Fraud Risk Assessment

Fraud risk assessment is an examination that an entity conducts to evaluate the potential fraud risk areas in the organization. It enables the organization to identify potential threats and develop appropriate risk mitigation strategies. This assessment is carried out across several departments and domains in the organization to detect the areas that are more likely to commit fraud.

Organizations of all sizes and types are exposed to fraudulent activities. Both internal and external perpetrators can commit such fraud. The risk assessment process aids in unveiling the vulnerabilities in the organizational structure that could facilitate such occurrences.

• A fraud risk assessment is an evaluation conducted by organizations to identify the potential fraud risk areas within the entity. This assessment allows the entity to recognize the possible threats and establish risk minimization techniques accordingly.
• The assessment is conducted in various domains and departments. It reveals which departments have higher odds of committing fraudulent activities.
• This process also enables the management to obtain more profound insight into employee behavior and perception. It reveals information about core areas like rewards and recognition, job satisfaction, and the commitment to reach the organizational objectives.

Fraud risk assessment is a process that enables organizations to identify and evaluate the potential fraud risk areas in the entity. It enables the management to recognize the vulnerabilities in the organization and take the necessary measures to mitigate the fraud risks. It also allows the organization to identify the areas and the departments that are more likely to conduct fraudulent activities and take appropriate measures to curb them.

Fraud can be of several types, including false representations and abuse of a position and its power. Furthermore, individuals may refrain from disclosing significant information, which may count as fraud. Internal and external offenders can conduct these activities. The internal offenders include employees, workers, and managers. The external perpetrators may include customers and suppliers.

Some crucial fraud risk areas include the following:

1. An inconsistency between the nonfinancial and financial data may indicate internal fraud in the organization. Fraud in the company's financial statement counts as a type of occupational fraud. Such frauds include exaggerating assets, profits, and revenues or downplaying losses, expenses, and liabilities.
2. Usually, company assets, cash, and inventory are subject to misappropriation. They must be assessed for potential fraudulent activities. These types of fraud may also include theft and embezzlement.
3. Fraud is essentially an illegal conduct. The management and the auditors must have adequate knowledge about the nature and indicators of fraudulent activities, the techniques that are employed to conduct such fraud, and the types of fraud related to the financial activities that are being examined. They must ensure that the company is maintaining compliance with the rules and regulations that allow the detection and prevention of potential fraud.

The steps for conducting the fraud risk assessment process are:

1. The organization must develop a clear fraud risk management framework. The framework must contain the roles and responsibilities assigned to various personnel and include the policies, processes, and rules of the risk assessment structure.
2. An entity must accurately identify potential fraud risks. Management must detect the operations, procedures, and systems for any possible threats of fraud. They may also collect data and conduct interviews to identify the areas, departments, or domains that are more likely to commit fraud.
3. This assessment requires the management to recognize and implement fraud risk mitigation strategies. Depending on the findings of the evaluation, the management must establish and implement various control measures that can help prevent fraudulent activities in the organization. They must focus on strengthening the internal control systems and improving the tracking and monitoring systems. They may also conduct frequent fraud awareness training programs to spread awareness among employees.
4. The management must regularly monitor and review the fraud risk mitigation techniques. They must constantly track and review the efficiency of the risk mitigation strategies adopted by the company. Moreover, they must factor in the dynamic risk scenario and the organization's evolving operational processes. They may need to update the risk assessment methods to ensure continuous compliance with the fraud prevention practices.

Let us go through the following examples to understand this risk assessment process:

Example #1

Suppose Jake owns a small bakery that has ten employees. While conducting an audit, the auditors informed Jake that the bakery's balance sheet was distorted. The numbers in the financial statements did not accurately reflect the bakery's earnings. Jake conducted interviews with the employees and thoroughly examined the entity's financial records. In that process, he found that David, the accountant in the bakery, was committing fraud. David would frequently steal money and equipment from the store for his personal use. This is a fraud risk assessment example.

Example #2

In September 2022, the Indian banks reported over 4,000 fraud cases involving substantial amounts of money of up to ₹36,000 crores. A study conducted by Deloitte revealed that over 60% of the private insurers in India experienced a significant increase in insurance-related fraud cases. However, companies have started relying on artificial intelligence (AI) for assessing fraud related risks. AI is proving to be invaluable in the fintech industry as it can study and analyze an individual's past behaviors to come up with an effective risk mitigation strategy.

The importance of the fraud risk assessment framework is as follows:

1. It is beneficial for identifying potential threats that could arise from fraudulent activities in an organization. The assessment and the following improvement program aid the entity in minimizing and preventing such fraud. Moreover, it is instrumental in protecting the finances and reputation of the entity and its management.
2. This assessment enables a company to evaluate various processes and their effectiveness. It can be beneficial for decision-making and enhancing efficiency in organizational processes.
3. The evaluation assists the management in gaining valuable insights into the perception and attitude of the employees in the organization. It can enable management to understand various aspects like job satisfaction, team spirit, rewards and recognition, and alignment with organizational goals.

This article has been a guide to what is Fraud Risk Assessment. We explain in detail its examples, how to conduct it, importance, and areas. You may also find some useful articles here –

• Corporate Fraud
• Fraud Red Flags
• Fraud Prevention