Fraud Risk Assessment

FRAUD RISK ASSESSMENT
Bryan Baughman

Numerous domestic and international studies indicate that fraud is a significant problem for all companies, regardless of their size. Based on a 2008 survey by the Association of Certified Fraud Examiners, losses from occupational crime and abuse were estimated to be about $994 billion annually, with the median loss per fraud occurrence reported from businesses of 100 or fewer employees being $175,000. The American Institute of Certified Public Accountants issued Statement on Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit (SAS 99). SAS 99 establishes a process for identifying fraud risks and responding to those risks.

SAS 99 discusses two types of fraud risk: fraudulent financial reporting and misappropriation of assets due to theft. Construction companies are specifically vulnerable to both of these risks. CFO’s and Controller’s are under constant pressure to produce positive financial results for third parties such as bonding companies and banks (risk of fraudulent financial reporting). The construction industry also requires valuable supplies and tools to be kept at many different job sites that often lack supervision at certain times of the day or night (risk of misappropriation of assets due to theft). Fraud occurring in either of these areas can lead to large financial losses.

The fight against fraud is not just the external auditor’s responsibility. Management is responsible for designing and implementing organization programs and controls to prevent, deter, and detect fraud. Antifraud programs and controls include the following key elements:

Create and maintain a culture of honesty and high ethics – the Company’s ethical culture is set by management through their daily words, and more important, their actions. Through a written code of conduct and daily adherence to these values, the Company should clearly communicate their ethical values, decision-making processes, and codes of conduct to all employees.

Evaluate the risks of fraud, and implement steps to mitigate them – evaluation of fraud risks involve the areas of fraudulent financial reporting and asset misappropriation. A response to the assessed risks may include preventative controls (reducing the opportunity to commit fraud), mitigation controls (reducing the impact of the potential fraud), or transference (selecting appropriate fraud insurance such as a fidelity insurance policy).

Develop an appropriate oversight process – Even though the entire management team shares the responsibility for implementing and monitoring fraud risk controls, the entire Company should adopt a level of fraud awareness similar to that of a “neighborhood watch” program. Employees should have a means to communicate wrongdoing without fear of retribution because tips from employees are still the number one way to uncover fraud. Further, independent verifications by external auditors help to ensure controls are operating effectively. Coupled with following up suspected wrongdoing, these reviews send a strong message of deterrence throughout an organization. Oversight needs to take a tiered approach so that override at any given layer may be identified and properly handled. The top level of this oversight process is reserved for the Board of Directors, who must ensure top management upholds its responsibilities to the Company.

If your Company is subject to an annual audit by an independent CPA then certain procedures related to fraud are performed by the auditor as a result of SAS 99. However, if an audit is not performed, business owners and managers must take it upon themselves to ensure that appropriate procedures are taken to prevent, detect, and deter fraudulent activity. It is recommended that Companies prepare a formal document identifying fraud risks and responses to those risks. Too many times Companies do not address fraud until losses have already occurred. Taking a proactive approach to managing fraud risks can help ensure the financial success of the Company’s future.

Bryan Baughman is a CPA in the audit department at Pickens Snodgrass Koch LLP (PSK). Bryan has 7 years of public accounting experience and works with various types of construction and manufacturing companies. PSK is an accounting firm that provides a variety of audit and tax services to companies located throughout Texas.