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The Cumulative Cost of Embezzlement: Two Real Life Cases of Employee Fraud

Every single day we may become victims of fraud, whether due to irreparable harm done to businesses in our communities or in the more subtle ways that corporate fraud trickles down to the consumer. For example, higher prices on goods and services, mistrust in elected officials or public employees, or an increase in government red tape. Regardless, the cumulative cost from fraud is enormous, whether from corruption, financial statement fraud, or asset misappropriation. The Certified Fraud Examiners (CFEs) that participated in the 2016 Global Fraud Study estimated that the typical organization suffers loses equal to 5% of revenues in a given year due to occupational fraud.

Two recent cases of embezzlement covered in the media have involved a trusted, long-time employee with jobs in a financial position. Both parties in each case pled guilty, though the fraud perpetrators themselves may have unintentionally been encouraged by the good intentions and optimistic outlooks of responsible parties, leading to ineffective or complete absence of oversight mechanisms and internal controls that could have prevented or detected the employee fraud.

  • The first case comes out of Alabama where a former Chief Financial Officer and CPA diverted customer payments for nine years, embezzling $11.2 million from his employer, Strickland Trading, a scrap metal brokerage company.
  • The second embezzlement involves check disbursements and credit card abuse within the Welcome Fire Department in North Carolina. A trusted member of the community and the department’s former treasurer stole $353,000 in government funds over a five-year scheme.

The common thread between these two embezzlements is that the perpetrator was situated in the finance or accounting department, which jointly account for 21% of the cases reported in the 2016 Report to the Nations on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners (ACFE). In addition, each of the perpetrators was in a position of trust within the victim organizations, with the former Strickland Trading CFO having a 25-year tenure with the victim company and the former Welcome Fire Department Treasurer having a 30-year tenure as a teacher in the community.

Effective oversight may have acted to prevent these asset misappropriations, thereby limiting or preventing financial losses to the victims and protecting the perpetrators from their own unfortunate tendencies.

As reported in the news, here are brief summaries of the embezzlement investigations with suggestions for how each organization may have added additional controls to help prevent these cases of employee fraud:

Strickland Trading: In 2007 the former CFO formed an entity with a very similar name to his employer, but this company was an LLC instead of an Inc. He also distanced himself through an associate who was involved with the LLC. This enabled him to intercept 225 checks from the true Strickland Trading Inc. and deposit them into a bank account for the LLC, which was under his separate control. He used those funds for personal purposes including buying real estate and automobiles, and concealed them with false entries into the accounting records.

What Could Have Prevented the Fraud? Suggested general preventative internal controls include those over sales entries, general ledger access and physical safeguarding; including proper segregation of duties and independent reconciliation processes. Additionally, the incoming mail could be opened by a neutral party and checks independently listed to establish the existence of customer payments received. Other effective procedures may involve analysis of unusual/unexpected gross profit and cost of goods sold ratios, along with identification of bad debt write-offs of accounts receivable and corresponding confirmation with customers.

Welcome Fire Department: The former Treasurer wrote over 100 checks made out to herself or members of her family and misused credit cards during her tenure, which she attempted to conceal in the accounting records. She used the funds to pay bills, student loans and credit cards, and to take multiple vacations and “shopping sprees.”

Since the perpetrator apparently prepared and signed checks herself, there arguably would not have been a need to conceal the payee or forge an authorized signature on the issued checks. Further, she failed to enter the “personal” checks into the accounting system or the checks entered did not match up with monthly reconciliations presented to the accountant or the Board.

What Could Have Prevented the Fraud? In these situations, performing or reviewing bank reconciliations may be an effective preventative measure. Further, to make it more difficult to hide the embezzlement, companies can trace monthly disbursements between the bank statements, cancelled checks and general ledger/bank reconciliation, including propriety of the payee, amount and endorsement. Anomalies arising from such verification procedures would likely have led to more thorough analysis and investigation, resulting in earlier fraud detection. Other effective procedures may involve review of credit card statements and underlying support to identify personal transactions.

If your organization is currently not using the suggested internal controls suggested in the two cases above, talk to an accountant about how you can create an environment that fights fraud. If you suspect a problem with an employee who has the access, ability and motivation to commit fraud, you may contact me, a CPA and CFE, to investigate potential employee fraud.

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Ready, Set, Audit

If your business issues audited financial statements and follows a calendar year end, your external auditing procedures have already begun. At a minimum, you’ve signed an engagement letter, sent over preliminary financial statements and allowed your CPA to observe any year end physical inventory counts. But there are some steps you can still take to streamline audit fieldwork.

Think Like an Auditor

An external audit is less intrusive if you anticipate your auditor’s document requests and inquiries. Auditors typically ask clients to provide similar documents year after year. They’ll accept copies or client-prepared schedules for certain items, such as bank reconciliations and fixed asset ledgers. To verify other items, such as leases, invoices and bank statements, they’ll want to see original source documents.

What does change annually is the sample of transactions that auditors randomly select to test your account balances. The element of surprise is important because it keeps bookkeepers honest.

Prepare for audit inquiries by comparing last year’s financial statements to the current ones. Your auditor is likely to ask questions about any line items that have changed materially. A “materiality” rule of thumb for small businesses might be to inquire about items that change by more than, say, 10% or $10,000.

Review 2015 Adjustments

Ideally, management should learn from the adjusting journal entries auditors make at the end of audit fieldwork each year. These adjustments correct for accounting errors, unrealistic estimates and omissions. Often internally prepared financial statements need similar adjustments, year after year, to comply with U.S. Generally Accepted Accounting Principles (GAAP).

For example, auditors may need to prompt clients to write off bad debts, evaluate repairs and supplies accounts for capitalizable items, and record depreciation expense and accruals. Making routine adjustments before the auditor arrives may save time and reduce discrepancies between the preliminary and final financial statements.

You can also reduce audit adjustments by asking your auditor about any major transactions or complicated accounting rules before the start of fieldwork. For instance, you might be uncertain how to account for a recent acquisition or classify a shareholder advance.

Plan Ahead

An external audit doesn’t have to be a time-consuming or disruptive event. The key is to prepare, so that audit fieldwork will run smoothly. Contact Bill Nelson for more information on getting ready for an audit.

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