No where in an organization is the opportunity for fraud the greatest and the catastrophic losses the highest than in the Accounting/Bookkeeping department.   The accounting department handles large inflows and outflows of cash and cheques, that a dishonest employee can find numerous ways to commit fraudulent acts. Not only can they commit the fraud, but they also have the means to conceal it, because they have too much control over the accounting function and the secrecy that surrounds the financial information.

As a Certified Fraud Examiner, I am seeing a huge increase in accounting fraud, with devastating consequences to the owners and shareholders of the business. If you read the papers, there is something every week about another organization finding themselves a victim of employee fraud. Many of these businesses actually close or go bankrupt because of the losses.  

In many small and medium firms, it is usually just one or two individuals who process accounts receivable and payables, receive cheques and make deposits at the bank.

As stated above there are many opportunities for bookkeepers to commit fraud, but most employees would never consider such a thing. The Association of Certified Fraud Examiners states that in order for fraud to occur, three things must be present. They call it the fraud triangle, which consists of Motive, Opportunity and the Rationalization by the employee, to commit the fraud. Employers cannot control the Motive and Rationalization, but they can do something about Opportunity.

Implementing internal controls and monitoring them is essential. 

In many of the cases I have worked on in the past 20 years, I have seen a number of red flags that are common. While every case is unique there are a number of warning signs that owners and managers should be aware of.   

1. Lack of Delegation of Duties: As stated previously, many small firms have only one or two people in the accounting department. They essentially control every aspect of the accounting function, from invoicing clients, to Accounts Receivable, Bank Deposits, Bank Reconciliations, Cheque signing authority, and post all entries into the accounting system. 

2.  Gambling or Addiction Problems: Employees that have such problems have a greater need for additional funds, giving them a motive and the rationalization to commit fraud.

 

3. The employee who seems to live beyond their means: Employees, who spend a lot of money on clothes, travel, cars, and any other consumer item, may have a greater need and resort to fraud. These employees are concerned about keeping up the image of being successful and well off.

 

4. The employee who always complains about money: Employees who regularly complain about not being able to pay their bills, who borrow money from other employees and consistently require cash advances. This could be a red flag for fraud.

 5.   I don’t know why we are not doing better financially: As an owner/manager you have a pretty good handle on your revenues and expenses. If you think you should be doing better financially then you are, investigate it. Don’t take the bookkeepers reasons for such shortages, get evidence not explanations. At the very least it will give you a better understanding of the cause and the ability to correct it. 

Here are 4 risk mitigation strategies to help prevent accounting fraud in small and medium enterprises;  

1.   Segregation of accounting duties: By far this is the most important control, yet in almost every case I have seen. There is either, a lack of segregation of duties or a break down in the accounting controls, because of staff shortages in the accounting department or an employee off sick. Segregation means that different employees handle the various stages of the receiving of and disbursements of cash and cheques. As an example; let’s assume that we are a service industry that invoices clients weekly and receives payments in the form of cheques in the mail In many enterprises the bookkeeper would open the mail and post the cheques to the various client accounts. They would then do up the deposit, take it to the bank and then do the monthly bank reconciliation. They would also prepare all invoices, have cheque signing authority, add new clients and suppliers to the accounting system and be able to make changes to or override accounting entries. Essentially, they have control over every aspect of the accounting function and when senior management or the external auditors require an explanation of a transaction, they also have control over what explanation is given. A simple system of segregation of duties is to not allow an employee to control the whole process. Here are some easy controls to put in place:

a. The mail is opened by two employees and all cheques received for that day are then recorded into a cheque registry, which records the company, cheque number, amount and date of cheque. The cheques should also be stamped “FOR DEPOSIT ONLY” at this stage.  The cheque registry can then be compared with the actual deposits. If cheques in the amount of $15,000.00 were received on July 1, then the deposit book and the bank statement should show a deposit of $15,000.00 on July 1. Timing differences can occur but all deposits should be matched. Once the cheques are received and recorded, they are then forwarded to the Account Receivable department, where they are posted, by another employee, the bank deposit is then done up and another employee takes the deposit to the bank.  

b. The bookkeeper prepares outgoing cheques, and then gives the cheques plus all supporting documentation including purchase order, invoice, expense forms and any other supporting documentation to a senior employee for review. After examining each cheque and supporting documentation for legitimacy and accuracy, they will then sign the cheque. Ideally all cheques should have two required signatures. Then the cheques are put in envelopes and another employee mails them. The key here is once the bookkeeper prepares the cheques, they no longer have anything else to do with them. 

c.   Ideally the owner/manager should control the cash. This means that all bank deposits should be made by the owner. If this is not possible, then trusted employees from other areas or departments can make the deposits. Different employees can do different days and be sure to let your bank know who is eligible to make deposits. A bank card can be obtained that only allows deposits to the bank account, withdrawals or other transactions cannot be made on this card. The key is that there is complete segregation of duties. From the receipt of cheques, to preparation of invoices and bank deposits, no one person has control over more than one function of this process. 

2.   Screen accounting employees properly by conducting Criminal Records Checks and verifying references. Criminal records checks are important for obvious reasons. You can request an employee obtain one from the local police agency or you can use a firm that provides criminal records checks. My experience shows that most accounting employees, who commit fraud, did not have a previous criminal record, but they may have left previous employers under suspicious circumstances. It is also essential that reference checks from past employers, be completed on employees. I recommend the last two questions be asked 1. Do you have any reason to doubt the honesty of the candidate? 2. If the opportunity presented itself would you rehire the candidate?  

3.    Know your business: As the owner you have a pretty good idea of what your sales and expenses are and what your profit margins should be. If you have cash flow problems and don’t know why, look into it. In many cases I have worked on, this was a red flag that owners told me they thought there was something wrong but did not look into it, until it was too late. I recommend, to have a good working knowledge of your revenues and expenses and to know your gross margins. When I ran my business I knew my margins were approximately 18%, so $100,000.00 of sales a month should have given me $18,000.00 cash flow. If you have offices or branches in other regions, make sure you monitor them individually. If you think something is wrong, discuss it with your managers and accountant. A vertical and horizontal analysis of the Income Statement and Balance Sheet may give you a place to start. 

4.    Listen to employees and customer complaints: Frequently when a fraud is being committed it may affect suppliers, employees or customers. If suppliers are not being paid, then employees, who purchase supplies, will be told the account is not up to date. If customers complain about their accounts not up to date, when they make payments, this could also be a red flag.        

In conclusion, organizations of all sizes and types are victims of accounting fraud. Even large accounting departments with CFO’s, accounting managers and internal and external auditors, fraud still goes undetected. Only through sound internal controls, and astute managers will fraud be prevented and detected. The purpose of this article is a starting point, to get owners and managers to think about their own vulnerabilities in the accounting department and the impact to the organization if fraud occurred. Every organization is different so get help in conducting a fraud risk assessment and to set up sound internal controls and monitor them.

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