Protecting Your Assets
Good supervisory controls, including an awareness
of the possibility of fraud, are vital for preventing fraud losses. Strong supervision is
particularly important in small businesses where the segregation of duties may be
difficult to achieve.
Owner/managers busy with prospecting new clients, chasing down problems and dealing with employees may be eager to delegate responsibility to employees. Delegation is essential in any business but with it comes the risk of internal fraud. This is especially true within an environment where one person is responsible for several accounting functions. Not only is cash susceptible to manipulation but also accounts payable, accounts receivable and inventory.
Fraud is motivated by opportunity, ability and
need. Fraudulent activity is not always embezzlement or theft of physical goods. For
instance, if your company offers a $5,000 bonus to sales staff for exceeding a sales
quota, a financially overburdened employee may be motivated to ensure that his or her
sales exceed that amount because of the need for $5,000.
The perpetrator may see an opportunity to increase
Selling to bad risk clients;
Overselling a product but promising to take the goods back in the coming months;
Creating fictitious sales to phantom customers;
Providing unapproved discounts or longer term payments to customers; or
personal cash incentive to the customer to purchase the product.
The ability to complete these fraudulent
transactions is provided by improper internal controls.
Of the two ways to combat fraud - prevention and
detection - an effective prevention strategy is obviously the preferred approach.
Generally, fraud prevention techniques involve two main elements: understanding the risks
and guarding against them.
Limit Banking Authority
Since suppliers and employees have to be paid even if the boss is away, owner/managers often delegate signing authority to an employee. This places any business at risk if the employee has signing authority on a major operating account. A devious employee monitoring the cash flow of a business can, with a simple signature, remove cash when it is at its peak and disappear. The company may have recourse through the courts but this will mean little if the loss of operating capital causes the business to fail.
As preventive steps:
Contract an outside payroll service or set up a separate payroll bank account and transfer payroll amounts to it;
Set up automated payments for monthly overheads such as vehicle leases, mortgage payments and utility bills;
Establish a secondary operations account. Transfer sufficient amounts to this account each month to allow an employee as signing officer to pay the bills;
Ensure all cash sales deposits and payments for accounts receivable are deposited in the main operating account;
Do not allow any employee access to the corporate bank card or the security code. Change your personal security code regularly. Keep the maximum daily withdrawal amount at a low dollar amount to prevent large cash withdrawals;
all financial institutions when a signing officer leaves your employ. This will prevent
dismissed officers from trading on familiarity with banking staff to transfer funds or
The perpetrator of accounts payable fraud will
often establish bogus suppliers. Once these are in place, fraudulent invoices are issued
to the company for products or services. The busy owner/manager assumes that service
contracts, computer repairs, courier services or new parts are just the cost of doing
As preventive steps:
Approve new suppliers;
Review accounts payable listings;
Visit new suppliers to determine their authenticity;
Cross reference addresses to Web maps or telephone numbers;
Establish an upper dollar amount that requires management approval before the order can be placed;
Require that all cheques for signature be supported by documentation;
Follow up on credits or returns to suppliers to ensure that any refunds or credits were received by the business;
low credit limits with all suppliers to prevent employees from maximizing company credit
by purchasing goods that they subsequently sell.
Physical theft of funds is a concern but so is collusion between staff and an outside party. For example, an employee introduces a new customer into the system. Product sales are made and the amounts are paid (either by the bogus client or through lapping). Product sales become larger and thus credit limits are extended. Payments stop. Requests for payment are met with minimal payments or ignored. A visit to the customer's business address reveals that the business is gone or the address was non-existent.
What happened? The customer took the product, sold it at a huge discount, paid some of what was owed to deceive the owner/manager into providing more product, which they sold at a discount and then disappeared.
Receivables can also be manipulated through a
process called lapping. Lapping is the fraudster's version of "robbing Peter to pay
Paul". For example, the fraudster steals the payment intended for customer A's
account. When a payment is received from customer B, the thief credits it to A's account.
And when customer C pays, that money is credited to B. If enquiries are made by the
customers, they are usually told that an error occurred, the payment was not received
until after the month end, or a credit is being allocated to the account through internal
journal entry. In most circumstances, this type of theft can go on for an extended period
of time with bad debt write-offs, credit notes or other deposit manipulation. Most lapping
occurs because of inadequate control over incoming payments.
As preventative steps:
Approve all new customers and establish credit limits;
Meet the customer and visit their premises or work site;
Issue monthly statements to clients;
Follow up on all complaints, enquiries or credits issued;
bank statements for unusual deposits.
Among the many methods used to steal inventory,
the most common include delivering orders to addresses other than the warehouse, over
ordering for job sites and removing the unneeded material, or not unloading the entire
shipment when it is delivered to the warehouse.
As preventive steps:
Maintain perpetual inventory for high-end items;
Conduct regular inventory counts and tie in with perpetual records;
Make your presence known by walking the warehouse or inspecting the locked areas on a regular basis;
Examine purchase orders and related invoices, the tie-in with sales of that product or item and the reasonableness of remaining inventory quantities;
Install surveillance equipment in shipping and receiving and review the tapes;
Approve all write-offs or transfer of goods; and
job sites and account for inventory used.
Management's involvement in the day-to-day
operations of a business must also involve establishing a system of exception-based
review. Take full advantage of data-based software programs and regularly review financial
output to be familiar with the usual transactions and note any exceptions. Usually further
investigation will be required to determine the reasons for any discrepancies, one of
which may be fraud.
As preventive steps:
Open the mail to ensure you are familiar with suppliers, complaints, returns, etc.;
Review bank statements and reconciliations for unusual deposits and withdrawals;
Examine the payroll to ensure that individuals on the payroll work for you, are paid for hours worked and at the correct rate;
Approve all major changes;
Examine the accounts receivable listing;
Monitor bad debts, unusual growth clients or changes in the collection cycle;
Review accounts payable listings for new or unusual suppliers, unpaid amounts or high growth suppliers, credits issued;
Check perpetual inventory records to understand inventory;
up on all differences or irregularities.
Financial software provides the means for both
monitoring the operational health of the business and safeguarding its assets.
Understanding how to use the software to access the financial data will reduce the
possibilities of misappropriation or theft, advance your understanding of business
operations and improve the bottom line.
Your chartered accountant can provide knowledgeable advice on your company's reporting systems and what you can do to strengthen your internal controls to reduce the risk of business loss.