The document summarizes key findings from a report on occupational fraud. It finds that while asset misappropriation is most common, fraudulent financial statements cause the highest losses. Small businesses are most vulnerable due to lack of audits and controls. Establishing anonymous hotlines is the most effective way to reduce fraud losses, more so than audits. Fraud by executives results in highest losses and is best detected through tips rather than controls.

1. The following article is related to deterring employee fraud
within organizations and answers some related questions. After
reading the case, answer the following questions:
Read the article the following article:
Wells, J. T. (2004, December). Small business, big losses.
Journal of Accountancy,
198
(6), 42-47. Retrieved from Business Source Complete database.
Section:FRAUD
Audits and hotlines stack up as the bestcrime busters in a new
ACFE study.
Occupational fraud has become--at least so far--the crime of the
21st century. It is a widespread phenomenon that affects
practically every organization. The frauds in the 2004 Report to
the Nation on Occupational Fraud and Abuse, from the
Association of Certified Fraud Examiners, caused over $761
million in total losses, with a disproportionate percentage
committed against small businesses--almost half of the frauds in
the study took place in businesses with fewer than 100
employees. Not surprisingly such businesses are less likely to
be audited or employ antifraud measures than the larger ones.
Several broad conclusions can be drawn from the 2004 report.
First, though the losses have been stable over the years, the fact
that in one year alone they are approaching $660 billion is cause
for concern. Dishonest executives and employees are plying
essentially the same schemes with the same results. Second,
although large financial statement frauds receive the most
attention, they are relatively uncommon compared to asset
misappropriations and corruption. Third, small businesses
remain the most vulnerable to occupational fraud because of
three factors: They are the least likely to have an audit, a
hotline or adequate internal controls. Fourth, audits--both

2. internal and external--although excellent prevention devices are
not the most effective means of detecting frauds. Fifth, hotlines
and other reporting mechanisms are a vital part of any
organization's prevention efforts but should go beyond
employees to vendors and customers, too. Finally, occupational
fraud cannot be eliminated but organizations that use both
hotlines and auditors can greatly reduce these costly crimes.
Occupational fraud schemes can be as simple as pilferage of
company supplies or as complex as sophisticated financial
statement frauds. This article summarizes some of the key
findings of certified fraud examiners (CFEs) in cases they
investigated. Internal and external auditors and CPAs advising
small business clients will learn of the most effective antifraud
measures.
MEASURING THE COST OF FRAUD
Determining the true cost of occupational fraud is an impossible
task. Because fraud is a crime based on concealment,
organizations often do not know when they are being
victimized. Many frauds never are detected or are caught only
after they have gone on for several years. Many of those are
never reported or prosecuted. In fact, there is no agency or
organization that is specifically charged with gathering
comprehensive fraud-related information. All of these factors
combine to make any estimate of the total cost of occupational
fraud just that--an estimate.
The study asked CFEs to give their best estimate of the
percentage of revenues a typical organization in the United
States loses in a year as a result of occupational fraud. The
median response was 6%, the same result obtained from
previous studies. This is a staggering figure. If multiplied by
the U.S. gross domestic product, which for 2004 will total over
$11 trillion, it would translate into $660 billion in annual fraud
losses (see exhibit 1, at right).
VICTIMIZED ORGANIZATIONS

3. The victims of occupational fraud are the organizations that
employ the fraud perpetrators and suffer losses as a result of
these crimes. Exhibit 2, at right, shows the distribution of
frauds in the ACFE survey, based on the type of organization
that was victimized.
Approximately 46% of the occupational frauds in our study
were committed in small businesses (defined as organizations
with fewer than 100 employees). The impact of occupational
fraud on small businesses was much greater than on larger
companies (see exhibit 3, at right). Part of the reason for the
larger losses is that small businesses are the least likely to be
audited. As noted in the 2002 report, the audit appears to be a
powerful deterrent to occupational fraud.
HOW OCCUPATIONAL FRAUD IS COMMITTED
A major goal of the study was to gain a better understanding of
how fraud is committed and the types of schemes that tend to
produce the largest losses. We classified each fraud according
to the methods used by the perpetrator. Breaking down
occupational frauds into distinct categories also helps CPAs
better understand the common characteristics, which in turn
assists in the development of better antifraud tools.
There are three major categories of occupational fraud to
consider:
Asset misappropriations.
These schemes involve the theft or misuse of an organization's
assets by such means as skimming revenues, stealing inventory
or committing payroll fraud.
Corruption.
Fraudsters wrongfully use their influence in business
transactions to procure some benefit for themselves or another
person. One of the most common is accepting kickbacks or
engaging in conflicts of interest.
Fraudulent financial statements.
These generally involve falsification of an organization's
financial statements by overstating revenues or understating

4. liabilities or expenses.
While asset misappropriations were by far the most common of
the three categories, occurring in over 90% of the cases, they
also had the lowest median loss, at $93,000. Conversely,
fraudulent financial statements were the least common (7.9%)
but had the highest median loss at $1,000,000. (See exhibits 4
and 5, page 44.)
CASH MISAPPROPRIATIONS
Of the cases in the study, 87% involved some form of cash
misappropriation. Cash frauds fall into one of three categories:
Fraudulent disbursements.
A perpetrator causes his organization to disburse funds through
some trick or device, such as submitting false invoices or
forging company checks.
Skimming.
Cash is stolen from an organization before it is recorded on the
organization's books and records.
Cash larceny.
Cash is stolen from an organization after it has been recorded
on the organization's books and records.
Approximately three-fourths of the cash frauds in the study
involved some form of fraudulent disbursement, making this the
most common category by far. Schemes that involved a
fraudulent disbursement also had the highest median loss, at
$125,000. (See exhibit 6, at right.)
FRAUDULENT DISBURSEMENTS
Just over half of the fraudulent disbursement cases in our study
involved billing fraud, making this the most common type.
Among these cases the highest median loss occurred in schemes
involving check tampering. (See exhibit 7, page 45.) The
schemes included the following:
Billing.
A fraudster causes the victimized organization to issue a
payment by submitting invoices for fictitious goods or services,

5. inflated invoices, or invoices for personal purchases. Example:
When a secretary for a public company interceded on behalf of
an unpaid legitimate supplier and the accounts-payable
department could not locate the original invoice, it nonetheless
agreed to pay the vendor based on a fax copy. Seizing on this
basic internal control deficiency, the secretary and two
nonemployee accomplices set up three phony companies,
submitting fax copies of doctored original invoices for
"consulting fees." The fraud was discovered when a manager
questioned a huge variation in the budget--but not until four
years and $1.7 million later.
Payroll.
An employee causes the victim organization to issue a payment
by making false claims for compensation. Example: A controller
for a small nonprofit organization, believing she should be
earning twice her salary, added a "ghost" employee to the
payroll. Since she managed both the bank accounts and the
books--a serious internal control deficiency--that was easy
enough to do. Every pay period, she wrote a paycheck to the
nonexistent ghost, but thanks to the company's direct payroll
deposit policy, the money actually went straight to her bank
account. The bank evidently never noticed the discrepancy.
During a surprise audit of the payroll account, the controller
mysteriously left town. It didn't take the auditors long to figure
out why when they matched the direct deposits and uncovered
the scheme, which had cost the nonprofit $208,000 over three
years.
Expense reimbursements.
An employee enters a claim for reimbursement of fictitious or
inflated business expenses.
Check tampering.
The perpetrator converts an organization's funds by forging,
altering or stealing a check. Example: The administrative
assistant to a CEO of a privately held company knew her boss's
habits all too well. Each week, right before lunch, she presented
him with a stack of checks, which he quickly signed. He didn't

6. notice the checks were prepared in erasable ink. The
administrative assistant--who also acted as the company's
bookkeeper--would change the payee on the checks, deposit the
funds to her own bank account and post the checks to various
company expenses in order to conceal the fraud. When the
checks were returned in the bank statement, the assistant would
change the name back to the payee to whom the payment was
originally directed. In her haste, however, she altered checks
meant to pay the boss's personal expenses. In the end, the boss's
appetite cost him a half-million dollars.
Register disbursements.
An employee makes false entries on a cash register to conceal
the fraudulent removal of currency. Example: A crafty service
station attendant discovered a flaw in the cash register system;
it could put a sale on hold until the transaction was completed.
Simply depressing the "hold" button for a few extra seconds
made the transaction disappear altogether. So when a customer
bought gasoline, the clerk would erase the sale and pocket the
proceeds. Company auditors finally noticed a large disparity
when they compared fuel inventory to sales. After exhausting
all other possibilities (including leaks in the fuel storage tanks),
they installed surveillance cameras over the cash registers and
caught the fraudster on tape. This simple scheme cost the
company $132,000.
DETECTING FRAUD
As in the 2002 study, the most common means of detection--by
a wide margin--was through tips (see exhibit 8, above).
Recognizing the value of encouraging tips, section 301 of the
Sarbanes-Oxley Act requires audit committees of publicly
traded companies to establish procedures for "the confidential,
anonymous submission by employees of the issuer of concerns
regarding questionable accounting or auditing matters."
Respondents were asked what, if any, antifraud measures they
had in place at the time the frauds occurred. They listed
anonymous reporting mechanisms (typically hotlines), internal

7. audit or fraud examination departments and external audits.
Exhibit 9, at right, shows the percentage of victimized
organizations that had implemented these mechanisms.
HOTLINES WORK
To test the effectiveness of each antifraud control, the study
measured the median loss for organizations with controls
against those without them. The figures showed that anonymous
reporting mechanisms had the greatest impact on reducing fraud
losses. Organizations that did not have reporting mechanisms
suffered median losses that were more than twice as high as
organizations with them. (See exhibit 10, at right.) This was
consistent with the findings of the 2002 report.
This result is also consistent with the data the ACFE gathered
showing the most common way for frauds to be discovered is
through tips. Obviously, hotlines and other reporting
mechanisms are designed to facilitate tips on wrongdoing. The
fact that tips were the most common means leading to detection-
-combined with the fact that organizations that had reporting
mechanisms showed the greatest reduction in fraud losses--
indicates this is an extremely valuable antifraud resource. The
effectiveness of these reporting mechanisms is significantly
higher when they are made available to customers, vendors and
other third parties--not just employees. Organizations that
rushed to implement employee hotlines to comply with
Sarbanes-Oxley might profit from adding these valuable
additional sources of information.
Curiously, anonymous reporting mechanisms were the least
common antifraud measure of the three we tested for; only
slightly more than one-third of victim organizations in our study
had established anonymous reporting structures at the time they
were victimized.
THE WAGES OF CRIME
Generally speaking, the position perpetrators held in an
organization and their annual income tended to be the most

8. significant factors in the size of losses in a fraud scheme. As
the employees' level of authority rose, so did fraud losses. In
just under 5% of the cases in the ACFE study, the perpetrator
earned more than $200,000 a year--but, in those cases, median
losses exceeded $1 million (see exhibit 11, page 47).
OBSERVATIONS
In many respects, the ACFE's 2004 report supported its findings
of 2002: Small businesses still were disproportionately affected
by occupational frauds, asset misappropriations still accounted
for approximately 90% of reported cases and the vast majority
of perpetrators were still first-time offenders. As in 2002
occupational frauds still were much more likely to be detected
by a tip than through an internal or external audit; and
anonymous reporting mechanisms such as hotlines still
exhibited the greatest impact on occupational fraud losses.
But the 2004 report also presents new information about
occupational fraud that is especially critical in the post
Sarbanes-Oxley world. For example, the ACFE found that over
half of all frauds committed by owner/executives were detected
through a tip, which was much higher than the rate for fraud in
general. By comparison, only 6% of these cases were caught
through internal controls. Obviously, this was because owners
and executives often were able to override controls to commit
fraud. Given the fact that schemes by owner/executives now
must be disclosed to audit committees regardless of whether
they are material, and that these schemes tend to be the most
costly, the study offers strong support for Sarbanes-Oxley's
requirement for the establishment of anonymous reporting
mechanisms.
The 2004 report also looked more deeply into the ways in which
small businesses were affected by occupational fraud. The
ACFE found one-third of the small business cases involved a
billing scheme, and one-third involved check tampering--two
forms of fraudulent disbursements that typically succeed when
there is a lack of control over the company checkbook. This

9. suggests that if there is one critical area where small businesses
should focus their antifraud efforts and resources, it is in
establishing solid controls--including a strong separation of
duties--over the check-cutting and payables functions.
The ACFE also found that very few small businesses in the
study--only 31%--had any form of internal audit or fraud
examination department. But among that group, it was the
internal audit department that detected half of the frauds. This
suggests that internal auditors can have a significant impact in
detecting occupational fraud and minimizing losses in small
businesses.
RESOURCES
AICPA Resources
Books
• CPA's Handbook of Fraud and Commercial Crime Prevention
(# 56504JA).
• Financial Reporting Fraud: A Practical Guide to Detection and
Internal Control (# 029879JA).
• Fraud Detection in a GAAS Audit (# 006615JA).
CPE
• Introduction to Fraud Examination and Criminal Behavior (#
730275JA).
• Identifying Fraudulent Financial Transactions (# 730244JA).
• Finding the Truth: Effective Techniques for Interview and
Communication (# 730164JA).
For more information, to register or to place an order, go to
www.cpa2biz.com
or call the Institute at
888-777-7077
FREE
.

10. AICPA antifraud initiatives
Antifraud and Corporate Responsibility Resource Center,
www.aicpa.org/antifraud
.
• SAS no. 99 information.
• Management Antifraud Programs and Controls (SAS no. 99
exhibit).
• Fraud Specialist Competency Model.
• Free corporate fraud prevention training and CPE.
• Academia outreach and assistance.
• Other antifraud activities.
The 2004 Report to the Nation on Occupational Fraud and
Abuse, from the Association of Certified Fraud Examiners, can
be downloaded at
www.cfenet.com
.
Exhibit 1: Total Occupational Fraud Losses
Legend for Chart:
B - Billions of dollars
A B
2004 660
2002 600
1996 400

11. Exhibit 2: Type of Organization Victimized
Legend for Chart:
A - Organization type (Median loss)
B - Percentage of cases
A B
Private company 41.8%
($123,000)
Public company 30.3%
($100,000)
Government 15.8%
($37,500)
Not-for-profit 12.2%
organization

12. ($100,000)
Exhibit 3: Median Loss Based on Size of Organization
Legend for Chart:
A - Number of employees
B - Median loss 2004
C - Median loss 2002
A B C
<100 $98,000 $127,500
100-999 $78,5000 $135,000
1,000-9,999 $87,500 $53,000
10,000+ $105,500 $97,000
Exhibit 4: Methods of Fraud--All Occupational Frauds
Legend for Chart:
A - Category (Percentage of cases)
B - Median loss

13. A B
Fraudulent statements $1,000,000
(7.9%)
Corruption $250,000
(30.1%)
Asset misappropriations $93,000
(92.7%)
Note: The percentages exceed 100% due to multiple schemes
in more than one category.
Exhibit 5: Breakdown of Asset Misappropriations
Legend for Chart:
A - Asset targeted (Median loss)

14. B - Percentage of cases
A B
Cash 93.4%
($98,000)
Noncash 22.1%
($100,000)
Note: The percentages exceed 100% due to multiple schemes
in more than one category.
Exhibit 6: Breakdown of Cash Misappropriations
Legend for Chart:
A - Category (Median loss)
B - Percentage of cases
A B

15. Fraudulent 74.1%
disbursements
($125,000)
Skimming 28.2%
($85,000)
Cash larceny 23.9%
($80,000)
Note: The percentages exceed 100% due to multiple schemes
in more than one category.
Exhibit 7: Breakdown of Fraudulent Disbursements
Legend for Chart:
A - Category (Median loss)
B - Percentage of cases

16. A B
Billing 52.1%
($140,000)
Check tampering 31.3%
($155,000)
Expense 22.1%
reimbursements
($92,000)
Payroll 19.6%
($90,000)
Register 4.3%
disbursements
($18,000)

17. Note: The percentages exceed 100% due to multiple schemes
in more than one category.
Exhibit 8: Initial Detection of Occupational Frauds
Legend for Chart:
A - Detection method
B - Percentage of cases 2004
C - Percentage of cases 2002
A B C
Tip 39.6% 43.0%
Internal audit 23.8% 18.6%
By accident 21.3% 18.8%
Internal controls 18.4% 15.4%
External audit 10.9% 11.5%
Notified by police 0.9% 1.7%

18. Note: The percentages exceed 100% because some respondents
identified more than one category.
Exhibit 9: Frequency of Antifraud Measures
Legend for Chart:
A - Antifraud measures
B - Percentage of victims with measure in place 2004
C - Percentage of victims with measure in place 2002
A B C
External audit 74.7% 73.0%
Internal audit 57.2% 57.7%
Anonymous hotline 36.8% 35.2%
Note: Some respondents had more than one measure in place.
Exhibit 10: Median Loss Based on Whether Organization Had a
Hotline
Legend for Chart:

19. A - Survey year
B - Median loss Hotline
C - Median loss No hotline
A B C
2004 $56,500 $135,500
2002 $77,500 $150,000
Exhibit 11: Median Loss Based on Perpetrator's Annual Income
Legend for Chart:
A - Income (Percentage of cases)
B - Median loss
A B
<$50,000 $47,000
(51.2%)

20. $50,000-$99,000 $135,500
(28.5%)
$100,000-$149,000 $429,000
(11.2%)
$150,000-$199,999 $200,000
(4.4%)
$200,000-$499,999 $1,000,000
(3.6%)
$500,000+ $2,010,000
(1.1%)
~~~~~~~~
By Joseph T. Wells
JOSEPH T. WELLS, CPA, CFE, is founder and chairman of the
Association of Certified Fraud Examiners and professor of fraud
examination at the University of Texas at Austin. Mr. Wells
won the Lawler Award for the best JofA article in 2000 and
2002 and has been inducted into the Journal of Accountancy

21. Hall of Fame.
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articles for individual use.
Answer the following questions related to the article:
According to Mr. Wells, how do you measure the cost of
occupational fraud?
Explain the three major categories of occupational fraud.
According to Mr. Wells, what is the best method to detect
fraud?
What types of companies are hit the hardest by occupational
fraud?
Explain what companies can to prevent (not detect) fraud.
Your essay must be at least 200-300 words in length. If using
outside sources all source citation should adhere to the
guidelines of the APA style guide.