Here’s the scenario: You’ve discovered a problem with your books. It has rippled through into your key financial reports and possibly also affected corresponding tax filings for that period. Your mind starts spinning.
How can you tell if this bookkeeping problem is fraudulent activity or just a simple mistake?We’re going to offer you some general guidance on what to look for so you can work towards solving the mystery. After all, there’s no sense in ringing the alarm bell if the problem was just a simple accounting oversight or manual bookkeeping error. However, if you find any telltale signs that illegal activity has occurred, we strongly recommend that you bring in a third-party forensic accountant to investigate the problem thoroughly so that you can gather the evidence needed to have the perpetrator(s) charged for their crime.
So, let’s look at how you can tell the difference between fraud and bookkeeping error and discuss how to respond!
- Look for Patterns
Is the issue predictable, like it’s following a pattern? Fraud is more likely to follow a pattern, whereas errors are more likely to be random. However, it’s important to note that that incompetence (and we’re using this term to simply mean lacking key bookkeeping/accounting acumen without any judgement regarding the person’s overall intelligence or motivation) can sometimes follow a pattern as well.
For instance, if your bookkeeper is not well-versed on how to depreciate a specific kind of asset and, therefore, makes a depreciation mistake, this will likely be carried forward through the asset’s useable life or across similar types of assets. This doesn’t indicate that fraud is occurring, but it does highlight an area where there is opportunity for improvement through additional accounting procedure specificity.
- Analyze How it was Handled
Where an issue is discovered, especially if it reveals a pattern, look at what happened next. An error is more likely to go unnoticed for a while and then have a one-time fix applied later that corrects it, whereas fraud is more likely to be accompanied by a “fix” immediately after that isn’t mentioned to anyone or ongoing bookkeeping adjustments that make it harder to discover.
- Peel It Back
Look closely at the issue itself. How easy is it to trace the cause of the problem? Incompetence is typically easier to uncover because the problem will be less complex overall, whereas fraud will often be more convoluted due to the subsequent work that’s typically done to try to cover it up.
- Consider the Offender
Consider who may be involved and what their experience level is (or was at the time of the issue). A more experienced bookkeeper or accountant, especially one with industry-specific knowledge, shouldn’t be making frequent or basic mistakes. If you see simple mistakes being made by your bookkeeper or accountant it could speak of carelessness, or it could signal something more nefarious is going on. It could be that someone else has gotten ahold of their login and is using that access to their gain, or it’s possible that the “errors” are intentional acts by your bookkeeper/accountant to defraud the company.
- Determine Who Would Benefit
Where possible, follow the money to try to understand who could benefit from the problem you’ve discovered. When there are bookkeeping issues, the company will always pay the price. But if there is someone like your bookkeeper, a vendor, or a customer that is directly benefiting from these issues, that is more likely to be a case of fraud.
Usually, when a bookkeeper is stealing from a company they won’t make it as obvious as just paying themselves (although it does happen from time to time), which may mean that you need to dig deeper to look for a connection. If the vendor or customer that’s benefitting is somehow related to a current or former employee, that may hint at impropriety occurring.
- Evaluate the Response
Any good employee will want to correct their mistake once it’s discovered… if the mistake was an accident. A bookkeeper or accountant is typically going to be far more eager to fix an honest mistake than their fraudulent activity. When it’s fraud they may shift blame, stall, or stop communicating altogether.
In some instances, an accounting professional may quickly fix the issue that’s discovered and downplay how it happened or went unnoticed to evade suspicion and then go back to their illegal activity once the dust has settled. If the problem you’re facing has happened before, it is far more suspicious than if it’s the first time the issue has arisen.
- Take Further Action
It’s important to get to the bottom of what happened and how so you can understand how to move forward. Conduct a full accounting audit (likely with the help of a forensic accountant) to understand the extent of the issues and the damage sustained. If fraud has occurred, you can pursue legal action. If your bookkeeper/accountant is just lacking the experience needed for the role, you can either upskill them or replace them with someone more qualified. An accounting consultant can provide the training needed to get your bookkeeper or accountant up to speed, or you may opt to outsource the role for greater accountability.
Whether they’re caused by fraud or incompetence financial difficulties can sink an organization. If your books are amiss, it’s time to get to the bottom of the problem and fix it to move your company forward. The time to act is now! Bringing in experienced financial leadership provides the oversight needed to find and fix errors as well as prevent the right conditions needed for fraud to occur.
When you need a part-time CFO or Controller, we can help! Our team of fractional financial executives can offer the experience you need to better protect your business. Contact us to find out more today!
