Employee Fraud and the Areas to Monitor

As a business owner, it is uncomfortable to consider that one or more of your trusted employees may be capable of fraud.  However, that unfortunate reality can harm your company in many ways, so we are devoting this week’s article to ways to spot and prevent employee fraud. 

How big is this problem? A 2014 study from the Association of Certified Fraud Examiners (ACFE), estimated that organizations lose about 5% of revenues each year from employee fraud, and that small businesses with less than 100 employees endure fraud disproportionately with 28% higher median fraud losses. 

So how can a company prevent fraud? The answer lies in both understanding the motivations of wayward employees, and implementing some effective internal controls.  

First let’s discuss motivations. Contrary to what you may believe, most people who commit occupational fraud are almost always first time offenders, with 87% of the occupational fraudsters in the ACFE’s 2012 study having never been charged or convicted of a fraud-related offense, and 84% of fraudsters having never been terminated from a previous employer for fraud-related conduct. Circumstances have to be just right for an employee to engage in the theft of company assets. 

According to the 20th century American sociologist and criminologist Donald Cressey, there are three factors that make up what is known as The Fraud Triangle, and these factors must be present at the same time for an employee to commit fraud. 

The first factor is pressure, which involves the perceived non-shareable financial need that a particular employee may be facing that cannot be solved through legitimate means, such as an inability to pay his or her bills at home, a need to meet earnings or productivity targets, or even just the need to buy status symbol items. 

The second leg of the fraud triangle involves rationalization. As previously mentioned, most employees that commit fraud are first time offenders with no criminal past. Consequently, employees have an easier time convincing themselves that they are good and honest people; they just happen to be caught in a bad set of circumstances. Employees may rationalize the theft of cash because they have every intention of paying it back, or some may feel like they haven’t been properly compensated for the amount of work that they have done. 

The last and most controllable piece, from the employer’s perspective, is opportunity. Mitigating the potential for fraud to occur by monitoring key areas is instrumental in eliminating fraud. Implementing a proper set of internal controls that segregates the duties of employees will drastically cut down on the opportunity for an employee to commit fraud.

Grocery stores can face fraud from both the retail environment and their corporate environment. In the retail environment, the most popular types of fraud occur either as a cash register transaction or the misappropriation of store merchandise. Refund fraud is prevalent in a system that allows refunds to be processed with incomplete customer information or without a receipt. The most common is for employees to take store merchandise from the floor and “return it” with fake customer information. Another type of fraud is discount abuse, where employees can buy merchandise at one location and then return it at a different location for full price. Also, having a system to keep track of inventory received or sold to mitigate theft is vital in grocery stores and the retail industry as a whole. 

The corporate side of fraud in grocery stores is something to monitor, also. Without the proper set of internal controls, employees have the opportunity to setup fake vendors or fake employees and have company resources diverted from business use to personal use. 

Also, questionable and informal accounting practices to meet earnings or productivity targets should be monitored. While fraud in the corporate environment is often harder to detect, segregating duties among employees can reduce the risk of fraud occurring. Not allowing one employee to have responsibilities in any two of the three following functions is important: authorization of transactions, recording transactions, and custody of assets. Segregating these duties significantly mitigates the opportunity for fraud to occur. It’s important to note that fraud can still occur due to management override or collusion between employees, even if the proper set of internal controls are set in place. Having a positive corporate culture that values trust and camaraderie is a surprisingly effective solution to this risk. 

Sometimes fraud starts out as nothing but greed, and sometimes it starts off as a one-time solution for an employee’s unlucky situation. It almost always snowballs out of control before much can be done about it. While the owners of the business can’t do much to help employees not rationalize or feel the pressure to commit fraud, employers can reduce the opportunity for one to commit fraud. Knowing common areas that are popular for retail fraud to occur is a big step towards reducing the unwanted risk. 

Consult with a trusted and experienced CPA to learn more about keeping your business safe from these internal threats.  


BGBC Partners, LLP is a full service certified public accounting and business consulting practice.