Three Types of Fraud and How to Prevent Them

Every organization is vulnerable to fraud. According to the most recently published Report to the Nations on Occupational Fraud & Abuse, the typical organization loses 5 percent of its revenues to fraud each year. Smaller organizations and nonprofits are even more susceptible to fraud losses because of lower staffing levels and technology investments.

Understanding the types of fraud and how they can happen is the first step to preventing and detecting fraud, and minimizing the impact. Fraud can be broken down into three major types — asset misappropriation, corruption and financial statement reporting.

 

Here is some insight on each type of fraud and tips to prevent them:

 

Asset Misappropriation

Asset misappropriations involve an intentional theft or misuse of the organization’s financial or non-financial resources. Common examples are stealing cash, over-billing, and inflated expense reports. This is by far the most common fraud, making up almost 90 percent.

 

The most powerful weapons against asset misappropriations are segregating duties and exception reporting. Segregating duties prevents one person from having too much control over financial activities, like separating expense approval and check signing from the person who reconciles the bank account. Exception reporting highlights things that are out of the ordinary or shouldn’t happen, like an expense report submitted for a business trip that the employee didn’t take.

 

Corruption

Corruption is the next most common form of fraud. Thirty-eight percent of the studied cases involved some form of corrupt act, often involving senior management with authority over essential elements of the organization, like sales and operations. About 70 percent of corruption cases were perpetrated by someone who misused her or his authority to gain direct or indirect benefit. Examples include bribery, kick-backs and conflicts of interest.

 

Segregation of duties and exception reporting are also useful tools to detect and prevent corruption. A zero-tolerance policy from the top is another useful deterrent to corrupt practices.

 

Financial Statement Reporting

Financial statement fraud is less common than the first two types, but is usually the most costly. While only 10 percent of fraud cases are from manipulating financial statements, the median cost is a whopping $800,000. This type of fraud is commonly perpetrated by middle or senior managers whose income is based on meeting projected financial targets. Methods to thwart financial statement fraud are independent oversight, such as audits, and effective governance. Not exactly the easy stuff.

 

Recognizing that fraud can happen and implementing a proactive action plan to minimize the impact are two steps to prevent and detect the three types of fraud. Powerful weapons like segregating duties, exception reporting and zero-tolerance policies can minimize the impact of fraud in your organization.