and proper ethics for your specific industry.
Remind them that fraud can affect them all, not just the person committing the fraud.
Division of Duties
The same employee should not tally receipts, prepare the deposit slip and bring the deposit
to the bank. If multiple people are handling these jobs, this could help reveal discrepancies
in the collections that point to embezzlement.
Perform Surprise Audits
A scheduled audit could give a fraudster time to cover their tracks. Performing a
surprise check on operations and bookkeeping, however, may catch irregularities that signal
embezzlement or another type of fraud.
Know Your Money
Do your best to understand how money goes in and out of your business. Know the
details surrounding methods of payment, who has authority to make those payments, and
what steps are in place to ensure payments are legitimate.
Documentation and Internal Controls
Proper documentation allows a business owner to verify deposits, cash totals, and
more. Another step is to consecutively number all checks, purchase orders and invoices.