September 01, 2013

Introduction

Research has shown that the overall cost, occurrence, and duration of occupational frauds have declined since 2008.1 This can be attributed to anti-fraud education, legislation, and internal controls, among others factors. However, expense reimbursement fraud is one area of occupational fraud that is increasing while other areas are decreasing. The Association of Certified Fraud Examiners (“ACFE”) has reported that both the cost and occurrence of expense reimbursement fraud has increased from 2008. While organizations are expanding their efforts to maximize their profitability through the deterrence, prevention, and detection of fraud, organizations can further maximize their profitability through policies and procedures designed to combat expense reimbursement fraud.

Opportunity / Threat

Expense reimbursement fraud represents a large threat to organizations as most employees have the ability to submit expense reimbursements. This differs from other organizational expenditures as only a few select individuals have the ability to spend or commit resources. Examples include falsified expenses (personal expenses, creation of falsified receipts, etc.) and inflation of actual business expenses (flying first class, inflated mileage, meals in excess of per diem amounts).

For a less than honest employee, this represents an opportunity to commit fraud unless the proper controls are in place to deter such activity.

In fact, JP Morgan reported that Travel & Entertainment (T&E) spending is currently at $156 billion annually and is expected to reach $186 billion annually by 2015.2 Middle market companies were responsible for the largest growth in T&E spending since 2008 at 9.7%. Applying statistics on fraud losses and expense reimbursement fraud losses to the current T&E spending, it is estimated that over $1 billion is lost each year to fraudulent expense reimbursement.3

Difficult to Monitor / Lack of Oversight

Consequently though, expense reimbursement fraud can be difficult to monitor even for sophisticated organizations that otherwise have a strong framework of internal control. A typical control in most organizations is “approval by a department manager” or dual signatures above certain dollar amount thresholds. However, many expenses submitted for reimbursement by individuals may contain an element of subjectivity that not all departmental managers have the experience or education to adequately judge. For example, consider an employee who submits an expense report for dinner while traveling at a conference. Without a written policy or training, the individual charged with reviewing an expense report does not have any basis for approving or rejecting the expense. It might be known that the individual was at a conference that benefited the company, and the manager might expect the individual to expense dinner, but how does one determine a reasonable amount of what is an acceptable charge for dinner?

For this type of control, the approval of an expense report is another burden that is placed upon managers and without proper policy or training, the path of least resistance is to simply approve the report and move on to other competing needs of the organization.

Case Study

Understanding that expense reimbursement represents a significant risk to organizations will help shape policy and lead to the reduction of this type of fraud. Take, for example, Bob, the Vice President of Sales for a middle market advertising company. Bob had been with the company from its inception and prior to the implementation of strong controls related to corporate expense reimbursement policies. Bob had a personal relationship with a number of other executives as well as the company’s board of directors. Bob often used his powerful position to intimidate other employees, especially when he felt pressure from accounting to substantiate certain figures in his expense report.

In his role as VP of sales, Bob frequently traveled on company business. He also attended national conferences so he could remain current on trends and issues effecting the organization. As a result of his frequent travel, it was common for Bob to submit sizeable expense reports. However, Bob was often delinquent in submitting his expense reimbursements, which made it difficult for the accounting department to match the business purpose of expenses he submitted due to the time between the expense date and the reimbursement request. Whenever he was questioned about his reimbursement practices Bob would often become irate and turn to intimidating behavior, which resulted in those questioning him to rescind their questions and process his reimbursement. This was a red flag that colleagues and other executives ignored.

That was until a new accounting manager, who had little history with Bob, requested additional back-up documentation for a number of expenses included in his most recent expense report. The charges were allegedly for meals, multiple flights, and hotel charges all without receipts. Rather than backing off after being unfairly ridiculed by Bob, the accounting manager went to his boss, but ultimately was told not to press too hard. Thankfully, the accounting manager decided to utilize the newly installed fraud hotline and shortly after, an investigation ensued. The independent investigation uncovered several years of reimbursements to Bob for purchases of jewelry for his wife, personal travel for himself and his family, purchases of recreational vehicles, fictitious receipts for cash spending, mileage for business trips never taken, fuel for his and his family members’ vehicles, and numerous other personal expenses. When confronted, Bob claimed that these items were merely “perks” for his stellar performance over the years.

During their investigation, the forensic accountants also identified the existence of vendors who purportedly provided “consulting” services to the Company. Through the forensic examination of the metadata contained on Bob’s computer hard drive, the investigators identified the creation of vendor invoices by Bob which had previously gone unnoticed by the Company. An examination of the bank records proved that the funds used to pay these invoices were ultimately deposited into an account of a Company owned by Bob’s wife.

Bob identified a weakness in his Company’s internal controls and thoroughly exploited this weakness for his personal gain. He used his executive authority (referred to as management override) to circumvent controls to carry out his schemes. With a proper expense reimbursement policy and consistent application at all levels Bob’s behavior would have likely been prevented or detected earlier.

Recommendations

Safeguarding an organization from expense reimbursement fraud is not any different than safeguarding company assets from other forms of fraud, waste, and abuse, which begins with a solid framework of policies and procedures designed to prevent and detect occurrences of fraud. In addition to a strong tone set at the top (and middle) of an organization that stresses the importance of ethical behavior, the following are general recommendations that companies may want to consider to strengthen their internal controls over expense reimbursement:

1I Create and Maintain a Reimbursement Policy. A strict policy that is communicated to employees sets the standards of what is allowed and what is not allowed and avoids putting approval managers in situations where they are forced to make subjective determinations. In addition, it is prudent to demand all employees read and acknowledge adherence to such policies.

2I Training. Training should be provided to those charged with approving expense reimbursement to educate managers on how to spot questionable items and inquire about those items to employees in productive ways.

3I Question Expenditures. Questioning of submitted expenses informs employees that their submitted expenses are reviewed and the company is not afraid to question or deny an expense.

4I Implement the Use of Corporate Charge Cards. When corporate cards are used for expense reimbursement, companies have the ability to request individual statements for more information on reimbursement requests. Additionally, a company can request activity reports to check for credits for reimbursed items.

5I Annually Audit a Sample of Reimbursements. Auditing a sample of reimbursements ensures that company policies and guidelines are being following as well as putting employees on notice that reimbursements are monitored closely.

6I Discipline Offenders. Offenders who are punished for violating company policy sets the correct tone that the company is serious about enforcing its policies and establishes consequences for any violations.

Conclusion

Occupational fraud as a whole has been on the decline since 2008; however, expense reimbursement fraud measured on its own has increased, signifying an area that has been overlooked by those establishing company policies and procedures. Expense reimbursement fraud represents a large threat to most organizations as large groups of employees have the opportunity to commit this type of fraud. Further, expense reimbursement is difficult to monitor and often those charged with approving expense reimbursements lack the necessary training or experience to do so effectively.

The importance of upper and middle management being committed to setting a strong ethical tone within the organization cannot be understated. That tone, along with proper planning and implementation of corporate compliance policies, can significantly limit an organization’s exposure to expense reimbursement fraud, which can have a meaningful impact to its bottom line.

Guest author:

Michael N. Kahaian