Creating Perception of Detection Reduces Incidents of Fraud


Years ago, a bus driver for a large school district was complaining that he was enduring physical and verbal abuse from unruly junior high kids who rode the bus to and from school.

In general, the driver liked the job as it seemed like a nice way to keep active during his retirement years. But the abuse progressed to the point he thought he may have to quit. Not wanting to lose such a dependable driver (among other obvious reasons), the district installed a camera at the very front of the bus.

The students, realizing their every move and word could be tracked, were immediately transfigured into blessed angels, sure to be in line for immediate canonization by Rome. Hoping to reap similar fortunes on other problematic routes, the district installed fake cameras on many of the other buses. Right away, the district noted the students' change in behavior was the same as what had been witnessed on the bus with the real camera. The perception of detection was clearly the driving force in changing the students' attitudes about how they acted on the bus.

It is widely known, within the community of auditors and fraud examiners, that proactive prevention of fraud, through the perception of detection, is more effective and much less costly than reactionary detection or investigation of fraud.

According to the Association of Certified Fraud Examiners' recently released 2008 Report to the Nation on Occupational Fraud and Abuse, the association's study of 959 cases of fraud found that small businesses - fewer than 100 employees - with little or no fraud prevention mechanisms, reported a median loss of more than $200,000. This was much more than the losses suffered by the largest corporations in the study.

The following are a few ways both large and small companies can work to prevent losses due to fraud whether it means avoiding a nasty lawsuit to recover the $1 million lost to the bookkeeper during the last 10 years or getting rid of problematic pilferage.

Financial Statement Audits

Quite often, when we have been engaged to perform an audit for a company that never has been through the process, their accountant(s) will often be a bit timid or scared of us. It's as if we work for the IRS, and that we will look far, deep and wide until we find that $50 income item that wasn't claimed on their personal income tax return. While instilling fear in the accounting department is not our intent, there is no question that the perception of detection has been increased.

Notwithstanding, big changes to auditing standards in recent years provide more responsibility for auditors to detect fraud, including expanded inquiries of company personnel and numerous added procedures designed to tailor the audit to focus on higher risk areas.

Fraud Risk Assessments

Fraud risk assessments are generally less expensive than an audit but can still provide many necessary improvements. Such assessments are usually performed in two steps. First, a company-wide assessment is performed to document and address the company's code of ethics and related implementation as well as the general tone at the top. Secondly, a more detailed assessment is performed by division or process to identify weaknesses within internal controls and to test areas prone to fraud.


According to the 2008 Report to the Nation, 43 percent of the frauds in the association's study were uncovered by a tip, and 31 percent of these were through the use of an employee hotline or similar formal reporting mechanism. This is a relatively high percentage when considering the fact that less than 50 percent of the companies in the study had any kind of formal reporting mechanism. As more than one-quarter of the frauds in the study suffered losses in excess of $1 million, hotline services, which can cost as little as $500 per year, can make a lot of sense. Though the use of a hotline is one of the most effective and least costly ways an anonymous tip can foil a fraud in its earliest stages, this mechanism is severely underused.

If you are an owner, manager or sit on the board of directors, ask yourself some easy questions. Does your company or organization have someone who handles too many functions, and you trust them too much? Does your company require mandatory vacations? (It should!) Does an approved vendor list exist? Does your company have an outside CPA or finance/audit committee looking at the bank reconciliations and general journal entries? These are great questions to ask, but don't forget to also focus on the positive.

If employees sense a strong, ethical tone at the top and the value of a financially sound company, you can go a long way in shifting personnel focus from individual gains to more rewarding goals of improving everyone's financial position while helping make the company a great place in which to solidify one's career.

This article was originally published in the Boulder County Business Report in August of 2008.