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Internal controls allow detection of fraud

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By Greg Wolf

The title this month, and the definition of it, might at first glance seem too corporate for rural America, and certainly irrelevant for the businesses in agriculture found there. Internal controls are simply those policies and procedures in place within a company that have been designed to avoid and/or allow the detection of fraudulent activities within. But in fact, studies have shown that smaller companies have higher incidences of fraud than larger corporate organizations. The one thing that makes any company vulnerable to any form of fraud is the idea that “it couldn’t happen to us.” Yet our experiences with clients remind us time and time again that it can happen to anyone, and it does. It is best to be aware of the risks, proactive in preventing it, and always vigilant to the signals that it could be happening to you. Farm and ranch operations are increasingly vulnerable as they continue to grow in both size and complexity, with more people becoming involved in their management.

The following are some common areas proven to be susceptible to fraud:

Payroll fraud—Payroll fraud most often happens when an employee causes an employer to issue payment or overpayment by making false claims for compensation. These have taken the form of “ghost employees”, inflated commissions, or falsified timesheet hours. Salaries are more challenging to manipulate but salary amounts and hourly amounts have been altered before. Another potential area of fraud that often related to the payroll function is the submission of fraudulent expense reimbursement requests.

Employee loans—Use caution when issuing employee loans and advances, and make sure they are appropriately monitored. These can disappear from the financial statements in small amounts that would not alert the reader of the financials that something out of the ordinary was happening.

Accounts Receivable—Someone in the business needs to periodically audit a group of receipts to make sure the payments are being applied directly to the appropriate customers. Someone committing fraud can steal money and begin moving deposits to cover their tracks. A particular customer account may appear in the system as if it were paid, when in actuality it wasn’t paid with their check, a possible signal of attempted fraud.

Accounts Payable—Office procedures need to include a comparison of check registers from the accounting system to the actual checks that clear the bank. Accounts Payable clerks can write checks to vendors so authorized signers will sign the check but can then change the payee name before they are mailed out. Another area to watch is grain suppliers and other vendors sending multiple invoices for the same product. Be very diligent and systematic about reviewing all invoices and matching them to statements, to detect any fraud attempts as well as errors.

There are things that owners and managers can do both to prevent and also to detect fraud. They include providing some segregation of responsibilities, such as separating the responsibility for preparation, disbursement, and distribution of checks. Also, separating the personnel function from the payroll function. However, in many businesses this may not always be feasible due to the limited number of office staff involved. In this case it might be best to think about an alternative strategy, such as the rotation of responsibilities on an occasional basis. This provides benefits not only in fraud prevention and detection but also for cross training purposes to extend backup capacity in the event someone is out of the office.

Also, it is worth thinking about forced vacations—not taking over an employee’s vacation plans, but rather simply verifying that all employees are in fact taking their vacation time. Many banks require employees to take vacation in one week increments to assure that any potential fraud tied to the office procedures of a particular day of the week can be more easily prevented or detected. No business should let an employee fail to ever take vacation time without wondering why. Other possible signals of fraud can include employees that seem to be clearly living beyond their means, evidenced by their clothes, vehicles, or travel. And often in retrospect managers have noted that those involved in fraud have been going through significant personal or financial stresses that possibly had a role in triggering the fraud.

In the concern for fraud, we do not advocate looking on employees or vendors with suspicion and distrust. However, strict office procedures are necessary to defend against any possibility of fraud, which frequently happens even among family members and others who were previously regarded with trust. Rather than viewing stricter controls in office procedures as a burden, employees should, and should be encouraged to, feel protected from possible suspicion and accusations that arise even unfairly in an office that operates chaotically and haphazardly. Management can set a tone as a workplace of consistent integrity that will attract and please honest employees. Furthermore, virtually all fraud prevention strategies make good business sense and serve as aids to business efficiency.

It is wise to use an outside advisor to provide an objective, “third party” set of eyes in the design and implementation of internal controls. Also, businesses evolve and change more rapidly than we think, and a set of internal controls must be evaluated periodically to assure they remain relevant and effective. Periodic review of internal controls can help prevent the likelihood of a costly and difficult situation developing in the future.

Editor’s note: Greg Wolf is a consultant with Kennedy and Coe, LLC (www.kcoe.com) and works to help clients of the firm navigate toward better returns in all areas of their businesses. He is based in the firm’s Pratt, Kan., office and can be reached at 620-672-7476.

Date: 4/8/2013



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