Canada: Fraud Prevention: Five Steps To Improve Internal Controls

Robert Jones has been working for you for over 15 years. More than a trusted employee, you consider Rob a friend. His dedication is unparalleled. Even as he navigated his way through a very difficult divorce a couple of years ago, he didn't take more than a couple of days' vacation.

You think that if Rob wasn't around, the accounting department would collapse. He does everything- from assessing and awarding some of the subcontractor bids to monitoring accounts receivable. The fact that he was granted bank signing authority on the company's bank account last year has allowed you to cut a few stokes off your golf game and finally enjoy the fruits of your hard work in building such a solid company.

These could be a set of fairly innocuous circumstances-unfortunately for the company's owner, the situation described above was in fact the setting for at least a half a million dollar fraud. The most unfortunate thing is that the fraud would have been discovered much sooner and the loss greatly reduced had the company implemented some fairly simple internal control improvements.

Internal control often takes a back seat to running your business, but there a few easy steps that you can take to reduce your risk. Here are five:

Understand your existing system

Don't worry- this doesn't mean that you need to become an expert in your company's "percentage of completion" accounting system module. You should, however identify where you think there is risk.

For example, perhaps your biggest concern is front-end loading. Sub-contractors with tenuous cash-flow positions may bill for work that has not yet been completed.

What systems do you have in place to reduce the risk of this happening? Is there a concerted effort made to scrutinize progress files and invoices. Is there a system in place for the comparison of job site activities to the payment of subcontractor invoices?

Whatever the particular issue, make an effort to obtain an understanding of:

  • Who, within your organization, is responsible to monitor the areas that you consider to be at the highest risk for fraud, and
  • What specifically are the control activities.
  • Perhaps most importantly, add a note in your calendar to test check that the controls are being executed.
  • Treat cash with the respect it deserves
  • As with most things in life, there are some things that are "nice to have," and some things that are "must have". With respect to internal control over cash, the following fall into the "must have" category:
  • Timely, monthly bank reconciliations: The preparation, review and approval of the bank reconciliations (i.e., the reconciliation of your bank account balance to your accounting records) is a key control over cash. There is really no excuse for bank reconciliations not to be completed by at least the middle of every month.
  • If you are the person reviewing the bank reconciliation –don't leave them in your in-tray for a week. Timely turnaround to the preparer with any questions will set the tone that you consider it an important component of your internal control program.
  • Have dual signatures for all cheques exceeding a pre-set amount: Business owners should be reviewing and approving any large disbursements. The easiest way to ensure this happens is to have the business owner's signature required for any significant disbursements.
  • Do not pre-sign blank cheques for use when you are away. The reasons for this are obvious.
  • Obtain on-line access to your bank accounts and perform, at minimum, an occasional review of the account. This will allow timely identification of any wires and branch to branch transfers that you may want to investigate.
  • The person who is responsible for cash should not have access to the accounts receivable records. Segregation of duties is difficult for small organizations, but implemented wherever possible.
  • Have controls over who can add an employee to the payroll register. You should also review the payroll register for any new employees on a test basis.

Review your accounts receivable ledger

Lapping is a fraud technique that may be difficult to detect. Lapping involves diverting customer receipts and applying later receipts to the earlier accounts receivable balance. For example, cash received for the receivable related to invoice #100 is stolen by the employee, the amount collected related to the next invoice #101 is applied to invoice #100, the amount collected related to invoice #102 is applied to invoice #101, and so on.

Segregating account receivable collections from the accounting for customer receipts is a good way to detect lapping.

In addition, a business owner's review of the accounts receivable ledger for older receivables may also uncover lapping schemes, not to mention uncover collection issues. A review will also detect any unauthorized credit notes.

Establish specific controls over vendor payments

Controls over your accounts payable do not necessarily have to make the system cumbersome. Some "must-have" controls are:

Supporting purchase orders and invoices should be attached to the cheque for review, prior to obtaining approval and payment.

"Payments by vendor" should be reviewed on a monthly basis. Assign a person outside of the accounts payable function to review a vendor report generated from the accounting system that groups amounts paid by vendor.

Perform sample testing to look for things such as P.O. Box addresses, unusual amounts (too low, round numbers), duplicate payments, unauthorized vendors and other oddities.

Protect your materials at the contract performance stage

Again, understand your biggest risks. You want to minimize fraud risks such as change order abuse, product substitution, conflicts of interest and secret commissions and kickbacks. Are you paying for 10,000 bricks but only need and receive 8,000? Some of the red flags may include changes to orders and the contract, performance variations and a lack of verification of contractor performance. Having an inspector on the job site will reduce the risk of product substitutions and theft. There should also be some oversight of the inspector. Surprise visits to the site should happen no matter how much you trust your employees.

If you have a professional accountant as your controller or CFO, he or she will have training in appropriate internal controls. If you don't already have a documented system, it is your accountant's responsibility to prepare one.

Give the accounting team your support in this task, which may at first, seem monumental. It is up to you to set the tone that short-cuts and overrides to controls are not acceptable.

If you know that your internal control system needs improvement you need to act now. The risk to your company will be reduced by your understanding key areas that need improvement, establishing controls and your oversight to ensure that appropriate controls are implemented and consistently applied.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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