Fraud is the act of dishonestly and illegally misrepresenting financial facts in order to obtain a financial benefit. In its simplest terms, it’s theft. But in most cases, fraud is much more complex than simply taking money.
Fraud usually involves complex planning and may even involve multiple people. In many cases, fraud results in a loss of a significant amount of money that can cripple a business or other organization.
Not all fraud is the same. There are many different types of fraud that can usually be classified into one of three categories. In this article, we will discuss the main three types of fraud and how those frauds are usually implemented in real life.
Asset misappropriation is the most common type of fraud in a business setting. Asset misappropriation involves the illegal use of a company’s money or assets for illicit purposes.
Examples of asset misappropriation include using company funds to pay fake invoices or setting up fake payroll schemes. Asset misappropriation is usually committed by people who have access to a company’s financials and are in decision making positions. For example, accountants, controllers, and even those in payroll and accounts payable.
A common example is an accounts payable person creating fake invoices and sending them to their employer on behalf of a fake vendor. The company thinks they’re legitimate invoices and pays the bills.
The money goes directly to the employee instead of to the vendor. If the company doesn’t have controls in place, this kind of fraud can go on for years undetected.
Another example is a payroll person setting up payroll for a fake employee or approving overtime or bonuses to an employee. The employee and the payroll split the money and both benefit in an illegal way. Again, this can often go on for years if undetected.
Companies that do not have strict controls and processes are vulnerable to asset misappropriation. This type of fraud often happens when too much trust is placed in one individual.
They feel they’ll never get caught, so they are brazen enough to do the crime. Depending on the complexity of the scheme and the amount stolen, asset misappropriation fraud can lead to years in prison.
Bribery and Corruption
Bribery and corruption involve the use of money to influence a decision or outcome. It happens everywhere, but it is most common in politics and public service. A donor or business may give a political official money in exchange for a certain vote or decision.
Another type of bribery involves kickbacks, in which an official receives money in exchange for their cooperation. For example, a public leader may vote to award a project to a specific construction company. And then the company may give money from the project back to the public leader. That’s a kickback and it is highly illegal.
Bribery and corruption crimes often lead to stiff prison sentences because they involve the betrayal of the public’s trust. Public officials can spend years in prison if found guilty of being involved in a bribery or corruption scheme.
Financial Statement Fraud
Financial statement fraud is the least common type of fraud, but it is often the most costly. It is usually committed by the highest-level officers within a company, and it involves misrepresenting a business’s financial position to obtain a better outcome.
There are many different types of financial statement fraud. A common one is faking financial statements in order to obtain loans. Another is using fake numbers to improve stock market performance.
Some company leaders have lied about numbers to inflate bonuses and payouts to themselves and others. The collapse of Enron in the early 2000s is one of the most extreme examples.
Again, financial statement fraud can lead to serious penalties. Sentences can be stiff because those who perpetrate the crime are in the most trusted positions. Financial statement fraud is difficult to implement but it’s also difficult to uncover. It can go on for a long period of time undetected.
Fraud may not be a violent crime, but it can have serious consequences for its victims. It can cause a company to go out of business, forcing hundreds out of their jobs and financially ruining those involved.
The best way to prevent fraud in any organization is to have a strict set of controls and guidelines in place to prevent illicit activity. Never put too much trust in one person.
Have a double-check system to identify errors and inaccuracies. Use an outside accountant to review the books and statements. A sound process can eliminate opportunities for fraud to occur.