The Good Bookkeeper Embezzled All The Company Assets
“The Good Bookkeeper” Embezzled Company Assets
In challenging financial times, the tendency for honest employees to stray into fraudulent activities grows. Although newspaper headlines have historically focused on the large-scale corporate frauds (i.e., Enron, WorldCom, Tyco, HealthSouth, Madoff, and R. Allen Stanford, to name a few), fraud actually occurs in small and medium sized businesses most frequently.
One of the most common types of fraud is defalcation, or misappropriation of assets. A defalcation can involve a misappropriation of cash, supplies, inventory or other tangible business property.
The “relied upon bookkeeper” in a small to medium sized business generally has a close relationship with the owner/operator and wears many hats within the organization – i.e. accounts payable clerk, payroll clerk, accounts receivable clerk and controller. This lack of segregation of duties, along with other inadequate internal controls, creates many opportunities for fraud. In larger organizations, the “good bookkeeper” merely holds a different position such as the Chief Financial Officer, Controller or Accounts Payable/Receivable Manager.
This article will focus on small to medium sized organizations and discuss potential signs of internal fraud, how to avoid the “good bookkeeper” syndrome, what you need to consider when responding to a fraud scheme and suggestions on how to investigate potential subjects of a misappropriation.
Potential Signs of Internal Fraud
Generally speaking, employees found to be engaged in fraudulent activities shared these characteristics:2
These characteristics are not meant to be used as a bright line test to determine if an employee is involved in a fraudulent act, but are merely signals that a problem may exist, or could eventually exist and should be investigated.
Risk factors that relate to financial statement misstatements arising from misappropriation can be classified into three categories:3
Some of these risk factors may also be present when misstatements arising from misappropriation of assets occur.
How to Avoid the " Good Bookkeeper" Syndrome
The key for any business owner to avoid the "Good bookkeeper" syndrome is to have a strong system of internal controls in place. All business owners should understand that the purpose of internal controls is to foster reliable financial reporting, safeguard assets, and promote ethical conduct. As the saying goes, “the devil is in the details” and therefore it is imperative that a business owner project a no-nonsense approach to financial accounting and reporting and internal controls.
Establishing a “tone at the top” that an effective control environment is a major priority of the company is another effective tool that a small business owner should employ to deter fraudulent activity as the mere presence of a future investigation can reduce the occurrence of fraudulent behavior. While time may not always permit a 100% review of all recorded transactions and related supporting documentation, the owner should always project his active oversight of the bookkeeping process by regularly requesting copies of the cash disbursement journals or of all checks and bank reconciliations.
The business owner/operator should also know who his or her vendors are, routinely scanning the list of current vendors and requiring approval of new vendors. These procedures not only serve as useful controls to ferret out potential asset misappropriation schemes, but they also establish management's active participation in the control environment.
What You Need to Consider in Responding to a Potential Fraud Scheme
It is important to note that once law enforcement or a prosecutor becomes involved, the business owner will most likely lose control of the investigation and that these third parties may not have the same priority to investigate the theft as the owner/operator because they have many other cases to address. Thus, business owners must take stock of the salient facts and what their ultimate objectives are regarding potential restitution and punishment for the perpetrator. Keep in mind that this is not a decision to be taken lightly as investigations (whether internal or external) can be time consuming and costly, and the likelihood of recovering the misappropriated funds or property may be remote.
Conducting an Investigation
A decision needs to be made early on identifying those responsible for the investigation – i.e. the business owner or manager, audit committee, internal audit department, board of directors, outside counsel, forensic accountant, or a combination of the above. This decision should be based on several factors such as the size of the potential fraud, the targets of the investigation, the ability to recapture stolen funds and the overall risks to the company. Once the decision is made, the responsible party should outline the scope of the investigation. Depending on the type of fraud, investigative efforts may include interviews with employees, vendors, and/or customers. A review of relevant records must also be undertaken.
The responsible person should also outline how evidence is to be preserved. Given that documentary evidence is the keystone to most civil litigations, it is important to address this issue early on in the investigation. To this end employees should be alerted to preserve relevant documents, including electronic evidence. The investigator may also want to consider hiring a firm qualified in computer forensics and electronic discovery if a significant amount of electronic evidence exists. Computer forensics can help to find hidden, or hard to find data and recreate critical computer related events. A firm experienced in using computer forensics will also ensure the integrity of the evidentiary chain of custody.
Conducting an Interview
An overall interview strategy must be established, a list of questions developed, and an effective and efficient plan of action commenced. However, the interviewer also needs to be flexible keeping in mind that no two interviews will be the same. It is difficult to know if someone is involved in the fraud until you begin your investigation. One interviewee may want to tell you what they have done, while another will not tell you anything and is only looking to find out what you know. The interviewer has to have the ability to gain quality information and cause the interviewee to respond, in order to detect deception. The interviewer also needs to keep in mind that once the investigation and interview process has begun, you may have only one chance to interview a person.
For these reasons, it is essential for management to engage an experienced professional who has conducted many fraud-related interviews.
McKenzie Forensic Group has professionals with years of experience interviewing witnesses regarding employee theft in large and small businesses involving company funds, inventory, and other types of assets and interests.
Experienced professionals, such as those in McKenzie Forensic Group, are available for assistance with the vast array of controls and techniques available for preventing and detecting employee fraud. If you can only remember one thing from this article, I suggest that you keep your friends close and your bookkeeper even closer
Nathaniel McKenzie | 04/01/2018