How To Detect and Prevent Fraud in Nonprofit Organizations

According to the Association of Fraud Examiners, ACFE 2022 Global Fraud Survey, nonprofit organizations lose an average of 5% of their revenue to fraud. While five percent may not sound like an alarming figure, that’s a portion of hard-earned revenue that should be contributing to the nonprofit’s core mission.

Nonprofit organizations, like any for-profit business, have a responsibility to their members, community, and volunteers to regularly assess fraud risks and learn the best practices to prevent fraud in their organization.

Common Types Of Fraud In Nonprofit Organizations

The three main types of occupational fraud include:

Asset Misappropriation 

The theft of a nonprofit’s assets or misuse of an organization’s assets. This type of fraud is the most common in nonprofits but generally results in smaller losses than other types of fraud. Asset misappropriation may include schemes using fake invoices or payroll fraud, like creating and paying a fake employee.

Bribery And Corruption 

Giving or receiving money for the purpose of influencing someone’s decision or actions. Types of corruption seen in nonprofits include leaders accepting kickbacks as incentives to work within certain communities, on specific projects, or turning a blind eye to deceptive donors. 

Financial Statement Fraud

Intentional misrepresentation of the organization’s financial health. This type of occupational fraud causes the most loss for nonprofit and for-profit organizations and may include understating profits or revenues, altering expenses or timing of expenses, and dishonest bonus structures.

How To Detect Fraud In Nonprofits 

Fraud can be committed at any level in the organization from part-time volunteers to long-term managing board members. The ACFE reports that most fraud is committed by individuals with lower levels of responsibility, but that fraud by upper-level executives proves the most financially damaging.

The ACFE reports also share that most of the material fraud in nonprofits is committed by individuals that had not previously been found guilty of fraud charges. In fact, only 5.2% of fraud cases involved an employee with a prior conviction. 

Protect your organization from financial harm by monitoring common methods of fraudulent activity including:

Check Fraud 

Check fraud is a disbursement scheme where the individual gains access to the organization’s cash by intercepting, altering, or forging a paper check with the nonprofit’s banking information on it.  The checks used in this type of fraud are usually obtained when an employee deposits into their own bank account a black check or a check made out to a vendor.

Theft Of Cash

Simple theft occurs when an employee, volunteer, or member takes money or property without permission. Examples of theft may include an employee misusing petty cash, pocketing deposits meant for the company, or even stealing office supplies for personal use. 

Ghost Employees

Ghost employees are part of a payroll fraud scheme. They are created when an employee enters the information of a fictitious employee with the intention of collecting wages on “their” behalf. Payroll fraud may also define employees who request payment for hours not actually worked or accept a duplicate paycheck without notifying the employer. 

Billing

Billing fraud may occur when an employee enters fake invoices and then later collects payment for the good or service that was never received. Vendor kickbacks can also appear through billing fraud when a staff member intentionally issues additional payment to a vendor who then agrees to pay a portion of the overage back to the employee.

Expense Reimbursements

Fraud through expense reimbursements is common in nonprofit organizations and occurs when employees accept reimbursement for unapproved expenses or inflate expense reports to collect more money than they are owed. 

How To Prevent Fraud In Nonprofits

There are two main defenses nonprofits can use to prevent fraud: knowing what to look for and engaging in fraud prevention tactics. Organizations with proper internal controls typically suffer fewer and smaller losses from occupational fraud. 

Take action to prevent fraud in your organization by following these tips:

Watch For Warning Signs

While there is no way to spot a dishonest person, there are some red flags to watch for including:

• An employee, board member, or manager living beyond their means.
• An employee with unusually close relationships with vendors.
• Volunteers or staff members with financial difficulties, addiction issues, or problems at home.
• Employees that contest help or are abnormally controlling in regard to their position.
• Employees that refuse to take time off or use paid vacations. 

Provide An Anonymous Reporting Method

Tips from other employees and clients are the most common detection method. Encourage anonymous information by setting up a separate anonymous email address or working with a third-party hotline provider. 

Have A Written Code Of Conduct

A written code of conduct or handbook encourages a culture of compliance and can educate individuals about common fraud methods and how to look out for them. Provide each employee with instructions on how to report fraud without fear of consequences.

Segregate Financial Duties

Proper internal controls can help deter fraud. While saving money is always a priority for nonprofits, it’s important to have enough staff in place to separate financial responsibilities. The following accounting responsibilities should be performed by separate employees

• Prints checks and makes payments
• Makes deposits
• Reconciles bank statements
• Reviews financial statements

Mandate Vacation Time

Require that employees take vacation time or personal days off. Allowing the person to step away from their daily responsibilities can indicate fraud by highlighting any changes in financial data while they are away and giving management a close look at their tasks.

Assemble An Audit Committee

An audit committee will take on the responsibility of implementing safeguards against fraud as well as monitoring the effectiveness of internal controls. 

Bottom Line

Your nonprofit organization matters to you and matters to the community. Follow the tips provided here to help deter fraudulent activity and protect your nonprofit’s assets. To learn more about reducing the risk of fraud, setting up internal controls, or assembling an audit committee, reach out to JFW Accounting Services today.