Protecting Your Company from Employee Fraud

by Duane Reyhl, CPA
Senior Manager, AHP

Other fraud articles by Duane Reyhl:
Create an Antifraud Culture (published in July 2004 by the Greater Lansing Business Monthly)

Overview

Fraud and abuse cost employers an average of $9 a day per employee, according to the 1996 Report to the Nation on Occupational Fraud and Abuse prepared by the Association of Certified Fraud Examiners. The report also cites that the moist costly abuses occur in organizations with fewer than 100 employees. Can you recognize employee fraud? What should you do if you suspect it? How can you safeguard your business against fraud? Where should you start?

The obvious types and methods are theft, forgery and embezzlement. Other types range from falsification of records and reports to use of employer assets. Fraud can be carried out by a single person or by more than one individual working together. Fraud is carried out in three stages:

• Action. The fraudulent activity is committed, for example, the theft of cash, creation of fictitious accounts payable.

• Concealment. Once the act is committed, the embezzler hides the act. In the case of a petty cash theft, false receipts might be created or the cash balance falsified.

• Conversion. After concealment, the embezzler must convert the assets to his or her personal use such as deposited stolen assets in a personal bank account.

These indicators are not proof of fraud, but one or more is usually present in circumstances where fraud has occurred. Here are some common red flags:

• Changes in lifestyles (i.e., exceedingly high purchases/expenses.)

• Frequent complaints from customers about merchandise or services not received or accounts not credited.

• Missing or altered documents.

• Employee’s inability to manage money.

• Poor internal controls.

• Erratic behavior.

• Employee in accounting that has not taken a vacation in years.

If you spot any of these red flags, you should consider whether you should make discreet inquiries as to the nature of the circumstances.

If you suspect fraud, don’t panic. Fraud investigations require a methodical accumulation of facts. Don’t try to solve it yourself. Instead contact a professional fraud examiner who can help you outline the steps that should be taken.

You have a vested interest in fraud prevention—whether as an executive or employee. As an executive, it’s profitability of the company and the safeguarding of assets. As an employee, it’s security, protection from the manipulation of others, and long-term company health since the latter directly affects your employment. Many fraud prevention tools help you attain these organizational goals in addition to combating fraud.

For example, effective controls over the receipt, recording and reconciliation of cash help deter fraud, but also strengthen your ability to monitor cash flow effectively. Inventory controls can help you spot unnecessary stock build-up, slow-moving parts or critical inventory levels. Similar benefit are available in areas like employee time and expense reporting, accounts receivable, purchasing, or asset management.

One of the best fraud prevention devices is adequate segregation of accounting duties. For instance, this means that the person who records cash receipts (including checks) should not also record accounts receivable activity. The person who prepares or approves payroll should not be the one to distribute payroll checks. The person who prepares accounts payable checks should not prepare the organization’s bank reconciliation. “Wait a minute,” you ask. “I don’t have nearly enough people to do all that.” And you’re probably right. The benefits should outweigh the costs. One way to mitigate a condition of limited segregation of duties is through greater management involvement. One of the best things to do is to have the organization’s bank statement sent directly to the owner’s home with the owner reviewing the statement and cancelled checks for unusual activity or unusual check payees.

Strong internal controls help your organization more than you think. More than forms and policy manuals, the process is people-focused, but objective-driven. This means that you can meet your organization’s objectives in three categories:

1. Effective and efficient operations. Addressing basic business objectives, this category encompasses performance and profitability goals and safeguarding of resources.

2. Reliable financial reporting. This category relates generally to how financial information is reported to those who use that information.

3. Compliance with applicable laws and regulations. This internal control component addresses an organization’s compliance with a host of federal, state and local requirements, including employment law, income tax regulations, workplace safety requirements, environmental regulations, and many others.

See our fraud services page for more ways we can help your organization.  We can also arrange a one-on-one session to confidentially discuss any matters with you. Please call or e-mail Duane Reyhl, CPA at (989) 497-5300 for more information. Let us show you what you can do to protect yourself and add to the value of your operations. After all, losing $9 dollars a day may not sound like much, but in an organization of 10 employees that’s more than $30,000 a year. Think about it.

Implementation of an antifraud program starts with your organization’s leadership. The selected resources below can provide more information to help you implement or refine your antifraud program and culture.

American Institute of Certified Public Accountants (www.aicpa.org):

Audit Committee Effectiveness Center (www.aicpa.org/audcommctr/homepage.htm)

Audit Committee Toolkit (www.aicpa.org/Audcommctr/toolkits/homepage.htm)

Antifraud Resource Center (www.aicpa.org/antifraud/homepage.htm)

Management Antifraud Programs and Controls (www.aicpa.org/download/antifraud/SAS-99-Exhibit.pdf)

Management Override of Internal Controls: The Achilles' Heel of Fraud Prevention

Sample fraud policy (www.aicpa.org/download/antifraud/81_sample_policy.pdf)

Sarbanes-Oxley Implementation Central (www.aicpa.org/sarbanes/index.asp)

Business Roundtable (www.brtable.org)

Corporate Governance Task Force (www.businessroundtable.org/taskForces/index.aspx)

Ethics Resources Center (www.ethics.org)

Reports from the Association of Certified Fraud Examiners:

2004 Report to the Nation  |  2003 Report to the Nation  |  1996 Report to the Nation