Preventing Fraud In Your Organization

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It seems that every day we hear a new story of significant monetary loss due to embezzlement or other crimes perpetrated from within a company by a trusted insider. We hope this column from an earlier edition of St. Louis Construction News & Review Magazine will help protect your business.

By Ken Van Bree

Here’s a statistic that will keep you up at night: according to the Association of Certified Fraud Examiners (ACFE), fraud within the construction industry is now costing an average median loss of $245,000 for organizations. Further, ACFE report that the construction industry’s median loss is approximately $90,000 higher than the average fraud losses across all industries.

Type of Fraud Schemes

The threat of fraud can never be wholly removed, but leadership should take steps to identify schemes their organization might face. Below are a number of schemes frequently used to defraud construction companies.

Billing Schemes

The ACFE indicates that billing schemes account for 35 percent of the fraudulent activity within construction companies. Such schemes can be payments to fictitious vendors, overpayment to vendors (often through collusion with an internal employee), and purchase of personal items with company funds.

Bid Rigging & Corruption

The ACFE reports that nearly 47 percent of the fraud cases examined in the construction industry had an element of corruption, whether it is bribery, kickbacks or quid pro quo situations The bid process can be riddled with opportunity for this type of fraud.

Theft

The construction industry is particularly susceptible to theft of materials due to the location of jobs and the difficulty of tracking construction materials. Job sites can be in remote areas or some distance from the corporate headquarters and subject to less supervision.

Additionally, materials on job sites are hard to track and measure during the construction process. Items lying around a job site such as lumber, concrete, copper pipe, wire and cable can create an opportunity for thieves if proper controls are not in place.

Misuse of Company Equipment

Similar to theft of materials, misuse of company equipment can also become an issue if there is a lack of controls present. For instance, an employee could operate a side business using a company’s idle equipment.

Other Fraud

The construction industry is subject to the same fraudulent activities faced by every other industry. These include payroll fraud through fictitious employees, check tampering, and fraudulent expense reports.

The Importance of Internal Controls

After identifying common fraud activities, an organization should design a control structure that will reduce the opportunity for fraud and increase the chances fraud will be detected. Although there are no guarantees, the foundation to a strong internal control environment is proper segregation of duties.

For example, the person in charge of setting up vendors should not be the same person who approves vendor payments or reconciles bank statements. Proper segregation of duties applies to all areas of business and can be employed effectively at little or no cost.

Here are some other simple yet effective internal controls organizational leadership should consider implementing:

  • Check all estimates for accuracy of calculations, labor rates and correspondence with drawings.
  • Compare job cost estimates with actual costs. Require approvals for cost adjustments or transfers of costs between jobs.
  • Require that estimates for materials above a specified amount include quotes from two or more vendors.
  • Make purchases only with pre-numbered purchase orders, and match them to both receiving reports and invoices before payment is made.
  • Check vendor invoices against estimates to ensure proper discounts and pricing.
  • Always refer to specific job numbers, phase codes or work order numbers in onsite communications.
  • Obtain ink or electronic signatures on change orders before work begins and revise contract values accordingly.
  • Allocate equipment usage to contracts weekly and record equipment maintenance expense in the ledger as they occur.
  • Review all billings for timeliness, accuracy, conformity with contract terms, and correct customer information.
  • Reconcile contract billings with general ledgers monthly, and calculate under-billings and over-billings.
  • Prepare and review monthly financial statements and reconcile them to supporting ledgers, bank statements, and loan schedules

Not all controls are created equal when trying to detect and prevent fraud.  For instance, according to the ACFE, an external audit was performed in 80 percent of the fraud cases reported, but detected the fraud in only three percent of those cases. The majority of fraud was uncovered through tips to a fraud hotline or management, and employees or customers were the leading sources of those tips. A fraud hotline was in place for 54 percent of the fraud cases examined.

Based on this information, it is important not to put too much reliance on a single control, but rather have a series of processes that will prevent and detect fraud.

Know The Signs

The profile of a fraudster can be as important to know as understanding the typical fraud schemes employed themselves. Per the ACFE, fraud typically is not perpetrated by a repeat offender. In fact, only 5 percent of fraudsters had been previously convicted of a fraud-related offense prior to committing fraud crimes.

Additionally, 82 percent of fraudsters had never been punished or terminated by an employer for fraud-related conduct, which shows that while background checks are useful in screening out some bad applicants, they might not be effective in predicting fraudulent behavior.

Most fraudsters were employed for more than one year before committing fraud, but most displayed some, such as living beyond their means, financial difficulties, or having unusually close associations with vendors or customers, that could have served as warning signs. Training management to recognize these warning signs for employees, vendors and auditors is important to help detect fraudulent behavior.

Protect Your Company’s Reputation

Ultimately, knowing the types of fraud, what controls to implement and the profile of a fraudster can help mitigate the chances of a significant fraud loss, but maintaining your reputation is another critical factor.

Reputation is a construction company’s most important asset since the construction industry is small enough for word of mouth to carry great weight in the decision process of sureties, bankers, suppliers or customers. Across all parts of the organization, companies should operate under a code of ethics that builds their reputation in the community.

Ken Van Bree, CPA, is a partner of St. Louis-based accounting firm RubinBrown and serves as the partner-in-charge of the firm’s Construction Services Group. For information, visit

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