Financial Fraud Uncovered Through a Surprise Audit

Weaver’s forensics accountants know that fraud has many causes and takes many forms. In fraud investigations among organizations of all sizes, forensics accountants find that in today’s economic climate, even trusted employees can and do commit fraud.

When a spouse loses a job, an employee might misappropriate and resell computers and other company equipment to pay the mortgage and other bills.

Leaders or managers feeling pressure to meet aggressive earnings or revenue growth targets may conceal deteriorating performance with creative journal entries to increase sales. They might inappropriately reduce or capitalize expenses to avoid loan defaults, preserve bonuses — or simply their jobs.

The pandemic has also opened up opportunities to defraud. Layoffs typically spread the remaining employees thinner, making it harder to implement or maintain strong internal control procedures, such as supervisory reviews and segregation of duties. Poor internal controls, weak management oversight and ineffective or nonexistent audits all create opportunities for fraud.

Likewise, leadership and top managers may be distracted from fraud prevention and detection efforts as they scramble to recover lost sales or focus on cost containment. Employees working harder without more pay — and with personal financial problems — may be more likely to rationalize a fraudulent act. They may mentally justify the fraudulent conduct by thinking: “I’ll pay back the money before anyone misses it,” or “My employer can afford the financial loss.” By rationalizing, perpetrators overcome ethical barriers that ordinarily guide their conduct.

Financial Statement Fraud

Financial statement fraud is the costliest type of occupational fraud, with a median loss of $954,000, but also the least common.

The Association of Certified Fraud Examiners defines financial statement fraud as “a scheme in which an employee intentionally causes a misstatement or omission of material information in the organization’s financial reports.” Methods for committing such fraud aren’t just limited to the overstatement or understatement of assets or revenues.

For example, liabilities or expenses might be recorded improperly to make the company appear more liquid or profitable in the current accounting period. Or a dishonest employee could manipulate accounting cutoffs by recording revenues early and expenses late, which violates the accounting concept of matching expenses with the associated revenues in the same period. Financial statement fraud also can easily occur when the accounting rules call for the use of subjective estimates.

Surprise Audits

One proactive measure to consider, especially if the suspected wrongdoing involves employees, is a surprise audit. The element of surprise is critical because most fraud perpetrators are constantly on guard. Announcing an upcoming audit gives wrongdoers time to cover their tracks by shredding (or creating false) documents, altering records or financial statements, or hiding evidence.

Surprise audits focus on high-risk areas such as inventory, receivables and sales, and technology is typically used to conduct sampling and data analysis.

In comparison to a traditional financial statement audit, a surprise audit more closely examines the organization’s internal controls intended to prevent and detect fraud. External auditors identify any weaknesses that could make assets vulnerable and help management determine whether any employees may have already exploited those weaknesses.

Fraud perpetrators likely have paid close attention to how previous financial statement audits were performed — including the order in which the audit proceeded. In a surprise audit, the procedures follow a different process or schedule and therefore are less predictable. For example, instead of beginning audit procedures with cash or receivables, a surprise audit may begin with vendor set-up or payment processes.

Other Ways to Prevent Fraud

Reviewing your organization’s bonus plans, familial dynamics and financial condition can also help identify (and alleviate) high-pressure situations that may lead to fraud. The process also can create a healthier work environment and reduce fraud risks.

Weaver’s forensic accountants can assess your company’s risk profile and determine whether you the need to dig deeper to evaluate whether and where fraud losses have been incurred. Contact us. We are here to help.

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