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Types and reasons of fraud in an organization

Updated on August 19, 2010

Fraud is an intentional act by management or employees in order to obtain an unfair or illegal advantage. Therefore, the difference between fraud and error is the state of mind. Fraud is always pre-planned and one-sided.  It may generally be defined as 'deprivation by deceit'.

In a corporate context, fraud can fall into one of two main categories.

  1. Removal of fraud or asset from the business

This is the category in which employees and managers fraud with the organization. This includes theft of cash, stock, payroll fraud, collision with the suppliers or customers, manipulation in bank reconciliation.

2. Intentional misrepresentation in the financial statement

These are major frauds and are mainly committed by the auditors. This includes over/under valuation of stocks, assets or liabilities; over/under estimation of sales, purchases, or expenses; manipulation in year and events.

Potential for fraud

There are three broad pre-requisities or 'per-conditions' that must exist in order to make fraud a possibility.

1. Dishonesty

Sometimes fraud arises due to dishonesty. Honesty is subject quality and it rises due to personality and cultural factors. A company may reduce the dishonest employee by hiring employees having good background and good culture.

2. Motivation

Sometimes fraud arises due to motivation which means the needs which are not satisfied. Due to these needs an employee commits a fraud. A company may promote its employees to motivate them and satisfy them by giving handsome salary.

3. Opportunity

Sometimes fraud arises due to opportunity, means when the employee gets option or chance to do it. A company may reduce opportunity by applying strict security and internal control system.

 The board of directors (BODs) are ultimately responsible for the detection and prevention of fraud and for setting up the internal controls because they received investment from the shareholders. Now a day, internal audit department is also responsible. The second responsibility lies on the shoulders of the external auditors. It is their responsibility to examine the financial statement and to express an opinion on the financial statement. At the end of the audit, the auditors report to the shareholders but also they report to the management in which they mention the weaknesses in the system they found and their recommendation.

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