Managing Risk: Fraud Deterrence Is Always a Priority

4/6/2016

As the economy continues to rebound, it’s easy for small businesses to become complacent about the risk of fraud and the need to maintain strong internal controls. After all, new jobs and new opportunities are demanding more and more attention, leaving less time for owners and managers to monitor potential risks.

Unfortunately, as the pace of business quickens, the risk of fraud also increases. In busy times, fraud deterrence actually becomes more important — not less.

Increased cash flows and distracted owners mean there are more opportunities for employees to commit fraud. In addition, as employees struggle with greater volumes of work, some might also find it easier to rationalize fraudulent activities by convincing themselves that they’re entitled to more compensation.

Expect the Unexpected
Every two years, the Association of Certified Fraud Examiners (ACFE) issues its “Report to the Nations on Occupational Fraud and Abuse.” The report tracks trends in the growth and detection of various internal fraud schemes such as embezzlement, misappropriation of funds, phony expenses, bribes and kickbacks.

The most recent ACFE study, completed in 2014, found that nearly half (46.5 percent) of the reported fraud cases involved some form of corruption, such as purchasing schemes, invoice kickbacks or bid rigging. Other fraud categories that posed high risks include billing schemes, check tampering, phony expense reimbursements and payroll fraud.

Many of these ploys have a long history in the construction industry. Yet fraudsters are resourceful and inventive, consistently devising ingenious new schemes to avoid detection.

For example, in one recent case of payroll fraud, a company controller awarded herself bonuses amounting to thousands of dollars. But rather than writing large checks to herself — which almost certainly would have been noticed — she applied all of her bonuses to her payroll tax withholding account.

As a result, she was due a very large refund on her income taxes — in effect, using the IRS to launder her stolen funds. Because the business was growing and adding employees, and the owner failed to regularly review payroll records, the larger payroll tax deposits attracted no attention and the scheme went undetected for some time.

As this example illustrates, fraudsters can be patient and clever, and no system of internal controls is foolproof. Nevertheless, certain internal controls can minimize the opportunities for fraud and deter all but the most determined thief.

Here are some effective steps you can take to reduce fraud risk:

Segregate financial duties. No single employee should handle all the steps of any transaction or all the activity in any account.
Limit access to assets. Just as you lock up tools, materials and vehicles, you should also protect financial and electronic assets — for example, through strong password requirements.
Make purchases only with prenumbered purchase orders. Also check receiving reports against invoices before payment is made.
Prepare financial statements monthly and compare them against general ledger entries,bank statements, loan schedules and other supporting documents.
Compare cash receipts to accounts receivable every month. Be alert for unusual credit memos on receivables, which could mask a diversion of funds.
Open every bank statement yourself instead of delegating this to an employee.
Monitor company credit card statements carefully to spot possible personal charges.
Review the employee payroll list regularly, looking for duplicate or missing Social Security numbers, addresses or phone numbers. These could indicate a phantom employee or overlapping payments to an employee.
Maintain personnel records independently of payroll and timekeeping functions. The payroll bank account should be reconciled by an employee who is not involved in preparing, authorizing or distributing paychecks or automatic deposits.
Periodically compare payroll with personnel records to make sure terminated employees are removed.
Always compare reported payroll tax withholdings to deposited withholdings.
Be inquisitive and unpredictable. For example, ask about expenditures you’ve never asked about before, and focus on something different every time you review a financial statement.

This is not a complete list of all the internal controls you should have in place, and even sophisticated controls may not stop a truly determined thief. But extra vigilance and a systematic approach to basic internal controls can make your company less vulnerable.