What is fraud?

“Fraud is deliberately deceiving someone else with the intent of causing damage.” [Cornell University Law School]

“intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right; an act of deceiving or misrepresenting” [Merriam-Webster]

“Fraud, in law, the deliberate misrepresentation of fact for the purpose of depriving someone of a valuable possession.” [Encyclopedia Britannica]

To simply summarize, fraud is the act of one party deliberately misrepresenting the truth or fact, in order to obtain something of value from or causing damage to another party.  From a financial standpoint, these acts could be deception, concealment of fact, omissions of fact, misappropriations of assets (including outright theft)….all intentionally done.

Why is fraud committed?

In a nutshell, because they can.  If you do not have sufficient fraud prevention measures in place, your business may be a victim of fraud.  Now, the fraud triangle is the model for explaining what causes fraudulent behavior.  It consists of:

Pressure –> motivation (financial problems, poor job performance, gambling debt, investor confidence, status symbols)

Opportunity –> method (thought to be undetectable or concealable, weak internal controls)

Rationalization –> justification (not my fault, bad situation, temporary loan, slighted, getting even)

What are the types of business fraud?

Business fraud is typically management fraud, employee fraud, or external fraud.  Small business fraud is commonly management or employee fraud due the lack of segregation of duties and the close-knit trust environment.

Management fraud generally is committed to protect one’s position or to manage investor/lender expectations.  Motives could include covering up poor business performance, noncompliance with financial covenants, covering up other illegal activities such as bribery, and gaining an unfair advantage. It can be perpetrated by:

  • False accounting entries
  • Misrepresentations of financial condition
  • Improper revenue recognition
  • Overstatement of assets
  • Misappropriation or embezzlement
  • Understatement of expense and liabilities
  • Financial statement fraud such as improper disclosures or improper accounting treatment
  • Misclassification of illegal expenditures as legitimate expense

Employee fraud is generally committed for the personal gain of one’s self or family.  Opportunities typically exist due to lack of sufficient internal control procedures, the lack of safeguards for assets, and trusting the wrong people.  The majority of employee fraud is outright theft:

  • Cash (stealing cash on hand, forging checks, cashing customer payments, fictitious vendors)
  • Inventory (Misappropriation to self or others, not ringing up sales)
  • Kickbacks (from vendors, overpayment for items not received)
  • Payroll (improper time reporting, improper pay rates, fictitious employees)

How can CJA help?

Even as a small CPA firm, we provide a number of forensic accounting services to assist you in detecting and preventing fraud in your small business.

Financial and source document fraud investigative services

  • identify false reporting
  • determine whether books have been manipulated
  • identify and analyze forgery of financial documents
  • trace and review related party transactions and preferential treatment
  • determine and review manual journal entries
  • analyze accounts receivable aging and trends
  • examine suspicious vendor relationships
  • examine suspicious financial performance by subsidiary or JV
  • investigate financial statement restatements
  • detecting asset misappropriation
  • Assisting your attorney with conducting interviews, evidence gathering and analysis, report preparation, and testifying.

Fraud prevention services

  • assessing fraud risk and illegal acts
  • consultations with the Board of Directors
  • evaluating adequacy of internal control systems (internal control assessment)
  • designing and implementing internal control procedures
  • proactive fraud auditing
  • consulting about employee bonding