Businesses are taking a microscopic
look at their numbers and “leaning”
their organizations in order to stay
afloat in this tough economy. But in the
process, how carefully are companies monitoring internal controls? What good is a lean
business if there are not stopgap measures in
place to help prevent fraud?
“As you start the new year, make sure you
have not let internal controls go by the wayside,” says Christopher Szuch, CPA, CFE,
director in the assurance services department at SS&G Financial Services, Inc.
“Statistically speaking, as the unemployment
rate increases and people are hurting for
money, those without sound moral ethics,
who have opportunities to commit fraud, are
more likely to do so. Effective internal controls will help mitigate those opportunities.”
Smart Business spoke with Szuch about
key risk areas for fraud and what to do to protect your business’s financial health.
How does management decide what internal
controls are necessary?
The first step is to identify key risk areas,
which requires analyses of business operations and systems that are currently in place.
What areas of the business are exposed and
present an opportunity for employees to
commit fraud (stealing inventory, misappropriation of funds, falsifying checks, etc.)? All
companies should tune in to these popular
fraud targets: accounts receivable and
payable, payroll and inventory.
How can fraud sabotage accounts receivables, and what is the solution?
Companies should not delegate accounting
duties to one employee. Whenever one person is responsible for every step in a process,
you give that employee an opportunity to
commit fraud. Here’s how one common
fraud scenario plays out: An employee steals
from an accounts receivable by taking a
receivables check and cashing it for him or
herself. To cover it up, the employee takes a
payment from another client and applies it to
the receivable he or she stole from. (This is
called ‘lapping.’) This creates a perpetual
cycle that does not end: the employee is constantly waiting for the next check to arrive in
order to cover the previous payment. One solution is to require employees to take a full
workweek off, and then have another
employee take over duties. Whatever the
employee has been covering up will rise to
the surface when someone else fills in.
What about accounts payable fraud?
Segregation of duties is equally important
here. Perhaps a key vendor and employee
have a strong relationship and go into collusion. The vendor charges more for the product, your employee pays the inflated invoice
and then gets a kickback from the vendor in
return. Involve more than one person in purchasing. Fraud is usually a solo act and the
guilty employee gets away with it because no
one else knows or is involved in the process.
What should business owners be aware of to
guard their inventory?
Companies with lax inventory controls can
be taken advantage of by employees who
quickly figure out how to dupe the system.
For instance, if your business produces a lot
of scrap metal in the manufacturing process,
employees can steal this scrap, sell it and
retain the profit. Inventory that is not
accounted for can be stolen and sold elsewhere. When obtaining inventory (i.e., materials) from vendors, an employee can botch
purchase orders or simply not record the
existence of inventory. Without an airtight
system to track every item in that warehouse,
a business is exposed to any number of fraud
scenarios that can bruise the bottom line.
What common schemes occur with payroll?
The lack of a true department and reliance
on a sole employee to process payroll can
entice an unethical worker to set up a
account for a fictitious person and cut paychecks to that ‘employee.’ Of course, those
checks are discreetly taken to check-cashing
institutions and processed. This scheme can
go on for a while before a manager or business owner catches on, and by then the damage can be significant. Especially in a down
economy where profit margins are tight,
fraudulent activity can strip away a company’s profits. Consider enlisting in a third-party
payroll firm to process employee checks. Or,
assign the internal task to a team, even if the
team is just two employees.
How does a business begin to create a culture of ‘control’?
Internal controls must start at the top.
Management should have strong ethical values and be intimately involved in the business and employee oversight. That atmosphere shows employees the opportunity for
fraud does not exist. Enact a whistle-blower
policy. Assign a few employees as point people should a worker want to report fraudulent activity or suspicions. Or, contract a hot
line that allows employees to call in anonymously. Nearly 40 percent of frauds are discovered via tips from employees, so give
them a way to safely tell all. Finally, if your
business does not already have a code of
ethics, it is important to establish a written
document that employees can sign off on so
all parties understand that the company will
not tolerate unjust behavior. For businesses
with a board of directors, establish a separate
audit committee. This sends a message to
outside auditors that the business is doing its
part to prevent fraud at all levels.
CHRISTOPHER SZUCH, CPA, CFE, is a director in the assurance services department at SS&G Financial Services, Inc.
(www.SSandG.com). Reach him at (800) 869-1834 or [email protected].
