Accounting Fraud Committed by a Business - dummies

Accounting Fraud Committed by a Business

By Kenneth Boyd, Lita Epstein, Mark P. Holtzman, Frimette Kass-Shraibman, Maire Loughran, Vijay S. Sampath, John A. Tracy, Tage C. Tracy, Jill Gilbert Welytok

Fraud comes in two forms: fraud against a business and fraud by a business. The first type of fraud can be classified by who does it, and unfortunately, a business is vulnerable to all kinds of fraud attacks from virtually everyone it deals with — vendors, employees, customers, and even one or more of the business’s own mid-level managers.

The other side of the coin is the conscious behavior of the business itself that is sanctioned by top-level owner/managers.

Fraud committed by the business

The truth of the matter is that some companies carry on unethical practices as their normal course of business, including bribing government and regulatory officials, knowingly violating laws covering product and employee safety, failing to report information that’s required to be disclosed, misleading employees regarding changes in their retirement plans, conspiring with competitors to fix prices and divide territories, advertising falsely, discriminating against employees, and so on.

Frauds perpetrated by businesses may very well be illegal under state and federal statutes and common law. Restitution for damages suffered from the fraud can be sought under the tort law system. In some cases, businesses deliberately and knowingly engage in fraudulent practices, and their managers don’t take action to stop it.

Basically, managers are complicit in the fraud if they see fraud going on in the business but look the other way. The managers may not like it and may not approve of it, but they often live with it due to unspoken pressure to follow the “three monkey” policy — see no evil, hear no evil, speak no evil.

External auditors and detecting fraud

Independent CPA auditors (auditors from outside the company) test a company’s internal accounting controls that are designed to prevent financial reporting fraud. However, audits aren’t always effective. Internal controls aren’t designed to catch all fraudulent acts involving collusion.

If you ask a CPA to audit your financial statements, the CPA may have to refuse you as a new client (or dump you if you’re already a client) if your internal controls are inadequate. If your internal controls are too weak, the CPA auditor can’t rely on your accounting records, from which your financial statements are prepared.

And the CPA may have to withdraw from the engagement if the auditor discovers high-level management fraud. CPAs can’t knowingly be associated with crooks and businesses that operate with seriously weak internal controls.

If you own or run a business, establish a no tolerance policy for fraud at all levels. Fraud begets fraud. If employees or people doing business with the company see fraudulent practices sanctioned by top-level managers, the natural inclination is to respond in kind, adopting an attitude of entitlement and committing some fraud of their own. And they may be very good at it.