Introduction
Accounting and financial professionals have a great deal of responsibility on their shoulders. They are required to keep all kinds of financial fraud out of the system by identifying and reporting them at the earliest possible time. Even with sophisticated technology and competent accountants, fraud sometimes slips by and causes an immense loss of money and company reputation, a loss of trust among investors, shareholders, and employees, and a reputational loss for the accountants. There are times when the accounting professionals themselves are involved in and spearhead financial fraud, thus making it harder to come to the attention of higher authorities. In all such cases, it is important to understand the weight of responsibility on the accounting professionals' shoulders, their mindsets, and the lack of ethics in such professionals so that companies may avoid such management and hiring failures in the future. In this article, we will cover some general elements of rampant financial fraud in the corporate world and its effects.
Types of Fraud in the Accounting and Finance Sector
1. Payroll Fraud
Even an insider in the company exploits the payroll system to steal money, all the while claiming on the papers that they are paying someone else in the company for their job. Generally, some high-ranking professional in the company who has access to the company's payroll or someone who can hack the company's credentials is responsible for this type of fraud. Submitting false timesheets to pay themselves or their colleague, issuing unauthorised bonuses, and sending money to a fake or former colleague are all examples of payroll fraud. In such cases, the company's employees, especially the accounting staff and management, are the primary defence against such fraud involving insiders. In the case of external hackers, cybersecurity measures and awareness of social engineering methods are key. With vigilance and initiative from all employees, the risk of payroll fraud can be greatly minimised or even avoided (Source: Bank Midwest).
2. Financial statement fraud
Financial statement fraud may be committed by an employee or business owner for various reasons. The most common motive is to manipulate financial records to make their overall net worth appear greater while downplaying their debts, liabilities, and losses. This is usually done to obtain loans or avoid consequences for failing to meet financial targets. At times, the fraudster seeks loans to steal the funds. Regardless, financial statement fraud is a grave financial offence.
3. Asset Misappropriation
Asset misappropriation is deliberately stealing from an employer. There are two categories of asset misappropriation - cash misappropriation and non-cash misappropriation. Stealing money directly from the company through fund transfers, making unauthorised purchases on behalf of the company, or taking cash from the safe are all examples of cash misappropriation. Stealing non-cash assets like office equipment, supplies, or inventory without being authorised falls under the second category.
Keeping detailed inventory and financial records to cross-check at regular intervals is the best measure against this type of fraud. Accounting professionals must be vigilant to find unauthorised bank transactions or spending outside the company's operational limits. Modern banks offer better security measures against this type of fraud through two-factor authentication, device authentication, multi-person approval processes, and batch limits.
4. Tax fraud
Tax fraud or evasion is the illegal act of avoiding or escaping tax payments. It is fine to misrepresent or conceal information to reduce or eliminate tax liabilities. It is a serious financial fraud that carries severe penalties like fines, imprisonment, and the seizure of assets. This type of accounting fraud harms the economy by reducing the government's revenue and increasing the tax burden on other citizens. Techniques like underreporting income, hiding assets, and claiming false deductions or exemptions are employed by companies and individuals to pay less in taxes. As an accounting professional or business owner, you must understand your responsibilities and liabilities in reporting your annual earnings and hold employees and contractors responsible for following financial laws.
5. Identity theft
This is more of a cybersecurity-related issue, as most transactions are now digital. Identity theft is when someone steals sensitive financial information from another individual or company and ends up stealing from them. A business or individual might commit this accounting fraud by stealing bank account information from its customers and using it for personal financial gain. Employees with sensitive insider information might use that data to steal money, damage reputations, or undermine the company's competitive advantage through unethical means. In this competitive corporate world, identity theft between different companies is also not rare.
6. Corruption
This is a widespread fraud that affects individuals, companies, and government institutions alike. When an individual in power at a business deliberately mishandles the finances or engages in any kind of dishonest behaviour that is contrary to the business's values or morals, it is corruption. Money laundering, election manipulation, and giving and accepting bribes are all examples of corruption. Making off-the-record transactions is also fraud that affects an institution's financial health. Accounting professionals can rarely find out about these scams as they are made off the records.
Why are managers and leaders involved in financial fraud?
Financial fraud can always be traced back, and those involved are always at risk of losing more than what they get out of the fraud. It includes their position, freedom, and, above all, reputation. The ability to take risks even with the knowledge that there is a way to find out the truth down the line is fascinating. It depends on two aspects. One is that the manager or professionals are more likely to commit fraud due to low moral standards, and the other is that the company provides favourable conditions for financial fraud (Source: EduCBA).
A manager's psychology plays a key role in the likelihood of being involved in a financial crisis. In general, they exhibit two kinds of behaviour that keep them from the possibility of committing a financial crime. One is their rational speech, and the other is their exaggerated arrogance. Through their rational speech, they back up their mistakes and arrogant attitude toward their actions. However, there is also a negligible group of individuals who commit these frauds to get out of an immediate financial crisis, like the health issues of family members or threats from other external forces. The mindset of an individual in a financial fraud can be driven by arrogance and greed as well as fear.
In the latter situation, an organisation will have little to no external control over a manager. They were given all freedom due to the lack of a control system or a failing control system. Such internal situations embolden a manager or a senior manager to get involved in financial fraud because they know that there is little control left in the company over them. Another opportunity that favours the financial sector is when the stock market bubbles. In such cases, a company is required to be at par with the growth patterns of the market. If a company is not exceeding the expectations of its investors, it might immediately withdraw, which would result in a sharp decline in the stock market. To avoid this, managers show exaggerated revenues and favourable conditions to get involved in fraud.
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How can accounting and financial professionals keep these mistakes at bay?
The finance professionals, employees, and board members are the primary defence against such fraud. Therefore, human resources managers must hire accountants and finance professionals with integrity, moral standards, and work ethics. It is also important that finance professionals are well-versed in accounting ethics and have an eye toward these pointers. They must be thoroughly educated about the possibility and risk factors of financial fraud and given further instructions to find out about these frauds as early as possible. Here is how you can be a controlling element in safeguarding a company from financial fraud.
The role of an auditor in avoiding financial fraud.
Every company audits its finances at regular intervals. Auditors and accountants are the primary line of defence against such financial fraud from an accounting perspective. They are generally retained by the board members and are responsible for detecting anomalies in the company's finances. For additional control, they must also control the strategic decision-making of the company. They must also be aware of modern financial fraud tactics and just stick to conventional ones. In recent times, fraudulent managers have changed tactics, and the classic financial frauds seem to be outdated. Hence, an auditor must be well-informed about modern tactics and stay vigilant. They must also recognise if the board's control is failing and if managers have unhealthy levels of control over the financial decisions of the company.
Conducting regular audits, which include reviewing the transactions, testing internal controls, and verifying the accuracy of this information, helps auditors identify fraud. Technologies like data analytics and artificial intelligence have made their tasks easier and more accurate. Auditors must also be responsible for communicating their findings to the company's management and board of directors, along with recommendations for improvement. This will help the company address any deficiencies in its internal controls and reduce the risk of future fraud. Moreover, auditors are expected to maintain their independence and impartiality when conducting audits. Thus, the audit process is not influenced by any conflicts of interest, and the results are credible and trustworthy. Read more on this blog - The Importance of Auditing.
The role of the board of directors in avoiding financial fraud
With several mistakes and hard-learned financial lessons, the modern board of directors has evolved to balance the power of centralization. Some unwritten rules to follow are: separating the roles of CEO and chairman of the board of directors; having fewer board members; holding regular meetings without the CEO; and continuously refining strategic action plans. Even recruiting external board members can help if they are well-versed in the field. The board members are responsible for setting the tone at the top and for the ethical and transparent operations of the company. Establishing strong internal controls and monitoring the company's financial reporting process will achieve this transparency and ethics. By regularly reviewing financial statements, establishing procedures for the proper segregation of duties, implementing technological solutions like AI and blockchain, having a whistleblower policy, and conducting regular audits, the board can detect and prevent fraud.
The role of chartered accountants in avoiding financial fraud.
The chartered accountant has all the experience, knowledge, and privilege in a company to detect fraud and thus be in control of the fraud. With their understanding of the economy, they can easily identify financial fraud. Other financial professionals, such as financial analysts, external or internal auditors, and accounting managers, can all detect financial fraud given the opportunity. Chartered accountants can minimise the risks of financial fraud by implementing strong internal controls, using technology to their advantage, and enhancing the ethical standards of the company through small steps. For example, when a small accounting error occurs that is negligible, they might correct it in front of the employee who made the mistake instead of neglecting it. When control is implemented on a smaller scale, it automatically gets implemented in the whole hierarchy as the accountability of the organisation increases. Chartered accountants can also use external audits for better accuracy to provide a second line of defence.
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The role of ethics in the accounting and financial professions
Due to the recent corporate collapses, accounting ethics are again the talk of the town. The accounting profession has suffered a reputational loss as a result of recent corporate collapses due to accounting frauds, stock manipulations, and other forms of financial misrepresentation. As a result, many accounting organisations and governments have launched initiatives to combat such criticism of the lack of ethical standards in accounting. In such a backdrop, accounting professionals must be looking for ethical standards in their profession. Due to unethical accounting practices and involvement in financial fraud, billions of dollars of taxpayer money have been lost, employees have lost their jobs, and the profession itself has lost its reputation. Despite strict regulations in many countries, like the AICPA in the USA, there are still professionals who value profit over ethics.
Hence, it is not an overstatement to say that the role of ethics in the accounting and financial professions is crucial. It provides the foundation for maintaining public trust and confidence in the accounting and finance sectors. Ethical behaviour ensures financial information is accurate, transparent, and reliable and that decisions are made with integrity and professionalism. Accountants and financial professionals are in highly responsible roles and are expected to act with integrity and maintain the highest ethical standards, without which the company's trust crumbles. This includes ensuring that financial information is accurate, complete, and unbiased and that decisions are made in the best interests of their clients and stakeholders instead of bending to the will of a few fraudulent individuals in key decision-making roles.
Conclusion
Accounting fraud will continue to happen due to the flaws of human nature. However, by taking some measures, like technology implementation, regular auditing, accountability, and internal controls, businesses can minimise the risk of accounting fraud. The company's employees, especially those working in the accounting and finance sectors, must be vigilant and take responsibility to identify and report suspicious transactions. Morals and ethics play a major role in avoiding these frauds. Moreover, implementing cybersecurity measures and creating awareness about social engineering will keep your organisation's digital environment and employees protected from external cyberattacks.
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Citations
Fischer, Laura. “6 Types of Fraud in Business - Bank Midwest.” Bank Midwest, 9 June 2022, www.bankmidwest.com/blog/6-types-of-fraud-in-business
Gerety, Mason, and Kenneth Lehn. “The Causes and Consequences of Accounting Fraud.” Managerial and Decision Economics, vol. 18, no. 7/8, 1997, pp. 587–99. JSTOR, http://www.jstor.org/stable/3108221