Using External Audits to Minimize Fraud Risks

If you think fraud can’t happen in your organization, think again. Business fraud—as defined by the FBI—consists of dishonest and illegal activities by individuals or companies often under the guise of legitimate business practices, and they may be more prevalent than you think.

The Association of Certified Fraud Examiners’ 2016 Report to the Nations on Occupational Fraud and Abuse reports that organizations lose an average of 5 percent of their revenues to fraud. And while management depends on external audits to detect fraud, the report disclosed that only 3.8 percent of all frauds are detected by an external auditor. Based on this study, the total loss exceeded $6.3 billion, with an average loss per case of $2.7 million.

This data should make all business owners pause, as it may be tough to distinguish between an error and a fraud in your shortages. Audit and compliance personnel and risk managers, this should quicken you to develop and refine hypothesis as to how a fraud may have been committed. Accounts payable supervisors and personnel, it should stir you to be on alert as you deal with different personalities and need to understand the circumstances that cause an honest person to commit fraud.

Case in Point: $40 Million Later…

Only a short time ago it was discovered that Rita Crundwell, former Comptroller of Dixon, IL, stole $53,000,000 over a 19-year period. During that period of time, the city was audited annually by three different public accounting firms who each issued unqualified opinions of the city’s financial statements.

As a result of each firm’s failure to comply with their own professional audit standards, none of the firms ever detected the fraud—although several common indicators of fraud were present. If any of the firms had performed one certain audit procedure, they would have discovered the fraud.

The city sued those auditors and settled for $40 million.

Think Like a Thief!

While there are some common failures external auditors make in detecting fraud, the bottom line is detecting fraud isn’t easy. In order to detect fraud, an auditor has to:

  • Know what the fraud looks like
  • Be able to think like a thief
  • Maintain a healthy professional skepticism at all times
  • Be able to recognize the risk of fraud
  • Build the audit program to look for fraud

So what are some common fraud indicators? lists 20 ways you can detect fraud, some of which include:

  • Unusual behavior. The employee may appear irritable, defensive or suspicious. He or she may not take vacation time, call in sick or delegate work even when overloaded, for fear of getting caught.
  • Inventory shortage. A normal range of shrink is expected, but excessive shrinkage could indicate theft or embezzlement.
  • Out-of-balance ledger. When funds, merchandise or assets are stolen, the general ledger will be out of balance. Look for inventory to confirm the missing assets’ existence.
  • Complaints. Tips and complaints are notoriously the best source for revealing fraud and should be taken seriously and investigated.

Learn How to Spot Fraud

Audit consultant Dennis Dycus discusses all these issues and more in an audio conference for EliFinancial, “Auditing For Fraud: What You Need to Know.” During this session, Dennis explores the personal attributes of a fraud auditor, reasons auditors fail to detect fraud, and the five-step approach to fraud detection. From common myths about fraud to how society often encourages fraud, Dennis uncovers the truth about who commits business fraud and the red flags to look out for.

To join the conference or see a replay, order a DVD or transcript, or read more

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