©2014 By the Association of Certified Fraud …...an organization. They cause the victim organization to buy goods or services that are nonexistent, overpriced, or not needed by the

©2014 By the Association of Certified Fraud Examiners, Inc.

Revised: 12/30/13

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TABLE OF CONTENTS

Fraud’s Hidden Cost

©2014 i

FRAUD’S HIDDEN COST

What Is Fraud? .............................................................................................................................1

Three Types of Fraud ...................................................................................................................2

Fraud by Employees ....................................................................................................................3

Fraud by Vendors .........................................................................................................................6

What Causes People to Commit Fraud ........................................................................................7

How Fraud Affects You and Your Organization .........................................................................9

Red Flags of Fraud .......................................................................................................................10

What to Do if You Suspect Fraud ................................................................................................12

Conclusion ...................................................................................................................................14



©2014 1

NOTES What Is Fraud?

Fraud is a silent crime. There are no exciting chase scenes,

no smoking guns, and no bleeding victims. But fraud is a

crime nonetheless. And worldwide, fraudin all its

formscosts billions of dollars in damage.

Fraud at its core involves taking something from someone

else through deception or concealment.

Although there are many forms of fraud, this training

program addresses those committed by people who work

for your organization or do business with it. These schemes

are known as occupational frauds because they occur in

connection with the fraudster’s occupation.

According to studies by the Association of Certified Fraud

Examiners, occupational fraud costs hundreds of billions of

dollars each year. The following are some of the ways that

employees at all levels cheat their companies:

Stealing money or inventory

Taking kickbacks or bribes from vendors or customers

Falsifying internal reports

Claiming overtime for hours not worked

Stealing or misusing confidential customer financial

information

Filing fraudulent expense reports

Stealing and selling company trade secrets

Giving friends or relatives unauthorized discounts on

company merchandise or services

Using company assets, such as computers or vehicles,

without permission

Claiming workers compensation for an injury that did

not occur

Adding ghost employees to the payroll



©2014 2

NOTES Withholding information from auditors, investors, and

creditors about major events that could impact the

company, such as obsolete products or pending lawsuits

In addition to these examples, consider the cost to

companies from employees who abuse sick time; pilfer

such items as stationery, postage, and computer supplies;

falsify time and attendance information; or work under the

influence of alcohol and drugs. Although these activities

can constitute fraud, they are more commonly called

“abuses.”

Three Types of Fraud

Based on previous research, the Association of Certified

Fraud Examiners (ACFE) has classified occupational fraud

into three main categories: asset misappropriation,

corruption, and financial statement fraud. Asset

misappropriations are those schemes in which the

employee steals or misuses an organization’s assets.

Common schemes include skimming cash from registers,

falsifying voids and refunds, tampering with company

checks, and overstating expenses.

Corruption schemes involve a fraudster wrongfully using

his influence in a business transaction for the purpose of

obtaining a benefit for himself or another person. Examples

of corruption schemes include engaging in conflicts of

interest, accepting illegal gratuities, and bribery.

Fraudulent statement schemes involve the intentional

misreporting of an organization’s financial information

with the intent to mislead others. Common examples

include creating fictitious revenues and concealing

liabilities or expenses.



©2014 3

NOTES By comparing the three main schemes, the ACFE has

identified common methods used by fraudsters and

vulnerabilities within organizations that provide an

opportunity for these frauds to occur. This information

helps organizations develop more efficient and effective

prevention and detection tools.

Common Frauds by Employees

Some of the more common frauds by employees include

both the theft of company assets, such as cash or inventory,

and the misuse of company assets, such as using a company

car for a personal trip.

Stealing Cash

Not surprisingly, most people prefer to steal cash.

Skimming is the process by which cash is removed

from the entity before it enters the accounting system.

This commonly includes such schemes as not recording

a sale or recording a sale for a lower amount. For

example, a customer wants to purchase a $500 item.

The cashier rings up the item, but he enters a $100

“discount.” He charges the customer the full $500. He

puts $400 in the register and pockets the remaining

$100.

Fraudulent Disbursements

Fraudulent disbursements leave an audit trail because

the funds are recorded on the company’s books before

the cash or checks leave the entity fraudulently.

Disbursement schemes can occur in many different

forms.



©2014 4

NOTES CHECK TAMPERING SCHEMES

Check tampering is a type of fraudulent

disbursement scheme whereby an employee either:

(1) prepares a fraudulent check for his own benefit,

or (2) intercepts a check intended for a third party

and converts the check to his own benefit.

REGISTER DISBURSEMENT SCHEMES

Refunds and voided sales are transactions processed

at the register when a customer returns an item of

merchandise purchased from that store. The

transaction entered on the register indicates the

merchandise is being replaced in the store’s

inventory and the purchase price is being returned

to the customer. In other words, a refund or void

shows a disbursement of money from the register as

the customer gets his or her money back.

BILLING SCHEMES

The most common and costly example of a

fraudulent disbursement is the billing scheme.

Billing schemes attack the purchasing function of

an organization. They cause the victim organization

to buy goods or services that are nonexistent,

overpriced, or not needed by the organization.

A billing scheme can result in an illicit gain of cash,

goods, or services for the fraudster. The purpose of

most billing schemes is to generate cash. In a

typical scheme, the perpetrator creates false support

for a fraudulent purchase. The fraudulent support

documents, which can include invoices, purchase

orders, purchase requisitions, receiving reports, and

so on, cause the victim organization to issue a



©2014 5

NOTES check. The fraudster collects the check and cashes

it, thereby reaping an illegal gain.

EXPENSE REIMBURSEMENT SCHEMES

Travel and expense budgets are a common target for

occupational fraud. Employees may falsify

information about their business expenses and cause

their employers to overcompensate them in the form

of inflated expense reimbursements. This type of

scheme is most commonly perpetrated by sales

personnel who overstate or create fictitious

expenses in areas such as client entertainment and

business travel. Outside sales personnel are not the

only employees who commit this type of fraud,

however. Any person who is in a position to incur

travel or business entertainment expenses is

potentially capable of committing expense

reimbursement fraud.

PAYROLL SCHEMES

Payroll schemes occur when an employee

fraudulently generates overcompensation on his or

her behalf. These schemes are similar to billing

schemes, in that the perpetrator generally produces

some false document or otherwise makes a false

claim for a distribution of funds by his or her

employer.

Inventory Fraud Schemes

Most inventory and warehousing frauds involve

misappropriating inventory for personal use, stealing

inventory and scrap, or charging embezzlements to

inventory.



©2014 6

NOTES Personal use of assets, such as personal use of

computers or making long distance calls on company

phones, can develop into a fraud or an abuse situation if

the subject is not addressed. In addition, the loss of

productive time might be more costly than the improper

usage of the asset itself.

Common Frauds by Vendors

Organizations must also be on the alert for fraud by

vendors. These dangers include the following:

Bid Rigging

Bid rigging occurs when two or more vendors, or in

some cases, employees, conspire to influence the

purchase of goods or services by a company or to avoid

competitive bidding controls.

Price-Fixing

Price-fixing is a conspiracy between two or more

competitors to set, control, raise, lower, or maintain the

prices charged for products or services. It does not

matter whether the prices agreed upon are ultimately

reasonable or unreasonable; price-fixing is illegal

because the aim of every price-fixing agreement is the

elimination of competition.

Overbilling Schemes

Overbilling occurs when a vendor submits inflated

invoices charging in excess for goods or services. The

vendor may simply raise the price of goods or services

above the contractual level, hoping the customer will

not catch the overcharge. It is also common for corrupt

vendors to bill for more merchandise than is actually

delivered or to change the date on a legitimate invoice



©2014 7

NOTES and re-bill it, thus collecting two or more times for the

same goods or services.

Kickbacks

Overbilling schemes may or may not involve collusion

with someone within the victim company. When an

employee of the victim is involved in the scheme, he

usually receives kickbacks in return for participating.

Proper authorization on purchases and review of

support documentation before issuing payment will

defeat most stand-alone overbilling schemes.

Shell Companies

Shell companies are vendors who don’t exist except on

paper; their only purpose is to bill businesses for

services not rendered or products not delivered.

Typically, unless a company insider is involved, the

fraudster simply sends a bogus invoice to the victim

organization’s accounting department in hopes that it

will be paid. Although these schemes take a variety of

forms, the most common one involves office supplies

or toner. The fraudster counts on businesses to send a

check without actually confirming whether the product

was received.

What Causes People to Commit Fraud

Dr. Donald Cressey was one of the first individuals to study

how white-collar criminals differ from other types of more

violent perpetrators. Dr. Cressey’s work has since been

summarized in what is known as the as “The Fraud

Triangle.” According to this theory, occupational fraudsters

rely on pressure, opportunity, and rationalization to explain

why they violated the trust of their employers.



©2014 8

NOTES Pressure

Employees often commit fraud because they feel they

need money. Dr. Cressey refers to this need for money

as an “unsharable financial need” because it is difficult

to share the burden with others. Examples of these

types of pressures include:

A gambling or drug habit

Personal debt or poor credit

A significant financial loss

Peer or family pressure to succeed

Most of the time people can resolve this problem

through legitimate means. If you need to make

unexpected repairs on your home, you can get a second

job. If you have to support a child through college, you

can apply for financial aid, scholarships, or grants.

Convicted fraudster Randy Pierce was under financial

pressure in his personal life from the IRS. Upper

management showed no signs of helping out financially

with a pay raise. Unfortunately, Randy felt he had

nowhere else to turn but his crooked friend Larry. He

decided to steal company parts from his employer for

Larry to sell as a way to make extra money. Eventually

his employers caught on to his game. Randy was

convicted of theft and given a long prison sentence.

Opportunity

The second leg of the fraud triangle is opportunity.

Barry Webne had the opportunity to take advantage of

his position as head of the accounting department.

Barry started his deception small by giving himself a

$2,000 bonus. These “bonuses” rapidly increased,

reaching as much as $20,000. For Barry and other

fraudsters like him, embezzling money without getting



©2014 9

NOTES caught becomes an addiction. Being in a position with

no supervision creates the optimal opportunity to

commit fraud.

Rationalization

Rationalization is the final element in the fraud triangle.

Rationalizations are justifications used to explain a

person’s dishonesty. The guilty person attempts to

make himself look like the victim in his own crime. The

following are some excuses people use to commit

occupational fraud:

I’m only “borrowing” the money and plan to repay

it.

The company won’t even realize this amount is

gone; it’s not that much.

My boss does it all the time.

I’ve been working with the company for 15 years.

They owe it to me.

I’ll stop once I pay off my debts.

I deserve this after the way the company has

treated me.

Convicted felon Walt Pavlo tried to justify his

deception of creating fake performance numbers. Walt

convinced himself that he was underpaid and felt his

bosses were paid undeserved higher salaries. He also

felt the company did not appreciate his hard work. The

rationalizations fraudsters use may not make sense to

us, just to them.

How Fraud Affects You and Your Organization

The Association of Certified Fraud Examiners estimates

that a typical organization loses 5% to 7% of their gross

revenues each year due to occupational fraud and abuse.



©2014 10

NOTES Think about your organization. The loss of those funds in

your company means:

Fewer pay increases

Increased layoffs

Greater pressure to increase sales and revenue

Decreases in employee benefits

If a co-worker or vendor is cheating your company, you’re

paying for it. Honest employees are penalized because

dishonest ones are stealing from the company.

Furthermore, occupational fraud also affects your

company’s reputation. Consider this example: When you

look for a bank, you want to choose one that can protect

your money. Would you feel comfortable in opening an

account with a bank that was constantly being ripped off by

its employees?

Do you think investors want to put their money into

companies that can’t prevent their employees and vendors

from stealing their assets? Not likely. Public losses due to

fraud hurt not only the bottom line, but the reputation and

goodwill of an organization. It can cost the company

customers and investors as well as dollars.

Red Flags of Fraud

Fraud can be committed by anyone, including the person

working next to you. Be aware and observant of certain

behavioral red flags that might indicate a potential

fraudster. However, keep in mind that sometimes these

indicators also apply to honest people. Walt, Barry, and

Randy all displayed red flags while they were involved in

cheating their companies.



©2014 11

NOTES Living Beyond Means

Big spending has often been an indicator of fraudulent

behavior. Barry Webne did not hesitate to spend his

extra money. He updated his wardrobe, ate at fancy

restaurants, and took every opportunity to live it up. He

admitted he was living a “flashy” lifestyle.

Financial Difficulties

People facing financial problems are often more

motivated to commit occupational fraud. Examples

include paying off huge student loans, car payments,

mortgage payments, taxes, or high credit card debt. In

the case of Randy Pierce, he was under pressure from

the IRS and desperate to make some cash.

Serious Addiction to Drugs, Alcohol, or Gambling

Fraudsters can sometimes try to escape their guilt

through drugs, alcohol, or gambling. Walt Pavlo’s

guilty conscience led to excessive drinking every night.

It was his relief to escape his deceptions at work. Barry

Webne found himself visiting Las Vegas frequently to

gamble away his undeserved money.

Other signs to be vigilant of include:

Rule breakers–People who are constantly looking

for ways to bend or avoid the rules

An unwillingness to share duties–They may be

stealing and can’t take a chance on someone

catching them in the act

A refusal to take vacations–If they leave, anyone

who takes over their duties may discover the fraud

A close personal relationship with vendors or

customers–May indicate more than a professional

relationship

Complaints about low pay–May be a

rationalization to commit fraud



©2014 12

NOTES Family problems–May create a financial need for

funds

Excessive pressure within the company–The need

to reach goals or targets can lead to thoughts of

“the end justifies the means”

What to Do if You Suspect Fraud

Every employee, regardless of rank or position, can help

reduce the extreme costs of fraud. Indeed, unless a majority

of employees is in favor of deterring fraud and actively

participate in the effort, success is highly unlikely. Here are

some of the things you can do.

Be Aware of Warning Signs

As discussed earlier, there were warning signs of

possible fraud in the cases of Walt, Barry, and Randy.

That is not unusual. But the people around them may

not have recognized the clues. Now that you have

learned some of the red flags, you must be aware of

them. That certainly does not mean being suspicious of

the people you work withfar from it; the majority of

your co-workers are honest.

By the same token, you shouldn’t look at everything

through rose-colored glasses. If you observe something

that does not seem right, stop long enough to consider

the situation. Then if you still have doubts or

suspicions, it is time to do something.

Report Irregularities

Admittedly, it is hard to report on someone, especially

if that person is your colleague. Moreover, if you have

no hard evidence, there is the matter of a wrongful

accusation. But who said that doing the right thing is

always easy?



©2014 13

NOTES Even though reporting irregularities is sometimes

difficult, the alternatives are even more unattractive.

We know now that in the cases of Walt, Barry, and

Randy, others around them either knew of or suspected

illegal activities. The failure of other employees to

actin all three caseshad even worse consequences.

You need to report at least two specific instances: (1) if

someone you work with asks you to do something that

you think is illegal or unethical, and (2) if you suspect

that someone in the companyregardless of rank or

positionis committing fraud or abuse.

Most companies have a “hotline” or other reporting

mechanism where you can furnish information without

identifying yourself. Understand, though, that if you

have personally witnessed an illegal act (for example, if

your supervisor instructed you to make false entries in

the company’s books), it may not be possible to prove

the allegation without you being a key witness.

If your company does not have a hotlineor if you

prefer not to use ityou have other choices. You could

write an anonymous letter to the proper official in your

company. (In the case of an employee, the matter would

normally be reported to that person’s immediate

supervisor. Should the allegation involve the

company’s top management, it can be reported to the

board of directors, the board’s audit committee, or to

the company’s independent auditors.)

In still other situations, it might be advisable to share

your concerns with the company’s internal auditors or

anti-fraud specialists. But the important thing is for you



©2014 14

NOTES to report your suspicions to someone in authority if you

truly believe something is amiss.

Conclusion

Preventing fraud is not just the responsibility of

management, the board of directors, the inspector general,

or the audit team. Everyone in an organization is

responsible for preventing fraud. Often, it is so much easier

to increase the bottom line by eliminating fraud than it is to

cut expenses, generate new customers, or create new

products.

Help your organization keep the revenue you have already

helped it earn. Be alert to potential fraud and report it to

your organization.

ABOUT THE ASSOCIATION OF CERTIFIED FRAUD EXAMINERS

©2014

About the ACFE

The Association of Certified Fraud Examiners (ACFE) is the world’s largest anti-fraud

organization and premier provider of anti-fraud training and education. Together with nearly

70,000 members, the ACFE is reducing business fraud worldwide and inspiring public confidence

in the integrity and objectivity within the profession.

Founded in 1988 by Dr. Joseph T. Wells, CFE, CPA, and former Federal Bureau of Investigation

(FBI) Special Agent, the ACFE has become the largest anti-fraud organization in the world. ACFE

members in more than 150 countries have investigated more than two million cases of suspected

criminal and civil fraud.

Members of the ACFE include CPAs; auditors; lawyers; investigators; law enforcement officers;

security professionals; executives; managers; and anyone whose job involves preventing,

detecting, or deterring fraud. The ACFE supports members and the anti-fraud profession by

providing conferences, seminars, and other training events year-round, while also offering self-

study and online learning opportunities, manuals, software, and other resources for fighting fraud.

By becoming an ACFE member, you will receive many valuable benefits that help to promote your

professional and career development. These benefits include access to members-only services and

resources, as well as discounts on many of the ACFE’s valuable products. To learn more about

becoming a member of the ACFE, visit our website at www.ACFE.com/Membership or call

(800) 245-3321 (USA & Canada only) or +1 (512) 478-9000.

A Leader in Research

The ACFE supports the future of fraud examination by providing funding and resources through

its Anti-Fraud Education Partnership and Law Enforcement Partnership. ACFE research, including

the Report to the Nations on Occupational Fraud & Abuse, provides benchmarking statistics on

fraud, and the ACFE is one of the founding members of the nonprofit Institute for Fraud

Prevention (IFP). The IFP is a consortium of domestic and international universities dedicated to

cutting-edge research into the causational factors of a wide variety of white-collar crimes.

Certified Fraud Examiners (CFEs)

The ACFE established and administers the Certified Fraud Examiner (CFE) credential. Globally

preferred by employers, the Certified Fraud Examiner credential denotes proven expertise in fraud

prevention, detection, deterrence, and investigation. Members with the CFE credential gain a

http://www.acfe.com/Membership

ABOUT THE ASSOCIATION OF CERTIFIED FRAUD EXAMINERS

©2014

professional advantage and quickly position themselves as leaders in the global anti-fraud

community. CFEs are knowledgeable in four major areas critical to the fight against fraud:

Fraudulent Financial Transactions

Fraud Prevention and Deterrence

Legal Elements of Fraud

Fraud Investigation

To become a CFE, one must:

Pass a rigorous examination administered by the Association of Certified Fraud Examiners

(ACFE).

Meet specific education and professional requirements.

Be approved by the ACFE certification committee.

Exemplify the highest moral and ethical standards and agree to abide by the bylaws of the

ACFE and the CFE Code of Professional Ethics.

Maintain annual CPE requirements and remain an ACFE member in good standing.

To learn more about becoming a Certified Fraud Examiner, visit our website at:

www.ACFE.com/CFE.

As experts in the four major areas of fraud, CFEs are trained to see the warning signs and red flags

that indicate not just actual fraud, but fraud risk―potentially saving organizations thousands of

dollars in losses through prevention and detection before it’s too late.

CFEs have the ability to:

Identify an organization’s vulnerability to fraud.

Examine data and records to detect and trace fraudulent transactions.

Interview personnel to obtain information.

Write fraud examination reports, advise clients about findings, and testify at trial.

Advise on improving fraud prevention and deterrence measures.

Learn more

For more information about the ACFE, visit our website at: www.ACFE.com.

http://www.acfe.com/CFE

http://www.acfe.com/

Documents

©2014 By the Association of Certified Fraud …...an organization. They cause the victim organization to buy goods or services that are nonexistent, overpriced, or not needed by the