Fraud at a Small Company
I talked to a company the other day about their experience with fraud. They are a small business whose revenues have ranged from $2.5 million to $5 million over the past several years. In the last 8 years, the owner has had 3 instances of fraud and embezzlement. He estimated that he had lost about $600,000 to fraud over this time.
He thinks the number could be higher, but was unable to quantify the total amount because some of the fraud took place so long ago that some of the needed records, like copies of checks, were not easy to locate.
Although each instance of fraud was perpetrated by a different person and had different facts and circumstances, there are some common themes that are worth pointing out:
- The owner was relying heavily on an internal employee or an external bookkeeper to keep the books, but was not very involved himself in reviewing the accounting records. He confessed to me that he frequently asked questions about the numbers, but was never able to get a satisfactory answer and never felt like he understood them.
- Accounting records were not being produced or reviewed very frequently. Financial statements were prepared every few weeks on an irregular basis, and were usually only available long after the activity had already occurred.
- The bank accounts were not being reconciled regularly, and when they were, original bank statements and other original supporting documents were not always used. As a result, documents were easily forged or altered.
These factors probably contributed the most to the company's fraud risk, providing the opportunity for the perpetrators to commit fraud and remain undetected.
How to Reduce Your Fraud Risks
From the above facts, you can see that the owner could have reduced his risk of fraud by doing a couple of things:
- Ensure accounting records and financial statements are being produced on a regular basis, review them in detail, and ensure you understand them. If you don't understand them, and your accountant or bookkeeper is not able to give you a satisfactory answer, have someone else you trust come in and review them. Don't be satisfied until your questions have been answered and you fully understand your financial statements.
- Make sure your bank accounts are being reconciled regularly (at least once a month). That means reconciling the original bank statement from the bank (not a copy or online download, because those are easily altered) to your accounting records. Any old or unusual reconciling items should be investigated. Make sure you get satisfactory answers about those reconciling items.
A few more notes about bank reconciliations. The bank reconciliation is one of the most important accounting controls there is. If done properly, it can do a lot to ensure your accounting records are complete and accurate, as well as reduce your fraud risk. If not done properly, it creates a false sense of security that can help mask fraud.
The best control is to have the bank reconciliation prepared by someone other than the person maintaining the accounting records (the general ledger or accounting software records), or the person who has custody of checks or cash. That reduces the risk that someone perpetrates fraud by altering the accounting records, stealing cash or altering checks and then covering it up on the bank reconciliation. If your company is too small to afford this segregation of duties, the next best thing is to perform an independent review of the bank reconciliation.
This independent review is very important. The following points are very important to keep in mind:
- Ensure the bank reconciliation is provided to the reviewer along with original supporting documents. That means the original bank statement from the bank, and an original accounting report printed from the accounting system showing the bank account balance according to the books.
- You should double-check that the "balance per bank" and the "balance per books" on the bank reconciliation schedule actually agree to the original supporting documents. Don't take this for granted. You should also ensure that each month's "balance per books" for the bank accounts matches the amount of cash reflected on that month's balance sheet.
- Look at any old or unusual reconciling items. Normal reconciling items that cause the "balance per bank" and the "balance per books" to be different should always be reasonable timing differences. For example, you write a check that is reflected in your books but hasn't cleared the bank yet and is not reflected on the bank statement. Or you make a deposit on the last day of the month, which you reflect in your accounting records, but is not posted by the bank until the following month. These timing differences should resolve themselves no later than the following month. If you see any old or unusual items, you need to investigate them until you know for sure they are valid reconcilinting items.
If you keep these points in mind, you'll do a lot to reduce your risk of fraud. Don't think the risk doesn't exist in your company. It happened to this particular company 3 times in 8 years.