Darkness is the environment of wrongdoing.
No one will see us–or so we think.
As you’ve seen many times, fraud occurs in darkness.
In J.R.R. Tolkien’s Hobbit stories, Sméagol, a young man murders another to possess a golden ring, beautiful in appearance but destructive in nature. The possession of the ring and Sméagol’s hiding of self and his precious (the ring) transforms him into a hideous creature–Gollum. I know of no better or graphic portrayal of how that which is alluring in the beginning, is destructive in the end.
Fraud opportunities have those same properties: they are alluring and harmful. And, yes, darkness is the environment of theft. What’s the solution? Transparency. It protects businesses, governments, and nonprofits. And while we desire open and understandable processes, often businesses have just a few employees that operate the accounting system. And many times they alone understand how it works.
It is desirable to divide accounting duties among various employees, so no one person controls the entire process. This division of responsibility creates transparency since multiple eyes see the accounting processes–but this is not always possible.
Lacking Segregation of Duties
Many small organizations lack appropriate segregation of duties and believe that solutions do not exist or that fixing the problem is too costly. But is this true? Can we create greater transparency and safety with simple procedures and without significant cost?
Below I propose two processes to reduce fraud:
- Bank account transparency and
- Surprise audits.
1. Bank Account Transparency
Here’s a simple and economical control: Provide all bank statements to someone other than the bookkeeper. Allow this second person to receive the bank statements before the bookkeeper. While no silver bullet, it has power.
Persons who might receive the bank statements first (before the bookkeeper) include the following:
- A nonprofit board member
- The mayor of a small city
- The owner of a small business
- The library director
- A church leader
What is the receiver of the bank statements to do? Merely open the bank statements and review the contents for appropriateness (mainly cleared checks).
In many small entities, accounting processes are a mystery to board members or owners since only one person (the bookkeeper) understands the disbursement process, the recording of journal entries, billing and collections, and payroll.
One set of eyes on an accounting process is not a good thing. So how can we shine the light?
Second Person Sees the Bank Statements
Allow a second person to see the bank statements.
Fraud decreases when the bookkeeper knows someone is watching. Suppose the bookkeeper desires to write a check to himself but realizes that a board member will see the cleared check. Is this a deterrent? You bet.
Don’t want to send the bank statements to a second person? Request that the bank provide read-only online access to the second person, and let the bookkeeper know that the other person will review bank activity.
Even the appearance of transparency creates (some) safety.
Suppose the second person reviewer opens the bank statements (before providing them to the bookkeeper) and does nothing else. The perception of reviews enhances safety. I am not recommending that you don’t perform the review, but if the bookkeeper even thinks someone is watching, fraud will lessen.
2. Surprise Audits
Another way to create small-entity transparency is to perform surprise audits. These reviews are not opinion audits (such as those issued by CPAs) but involve random inspections of various areas such as viewing all checks clearing the May bank statement. Such a review can be contracted out to a CPA or performed by someone other than the bookkeeper–such as a board member.
Adopt a written policy stating that the surprise inspections will occur once or twice a year.
The policy could be as simple as the following:
Twice a year a board member (or designee other than the bookkeeper) will inspect the accounting system and related documents. The scope and details of the inspection will be at the judgment of the board member (or designee). An inspection report will be provided to the board.
Why word the policy this way? You want to make the system general enough that the bookkeeper has no idea what will be inspected but distinct enough that an actual review occurs with regularity (thus the need to specify the minimum number of times the review will be performed).
Sample Inspection Ideas
Here are some sample inspection ideas:
- Inspect all cleared checks that clear a particular month for appropriate payees and signatures and endorsements
- Agree all receipts to the deposit slip for three different time periods
- Review all journal entries made in a two week period and request an explanation for each
- Review two bank reconciliations for appropriateness
- Review one monthly budget to actual report (to see that the report was appropriately created)
- Request a report of all new vendors added in the last six months and review for appropriateness
The reviewer may not perform all of the procedures and can perform just one. What is done is not as important as the fact that something is done. In other words, the primary purpose of the surprise audit is to make the bookkeeper think twice about whether he or she can steal and not be caught.
Again multiple people seeing the accounting processes reduces the threat of fraud.
Shine the Light
The beauty of these two procedures (bank account transparency and surprise audits) is they are straightforward and cheap to implement but nevertheless powerful. So shine the light.
What other procedures do you recommend for small entities?
For more information about preventing fraud, check out my book: The Little Book of Local Government Fraud Prevention.