By David Alexander, Fraud and Financial Investigations Director at Smith & Williamson

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

This risk of fraud or false accounting 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 policies, declining earnings, undue secrecy and remote operations are often harbingers of misstatement. Taken together they can produce a lethal cocktail of factors which significantly increase the risk of financial statement fraud.

Given the increased pressures brought about by the recession, understanding these 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 these could also grind the business 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 of controls. Consideration therefore needs to be given to 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.

Your response to a fraud can impact your future survival. The chances of recovery diminish with every day, so it’s imperative that those charged with dealing with fraud understand the protocol for investigating it. A response plan is a vital precaution and this should clearly determine who to involve and, just as importantly, who not to involve in the process.

The three core principles of prevention, detection and investigation should be linked in a virtuous circle where lessons learnt from investigation are used to improve controls, leading to better detection procedures and increasing the chances of prevention.

And finally, a word of warning: don’t just think it won’t happen to you. Rather than courting disaster, make sure your anti-fraud procedures are up to scratch now.

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

By necessity this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Article correct at time of writing.

Smith & Williamson LLP
Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International

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