Test Your Fraud IQ
March 4, 2015 by Gordon Advisors
If you think occupational fraud and abuse can’t happen at your company, think again. Fraud is a global epidemic. In a recent study, the Association of Certified Fraud Examiners (ACFE) estimates that the typical business loses 5 percent of its revenues each year to fraud. Put another way, this equates to $50,000 for every $1 million in annual revenues.
Part of the problem is that many owners and managers believe they’re too smart to be duped by a fraudster. But fraud awareness is often a company’s first line of defense against white collar crime. Test your fraud IQ with this 10-point quiz (the answers are below):
1. What’s the most common way to catch a thief?
a. Employee tip
b. Management review
c. CPA audit
d. Accidental discovery
2. When a perpetrator is caught, what is the average amount of time that lapsed between commencement of the fraud scheme and detection?
a. 6 months
b. 1 year
c. 18 months
d. 5 years
3. Which type of asset do fraudsters steal most often?
b. Accounts receivable
4. What do you call a method of concealing receivables skimming by crediting one account with money stolen from a different account?
d. Account substitution
5. Which of the following are examples of vendor fraud schemes that cause companies to overpay for personnel, services and goods?
a. Fictitious invoices
b. Double-billing scams
c. Commingling of contracts
d. Change order abuse
e. All of the above
6. Who steals more from retailers?
7. Which of the following is a red flag that contractors are working together in a bid-rigging scheme?
a. Fewer qualified bidders respond to the request than normal
b. The winning bid is unusually high
c. The losing bidders end up as subcontractors when work is performed
d. All of the above
8. Which of the following technology snafus is least likely to result in a data breach?
a. Thefts of encrypted laptops
b. Unsecured wireless networks
c. Failure to download the latest updates to network security systems
d. Stolen passwords
9. How many firms that unearth fraud never recover a dime?
a. 8 percent
b. 38 percent
c. 58 percent
d. 88 percent
10. What percentage of business failures are attributed to internal fraud?
a. 13 percent
b. 33 percent
c. 53 percent
d. 73 percent
1. a. Tips are the most common fraud detection method, accounting for more than 40 percent in cases reporting in the latest ACFE study. Employees made about half of all tips that led to the discovery of fraud in the ACFE study. This proves that insiders often know about co-workers’ unethical behaviors. So, it’s important for organizations to make it as easy as possible for employees to make anonymous tips without fear of retaliation. It’s also crucial to follow up on tips and to punish wrongdoers.
2. c. The median duration for the fraud cases reported was 18 months, according to the ACFE’s 2014 Report to the Nations on Occupational Fraud and Abuse.
3. a. Cash is involved in approximately 90 percent of all misappropriation (theft) cases. Other scams involve the misuse or theft of inventory and other noncash assets. Common cash schemes include larceny, kiting and fraudulent disbursements.
4. b. Lapping occurs when an employee steals a remittance from Customer 1 and later covers it up by applying a payment from Customer 2 to Customer 1’s account. Customer 3’s payment is posted to Customer 2’s account (and so on) until the thief repays what’s been taken or gets caught.
5. e. All of these scams are just some of the ways vendors can artificially inflate their revenues, which, in turn, causes their customers to incur higher expenses. Fictitious invoices are the most straightforward way to defraud customers by sending bills for items never delivered. A slight twist is a double-billing scam in which the vendor invoices the customer more than once for items delivered — often under a new invoice number but using the same delivery date and line items as the previous order’s. These schemes often involve collusion between the vendor and someone inside the victimized organization.
Commingling of contracts occurs when a supplier bills for the same expenses under multiple contracts. To ward off these scams, managers need to carefully review each contract to ensure the work performed isn’t duplicated in another contract. Change order abuse is a problem in construction and other industries that use long-term contracts. Once they’ve won the bid, contractors may use inflated change orders to make up for low bid prices. That’s because customers tend to scrutinize change orders less closely than the original contract.
6. a. The ACFE estimates that 30 percent of retail losses are from shoplifters and 70 percent of thefts are committed by employees.
7. d. When competitors work together to secure a high priced bid, it’s called bid-rigging — and it causes customers to overpay for goods and services. Sometimes employees are involved to make sure that the fraudster isn’t underbid by an unexpected bid submission from someone outside the group of fraudulent bidders.
8. a. Laptops are mobile, making it easier for employees to work from home. But mobility also makes laptops vulnerable to theft. Encryption can substantially reduce the risk of data breach when laptops are stolen. Encryption encodes data, requiring users to enter special passwords and keys to gain access.
9. c. Nearly three-fifths of companies recover none of their fraud losses. Financial recovery takes time and effort. Many companies sweep fraud under the rug to avoid bad press and legal fees associated with pursuing criminal action against the perpetrator. But going after wrongdoers can help companies recoup losses and set a powerful example to other would-be fraudsters. In the 2014 ACFE study, 14 percent of the victims fully recovered their fraud losses.
10. b. The ACFE estimates that about one-third of business failures are due to internal fraud. Many of these failures involve small businesses, which tend to be disproportionately affected by white collar crime and abuse. Often these organizations don’t have enough resources to absorb fraud losses and frustrated business owners eventually close shop. Stronger fraud prevention and prosecution efforts can help reduce losses, however.
|Bonus Question: Which Industries Have the Highest Fraud Risk?
The term “risk” has many different meanings. On one hand, risk could be measured by the prevalence of fraud schemes. Based on this interpretation, the ACFE’s 2014 Report to the Nations on Occupational Fraud and Abusereports that the following industries had the highest number of reported fraud cases:
1. Banking and financial services,
2. Government and public administration,
4. Health care, and
While the ACFE list demonstrates the distribution of cases in this study, it does not necessarily mean that these industries are more at risk of fraud than others. It could also be a sign that they’re more proactive in dealing with antifraud issues.
Another measure of risk is the likelihood that an investor or creditor will receive a negative return on an investment in a particular industry over 12 to 18 months. Using this alternate interpretation of risk, another recent study, Top 10 Riskiest Industries of 2014-2015, published by research firm IBISWorld in October, reports that the most risky industries are:
1. Appliance repair,
2. Recordable media manufacturing,
3. Cigarette and tobacco products wholesaling,
4. Vacuum, fan and small house appliance manufacturing,
5. Cigarette and tobacco manufacturing,
6. Women’s and girls’ apparel manufacturing,
7. DVD, game and video rental,
8. Computer manufacturing,
9. Corn farming, and
10. Men’s and boys’ apparel manufacturing.
Many of these industries are in a state of decline or face intense competition from global suppliers. In turn, weak financial performance and pressure to meet stakeholder expectations could motivate employees and managers in these high-risk industries to commit fraud.