The sudden awareness you’ve been defrauded happens in an instant: it’s an email from a coworker asking why a large capital outlay occurred or a spelling error that you notice in a vendor’s name. Even worse, it could be a voicemail from the state Attorney General’s office. That sinking feeling is all too familiar to fraud victims.
Fraud is a concern for all organizations, but construction companies face additional risk. Common practices such as progress billings, contract bidding, contract accounting, and multiple temporary work sites make construction companies attractive targets. In a 2017 study , 83% of construction industry respondents had experienced some type of fraud, losing an average of $220,000+ per event.
In general, smaller companies can be more attractive fraud targets than larger companies – and they feel the pain of fraud more acutely. Several conditions in the current business climate contribute to increased fraud risk. Rising material and labor costs, labor and material shortages, new regulations, and supply chain issues all drive fraud schemes and contribute to pressure, one of the three legs in the “fraud triangle.” The other two are opportunity and rationalization. Opportunity is obvious, but rationalization is less so. Rationalization can be an employee thinking they’re underpaid and they deserve something extra, or a third party rationalizing that your company makes plenty of money and won’t miss the “pocket change” stolen through fraud. Smart technology and strong processes can defend against opportunity, while people and culture can defend against rationalization.
While the repertoire of fraud schemes is too long to list, here are several common schemes.
Construction companies tend to have many employees, and often a high turnover rate. These two factors create the opportunity for payroll fraud.
- Duplicate or ghost employees might be set up and paid.
- Employees may falsify hours to increase their pay.
- Third parties may obtain access to payroll change documents and falsely change employee banking information to steal employee wages.
Phony Job Costs
Construction companies utilize contract accounting, which involves more subjectivity than other methods of accounting.
- Change orders can be requested and pushed through to make up for poor efficiency, to cover up falsified hours, or to cover materials and equipment theft.
- Substandard materials may be used to falsify expenses and thus cover up phony expenses
Construction companies have significant expenditures associated with a variety of vendors. This creates opportunity for expense fraud.
- Scammers may create fictitious invoices from vendors with similar names to actual vendors but different pay methods or addresses.
- A vendor may submit invoices on a large job in the hopes that the false invoice looks reasonable enough to be paid.
- Less reputable vendors may intentionally miscalculate the total on invoices, hoping that no one will catch the miscalculation.
The good news is that technology and sound business practices are available to limit risk and minimize losses should they occur. Smart technology can flag unusual transactions and strong processes for setting up new vendors and employees are critical. Successful companies know that everyone has a role in preventing fraud – it is not just up to the IT department or accounting department.
If you would like to learn more about assessing and implementing internal controls, and cutting fraud risk, Clark Schaefer Hackett is here to help.