Occupational Fraud – (Part 3 of 7)
By: Mark Palmer, President e:countable, LLC
One of the most common ways that fraud occurs in businesses is through the process of paying your bills.
You know how it goes. Your business purchases a product or service. You receive a bill. The bill is entered into accounts payable. When the due date arrives – you pay it. Sounds simple enough, but the process is wide open for some unethical person to complicate your life in any number of ways.
Let’s start by first looking at how you pay your vendors. Just as we mentioned in our previous post, leaving all your financial processes in the hands of one person can be a dangerous thing. A dishonest bookkeeper for instance – left to his or her own devices – could create a fictitious vendor without ever raising a red flag.
That would be easy enough, when the bookkeeper is savvy enough. All they have to do is create a fake vendor very similar to a legitimate vendor’s name, and produce bogus invoices for services or product that could be considered reasonable for your company to purchase. Periodically the bookkeeper processes these bogus invoices from the fictitious vendor with all of the other bills to be paid. Unless paying extremely close attention even the owner may end up signing checks to vendors that don’t really exist. And the bookkeeper simply deposits your check in their checking account.
How in tune are you with all the vendors from which you can reasonably expect your company to make purchases?
Here are five ways to prevent or mitigate the risk of this type of fraud:
1. Have a strict system for setting up new vendors in your accounting system. If your company is large enough for two or three administrative staff (they don’t all need to be bookkeepers) then segregate the responsibility of creating new vendors in your accounting system. Keep that ability away from the person who is responsible for entering payables and processing check runs. The person responsible for setting up new vendors would be required to do a quick check online with the state corporation commission to ensure it’s a valid company. They would have to contact the vendor directly to obtain a W-9 (for 1099 purposes), and most importantly, receive approval from the business owner prior to setting up the vendor.
2. Use purchase orders. Particularly if you are a product-based company, utilize purchase orders for both managing inventory and mitigating the risk of fraud. Purchase orders should be created by your buyer or inventory manager (not your bookkeeper) and no vendor bill should be paid unless it has a valid purchase order that matches the vendor bill. Most decent accounting software and systems used to run businesses (ERP, manufacturing or WMS software) have purchase order capability integrated with the payables functionality. They even have the capability to require approvals in order for the purchase order to be considered valid.
3. Review all source documents for the checks being signed. If the bookkeeper knows that the business owner never looks at vendor bills, then he or she may think the owner isn’t paying attention, which may increase the likelihood of a dishonest person committing fraud. With only so much time in the day you can’t – and shouldn’t have to – look at everything, but you need to let your bookkeeper know that you’re looking at the supporting documents. Make sure you periodically ask questions or ask to see additional detail on bills, even if you really don’t see anything wrong.
4. Request monthly reviews. This is where you take a step back to check for reasonableness. Each month ask to see a report generated directly from your accounting system that lists all vendors and the amount paid to each for the month. Take a couple of minutes to review it to ensure you’re comfortable with the vendor names and amounts paid. Once again, ask questions periodically to let your bookkeeper know you are in touch with payments being made.
5. Outsource accounting services. This can provide structure and controls not available when just one person is involved. At e:countable, we perform all bookkeeping services, but we also have mandatory monthly review meetings with all owners to review their financials, including how much is spent on every vendor each month.
One example of paying fraudulent vendors will be etched in my mind until the day I am laid to rest. The company in question had three owners; one active and two silent partners. When the company was formed, the active partner didn’t have enough money to contribute his share of the capital. The two silent partners agreed with a loan request that allowed him to pay in over time. Unfortunately they also chose not to participate in any oversight of the company.
Hence, the active owner had his bookkeeper set up a bogus vendor for a professional consulting firm and he started billing the company for “consulting services.” Upon receipt of payment from the company for the bogus invoices (for which no service was ever rendered), he would turn around and make payments to the company for his portion of contributed capital. In essence, he stole his percentage ownership in the company, along with additional cash. This added up to hundreds of thousands of dollars. If the non-active owners had invested even 1 hour per month in the financial review meetings, they would have seen what was happening behind their backs.
In this case it wasn’t a bookkeeper that was involved in the fraud. It was one of the owners, which is all the more reason for companies with multiple owners to ensure everyone is engaged, especially if they are not all active. Checks and balances are no substitute for business owners being engaged. There needs to be a visible culture within the company that lets all employees know the owners are paying attention.
NEXT ISSUE: “Thieves in Plain Site.” Do you have in-house thieves in your company? They could be stealing from you through your payables process. Learn how to put procedures in place in prevent theft of property or assets. Want to know now? Contact us at: (757) 962-1080
Mark Palmer: Bio