Academic journal article Management Accounting Quarterly

Minimizing Fraud during a Boom Business Cycle

Academic journal article Management Accounting Quarterly

Minimizing Fraud during a Boom Business Cycle

Article excerpt

EXECUTIVE SUMMARY

Companies need to be alert to potential opportunities for fraud to be committed and aware of any outdated internal controls, processes, and procedures. Good internal controls are one of the best fraud-prevention methods.

Rapid growth such as that currently in the oil and gas hydraulic fracturing (or fracking) industry can be both newsworthy and profitable. The excitement surrounding the accelerated economic growth of the Eagle Ford Shale project in Texas provides an excellent example. By the end of 2011, digital and print media outlets were covering the project extensively. At that time, the Center for Community and Business Research estimated that Eagle Ford business activities supported 38,000 full-time jobs and had an estimated economic impact of slightly less than $20 billion in 14 Texas counties. By the end of 2013, the project was supporting approximately 155,000 full-time jobs, had an estimated economic impact of $87.8 billion in 21 counties, and had professionals projecting continued growth decades into the future. (1) Most current reports about the impact of fracking in the Eagle Ford Shale project and other locations still portray a promising economic future, but history provides many reminders that projections of corporate profits and national economic growth can be as fluid and vaporous as, in this case, the natural products being extracted.

Boom-to-bust cycles reflect periods of economic strength, prosperity, and growth followed by periods of recession, hardship, and contraction. Boom-to-bust cycles similar to the one the fracking industry is experiencing are relatively common and can affect businesses operating in virtually any industry. Indeed, they have affected the hotel, airline, automobile, real estate, credit card, tourism, and even pornography industries. The rapid growth and, later, contraction of companies in a boom-then-bust period can cause unique challenges in managing company resources, developing and implementing reliable internal controls, and ensuring dependable, accurate reporting.

Many companies have lost the hard battle of boom-to-bust, but others have managed to survive and continue operating after economic conditions have returned to a less volatile state. The rapid explosion of growth in a boom company creates varied challenges that can actually lead to conditions that act as a miniature incubator for fraud development. Having so many changes occur in such a short time span creates an almost perfect laboratory environment with exponential growth in the potential for fraud.

Unfortunately, many managers who are balancing the demands of rapid growth do not discover that fraud is occurring until the bust phase of the cycle has begun and embezzlement of many dollars or assets has taken place. Indeed, studies have shown that fraud often occurs during a boom period, but the company finds it only during the later bust phase as the business contracts. (2) Perhaps when a company is doing well, it is often easy to overlook the fact that assets are being lost to fraud and theft. Therefore, managers need to protect against fraud while the boom phase is still under way. This article addresses these issues and uses the Eagle Ford Shale project to illustrate ways in which companies experiencing extensive and rapid growth can improve internal controls to minimize fraud.

Boom-to-Bust Cycles and Fracking

In many boom-to-bust industry sectors, the business life cycle is quite different from that of a more traditional company. Companies generally move at a steady pace among the start-up, growth, expansion, maturity, and transition or dissolution phases. As Figure 1 shows, in boom-to-bust companies the following happens:

* A company recognizes an idea and acts on it quickly;

* Irrational exuberance in the marketplace embraces the idea, which causes a rapid explosion of positive business activity;

* Market rationality takes hold, or another boom idea occurs; and

* Activity sharply contracts, leaving depressed prices, limited capital market access, and economic downturn for the company and industry. …

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