07/04/2011

By David Alexander, Fraud And Financial Investigations Director, Smith & Williamson

False accounting or fraudulent financial reporting is a significant risk for any sizeable business. In tough economic times, management teams will often try to anticipate future growth to justify any over-reporting in their desire to keep things going. For a few there will be the temptation to plug any holes in the accounts with false accounting entries and fictitious supporting documentation.

This risk is compounded by the ability of senior management to override controls through collusion or by browbeating staff into manipulating the books and records. Business owners need to be aware of the risks associated with financial statement fraud, including why it might be committed and what motivates the fraudsters to commit it.

Pressure to achieve results, aggressive accounting polices, declining earnings, undue secrecy and remote locations are all examples of such risks. Put together they can produce a lethal cocktail of factors which significantly increase the risk of financial statement fraud.

However, given the increased pressures brought about by the recession understanding the risks is no longer enough. Research carried out by The Federation of Small Businesses shows that as many as a third of businesses have been affected by fraud.

The guiding principles for an effective fraud risk strategy are prevention, detection and investigation. The strategy must address all three principles in equal measure. In an ideal business world, prevention controls would be strong enough to stop all fraud, but this would also grind the company into the ground due to the sheer bureaucratic burden. Also, experience suggests that if a fraudster is sufficiently motivated, fraud will happen despite the tightest controls. You therefore need the other two principles, to be able to detect fraud as it is happening and then investigate it once detected, or more likely when someone blows the whistle.

How you respond to a fraud can mean the difference between the business surviving or going under. A response plan is a vital precaution in a company’s response to financial statement fraud. The chances of recovery diminish with every day after a fraud has been detected. It is therefore imperative that those charged with dealing with fraud understand the protocol for investigating, who to involve and, just as importantly, who not to involve.

These three principles should be linked in a virtuous circle where lessons learnt from investigation are used to improve controls, where weaknesses in controls identified lead to better detection procedures, which in turn instigate investigations.

Finally, don’t just think it won’t happen to you. Rather than waiting for the inevitable, make sure your anti-fraud procedures are up to scratch now.

If you want to find out more about protecting your business against fraud, contact David Alexander on 020 7131 8290 or email david.alexander@smith.williamson.co.uk

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