Business Advisor: May 2011

Fraud is a growing problem in bakeries and many other manufacturing businesses. Most organizations only take steps to improve their controls after a fraud has been discovered. The good news is that you can help to prevent fraud by being aware of the red flags to look out for.

Fraud is a growing problem in bakeries and many other manufacturing businesses. Most organizations only take steps to improve their controls after a fraud has been discovered. The good news is that you can help to prevent fraud by being aware of the red flags to look out for.

This article will illustrate three warning signs of employee fraud and what measures you can take to prevent the fraud in each case. 

Red flag #1
One of the warning signs of employee fraud is a supplier who insists on dealing with one employee. Some purchasing frauds are committed by inflating supplier invoice amounts. A corrupt purchasing agent may be receiving a kickback payment from a supplier for goods purchased from that supplier. The kickback will often be paid directly by the supplier to the employee. Alternatively, the employee may establish a fictitious purchasing company, which then submits invoices for payment.

In order to detect this type of fraud:

• Have an employee outside of the purchasing department check supplier invoice prices to price lists and documentation of quotes obtained.
• Review contracts that were issued without competitive bids.
• Require two signatures on all cheques with careful scrutiny of invoices and supporting documentation. Be suspicious of invoices that indicate a post office box as the address.
• Compare all addresses and telephone numbers recorded for employees to the master file of suppliers.

Red flag #2
When personnel are not taking annual vacation time, it could indicate that the employee does not want his or her responsibilities taken over by other employees involved who may detect fraudulent acts.  Consider insisting that employees take annual vacations and have other employees perform their duties during their absence. In addition, it is a good idea to implement a policy of rotating job responsibilities and cross-training employees to perform different functions.

Red flag #3
Another warning sign of employee fraud is a sudden change in lifestyle. Management should be suspicious if an employee has a sudden change in lifestyle or if they appear to be living beyond their means. In many cases, fraud occurs because an employee is desperate for funds beyond their income earned from employment.

What you can do
One of the most important internal controls that can easily be implemented is a “segregation of duties.” For example, segregation of duties can be accomplished by separating the purchasing/receiving functions from the invoicing/cash/payables and general ledger functions. Further, the bank accounts should be reconciled by someone other than those responsible for cash receipts and disbursements. Restricting access to records and databases depending on the employee’s position and responsibilities is another effective internal control that can help prevent fraud.

Your business advisor can be a valuable resource by evaluating the state of your internal controls, recommending best practices, and implementing improved fraud risk management strategies, policies, procedures and internal controls. 

In today’s uncertain economic climate, certain employees may be more motivated than usual to perpetrate a fraud. It is important for management not to overlook or ignore the early warning signs.

Bruce Roher is a partner in the forensic accounting and valuations practice at the Toronto office of Fuller Landau LLP.