RESEAR

CH
PAPER
EMPLOYEE
ON FRAUDS

CA SRINIVASULU SUDI
Membership No. 205033
Batch 8 : Virtual Certificate Course on Forensic Accounting and Fraud Detection
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INDEX

PARTICULARS PAGE NO

Introduction 2

Fruad Definition 2-3

Challenges in Employee Fraud 3

Fraud Triangle – Deginition 3-4

Types of Frauds 4

6 Signs for abusing Employee frauds 4-5

Red Flags 6

Impact on Expense Reimbursement 6-7

Recommendations, 10 ways to protect 7-8

Case Study 8-9

Conclusions 10

Bibliography 11

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Introduction
As an auditor we always have this responsibility of giving utmost justification to the scope with which
we are assigned with. When it comes to special assignments like Forensic Accounting and Fraud
Detection, this responsibility unifies with our passion, which is of the essence in investigations, helps
identifying the fraud and shall help in coming out with a report which is a fact finding report and
which may be used as evidence in court of law. As the services of forensic accountants include
analysing, identifying and preventing, so is the requirement of developing or assisting in developing
specialised system or software for early warning bells. To be a successful Forensic Accountant, one
must have the intensity in investigating, good understanding about the domain, bit of experience in the
field and tremendous common sense. More so, when the subject matter is of investigating the
Employee Frauds.

Fraud
Fraud is deliberate deception to secure unfair or unlawful gain, or to deprive a victim of a legal right.
Fraud itself can be a civil wrong, a criminal wrong or it may cause no loss of money, property or legal
right but still be an element of another civil or criminal wrong.

The purpose of fraud may be monetary gain or other benefits, such as obtaining a driver's license
or qualifying for a mortgage by way of false statements

Section 447(1) of the Companies Act, 2013 has given an inclusive definition of Fraud, which is
reproduced here under:

“fraud” in relation to affairs of a company or any body corporate, includes any act, omission,
concealment of any fact or abuse of position committed by any person or any other person with the
connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the
interests of, the company or its shareholders or its creditors or any other person, whether or not there
is any wrongful gain or wrongful loss; (ii) “wrongful gain” means the gain by unlawful means of
property to which the person gaining is not legally entitled; (iii) “wrongful loss” means the loss by
unlawful means of property to which the person losing is legally entitled.

Likewise, “Fraud” has been defined by Section 17 of the Indian Contract Act, 1872

Fraud”, means and includes any of the following acts that are committed by a party to a contract, or
with his connivance, or by his agent with an intention to deceive the other party or his agent, or to
induce the other party to enter into a contract:-

(1) the suggestion, as a fact, of that which is not true or right, by one who does not believe it to be true
or right
(2) the active concealment of a fact by one having some knowledge or a belief of the particular fact
(3) a promise made without nay intent to perform it or bring it into action
(4) any other act which amounts to deceiving the other person
(5) any act or omission which is declared by the law as fraudulent.

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and also under Clause 11 of SA 240

Fraud - An intentional act by one or more individuals among management, those charged with
governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal
advantage

However, the inclusive definition given under Companies Act, 2013 has given much scope for
reporting a fraud, as the definition draws the intention irrespective of any wrongful gain or wrongful
loss.

CHALLENGES OF EMPLOYEE FRAUD

Employee fraud is one of the most pervasive types of fraud in organizations. According to the
Association of Certified Fraud Examiners (ACFE), 13.8 percent of fraud schemes involve expenses.
About 27 percent of expense reimbursement fraud comes from employees that hold executive or
upper management positions. Because they are in higher positions and engage in many activities
involving business, managers may feel less inclined to separate business expenses from personal
expenses. Countless headlines have highlighted top officials who have treated company or
government funds as their own personal piggy banks. Former agriculture commissioner Richie
Farmer, for instance, was found guilty of using state funds to pay for shirts, laptops, and filing
cabinets; using $20,000 for a buy local initiative to sponsor a racing team owned by a relative; and
pocketing extra gifts that were purchased with state funds for agriculture commissioners.

This lavish spending by top officials sets a tone at the top in which excessive spending and expense
account padding is an acceptable practice. Employees are less likely to consider it unethical to falsify
or exaggerate expenses if they observe top management doing it. Perhaps this is why employee fraud
is four times more likely to occur in a company than corruption or financial statement fraud. Over
time these false expenses add up. In one study, it was estimated that $13.7 million was lost due to
fraudulent transactions in a mere three months. It takes a company approximately two years to
discover expense accounting fraud, which typically allows this fraud to go on a long time without
detection.

Fraud Triangle – Overview

The Fraud triangle is a framework designed to explain the reasoning behind a worker’s decision to
commit workplace fraud. The three stages, categorised by the effect on the individual, can be
summarised as pressure, opportunity and rationalisation. Broken down, they are:

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 Step 1 – the pressure on the individual – is the motivation behind the crime and can be
either personal financial pressure, such as debt problems, or workplace debt problems, such as
a shortfall in revenue. The pressure is seen by the individual as unsolvable by orthodox, legal,
sanctioned routes and unshareable with others who may be able to offer assistance. A
common example of a perceived unshareable financial problem is gambling debt.
Maintenance of a lifestyle is another common example.

 Step 2 – the opportunity to commit fraud – is the means by which the individual will
defraud the organisation. In this stage the worker sees a clear course of action by which they
can abuse their position to solve the perceived un shareable financial problem in a way that –
again, perceived by them – is unlikely to be discovered. In many cases the ability to solve the
problem in secret is key to the perception of a viable opportunity.

 Step 3 – the ability rationalise the crime – is the final stage in the fraud triangle. This is a
cognitive stage and requires the fraudster to be able to justify the crime in a way that is
acceptable to his or her internal moral compass. Most fraudsters are first-time criminals and
do not see themselves as criminals, but rather a victim of circumstance. Rationalisations are
often based on external factors, such as a need to take care of a family, or a dishonest
employer which is seen to minimise or mitigate the harm done by the crime.

The term fraud triangle was first coined by American sociologist Donald R. Cressey who worked
extensively in the fields of criminology and white-collar crime. Fraud is often a white-collar crime but
not always.

Types of Employee Fraud

Thanks to the Association of Certified Fraud Examiners (ACFE), we know there are four broadly
defined categories of fraud by employees:

 Mischaracterized Expenses—Employee requests reimbursement for a personal expense but

claims it to be business-related.
 Overstatement Expenses—Reimbursement requested for a legitimate business expense, but
a trumped-up amount.

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 Fictitious Expenses—Employee seeks reimbursement for fake purchases often “backed up”
with fake receipts.
 Multiple reimbursements—When an employee submits the same expenses and receipts on
multiple reports.

6 Signs Your Employees Are Abusing Expense Reports

1. Some employees are spending more than others
Employees in comparable positions should have similar expenses.

2. Claiming non-business related items

Regardless of how your employee positions it, a half-hour massage at the hotel probably does not fit
within your expense policy. To deter this type of frivolous spending, your company needs to solidify
what types of expenses are to be charged to the business.
One way to do so might be to educate the employees and train the managers approving the reports.
Managers have to be fair about charges they accept.

While sales people may need to have some flexibility on spending, other roles in your organization
may not. Look at the ROI on your expenses to determine what makes the most sense for your
business. Communicate that to all your employees, but at the same time, hold people accountable.

3. Inflating acceptable expenses

When using their own personal accounts, a dishonest employee could turn a profit from business
trips by tacking on a couple of dollars to common business expenses. So a $5 taxi ride suddenly
becomes $10. Since it’s such a minimal amount and a standard expense, it often gets overlooked.
Whenever possible, a receipt should accompany every claim on an expense report. To avoid getting
drained by employees’ cash purchases, some businesses put a limit on the reimbursable amount
allowed without a receipt.

4. Overcharging the company card

Many business owners provide corporate credit cards to employees who do a lot of traveling or
entertaining so that they don’t have to worry about reimbursement. Corporate credit cards consolidate
expenses, making it much easier for your finance department to track trends and verify charges.

However, when you issue corporate credit cards, there’s a risk that employees will spend more than
necessary. When the company credit card bill arrives, don’t just blindly sign a check and send it on its
way. Review the charges to ensure your card hasn’t become your employees’ fun money. Another
option might be to issue prepaid debit cards to travelling employees, so that you can set spending
budgets for trips ahead of time. This helps to deter employees from overspending, and keeps them
budget conscious.

5. Double billing
Some employees may try to double dip. For example, they’ll list a charge twice, but under different
trips. Additionally, if not monitored carefully, some employees may make a charge on their company
credit cards and later submit a receipt for the same purchase as a cash claim. When you provide
company credit cards, you need to be especially diligent about monitoring usage. W ith automated
expense management software, you can put controls in place that will automatically alert you to

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duplicate transactions. This way your finance department doesn’t have to sift through paper
statements or old spreadsheets.

6. Exceeding the limits for allowable expenses

Employees sometimes split large amounts into two or three items on the expense report. Instead of
setting limits on individual purchases, you might consider setting a company’s expense limits based
on a per-trip cost. Employees who travel for the company will likely have a larger budget than those
who entertain partners and clients locally.

RED FLAGS

ARed Flag as the symbol of socialist revolution or a warning of danger.

Red flags that employee fraud is present include:

One employee is spending far more than others, even when sent on the same or on similar
business trips.
Expenses are being processed on weekends and days that aren’t working days.
Closer examination could show that larger expenses are being broken down into smaller
charges.
Trip costs fluctuate wildly, with one trip costing a small amount and the next costing
thousands.
Expenses are for exorbitant things – massages, high-end dinners, luxury hotels, and so on.

The Impact of Employee Fraud

Research has shown that the overall cost, occurrence, and duration of occupational frauds have
declined since 2008.Thiscan be attributed to anti-fraud education, legislation, and internal controls,
among others factors. However, employee fraud is one area of occupational fraud that is increasing
while other areas are decreasing. The Association of Certified Fraud Examiners (“ACFE”) has
reported that both the cost and occurrence of expense reimbursement fraud has increased from 2008.
While organizations are expanding their efforts to maximize their profitability through the deterrence,
prevention, and detection of fraud, organizations can further maximize their profitability through
policies and procedures designed to combat employee frauds.

Opportunity / Threat
Employee fraud represents a large threat to organizations as most employees have the ability to
submit expense reimbursements. This differs from other organizational expenditures as only a few
select individuals have the ability to spend or commit resources. Examples include falsified expenses
(personal expenses, creation of falsified receipts, etc.) and inflation of actual business expenses
(flying first class, inflated mileage, meals in excess of per diem amounts)

For a less than honest employee, this represents an opportunity to commit fraud unless the proper
controls are in place to deter such activity. In fact, JP Morgan reported that Travel & Entertainment

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(T&E)spending is currently at $156 billion annually and is expected toreach $186 billion annually by
2015.2 Middle market companieswere responsible for the largest growth in T&E spending since2008
at 9.7%. Applying statistics on fraud losses and expensereimbursement fraud losses to the current
T&E spending, itis estimated that over $1 billion is lost each year to fraudulentexpense
reimbursement.

Difficult to Monitor / Lack of Oversight

Consequently though, employee frauds can be difficult to monitor even for sophisticated
organizations that otherwise have a strong framework of internal control. A typical control in most
organizations is “approval by a department manager” or dual signatures above certain dollar amount
thresholds. However, many expenses submitted for reimbursement by individuals may contain an
element of subjectivity that not all departmental managers have the experience or education to
adequately judge. For example, consider an employee who submits an expense report for dinner while
travelling at a conference. Without a written policy on training, the individual charged with reviewing
an expense report does not have any basis for approving or rejecting the expense. It might be known
that the individual was at a conference that benefited the company, and the manager might expect the
individual to expense dinner, but how does one determine a reasonable amount of what is an
acceptable charge for dinner? For this type of control, the approval of an expense report is another
burden that is placed upon managers and without proper policy on training, the path of least resistance
is to simply approve the report and move on to other competing needs of the organization.

Recommendations
Safeguarding an organization from expense reimbursement fraud is not any different than
safeguarding company assets from other forms of fraud, waste, and abuse, which begins with a solid
framework of policies and procedures designed to prevent and detect occurrences of fraud. In addition
to a strong tone set at the top (and middle) of an organization that stresses the importance of ethical
behaviour, the following are general recommendations that companies may want to consider to
strengthen their internal controls over expense reimbursement:

1I Create and Maintain a Reimbursement Policy.

A strict policy that is communicated to employee’s setsthe standards of what is allowed and what is
not allowedand avoids putting approval managers in situations wherethey are forced to make
subjective determinations. Inaddition, it is prudent to demand all employees read andacknowledge
adherence to such policies.
2I Training.
Training should be provided to those chargedwith approving expense reimbursement to
educatemanagers on how to spot questionable items and inquireabout those items to employees in
productive ways.
3I Question Expenditures.
Questioning of submittedexpenses informs employees that their submittedexpenses are reviewed and
the company is not afraid toquestion or deny an expense.
4I Implement the Use of Corporate Charge Cards.
Whencorporate cards are used for expense reimbursement,companies have the ability to request
individual statementsfor more information on reimbursement requests.
Additionally, a company can request activity reports tocheck for credits for reimbursed items.

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Ten Ways to Protect Your Organization

1. Maintain a travel reimbursement policy or guidelines that govern this activity, prohibited activity
and per diem amounts should be detailed in this policy and regularly communicated to your
employees.
2. Require original documentation to be either submitted with the reports or maintained for a period of
time for audit purposes.
3. Initiate a formal review process in which a department manager or equivalent reviews employees’
reports. Payroll or human resources should perform a cursory review as well.
4. Routinely question expenditures that look extraordinary or abnormal. Waiting for a larger problem
to build will only be more difficult and costly to resolve later.
5. Have all disbursements made in a formal manner through either accounts payable or payroll. Cash
shouldn’t be advanced to employees, if at all possible.
6. Implement the use of corporate charge cards for greater control. With corporate cards, companies
can query each card individually and ensure that payments are being made against them.
7. Receive credit activity reports on a monthly basis from the issuing company, if using corporate
charge cards. These reports can help you determine how many charges are being cancelled or credited
back to the accounts. This activity can be compared to actual expense reports to determine if it is
being accurately reported.
8. Annually audit a sample of employees’ expense reports to ensure they meet the company’s
established guidelines. Be sure that proper documentation exists to support the expenditures that were
requested. If a company card is used, verify that the balance is being paid promptly.
9. Treat reimbursement activities consistently by having employees pay expenditures and seek
reimbursement, or by having the company pay these expenses directly. Flip-flopping between the two
could allow for duplicate reimbursement to occur.
10. Prosecute offenders found to be violating or falsifying their expense reports. If they are allowed to
escape unpunished, others will follow their actions.
Expense reports could represent a significant risk exposure for certain organizations. In most cases,
employees are assumed to be honest and trustworthy, and their reports go unexamined. Maintaining
tight controls and frequently reviewing expense reports for compliance can alleviate dealing with
larger problems down the road. Remember also to lead by example. Employees follow the actions of
their supervisors or management. The tone is set at the top. If travel and expense guidelines exist,
everyone must follow them, including top management.

CASE STUDY
Employee fraud at Food Company
I have witnessed many cases of expense reimbursement fraud in the course of my career, and the one
that really stood out was an incident at a food company.

The company began as a distributor of specialty foods. Its founders brought many years of experience
in the food sector to their new venture, where one became managing director and the other a sales
director. The rapid growth of the business created an urgent need to scale the workforce up, too. The
sales director was able to persuade some of the people he had worked with before to join his company
as sales managers. The company also hired an accountant to handle its finances.

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The company’s client base increased rapidly, and over a wide area, to the extent that the sales director
and his team were constantly on the road. New sales employees were hired regularly to keep up with
the increasing number of clients.

No specific travel and expenses policy was in place, however, the general, unwritten rule was to use
common sense. Any employee who needed to claim business expenses had to fill out a paper form
and submit receipts for each purchase. The report had to be authorised and signed by the employee’s
line manager before being submitted to the accountant. The accountant had to check whether the
report was signed, the expenses were reasonable, and the receipts for each expense were attached to
the report.

One evening, one of the new junior salesmen was about to leave the office. His sales manager asked
him to drop off an expense report for the past month with the accountant. He left the office and
headed towards the accountant’s office. The junior salesman was just glancing through the document
as he walked and noticed something very puzzling. The sales manager was making a mileage claim
for a business trip that happened two months before. This struck him as being very strange because he
remembered that particular day clearly; it was his first visit to a client, and he and the sales manager
went to the client’s office by train.

The junior salesman pointed this out to the accountant when he submitted the report, thinking that
there had been an innocent mix-up in the dates. The accountant went through the past month’s records
to try to rectify the error, and she found that the sales manager had already submitted a claim for a
train ticket for that same trip. She also noticed that the report included another two mileage claims
made for business trips for which train tickets had been already reimbursed. She checked the past six
months’ records and was astonished to discover that it was a regular practice by the sales manager.

The sales manager would submit receipts for train tickets purchased to visit a client. Then, after one or
two months, he would claim mileage for that same trip. She also found something else: The meals he
supposedly had with clients on weekdays actually happened on weekends, as evidenced by the dates
of the original receipts.

This discovery was taken to the managing director, and he asked for a full report on expense claims
made by the sales manager over the years. The report submitted by the accountant showed that the
sales manager had claimed £12,000 ($15,720) in the last three years for personal weekend meals and
mileage claims on trips that had already been reimbursed.

The managing director called a meeting with both the sales manager and director, and revealed the
report. The accused sales manager initially denied any wrongdoing, saying that he must have mixed
up a few dates and he needed to check his records. When he saw how much incriminating evidence
there was against him, however, he couldn’t deny the accusations any longer. He finally admitted that
he had inflated expense reimbursements by claiming more than once for the same trip and that most of
the client meals were his personal expenses. He had been able to get away with it for so long because
he realised that neither the sales director nor the accountant ever checked the dates on the receipts or
compared claims with past records to check for duplicate expenses.

The sales director couldn’t hide his surprise – he had trusted this sales manager completely as they
had worked together for many years, and he was his best salesman. He admitted that due to his
frequent travel and his extremely high workload, he barely had time to do a reasonableness check of
the expense claims. He was confident that this check was enough to spot fraudulent expense claims.

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After the formal internal investigation was completed, the sales manager was dismissed from his job
and asked to pay back the stolen money.

CONCLUSION
Following are general recommendations that companies may want to consider to strengthen their
internal controls over expense reimbursement:

1. Know Your Employees

Fraud perpetrators often display behavioural traits that can indicate the intention to commit
fraud. Observing and listening to employees can help you identify potential fraud risk. It is
important for management to be involved with their employees and take time to get to know
them.

2. Make Employees Aware/Set Up Reporting System

Awareness affects all employees. Everyone within the organization should be aware of the
fraud risk policy including types of fraud and the consequences associated with them. Those
who are planning to commit fraud will know that management is watching and will hopefully
be deterred by this.

3. Implement Internal Controls

Internal controls are the plans and/or programs implemented to safeguard your company’s
assets, ensure the integrity of its accounting records, and deter and detect fraud and theft.
Segregation of duties is an important component of internal control that can reduce the risk of
fraud from occurring.
Documentation is another internal control that can help reduce fraud.

4. Hire Experts
Certified Fraud Examiners (CFE), Certified Public Accountants (CPA) and CPAs who are
Certified in Financial Forensics (CFF) can help you in establishing antifraud policies and
procedures. These professionals can provide a wide range of services from complete internal
control audits and forensic analysis to general and basic consultations.

5. Live the Corporate Culture

A positive work environment can prevent employee fraud and theft. There should be a clear
organizational structure, written policies and procedures and fair employment practices.

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BIBILOGRAPHY

e Learning Material
Forensic Material
http://www.cgteam.com/blog/six-strategies-for-fraud-prevention-in-your-business
http://www.insperity.com/blog/6-signs-your-employees-are-abusing-expense-reports/
https://www.keepek.com/blog/business-expenses-frauds-and-solutions/
https://stonebridgebp.com/library/uncategorized/expense-reimbursement-fraud-ten-ways-to-
protect-your-organization/
http://www.hrzone.com/hr-glossary/what-is-the-fraud-triangle
http://www.cgma.org/magazine/news/pages/how-to-stop-expense-reimbursement-fraud-
201614675.aspx?TestCookiesEnabled=redirect

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