Fixed assets: popular frauds and how to prevent them

Fixed assets: popular frauds and how to prevent them

Fixed assets: popular frauds and how to prevent them

 

Depending on the business a company operates in, fixed assets could have a significant value.
However, the internal controls around this area are often overlooked due to the complexity of keeping track of a great number of assets spread over different locations, the lack of time or just because the risk of fraud is underestimated.
Let’s have a look at the 4 most common fixed asset fraud schemes.

Misappropriation of assets

This is what is commonly known as theft of assets which happens when employees abuse their position to steal from the company.
Based on the “2016 Report to the Nation on Occupational Fraud and Abuse” issued by the Association of Fraud Examiners, this is a very common scenario and it represents 19% of all fraud cases analysed, with an average loss of $70,000.

Recognition of fictitious assets

Under this scheme the fraudster produces fake documents (such as invoices or purchase orders) to support the fraudulent accounting entries.
This type of fraud is aimed to show a stronger company’s performance and might be used by middle and high level management to achieve specific financial targets.

Misrepresentation of asset value

The asset value can be overstated or understated to show a stronger or weaker company’s financial position depending on the fraudster’s goal.
In the case of overstatement of values, the asset is recorded in the financial statements with a value higher than the value allowed by the applicable accounting framework.
In a number of fraud cases the higher value of the asset is supported by fake asset valuations.
In the case of understatement of values, the asset is depreciated at a higher rate compared to the estimated useful life of the asset.
This is a technique commonly used by companies who want to show a lower asset value to benefit from public funding or to avoid higher taxation charges.
Fixed asset misrepresentations include the case of misclassification of assets to meet budgetary or covenants requirements.

Capitalisation of non-asset expenses

This fraud scheme consists in capitalising costs which do not meet the requirements for capitalization under the applicable accounting standards to show a stronger company’s performance.
An example could be the capitalization of research and development costs when not allowed.

How to prevent fraud

There are a number of internal control best practices which could help businesses preventing frauds in the fixed assets area:

  • Physical counts
    The fixed asset physical count plays a key role in the prevention and detection of the asset misappropriation and fictitious asset schemes because, in those type of frauds, the physical asset is not found in the expected location but it is still appearing in the company’s asset register.
    A complete fixed asset count should be performed every year.
    An increasing number of companies are performing cycle counts instead of counting all the assets in one go.
    Anyhow, the key objective is to cover all the locations to ensure completeness of the counting procedure.
  • Analysis of unusual patters
    Another useful control to prevent and detect frauds is the analysis of unusual patterns in the value of the fixed assets.
    For example, the depreciation schedule could be checked to identify any unusual pattern in the depreciation amounts.
    The disposals schedule could be used to analyse write-offs and scrap sales transactions which might hide a fraudulent activity while the acquisition schedule could be reviewed to assess whether the new assets acquired in the period are legitimate and meet the requirements to be capitalised.
  • Fixed assets procedure
    A clear fixed assets procedure should be in place.
    It should cover at least the following areas: fixed assets accounting and reconciliations, fixed assets additions and disposals, and fixed assets physical counts.
    Instances of non-compliance with the procedures should be investigated and, if they are proven to be frauds, should be persecuted in accordance with the company’s internal procedures and the law.
  • Approval of additions and disposals and related documentation
    It is crucial to have a written policy on additions and disposals of assets in place. This policy should detail the approval steps required for new and obsolete fixed assets.
    The approval chain should include at least two level of approvals and rules around additional approvers should be considered for fixed assets with higher value.
  • Reviews and random spot-checks
    A senior finance person should periodically review the additions and disposals and spot-check the supporting documentation to assess its completeness and trueness.
    Performing random checks is a very effective method to communicate to all employees that management cares about and controls the integrity of the fixed assets.
  • Assets tags
    Each fixed asset should be tagged and should be recorded in a fixed asset register to ensure traceability.
    Usually, companies with large amounts of fixed assets use barcode systems to easily track the assets.
  • Up-to-date fixed assets register
    The asset register should identify clearly and univocally each asset and it should include the following details: description, tag number, serial number, location, year of acquisition, initial cost, asset category, useful life, department or person responsible.
    Every time that a new asset addition is made, the register should be updated in order to avoid inaccuracy of the data.
  • Reconciliations with general ledger
    The asset register should be reconciled to the general ledger to ensure the accuracy of the financial statements.
    The reconciliation of the fixed asset accounts should be performed every month by the accountant responsible for it and it should be reviewed by the accounting supervisor to ensure accuracy.
  • Evaluation of assets’ condition
    During the inventory count the conditions of the assets should be evaluated as well.
    The value of damaged or deteriorated assets which are not going to be used again, should be adjusted to reflect the current condition.
  • Physical controls
    CCTV systems can be used as deterrence for frauds, however they might involve privacy issues.
    Even without a CCTV system in place, management could monitor employee behaviours to identify red flags of potential frauds (i.e. low job satisfaction).