Internal Control And Fraud Prevention

The foundation for preventing fraud in any organization begins with its internal environmental controls. Fraud is a term associated with identity theft and fraudulent credit card charges. However, there is another definition of fraud termed as employee fraud or occupational fraud. This type of fraud usually occurs because internal controls are weak allowing for exploitation by an outsider. Detecting fraud may be a strong objective for companies, but they should also have an internal control program to safeguard against fraud.

Preventing Fraud through effective internal controls

The Fraud Triangle

Employee fraud is borne out of the ‘fraud triangle.’ The fraud triangle is whereby an outside party discovers a weakness in a company’s internal controls allowing them to rationalize their actions in response to a pressure trigger in their lives.

For instance, if an employee’s relative has been ill causing a pile up in medical debt, the person may take advantage of the vulnerability in your control environment to help pay off the expenses. The external pressures from the employee’s personal life make them rationalize that the firm will not notice the fraud or that their personal problems take preference to their work responsibilities.

Safeguarding your company from fraud, therefore, means keeping a tight lid on all your controls.

The cost of operational fraud

The Association of Certified Fraud Examiners (ACFE) conducted a report in 2018 to investigate the losses arising from fraud. They found that the average corporate loss arising out of fraud this year was $2.75 million. They, however, acknowledged the fact that their study incorporated a few large corporations that affected their findings. They, therefore, concluded that the mean loss of $130,000 was more appropriate.

Despite the large difference between the mean and average loss, the total loss of all 2690 members of the study was $7.1 billion in 2018.

How is operational fraud committed?

The three major types of occupational fraud are corruption, asset misappropriation, and financial statement fraud. Occupation fraud arises mostly out of asset misappropriation but organizations lose money mostly through financial statement fraud.

Financial statement fraud includes overstatements and understatements of net income. For instance, employees may create fake revenues or understate revenues. Financial statement fraud also includes improper disclosures.

Controls that help safeguard against fraud

When it comes to safeguarding against fraud, you can have controls that relate to your employees or automated controls.

For instance, you can begin by establishing a code of conduct as a control that relates to your employees. However, this technique is not assured as your employees can choose to follow the policy or choose to ignore it. Additional controls are therefore necessary.

Internal audits are another form of control in combination with management assessment. These two aspects can oversee controls to ensure appropriate layers of review. Management needs to continuously oversee controls and ensure they still work. Internal audits provide an extra layer of protection over management to ensure your fraud controls work.

Controls that help mitigate the duration of fraud

While internal audits, code of conduct and management review help safeguard against fraud to some extent, they may not be a 100% effective. If an employee is determined to commit a crime, they will. Therefore, you need to develop and execute controls that ensure fraudulent activities are detected immediately.

Proactive monitoring, surprise audits, and management certification of financial statements are controls that can assist with the early detection of fraud.

According to the AFCE report, 72% of instances where companies instituted management’s certification of financial statements for twelve months saw a 50% reduction in fraud. It is important to note that while owner/executive occupational fraud constitutes to 19% of the cases, it represents the majority of the losses.

Sarbanes-Oxley compliance role in protection against fraud

Sarbanes-Oxley Act of 2002 (SOX) compliance covers several different areas including corporate responsibility and governance and information security.

SOX 404 focus on IT controls that relate to financial reporting. Control failures that could lead to misstatements in financial reports should be the ones investigated more closely. Misstatements in financial reports signal potential fraud. These controls, therefore, require more testing and documentation.

SOX compliance concentrate on ensuring management is held responsible for financial reporting. By mandating management and the Board to certify financial statements as part of SOX compliance holds them ethically and legally accountable for their actions as well as those of their peers.

How automating SOX testing documentation streamlines audits

Audits mandate a constant flow of information and documentation between internal and external stakeholders. Various software platforms offer organizations tools to assist efficient SOX audit tracking. These platforms allow firms to map controls in order to maintain consistency.

External auditors need proof that a firm has tested controls while compiling documentation in an easy-to-access single location. The platforms that provide a single source of information enable streamlined audit information sourcing.

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