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Corporate Fraud: Knowing the Signs and How to Fight It

Posted by: Zhorea Garcia
Category: Business in Asia
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Fighting corporate fraud is now more relevant than ever before. With easier access to more tools and data, fraudsters can readily take on businesses and their clients. This has been a growing concern not only in China but worldwide. Therefore, companies should learn to protect their businesses from fraud and gain insights from these incidents to monitor and detect fraud in the future.

Check out a case study about Inventory Fraud in a Chinese Company

In this article, you will learn more about the types of fraud, its common red flags and the five ways to prevent it.

What is corporate fraud?

Fraud is a crime committed by someone yearning for a potential gain which can be obtained through the deception of any form such as trick, ruse, sham, cheating, hiding, and others.

According to ACFE (Association of Certified Fraud Examiners) report on vulnerability to fraud, most organizations are mainly concerned about the risks brought by fraud including five areas. These are:

  • Inability to effectively identify or address known fraud risks
  • Lack of effective checks and balances
  • Lack of communication between departments
  • Unwillingness to identify or address fraud risks
  • Absence of a fraud prevention budget

Furthermore, ACFE also identified three categories of fraud schemes including corruption, asset misappropriation, and financial statement fraud schemes. There are also different conditions in which people commit fraud. It could be due to pressure, open risks and mindset. Pressure usually comes in the form of financial pressure which can also stem from having an inappropriate lifestyle such as gambling. An open risk refers to an opportunity that fraudsters can take advantage of such as easy access to critical data and lack of internal risk controls within the company management. Furthermore, having an insufficient audit mechanism can also give way for fraudsters to manipulate data and perform fraud.

On the other hand, fraud can also be due to a mindset involving revenge, disloyalty or rationalization that fraud exists everywhere and so committing a fraudulent behavior is justified.

What are the red flags?

Spotting a fraud scheme is not easy because it involves strong deception and pretention. However, fraud is like a disease that has its symptoms. Let’s take a look at some of the red flags in identifying the different fraud schemes.

Corruption

Lifestyle changes, close relations with officials, frequent gift budgets and addiction are the most common red flags of corruption. There is also a tendency for corruption if there is no segregation of duties in which only one person does everything. This means that he or she can have full control of all transactions that may suit his or her advantage.

Moreover, people can be vulnerable to committing fraud when they have significant debt or credit problems as well.

Asset Misappropriation

This type of fraud is common in most fraud cases and is the easiest scheme to understand. According to the 2018 Report to the Nations Global Study on Occupational Fraud and Abuse, 89% of fraud cases were associated with asset misappropriation. It is also the least costly type of fraud. On the other hand, corruption was the most common scheme in every global region.

There are several red flags included in asset misappropriation such as cash skimming, unusual fluctuations in payroll expenses or hours, or ghost employee frauds.

Misappropriating assets via non-cash can also involve discrepancies between sales and inventory growth, unusual or unexpected asset purchases or missing assets and fraudulent use of equipment.

Financial Statements Fraud

Fraud schemes regarding financial statements exhibit only 10% of the fraud cases. It is the least common yet most costly. The red flags can be seen through manipulated or altered financial statements including, for example, balance sheets, and income or cash flow statements. Furthermore, this type of fraud extends to the following aspects:

  • Account receivables (i.e. increased amount of write-offs)
  • Unrecorded liabilities
  • Hidden expenses
  • Fixed assets (i.e. unexplained increase in value)
  • Disclosure of legal contingencies

5 ways to prevent fraud 

  1. Improve internal control
  2. Investigate or review fraud cases
  3. Establish an anti-fraud culture
  4. Provide corporate fraud awareness or training
  5. Encourage employees to expose fraud

Key takeaways

Since 2008, ACFE has been identifying the most common behavioral red flags of corporate fraud. Over the years, there have been six factors with a “remarkably consistent distribution”. These include living beyond the means, divorce or family problems, control issues, unwillingness to share duties, unusually close association with vendor or customer, financial difficulties and “wheeler-dealer” attitude.

The ACFE report also found that 35% of fraud perpetrators were employees while 24% of them were owners and executives. The red flags were determined to be financial difficulties and unusually close relationships with clients, respectively.

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Author: Zhorea Garcia

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