Fraud in Australia

Simple greed and the opportunity to live beyond one’s normal lifestyle are the primary motivations for fraud.

(Pages 47-51 of the printed journal)

By Colin Ferguson

 

Fraud in Australia illustration

With so many pressures on the bottom line in today’s fraught business world, companies cannot afford to face the high cost of fraud. Yet, as the recent Fraud and Misconduct Survey (2010) shows, it is a serious issue in Australia and New Zealand – and it is proving a significant cost to business.

The Fraud and Misconduct Survey was undertaken by financial services firm KPMG in conjunction with staff from the Department of Accounting at the University of Melbourne. This biennial survey, which dates back to the early 1990s, is comprised of a questionnaire sent to Australasian firms of different sizes across a wide range of industries. The 2010 results – based on the responses of 214 firms – highlight the extent of fraud in Australia and New Zealand. The report profiles the main perpetrators and the motivations for their dishonesty, identifies how frauds were eventually discovered, and highlights the main factors that allowed fraud to occur.

Corporate Australia needs to be aware of the incidence and magnitude of fraud, particularly because of its impact on company net incomes. Losses through fraud reduce net income (not revenue) directly, and it takes significantly more revenue to recover the effect of fraud on net income than the ‘cost’ of the fraud itself. For example, a company with a variable profit margin of 40 per cent that discovers a fraud loss of $400,000 needs to generate extra revenue of $1 million just to achieve the aggregate profit that would have been earned in the absence of fraud.


Definition of fraud

While a definition of fraud does not exist in the criminal code in Australia, the Australian Fraud and Corruption Control standard defines fraud as:

A dishonest activity causing actual or potential financial loss to any person or entity including theft of moneys or other property by employees or persons external to the entity and whether or not deception is used at the time, immediately before or immediately following the activity. This also includes the deliberate falsification, concealment, destruction or use of falsified documentation used or intended for use for a normal business purpose or the improper use of information or position.

In essence, the key elements of a fraud include a representation about a material point which is false and intentionally so, which is believed and acted upon by the victim to the victim’s damage.

The Fraud and Misconduct Survey focuses primarily on ‘misappropriation of assets’ fraud. Wells’ taxonomy of organisational fraud describes misappropriation of assets fraud as the theft or misuse of an organisation’s assets via, for example, stealing cash or inventory, falsifying payroll records to create ‘ghost’ workers, and ‘skimming’ revenues.


Extent of fraud

So, what is the state of misappropriation of asset fraud in Australia? Analysis of the responses to the 2010 KPMG survey strongly suggest that fraud is a significant economic problem in Australia (and, for that matter, internationally). Fifty-three per cent of all respondents reported incidences of fraud in their organisations. Figure 1 shows that the larger the organisation, the more likely it is that fraud will occur. In firms with less than 100 employees, only 30 per cent experienced fraud. Some 75 per cent of organisations with over 500 employees reported experiences of fraud, while the comparable rate for firms with more than 10,000 employees was 86 per cent. The average loss from fraud in each organisation amounted to $3 million and, on average, there were 813 frauds per organisation. Asked to estimate the extent to which detected fraud represented the total underlying incidence of fraud, respondents believe that only one-third of total losses due to fraud are being detected.

Figure 1: Fraud and firm size

Figure 1, Fraud and firm size

These results highlight the fact that it is much more difficult and costly to build and maintain adequate control systems and processes in large complex organisations compared with smaller organisations. Against this background, it is clearly very important that large firms develop and maintain strong corporate governance systems that ensure continual monitoring and testing of business processes, to better withstand attempts by potential fraudsters to circumvent them. While it may appear costly for organisations to undertake this monitoring and testing, it is important to remember the bottom-line impact of fraud in organisations.

The underlying real rate of fraud strongly supports the notion that fraud has a significant impact on the profitability of organisations and consequently on the economy generally. For example, if fraud in the corporate sector approximated zero during the period of the Global Financial Crisis (GFC), the negative impact on superannuation funds would have been significantly lower. Self-funded retirees would likely have been much less affected by the GFC.

Is fraud a major problem in Australia? Figure 2 below provides some interesting results when this question is posed. While 75 per cent of respondents agree that it is a problem generally for business and over 50 per cent believe it is a problem for the industry they are in, most don’t believe it is a problem for their organisation. These results strongly suggest that many organisations are in denial about what the real effect of fraud might be for them. This attitude could well be seen as one of the main reasons why we have seen no significant reduction in the rate of misappropriation of asset fraud in Australia over the last decade.

Figure 2: Is fraud a major problem?

Figure 2, Is fraud a major problem?


Industry factors

The Fraud and Misconduct Survey identifies the financial services sector as being the most vulnerable to fraudulent behaviour. While overall, the most common type of fraud within an organisation is the theft of cash or inventories, banks and insurance companies are the organisations that feel the greatest financial effects of fraud. For banks, credit card fraud (a form of identity fraud) poses the greatest challenge, whereas in the insurance industry, false claims for motor vehicle accidents and for general insurance incidents are the biggest concerns.

Figure 3: Fraud perpetrator by value

Figure 3, Fraud perpetrator by value

Figure 4: Fraud perpetrator by number of incidents

Figure 4, Fraud perpetrator by number of incidents

Consistent with these observations, Figures 3 and 4 clearly show that external parties are responsible for the overwhelming majority of frauds in the financial services and insurance sectors. However, we can also see that while management commit frauds that are the most costly to organisations in the public sector (Figure 3), non-managerial employees are involved in most frauds in these organisations (Figure 4). These results suggest again that an organisation’s controls and processes should be the continual focus for management with a view to ensuring that a firm’s transactions are complete, valid, and accurate.


Identity of fraudsters

So, who are the people that commit fraud within organisations? An analysis of the responses to the Fraud and Misconduct Survey provides us with a profile of the typical fraudster in Australia. He is a male non-management employee who acts alone with no known history of dishonesty. He is 38 years of age, earns around $113,000 per annum, will have been employed by the organisation for a period of five years and held his current position for three years at the time of detection. Typically, he steals $229,000 and will be detected by the organisation’s internal control system some 12 months after the commencement of the fraud.


Motivation for fraud

A range of factors motivate fraud as shown by Figure 5.

Figure 5: Major fraud motivators.

Figure 5, Major fraud motivators.

These results may run counter to expectations and are explained by the context of the survey – that is, workplace fraud perpetrated against employers. Substance abuse is associated with much petty crime and anti-social behaviour, while problem gambling can devastate personal and household budgets, but as causes of workplace fraud, their incidence is relatively minor. Much more typical is the lower- or middle-ranking employee who takes advantage of weak control systems to misappropriate funds to purchase prestige cars, indulge in expensive holidays or spend heavily on big-ticket consumer items. Simple greed and the opportunity to live beyond one’s normal lifestyle (until detection occurs) are the primary motivations for fraud.


How do frauds occur?

Figure 6 below shows quite clearly that the greatest continual threat to an organisation from potential fraudsters (and this applies equally to internal and external parties) is through the overriding of internal controls that are in place and/or through the complete lack of adequate internal controls.

Figure 6: Factors allowing major frauds to occur

Figure 6, Factors allowing major frauds to occur

These results, while disturbing to organisations, suggest that there is a remedy, and one that is not necessarily costly or complicated. That remedy is for organisations to develop, implement and, most importantly, monitor and maintain strong internal controls that ensure that there are few opportunities available for potential fraudsters.


Conclusions

Analysis of the results from recent years’ KPMG Fraud Survey data consistently shows that misappropriation of asset fraud is a serious problem for organisations in Australia. This type of fraud has a significant impact on corporate profits. Most fraud in financial and insurance organisations is perpetrated by external parties; while for other organisations most fraud is committed internally by male employees exploiting poor control systems to fund excessive lifestyle needs. The single most important step an organisation can take to reduce the risk of fraud is to build and maintain strong internal control systems.


References

KPMG 2010, Fraud and Misconduct Survey, Australia and New Zealand.

Standards Australia 2008, Fraud and Corruption Control (AS 8001–2008)

Wells, JT 2005, Principles of Fraud Examination, John Wiley, Hoboken, NJ.

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An edited version of a presentation to the Faculty’s Alumni Master Class series on 21 September 2011.

Colin Ferguson is Professor of Business Information Systems at the University of Melbourne


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