CHAPTER 14

Fraud Against Organizations

 LEARNING OBJECTIVES

After studying this chapter, you should be able to:

q Understand the extent to which employees and

others commit occupational fraud.

q Describe the nature and various types of asset

misappropriations.

q Discuss the nature and various types of

corruption.
FRAUD STATISTICS RELATED TO LOSS*

q Occupational fraud and abuse impose enormous

costs on an organization.
Ø The median loss caused by occupational frauds in
the study was $150,000.
Ø Nearly one-quarter of the cases caused at least $1
million or more in losses.
q Participants in the study estimated that
organizations lose 5 percent of their annual
revenues to fraud.

*These statistics about occupational fraud are based on 2,410

fraud cases reported in the ACFE’s 2016 study by Certified Fraud
Examiners (CFEs).
FRAUD STATISTICS RELATED TO DETECTION*

q Occupational fraud schemes can be very difficult to detect.

Ø The median length of the schemes in the study was 18
months from the time the fraud began until it was detected.
Ø Occupational frauds are more likely to be detected by a tip
than by other means such as internal audits, external
audits, or internal controls.
q Whistle-blowers were most likely to report fraud to their
direct supervisors or company executives.

*These statistics about occupational fraud are based on 2,410 fraud

cases reported in the ACFE’s 2016 study by Certified Fraud Examiners
(CFEs).
FRAUD STATISTICS RELATED TO PREVENTION*

q Certain anti-fraud controls have a significant impact on an

organization’s exposure to fraud.
Ø Anti-fraud controls include internal audit departments,
surprise audits, and anti-fraud training for employees and
managers.
Ø Victim organizations that had such anti-fraud controls in
place had lower losses compared to organizations without
antifraud controls in place.

*These statistics about occupational fraud are based on 2,410 fraud

cases reported in the ACFE’s 2016 study by Certified Fraud Examiners
(CFEs).
FRAUD STATISTICS RELATED TO ORGANIZATION SIZE*

q The median loss suffered by small organizations (those

with fewer than 100 employees) was the same as that
incurred by the largest organizations.
Ø However, this type of loss is likely to have a much greater
impact on smaller organizations.
q The size of the loss caused by occupational fraud is
strongly related to the position of the perpetrator.
Ø For example, frauds committed by owners/executives were
more costly when compared to frauds committed by
managers.
*These statistics about occupational fraud are based on 2,410 fraud
cases reported in the ACFE’s 2016 study by Certified Fraud Examiners
(CFEs).
ASSET MISAPPROPRIATIONS

q Employees, vendors, and customers of organizations

have three opportunities to steal assets:
Ø Steal receipts of cash and other assets as they are
coming into an organization.
Ø Steal cash, inventory, and other assets that are on hand.
Ø Commit disbursement fraud by having the organization
pay for something it shouldn’t pay for or pay too much
for something it purchases.

q With each of these three types of fraud, the perpetrators

can act alone or work in collusion with others.
q Figure 14.1 outlines the misappropriation possibilities.
Assets − Liabilities = Net Worth
FIGURE 14.1 TYPES OF ASSET MISAPPROPRIATIONS
ASSET MISAPPROPRIATIONS—WELLS’S CLASSIFICATION SCHEME

q Thefts of cash
Ø Larceny (intentionally taking away an employer’s cash
without the consent and against the will of the employer)
Ø Skimming (the removal of cash from a victim entity prior
to its entry in an accounting system)
Ø Fraudulent disbursements

q Thefts of inventory and other assets

Ø Misuse
Ø Larceny

q Figure 14.2 illustrates the main elements of Wells’s

classification scheme.
FIGURE 14.2 OCCUPATIONAL FRAUD CLASSIFICATION SCHEME
THEFT OF CASH THROUGH LARCENY

q When larceny occurs, cash is stolen by employees or others

after the cash is recorded in the company’s accounting system.
Ø As a result, larceny schemes are easier to detect than
skimming schemes and are far less common.
q Cash larcenies can take place in any circumstance in which an
employee has access to cash.
Ø Common larceny schemes involve the theft of cash or currency
on hand (in a cash register or petty cash box, for example) or
from bank deposits.
Ø Cash larcenies are most successful when they involve relatively
small amounts over extended periods of time.
Ø With such thefts, businesses often write the small missing
amounts off as “shorts” or “miscounts,” rather than as thefts.
 THEFT OF CASH THROUGH SKIMMING

q Skimming is any scheme in which cash is stolen from an

organization before it is recorded on the organization’s books and
records.

q Basic skimming scheme

Ø Taking money from the sale of goods or services but making no
record of the sale
THEFT OF CASH THROUGH SKIMMING

q More complicated skimming schemes occur when employees

Ø Understate sales and collections by recording false or larger-
than-reality sales discounts.
Ø Misappropriate customer payments and write off the
receivable as “uncollectible”.
Ø Embezzle a first customer’s payment and then credit that
customer’s account when a second customer pays (a delayed
recognition of payment, called lapping).
Ø Work together with customers to allow them to pay later than
required or less than required.
CASH THEFT THROUGH FRAUDULENT DISBURSEMENTS

q The ACFE found that fraudulent disbursements

comprised by far the highest percentage of asset
misappropriations.
q It identified six cash schemes involving outgoing
disbursements of cash:
Ø Billing schemes
Ø Check tampering
Ø Expense reimbursements schemes
Ø Payroll disbursement schemes
Ø Wire transfer schemes
Ø Register disbursement schemes

q Table 14.1 summarizes these six disbursement schemes.

 CHECK TAMPERING

q Employee prepares a fraudulent check for his or

her own benefit.

q Employee intercepts a check intended for another

person or entity and converts the check to his or
her own benefit.
REGISTER DISBURSEMENT SCHEMES

q False refunds

q False voids
BILLING SCHEMES

q Setting up dummy companies (shell companies) to

submit invoices to the victim organization.

q Altering or double-paying a nonaccomplice

vendor’s statements.

q Making personal purchases with company funds.

 PAYROLL DISBURSEMENT SCHEMES

q Ghost employees

q Falsified hours and salary

q Commission schemes

q False workers’ compensation claims

 EXECUTIVE CASH FRAUDS

q Examples
Ø Tyco scandal

Ø Adelphia scandal
MISUSE OF COMPANY ASSETS

q A person can misappropriate company assets

other than cash in one of two ways.
Ø The asset can be misused (or “borrowed”), or it
can be stolen.
q Simple misuse is obviously the less egregious of
the two types of fraud.
Ø Assets that are misused but not stolen typically
include company vehicles, company supplies,
computers, and office equipment.
Ø These assets are also used by some employees
to conduct personal work on company time.
 THEFT OF INVENTORY AND OTHER ASSETS

q Noncash types of frauds against organizations:

Ø Inventory
Ø Information
Ø Securities

q Table 14.2 describes the most common

noncash types of frauds against organizations.
CORRUPTION

q The tradition of “paying off” public officials or

company insiders for preferential treatment is
rooted in the crudest business systems
developed.
q Corruption can be broken down into the
following four scheme types:
Ø Bribery schemes
Ø Conflict of interest schemes
Ø Economic extortion schemes
Ø Illegal gratuity schemes
q Table 14.3 from the 2012 ACFE report
summarizes these types of frauds.
 BRIBERY

q Bribery involves the offering, giving, receiving, or

soliciting of anything of value to influence an official act.
Ø The term “official act” means that traditional bribery
statutes only proscribe payments made to influence the
decisions of government agents or employees.
q Many occupational fraud schemes involve commercial
bribery—something of value is offered to influence a
business decision rather than an official act of
government.
q Bribery schemes generally fall into two broad categories:
Ø Kickbacks
Ø Bid-rigging schemes
CONFLICTS OF INTEREST

q A conflict of interest occurs when an employee, a

manager, or an executive has an undisclosed economic
or personal interest in a transaction that adversely affects
the company.
Ø Conflicts usually involve self-dealing by an employee.
Ø In some cases, the employee’s act benefits a friend or
relative, even though the employee receives no financial
benefit from the transaction.
q To be classified as a conflict of interest scheme, the
employee’s interest in a transaction must be undisclosed.
q Most conflict schemes fall into one of two categories:
Ø Purchase schemes
Ø Sales schemes
 MUTUAL FUND FRAUDS

q Market timing

q Late trading
ECONOMIC EXTORTION

q Economic extortion is basically the flip side of a bribery

scheme.
Ø Instead of a vendor offering a payment to an employee
to influence a decision, the employee demands a
payment from a vendor in order to make a decision in
that vendor’s favor.
Ø In any situation where an employee might accept bribes
to favor a particular company or person, the situation
could be reversed to a point where the employee extorts
money from a potential purchaser or supplier.
 ILLEGAL GRATUITIES

q Illegal gratuities are similar to bribery

schemes, except that there is not necessarily
an intent to influence a particular business
decision but rather to reward someone for
making a favorable decision.

q Illegal gratuities are made after deals are

approved.