May 25, 2019
Accounting Controls Are Key to Preventing Employee Fraud

December 12, 2008 — In this post Sarbanes-Oxley world, transparency is the buzzword for nonprofits. Donors, funders and watchdog groups are taking a closer look at your organization’s finances. As with any other investment, they want to be able to evaluate how well you are using resources.

Implementing sound internal controls enables nonprofits to increase transparency and minimize the risk of employee fraud, an increasingly common pitfall. There are many strategies you can employ to not only deter fraud, but also to detect a fraud more quickly and easily.

According to David A. Gruber and Sheldon H. Eveloff, both CPAs with Amper, Politziner & Mattia’s Nonprofit Services Group in Philadelphia, fraud occurs most frequently in nonprofits where financial controls are inadequate or non-existent and can take on many forms.

The accounts payable operation, because of the sheer volume of transactions, poses an especially big risk. Without tight controls, someone intent on committing fraud can easily slip an improper vendor invoice or other fraudulent document through the cracks. Even an otherwise honest staff member may be tempted to float him/herself a “short-term loan” if they should fall on hard times.

To minimize this risk, you might need to beef up the security of your accounts payable system. Establishing well-thought-out internal control policies and practices with adequate checks and balances is the first step.

According to Gruber and Eveloff, you should start by giving each staff member a written job description, with a well-defined set of duties and a clear sense of how those duties fit into the overall system. Avoid having one person handle the entire accounts payable operation; dividing up the duties makes it more difficult for any single individual to circumvent controls.

Sound policies and procedures will help to safeguard assets, limit liability, and make your organization’s financial information system more reliable and accurate - provided you follow them closely.

Gruber and Eveloff have seven key fraud prevention measures that can be implemented immediately:

1. Watch for unusual entries. Have an executive approve all adjustments and write-offs. The essence of double-entry accounting is that every transaction is two-sided, one action causing an equal and opposite reaction. For example, when you are paid, your cash increases while your accounts receivable decreases. But what if a payment’s offsetting entry is an employee loan account, exchange account, or fund balance account? In such cases, a warning bell should go off, signaling that the accounts payable entry may have been improperly diverted.

2. Validate purchases and expenses. Dual signatures should be required on all checks over a predetermined amount, and authorized check signers should not have access to accounting records. Designated staff should always check that products and services have been received by comparing original vendor invoices, purchase orders, and receiving reports. All should be marked “paid,” along with a record of the check numbers. Investigate any transactions in which the same person who authorized the purchase approves the vendor invoice and makes the payment.

3. Be wary of “impatient” vendors. Legitimate vendors typically won’t ask you to rush a payment, since they understand your need to maintain internal procedures and controls. A vendor who pressures you to circumvent those controls may be in collusion with an employee set on misappropriating funds. Warning signs include vendors who insist on dealing with the same staff member, or whose bills are always paid by the same person. If you suspect something, verify that the vendor is legitimate.

4. Verify that your bills alone are being paid. If your accounts payable staff uses one checking account to pay a group of bills, it’s not difficult for someone to slip in their personal telephone, utility, or credit card bill. Be alert to this possibility and lookout for bills which include products or services delivered elsewhere.

5. Scrutinize canceled checks. Legitimate vendors deposit checks into their business accounts, so make it a habit to review both sides of canceled checks. A check that appears to have been cashed rather than deposited should raid alarms. So, too, should checks that have been deposited into personal rather than business accounts, as well as checks bearing unfamiliar endorsements. A check payable to a vendor but endorsed by one of your employees is a sure sign of trouble.

6. Track vendor billing patterns. If you’re used to receiving 12 vendor invoices per year and you now have 14 or 15 payment entries, find out why. An unexplained jump in the number of payments could signal not only employee fraud, but also related vendor kickbacks. If your billing records suggest that you are paying two companies for the same service, investigate immediately.

7. Be alert to tax fraud. Carefully review tax returns before submission. Fraudulent activity that gets the attention of the IRS can have devastating consequences for you and your organization. The attempt to cover up foul play by filing bogus payroll tax returns, for example, can heap additional liabilities on the organization. For this reason, extra vigilance is in order.

Republished with permission from NPT Instant Fundraising, a publication of The NonProfit Times. For a free subscription, click here.

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