How to Successfully Prevent Accounting Fraud Using the Pareto Principle
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GUEST BLOGGER
Cecilia E. Locati, CFE, FCMA, CGMA
Director
Internal Control Toolbox and Fraud Fence Ltd.
In February 2019, a Meals on Wheels bookkeeper pleaded guilty to stealing more than $88,000. According to court documents, between May 2013 and April 2018, the bookkeeper had access to the organization's bank accounts, debit cards and payroll system. Documents said the bookkeeper used the bank accounts to pay for things like her mortgage, utilities and property tax payments. She frequently disguised these transfers in Meals on Wheels’ internal accounting system to make them appear as they were legitimate Meals on Wheels expenses. She was also responsible for paying Meals on Wheels’ quarterly payroll taxes to the IRS. The documents showed she frequently underpaid the organization's payroll taxes, or failed to file tax returns at all, then falsified internal accounting records to reflect that it had been paid in full.
This is just one example of the most recent headlines on accounting fraud. It is striking that many accounting fraud cases are caused by basic, to say the least, internal controls failures. There are countless controls which can be implemented to prevent accounting fraud, from entity-level controls such as tone at the top and ethical hotlines, to operational controls such as accounts reconciliation and the segregation of duties. The challenge facing fraud-prevention professionals is finding the controls which are most effective and efficient to prevent accounting frauds in a specific company.
The Pareto Principle, also known as the 80/20 rule, can help solve this challenge. The principle, elaborated by the Italian economist Vilfredo Pareto in 1896, states that roughly 80% of the effects come from 20% of the causes. The 80/20 rule has been successfully applied to a wide range of fields, from software bug fixing to athletic training. In the fraud prevention world, the Pareto Principle can be used to identify key accounting fraud risks and to establish an effective and efficient internal control framework.
C-executives, especially in small and medium-sized companies, like this pragmatic approach for a couple of reasons:
It gives them comfort that big accounting fraud risks are addressed
Organizations face very different accounting fraud risks, as well as differing reasons why accounting fraud is committed. Therefore, it is essential that all the possible accounting fraud schemes are identified and evaluated before they are analyzed to identify the most crucial.
For this reason, for the internal control framework to be effective and efficient, it must be highly customized to the organization and laser-focused in addressing its own specific risks of accounting fraud.It is cost effective
One of the biggest resistances to anti-fraud controls is the widespread belief that they will over-complicate the existing processes and increase the internal bureaucracy, which ultimately makes the company slower with little added benefit. However, by using a laser-focus approach to build an internal control framework that prevents accounting fraud, the number of controls can be significantly limited and restricted to only the essential with the greatest impact.
The ACFE’s upcoming webinar “How to Successfully Prevent Accounting Fraud Using the Pareto Principle” will guide you through the step-by-step process of applying the Pareto Principle to identify crucial accounting fraud risks in your organization and describe how to build an effective and efficient internal controls framework.