Employee Theft

Employee theft is a considerable problem for many companies, but its precise extent is poorly documented. The U.S. Census Bureau does not track employee theft as a category but refers researchers to the Annual Retail Theft Survey conducted by Jack L. Hayes International. The U.S. Bureau of Justice Statistics publishes data on larceny, theft, and embezzlement but not in categories that permit inference of the extent of employee involvement. The most recent Annual Retail Theft Survey was based on data from 27 retail organizations employing 1.7 million people. In 2004, 3.7 percent of the employees were apprehended stealing from their employers to the tune of $671 per incident. By contrast, the average "take" of shoplifters in the survey was $149. Employee apprehensions were up 4 percent over 2003—the numbers breaking a multi-year trend of declining employee theft.

The Hayes International survey identifies what might be called mid-level cases of employee theft. Minor theft is the taking for at-home use of rolls of adhesive tape or boxes of paperclips, etc., for instance, a very wide-spread practice. Major theft is of the magnitude reported by Leslie Shiner writing for The Journal of Light Construction. Shiner analyzed the case of a high-end remodeling firm where the sole bookkeeper of the organization had embezzled $550,000 during a seven year engagement—caught in the end because the business owner could not understand how, despite very profitable contracts, his company never seemed to have any money. Shiner reported on a small business case. Major fraud by very high-ranking employees of businesses like Enron are the theft-peak of the employee crime pyramid.

FORMS OF EMPLOYEE THEFT

Employee theft may be grouped into four major categories: 1) manipulation of company records either to embezzle money outright or to hide the theft of goods; 2) direct theft of inventory, products, or cash; 3) abuse of power in order to aid and abet thievery by partners; and 4) theft of information for sale to others or for direct use (e.g., credit card theft).

Records

Employees directly involved in financial administration and with access to company checks and corporate records may engage in forging company checks for personal use. Creating "ghost payroll entries" and then paying "phantom" employees is another method, sometimes quite elaborate in implementation involving phony time cards. Forged billings by non-existent vendors is another method—with the accounts payable clerk writing checks to him or herself when paying the fake billing. Employees also destroy paper records so that "lost shipments" cannot be traced—or fake orders to cover items missing from inventory through their own thefts.

Direct Theft

In its simplest form employees simply take cash from cash registers to which multiple individuals have access to dip into petty cash resources generally easily accessible to several employees. Direct theft of valuable products or materials invariable relies upon trust (the employee comes and goes, often with a truck, stashes goods away, is never checked) or opportunity (the employee has access to the warehouse and the warehouse is not effectively guarded).

Abuse of Position

In one form of this abuse, known as "sweethearting," an employee grants a friend a discount or rings up fewer items than are packaged for taking out—or rings up a cheaper item than the item that leaves the store actually cost. The goods acquired in this manner may later be shared. Individuals taking inventory may abuse this privileged status by counting fewer item than are present and, if this "mistake" is not detected, later personally "adjusting" the inventory by taking the uncounted items home.

STEALING INFORMATION

As reported more fully in the Computer Crime essay in this volume, an increasing proportion of attacks on computer systems take place from within the company. The target of this type of thievery is protected personal data, such as credit card information, which, in the wrong hands, can be turned into cash. More sophisticated forms of such theft are conducted in order to sell information to third parties.

Signs of Employee Theft

Managers and small business owners need to be aware of tell-tale signs which, when they frequently repeat, may be the tracks of a thief at work inside the company. A useful checklist to keep in mind mentally includes—

• Missing records (such as shipping and/or receiving bills).
• Company checks that bounce or someone is surprised that the company is doing business with XYZ and then adds: "Who is XYZ anyway?"
• Customer complaints about missing, late, or short deliveries.
• Hefty payments made for "miscellaneous" purposes in employee expense claims.
• Frequent and puzzling mix-ups in inventory. And
• Managers who insist on performing clerical duties.

STOPPING EMPLOYEE THEFT

In the well-run small business employees are trusted to be honest but sensible policies and practices will be in place to detect the loss of product and closely to monitor financial and administrative transactions. Some of the tools include the following:

1. Clear Policy and Good Example. The company will have and will publish its ethical stance and its managers will be seen to adhere to it strictly in spirit and in action, inside and out, with customers, vendors, and employees alike.
2. Hiring Orientation. Newly hired employees must leave their orientation session fully aware that the company has zero-tolerance for any kind of irregularity—and the dire consequences that will follow pilfering, never mind theft.
3. Adequate Controls. Controls will be in place so that physical goods are locked up, protected at night, and closely checked on paper. In a small business particularly, where time is difficult to find, the owner will, nonetheless, show a keen interest in accounting details, probe into them occasionally, and not simply let the "number crunchers" drift unsupervised. Financial controls will include some of the following:
   • Checkbooks will be locked up, and access to cash and checks will be given only to authorized employees.
   • Few individuals will have the authority to write a check, by preference one writing and one signing the check.
   • More than one person will have insight into the total finances so that "lone wolf" strategies are forestalled.
   • Handling of cash will always be accompanied by documentation.
   • Books will be audited at intervals not necessarily known to accounting people in advance.
   • Cash will be rapidly and immediately deposited rather than accumulating in cash registers.
   • All invoices will be formally checked against deliveries before vendors are paid.

BIBLIOGRAPHY

Berta, Dina. "Toomey: Ward off employee theft with internal checks and balances." Nation's Restaurant News. 12 December 2005.

Brandman, Barry. "Inside Job: Many food distributors find themselves victimized by internal theft. Most are guilty of committing at least one of the Seven Sins of Distribution Center Security." Food Logistics. 15 September 2005.

Fishman, Neil H. "Signs of Fraud." CPA Journal. December 2000.

McTaggart, Jenny and Joe Tarnowski. "Employee Theft, Shoplifting Prevail at Retail." Progressive Grocer. 1 November 2005.

"Mojoes Coffee House." Specialty Coffee Retailer. December 2005.

Niehoff, Brian P., and Robert J. Paul. "Causes of Employee Theft and Strategies that HR Managers Can Use for Prevention." Human Resource Management. Spring 2000.

17th Annual Retail Theft Survey, 2004. Jack L. Hayes International. Available from http://www.hayesinternational.com. Retrieved on 14 March 2006.

Shiner, Leslie. "Protect Yourself from Employee Theft." The Journal of Light Construction. October 2005.

                                Hillstrom, Northern Lights

                                updated by Magee, ECDI

FORENSIC ACCOUNTING

Forensic accounting, sometimes referred to as fraud examination accounting, is an emerging area of specialization within the accounting discipline. Webster's Dictionary defines forensic as "belonging to, used in, or suitable to courts of judicature or public discussion and debate." Forensic accounting can, therefore, be defined as accounting that is used in a court of law, including, but not limited to, the application of accounting theory, principles, and calculations to actual or to hypothetical issues in legal proceedings. The term is broad enough to include the many procedures that an accountant or auditor applies in a fraud investigation.

Job titles commonly used in this field include forensic accountant, investigative accountant, fraud examiner, and fraud auditor. These terms are essentially interchangeable. Forensic accountants draw their expertise from many areas, including accounting, auditing, cost accounting, taxation, and information technology. Forensic accounting is more than accounting—more than detective work—it is a multifaceted activity that requires the use of knowledge from a number of disciplines.

Detecting fraud or white-collar crime used to be thought of as part of the accounting function. Fraud was assumed to occur infrequently because of the presence of internal and external auditors, who would likely identify the presence of fraud in the financial statements. The problem of fraud, however, has become to be perceived as serious, and at times, occurring more than infrequently. Such awareness is the motivation for this new specialization in the accounting field.

Forensic accounting has been subdivided into two categories, (1) litigation support and (2) investigation and dispute resolution. Some practitioners choose to specialize in one of the categories. Other practitioners provide both types of services.

LITIGATION SUPPORT

Litigation support involves the presentation and interpretation of various issues related to assisting existing or pending litigation. In this area of expertise, the forensic accountant may be asked to assign an estimated value for damages sustained by parties involved in legal disputes and to assist in resolving disputes, even before they reach the courtroom.

For example, this area of litigation support provided to the legal profession might include such assignments as assisting in obtaining documentary evidence to support or rebut a claim, reviewing relevant supporting documents to form an initial assessment of the situation and identify possible areas of loss, assisting with suggesting and designing questions to be asked during the gathering of both the financial and nonfinancial evidence, attending the initial disclosure phase (called the discovery phase) of the trial proceedings to review various testimonies and assisting with the understanding of the financial issues, reviewing opposing damage reports and reporting on both the strengths and weaknesses of the positions taken, and assisting with the settlement discussions and negotiations.

INVESTIGATION AND DISPUTE RESOLUTION

The second category of forensic accounting is investigation and dispute resolution. It is part of the process to determine whether criminal matters, such as employee theft, securities fraud (including falsification of financial statements), identity theft, and insurance fraud, have occurred. Some of the work of the forensic accountant may include recommending actions that can be taken to minimize future damages and risk of loss.

Investigation may occur in civil matters, such as the forensic accountant searching for hidden assets in a divorce case. Another typical example would be the forensic accountant being engaged to investigate employee theft. Not only are forensic accountants often engaged to review the facts of a given situation and provide suggestions regarding possible courses of action, but they are also involved with assisting in the many other ways to protect and recover assets.

EXPERT CONSULTANT VERSUS EXPERT WITNESS

Because of the expertise forensic accountants possess, they are often engaged as expert consultants and/or expert witnesses. As expert consultants, the forensic accountants (investigators) are engaged by attorneys to develop evidence used by the attorneys in a variety of ways. Even if litigation is intended, the expert consultants may not be expected to testify; therefore, the various documents the consultants prepare may be protected by the attorney/client privilege or attorney work-product privilege. This means that the documents may not have to be provided to the opposing side in any litigation. If the expert consultants do not testify, their role may end when the fraud has been established, an estimated range of loss established, and a suspect identified. Additionally, expert consultants may be engaged to assist attorneys by identifying and recommending expert witnesses, helping attorneys to prepare for testimony, and reviewing various documents.

Forensic accountants are in high demand to provide expert witness services. An expert witness is a person who can offer opinions about the situation based on insight developed through education, experience, and training. In the process of a court proceeding, the judge rules on whether an expert witness is qualified to provide evidence on the matter before the court. The need for an expert witness who is a forensic accountant generally arises when there is a dispute involving some area of accounting expertise. When investigators (forensic accountants) are engaged as expert witnesses, litigation is intended, and the investigators will often have to provide deposition and courtroom testimony. They can testify about the facts of the case and can also give opinions. Regardless of how educated, experienced, and trained forensic accountants may be, their credibility is weakened if they are unprepared or not familiar with the facts of the case.

CIVIL VERSUS CRIMINAL TRIALS

When an adequate level of evidence is obtained by the forensic accountant, a decision is made whether to pursue the case in court. As noted previously, forensic accountants often play an important role in civil and criminal action. Civil refers to private rights and remedies sought by civil actions, where the individual has been harmed, for which he or she can claim compensation. Civil fraud trials are typically started by the party suffering the loss and may result in a judgment for reimbursement for actual losses and attorneys' fees. Civil trials do not result in imprisonment.

Criminal fraud involves violation of a law (known as a statute) enacted by the state or federal legislation. Criminal fraud is prosecuted by the state and may result in punishment, such as fines, restitution, and/or prison time.

One of the major differences between civil and criminal fraud is the extent, or burden, of proof required for conviction. In a civil case, the burden of proof is to the extent of a "preponderance of the evidence" (which is usually interpreted to mean more than 50 percent), and the verdict may not be unanimous. In a criminal fraud case, the burden of proof is "beyond a reasonable doubt," and the verdict must usually be unanimous. Thus, it is more difficult to obtain a conviction for criminal fraud than one for civil fraud. The forensic accountant is well versed in the quality and type of documented evidence required for each court.

THE NEED FOR FORENSIC ACCOUNTANTS AND FRAUD EXAMINERS

Between 2001 and 2005, a number of top business stories disclosed financial statement fraud and its impact on the accounting profession, businesses, consumers, and investors. In response to several large businesses seeking bankruptcy, the federal government enacted very specific accounting and business laws, including the Sarbanes-Oxley Act of 2002. This act, among other regulations, states that chief executive officers and chief financial officers are directly responsible for the accuracy of financial statements, with significant fines and extensive prison terms for violators. The act also defines prohibited activities that are outside the normal scope of external auditors. Many businesspeople found the act to be the most sweeping legislation to affect the accounting profession since the Securities Act of 1933 and the Securities Exchange Act of 1934.

Many professional organizations, including the American Institute of Certified Public Accountants and the Association of Certified Fraud Examiners (ACFE), emphasize the need for education in the prevention, detection, and prosecution of accounting fraud. As a result, the field of forensic accounting and fraud examination has emerged in the effort to combat financial abuse.

According to the ACFE Report to the Nation in 2005, organizations lose an estimated $670 billion per year (approximately 6 percent of all small businesses' annual gross revenue in 2004) to fraud and abuse. It is no wonder forensic accounting and fraud examination is one of the fastest-growing sectors, not just within the accounting profession, but within all fields of employment.

According to Accounting Today, nearly 40 percent of the top 100 accounting firms in the United States have expanded, or were planning to expand, their forensic-related services. U.S. News & World Report (February 8, 2002) called forensic accounting one of the "20 hot job tracks of the future" and in 2002 designated the forensic accounting profession as one of the eight most secure career tracks in America. SmartMoney Magazine also in 2002 (Accounting Web US May 16, 2002) stated that this profession is one of the "ten hottest jobs" for the next decade with a salary potential of over $100,000. In addition, a national study conducted by Kessler International (August 2, 2001), a forensic accounting firm headquartered in New York City, revealed that two-thirds of the companies that responded to a national study stated that they have either used the services of a forensic accountant already or have considered doing so. The Cincinnati Business Courier in February 2003 stated that the major scandals at the beginning of the twenty-first century had prompted business owners to turn to forensic accountants and fraud examiners for proactive fraud checkups.

Other organizations and companies are also asking forensic accountants to search for wrongdoings. The Federal Bureau of Investigation (FBI), the Internal Revenue Service, and the U.S. Bureau of Alcohol, Tobacco and Firearms have forensic accountants who investigate situations from money laundering and identity-theft-related fraud to arson for profit and tax evasion. Law firms use forensic accountants to help divorcing clients uncover assets hidden by their spouses, and in the first decade of the twenty-first century, forensic accountants have uncovered instances of companies misstating their financial statements to inflate company profits or minimize losses.

Forensic accountants work in most major accounting firms and are needed for investigating mergers and acquisitions; they are also employed in tax investigations, economic crime investigations, all kinds of civil litigation support, specialized audits, and even in terrorist investigations. Forensic accountants work throughout the business world, in public accounting, corporations, and in all branches of government (from the FBI and Central Intelligence Agency to the offices of the local authorities). Forensic accounting firms are everywhere.

A GROWING TREND IN HIGHER EDUCATION

Since 2002 some colleges and universities have developed degree programs in forensic accounting and fraud examination, both at the undergraduate and graduate level. Additionally, many academic institutions have developed and are offering stand-alone courses in this field. Many other academic and professional organizations are developing seminars and training modules to handle the demand for training in this area.

see also Association of Certified Fraud Examiners; Fraudulent Financial Reporting

bibliography

Albrecht, W., Albrecht, S., and Albrecht, C. C. (2006). Fraud examination (2nd ed.). Mason, OH: Thomson South-Western.

Association of Certified Fraud Examiners (2004). Report to the Nation. Available from http://www.acfe.com/fraud/report.asp.

Forensic Accounting. (2002). Forensic accounting demystified. http://www.forensicaccounting.com/home.html. Retrieved January 3, 2006.

PPC's guide to fraud detection (5th ed.). (2002). (Vols. 1–2). Fort Worth, TX: Thomson-Practitioners.

Wells, J. T. (2005). Principles of fraud examination. Hoboken, NJ: Wiley.

Richard O. Hanson

Forensic Accounting

Over the years, the role of the certified public accountant (CPA) has changed dramatically, with some of today's CPAs becoming quasi-private investigators in order to keep up with demands for fraud examinations. These specialized individuals use investigative procedures in an effort to uncover fraudulent activities being perpetrated on a business. Forensic accounting is a term used to describe the work being performed by accountants in advance of litigation and may include bankruptcy, valuation, fraud, and a variety of additional services. It is estimated that each year approximately $400 billion is lost due to employee fraud. To determine the depth and scope of the crime, a fraud examination is conducted in order to find where it is being perpetrated and by whom. Often the auditor must delve into the psyche of the suspect to find a motive for the crime. There are three main reasons why an employee generally steals from his employer, making up what is termed a fraud triangle.

The key elements that comprise most every fraud triangle include opportunity, pressure, and rationalization. The first and most important segment of a fraud triangle is opportunity. Often, companies unknowingly and unwisely offer their employees the opportunity to commit fraud. Typically it is a lack of adequate control and monitoring of employee actions that afford the chance to steal. An example to demonstrate opportunity would be a cashier or accounts receivable person being responsible for the daily collecting and depositing of payments. Without adequate control measures to authenticate the employee's accuracy, funds could easily be embezzled without notice.

Of course, not all employees will seize the opportunity to steal, so what additional factors also figure in to a fraud triangle? Succumbing to pressure is very often the reason why someone chooses to steal when others do not. Financial pressure can arise from a myriad of sources such as personal debt, business losses, and lifestyle standards. Therefore, employees with known financial trouble should not be placed in positions involving money transactions or other duties that would offer a chance to commit fraud. Even peer pressure can be a factor in an employee choosing to steal.

Rationalization is the third element of the fraud triangle. Regardless of the reason for taking money, the thief must then try to rationalize why he or she committed the fraud. The employee who steals often attempts to justify the crime psychologically. Such rationalizations might include thinking the company has so much money that the theft would not be noticed, or the money is for a worthy endeavor such as college tuition or emergency medical expenses. In this way, the perpetrator often attempts to ease a nagging conscience about stealing. In most cases however, the employee makes a mistake or error that places a cloud of suspicion upon them. This is when the fraud examination is conducted.

A fraud examination generally consists of four successive segments: analyzing the available data, developing a fraud theory, revising it as necessary, and confirming the theory. The first step is analyzing financial information culled from the books and records. The particular type of fraud that is being investigated will determine which documents, files, records, and other information are needed for studying. Once the information has been gathered, sorted, and processed, the examiner begins to review and analyze the data in order to develop a theory of what could have happened and who was the perpetrator.

Usually the theory addresses one of three types of internal or occupational fraud: asset misappropriation, corruption, or fraudulent financial statements. The examiner goes through a series of tests and retests in order to determine if there is sufficient evidence to proceed further. The evidence must be substantial enough to stand up in a court of law. If the examination is sound and has merit, then the corporate legal counsel is apprised of impending litigation, interviews are ordered, and third-party and corroborative witnesses are questioned. The examination must be detailed, in depth, and substantiated with indisputable evidence in order to move to the next stage, which entails confronting the suspect or target. This procedure is called an admission-seeking interview, and involves a deliberate process that lays out the evidence to the target in a specific order. The questions must be precisely phrased and the answers correctly interpreted so as to avoid any confusion or misunderstanding. While these procedures help detect and find fraud, the more practical solution would be to prevent fraud from occurring.

The problem with prevention is that certified fraud examiners and forensic accountants cannot affect the internal and external controls that tend to lead to fraud. The problem of company fraud is a social issue, not an accounting issue, and without effective punishment measures, the practice is expected to rise. Punishment is often neither swift nor certain when is comes to fraudulent crimes. It is also difficult for courts and judges to determine the punishment when an accounting crime ended with the destruction of a company that had employed many individuals who lost pensions and retirement investments as well as jobs.

The idea of prevention would seem like the correct response to an ever-increasing crime wave. However, given the current methods of detection of fraud, the fraud examination, and employing the methodology of the fraud triangle, prevention suddenly becomes closer to invasion of privacy and targeting of persons. If the manager of a clinic tells his employer about his spouse being laid-off from work, should the employer then keep a close eye and ear on the manager in order to prevent the possibility of an opportunity to defraud the clinic by the manager? The idea of profiling an employee for any potential of defrauding a company is not consistent with ethical standards of business.

Fraud examination and the fraud triangle are two of the most effective and important procedures a CPA or auditor can use when determining the existence of fraudulent behavior or activities in a company. Both of these concepts constitute the science of forensic accounting and help to uncover any illegal activities. The modern day accountant must have working knowledge of forensic accounting in order to be a success in the field. The government binds an accountant by various laws and statutes in order to obligate them to report any financial mishaps or miscues on the part of the company.

see also Document destruction; Document forgery; Evidence; Federal Rules of Evidence.

FORENSIC ACCOUNTING

Forensic accounting, sometimes called investigative accounting, involves the application of accounting concepts and techniques to legal problems. Forensic accountants investigate and document financial fraud and white-collar crimes such as embezzlement. They also provide litigation support to attorneys and law enforcement agencies investigating financial wrongdoing.

Many different organizations consult forensic accountants. Corporations hire forensic accountants to investigate allegations of fraud on the part of their employees, suppliers, or customers. Attorneys consult forensic accountants to obtain estimates of losses, damages, and assets related to specific legal cases in many areas of the law, including product liability, shareholder disputes, and breaches of contract. In criminal investigations, forensic accountants analyze complex financial transactions such as those in stock market manipulations and price fixing schemes. They also help governments achieve compliance with various forms of regulation.

Forensic accountants typically become involved in financial investigations after fraud auditors have discovered evidence of deceptive financial transactions. After conducting an investigation, they write and submit a report of their findings. When a case goes to trial, they are likely to testify as expert witnesses.

further readings

Arnoff, Norman B., and Sue C. Jacobs. 2001. "Forensic Accountant's Role as Expert Before and During Trial." New York Law Journal 226 (August 17): 3.

Bologna, G. Jack, and Robert J. Lindquist. 1985. Fraud Auditing and Forensic Accounting. 2d ed. New York: Wiley.