What To Do When You Discover Fraud

By Charles Hall | Fraud

Jul 10

You need to know what to do when fraud is discovered. Today, I discuss steps to take when theft is detected.


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What To Do When Fraud is Discovered

When fraud is suspected at your governmental entity, two gnawing questions arise:

  1. Is fraud really occurring?
  2. If yes, how much money was taken?

And possibly a third  – Am I going to be fired? (It’s normal to feel some fear. The thermometer goes up when fraud is suspected.)

It’s at this point that two more questions arise:

  1. Who should I hire to answer the two questions above?
  2. How much will it cost for this service?

You can pick up the phone and call those who are in the know about fraud audits – possibly another government or an audit firm – or you can issue a request for proposal (RFP). Many governments do the later (though I’m not sure it’s the best option). If you can find a reputable, fair audit company, hire them. (Ask for at least two references.) If not, then here’s some information about issuing fraud-related RFPs.

RFPs for Fraud Services

First let me say that governments may need outside assistance in preparing an RFP for fraud-related services. It’s not every day that fraud is encountered; consequently, when fraud occurs, governments often struggle with writing the RFP. Copying your financial statement audit RFP will probably not work; fraud audits and financial statement audits are two completely different types of services. Additionally you may not desire to seek out the lowest bid (yes, you read that correctly). There’s one thing worse than fraud: it’s handling the effects of fraud incorrectly. Let me suggest a method that I believe will minimize costs while providing you with quality audit services.

Governments may want to break down the engagement into two phases:

  1. Predication
  2. Audit

What is predication? It is the early part of the investigation where the auditor determines whether there is enough evidence to merit the second phase of the investigation: audit. The auditor is simply sniffing around in the suspected areas to see if more work should be performed.

Once the auditor has performed the predication phase, the government can decide, based on the evidence uncovered thus far and the estimated price of the audit phase, whether it desires to proceed. This method allows the government to minimize costs; rather than asking for a full-blown investigation up front, you take steps. I have seen some investigations end with the predication phase – there simply was not enough evidence to proceed.

The government should ask for a maximum price (or range of pricing) for the predication phase. Also the government may desire to request a schedule of hourly rates; those same rates may be used in the second phase of the investigation.

The government should normally use the same firm to perform the two phases of the investigation. So basically the firm that wins the predication bid will be the auditor for the full project. If the government elects to proceed with the audit phase of the project, the government should request that the audit firm invoice by hours worked, staff level, and hourly rates. (This creates some transparency in the billing process.)

Summary of Work Flow and Billing

In summary, I am recommending that you:

  1. Bid the predication phase and allow the audit firm to provide you with a maximum price or range estimate (e.g., $8,000 to $10,000).
  2. Select the audit firm.
  3. Allow the firm to perform the predication phase and provide a report.
  4. Make a decision about whether to continue the investigation.
  5. Allow the audit firm to perform the audit phase (if needed).
  6. Receive a final audit report.

I recommend that the audit phase be billed at hourly rates. Why? Because fraud engagements tend to be amorphous. The auditor may dig and find additional issues that could not be discovered in the predication phase. Think of this like an archeologist excavating a house; rather than just a house, he may find a village – though we hope not. As a trade-off to receiving a full bid price, the audit firm can provide detailed invoices that reflect the hours worked, staff level, and hourly rates.

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About the Author

Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.

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(1) comment

armando balbin July 10, 2013

Interesting subject not discussed enough. As the regular financial statements annual auditors we can determine when there is enough evidence to suggest a fraud investigation. Years ago, I performed the audit of a school district, which had the attendance records recorded and summarized by computer. The attendance record is an important factor determining the funds of the district. After some review and testing, I determine that the attendance recording and reporting system was out of control causing the risk of over reporting the number of attendances. However, the final determination of the actual count was beyond the scope of my engagement. Therefore, I recommended engaging outside services to test the system and generate recount of the attendances. It resulted that the district, probably unintentionally, was over reporting the numbers of attendances.
In another situation, a governmental unit large enough to self-insurance having their own workmen’s compensation department. My company was engaged to test the control of the EDP. We had a technically capable person in charge of this task. One of the findings was that the system generates checks not requested but “spontaneously”. We made some recommendations; the administrator of this system rejected our recommendations. A few months later, we read in the local newspaper that a person was arrested because had been collecting these checks fraudulently generated.

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