Corporate fraud comes in many forms, including payroll fraud, billing fraud, kickbacks, bribery, etc. However, another common type of corporate fraud is financial statement fraud. It is a technique to misinterpret a company’s financial information to deceive financial authorities or others. As per an ACFE (Association of Certified Fraud Examiners) study, financial statement fraud accounts for around ten percent of all occupational fraud incidents, leading to a mean loss of 975,000 dollars.
People still commit such acts of fraud despite the danger of being discovered and the possibility of imprisonment for personal gains, such as receiving a bonus for exceeding sales targets. So, whether high-level management is trying to inflate a company’s worth or an individual is trying to ruin a business’s reputation, here are a few ways to prevent financial statement fraud.
Utilize ERP and Lease Accounting Software
According to financial analysts and auditors, choosing an ERP accounting software system is one of the easiest ways to identify, diagnose, and look into accounting-related fraud, such as financial statement fraud. Numerous cutting-edge ERP programs have been created over time to help businesses carry out all finance and accounting-related tasks while maintaining regulatory compliance. Such software also segregates duties and enforces strict approvals mechanisms, preventing unauthorized access to financial transactions.
Furthermore, lease accounting software allows your company to maintain GASB 87, IFRS 16, and ASC 842 lease accounting regulations. In fact, with the help of lease accounting software, you can always track when and who is making modifications. It will decrease the likelihood of financial problems tenfold!
Set a Tone of Honesty
Employees turn to the leadership to learn the moral and behavioral norms of the company. They should exemplify the ideals management wants to see reflected in the business culture. Therefore, training staff to spot fraud, adhere to ethical and legal norms, and understand the repercussions of engaging in unethical behavior beginning with onboarding should be a no-brainer.
Set a Reporting or Hotline System in Place
The ACFE reports that in 2020, enterprises with hotlines discovered fraud significantly higher than those without any reporting system in place. Therefore, establishing a formal mechanism for reporting fraud allows all employees to participate in fraud prevention.
Furthermore, making everything anonymous removes the threat of retaliation that would discourage a potential whistleblower from coming forward with information about wrongdoing.
Audit Your Financial Statement Periodically
Businesses should routinely check the accuracy of their financial accounts to ensure that nothing is out of place. A thorough examination of the financial data can reveal internal control vulnerabilities and the need for remedial action. After all, employees are less likely to deviate from the truth when they know that an auditor will review their work.
Of course, you can perform an audit yourself. However, initiating an annual examination with the help of a third-party auditor is a better option. So, have an unbiased party review your financial statements yearly to stop management from making excessively drastic revisions to the financial statements. Hiring an auditor to conduct a financial statement review or audit will discourage your employees from purposefully submitting false financial statements.
Enforce Strong Ethics Policies
A strong tone at the top, often known as a strong control environment, encourages managers and employees to act morally. The ACFE points out that a company’s employees will pick up on management’s tone. Adopting and adhering to a defined set of policies will create a strong tone.
Consequences for failing to follow procedures must be included in the policies, and you should be as brief as possible. Additionally, according to the ACFE’s Fraud Examiners Manual, hiring morally upright employees is one of the easiest methods to create a strong moral tone for a firm. It will do wonders for preventing any fraud, let alone financial statement fraud.
Enforce Strong Internal Controls
Establishing robust internal accounting controls is one of the easiest ways to avoid financial statement fraud. That said, the key to preventing fraud is the segregation of duties, which includes assigning different employees different responsibilities such as bookkeeping, deposits, reporting, and auditing to lessen the temptation and opportunity for fraud.
Furthermore, don’t forget to use passwords, lockouts, and electronic access logs to prevent unauthorized users from accessing the accounting system. Also, regularly perform accounting reconciliations to ensure that the accounting system balances correspond to data from external sources, such as bank statements and customer information. These procedures will help thwart all fraud attempts quickly and effectively.
Review All Financial Activities
Checks and balances are essential to ensure everything is accounted for. However, this should be done by a random person without a motive to submit false information. Furthermore, don’t forget to review journal entries at least once every two months. If you find any red flags, you should quickly investigate and hold your accounts department accountable.
Also, all wire transfers should be frequently examined to ensure that they are authentic, involve authorized parties, and are supported by the necessary documentation. It is especially the case if your business transfers funds to off-shore accounts.
Don’t Tie Management Compensation and Bonuses to Short-Term Objectives
Performance-based compensation has potentially harmful effects, such as encouraging fraud. The Academy of Management found that employees with unfulfilled career goals were more likely to act unethically and commit financial statement fraud than those who were making an effort.
The use of illegal strategies to improve performance, such as fabricating financial statements, might appear like an alluring route to “success.” It is especially the case when executives are more concerned with looking good on paper than with generating value over the long term. However, it would be wise to avoid such a strategy and focus on long-term success instead.
The Final Words
Fraud prevention and detection measures must be enforced to minimize this financial loss. Since avoiding fraud is considerably easier than recovering damages after fraud has been committed, every business should regularly review financial activities. It will not only ensure that your employees are held accountable but also helps you spot defects in your strategies so you can fix them swiftly. Furthermore, feel free to hire outside help. In such situations, onboarding someone who knows the ins and outs of financial statement fraud will be better equipped to ensure management is not participating in fraudulent activities.