McGovern Greene - Fraud Alerts

When is a gift a kickback?

When is a gift a kickback?

It’s not unusual for companies to send clients small tokens of appreciation after closing important business  deals, or to invite them to the occasional lunch. As long as these gestures don’t come with strings attached, they’re generally considered gifts. If, on the other hand, they’re meant to induce or reward favours or special treatment, even nominal gifts become kickbacks — and may be illegal.

A question of intent

The difference between gifts and kickbacks may seem difficult to discern. It all comes down to intent. If someone expects something in return for a gift, the gift is a kickback or bribe. Kickbacks might be offered in exchange for steering business to a particular company. A banker who takes a fee for recommending a particular mortgage broker is getting a kickback, for example. Big-box retailers that accept incentives from vendors in return for valuable shelf space also might be guilty of taking kickbacks. At the very least, these kinds of actions compromise business ethics and improperly influence decisions.

Are gifts acceptable?

Gifts with no strings may not be illegal, but many companies frown on or even prohibit them because they might appear compromising or create a sense of obligation to the gift giver. You might, however, make exceptions for gifts of nominal value — say those worth less than $100. If you want to avoid any potential conflicts, however, don’t give or receive any remuneration. A zero-tolerance policy will show you’re committed to the highest level of legal and ethical standards in the interests of honesty, fair dealing and open competition.

Consider the motives

Sealing a business deal with a handshake is one thing. Making the deal conditional upon remuneration is unethical — if not illegal. The best gift policy is not to accept or offer anything of value that can compromise business dealings and lead to sticky situations.

(Reprinted with permission McGovern & Greene)

Inventory Theft

Investigative Secrets for Accountants

When a company suspects that a current or former employee has stolen inventory, it can sometimes be difficult to determine whether the suspicions are valid, and if they are, to document and prove the theft.

Reasons:

• Companies often give too many employees access to inventory…and/or neglect to remedy their inadequate record keeping “systems.” The results can be an invitation to commit fraud…or just unchecked vulnerability to costly record-keeping errors.

• Some companies perform a complete inventory only once a year, or use haphazard methods if they count more often. Again the result can be theft or record-keeping blunders.

The bottom line: Management usually has no clue how much inventory the company should have at a given time. Or if inventory is missing, executives are hard pressed to prove whether it was stolen…or whether their own neglect of internal controls was to blame.

THEFT VERSUS ILLUSION

Before assuming that theft has occurred, your accountant should always determine whether the assets were really stolen, because they may have been on the premises all along…shipped out to customers…or never delivered.

Example: Weak physical controls can cause big mistakes in recording items taken from storage. A company without a location assignment for each item, an effective method of keeping tabs on overflow stock or even a well run returns system might have caused inventory to be misplaced. Other conditions that can give the appearance of inventory theft are short vendor shipments nobody notices because of lax receiving and inspection procedures…and unobserved vendor overcharges.

Even worse, some companies simply fail to bill customers for shipments because the shipping and billing functions don’t work in tandem.

IDENTIFYING THE PROBLEM

In cases where the missing inventory is not located or accounted for, many companies ask their accountants to start by checking their receiving and inspection procedures before concluding that a theft has taken place.

Key: If sifting through haphazard financial records doesn’t explain the inventory shortage, your accountant will usually look for signs that fraud is occurring.

Example: Companies with poor purchasing, receiving and cash disbursement controls are at serious risk of inventory theft. One person performing multiple duties can both commit and conceal fraud. If he or she believes that existing controls—or lack of them—led to theft, your accountant should begin combing the records for clues. Anything that doesn’t follow established inventory standards can raise a red flag.

Examples:

• Odd journal entries posted to inventory.

• Unusually large declines in gross margin.

• Sudden problems with out-of-stock inventory.

• Unusually large account adjustments after staff performs a physical count.

Next step: Having found one or more red flags of inventory theft, your accountant will most likely try to establish sufficient evidence to prove that fraud is in fact the explanation for the shrinkage.

SEARCHING FOR EVIDENCE

Inventory fraud often leaves a paper trail, which enables forensic accountants to screen journal entries for unusual patterns.

Example: An entry recording a physical count adjustment made during a period when no count was taken  obviously is cause for suspicion. Your accountant should probe further by tracing all unusual entries to supporting documents (assuming they exist).

Important: Financial records aren’t the only “paper” evidence. Vendor lists sometimes reveal suspicious patterns, such as post office box addresses substituting for street addresses…vendors with multiple addresses … and names closely resembling those of known vendors.

Key: Even if he or she has found no evidence of bogus vendors, your accountant should look at all vendor invoices and purchase orders for anomalies.

Examples:

• Unusually large invoices or alleged purchases with no record of delivery of goods.

• Discrepancies between the amounts due per invoice, the purchase order and the amount actually paid.

Your accountant should also fully analyze the cost, timing and purpose of routine purchases and flag any that deviate from the norm.

WATCH WHAT’S GOING ON

Whether employees or an outside firm counts inventory, an accountant, auditor or inventory expert should carefully observe warehouse activity once employees realize a count is imminent.

What to watch for: Fraudsters may make frenzied attempts to shift inventory from another location to substitute for missing items they know will be discovered. Inventory at remote locations also can disappear, so your accountant should confirm quantities with the storage facility or go with someone from your company to personally inspect them. In pinning down suspected theft, it’s best to do the count in person rather than delegate the job to a possible fraudster.

(Reprinted with permission McGovern & Greene)

Use a risk assessment to fight fraud before it starts

If you discover an employee is embezzling from your company, you’re likely to act quickly to learn the extent of the fraud and how it occurred. But if you’re like most business owners and executives, you may not be as quick to search for weaknesses before a fraudster gets a chance to exploit them.

Under the Sarbanes-Oxley Act (SOX), publicly traded companies must conduct fraud risk assessments, though SOX and federal regulators have offered little guidance on how to do that. Privately held businesses are under no such legal obligation, but it’s in their best interests to assess their fraud vulnerability with the assistance of a forensic accountant. In fact, a thorough risk assessment should be the core of every company’s antifraud program.

Don’t skimp

But where in the company do you start looking for vulnerabilities? Accounts payable? Purchasing? Information technology? A comprehensive fraud risk assessment should include all those areas, and more; you really can’t afford to skimp. If you close a door in only one department, those bent on fraud will find openings elsewhere.

Look at your internal controls in the same way a dishonest employee would assess them — as opportunities with relatively little risk of exposure. There are four major ways employees might exploit holes in your system:

1. Fraudulent financial reporting, such as improper revenue recognition and overstatement of assets,

2. Misappropriation of assets, including embezzlement or theft,

3. Improper expenditures, such as bribes,

4. and Fraudulently obtained revenue and assets, including tax fraud.

Some schemes, such as payroll fraud or kickbacks, may involve external people in addition to internal ones. And bear in mind that fraud may be limited or widespread — affecting everything from individual accounts to entitywide processes. Your controls should address all levels, as well as all types, of fraud.

Ask questions

Start assessing your risk by interviewing key executives and managers. They’ll provide you with a first glimpse of potential risk areas. Perhaps more important, these conversations will help you judge whether company leaders are setting the ethical “tone at the top” that’s integral to fraud prevention.

Next, identify the number and names of employees who handle or review accounting functions. How many, for example, reconcile bank statements or are authorized to make bank deposits? And are accounting employees required to take at least one week of vacation each year? The fewer employees involved in financial functions, and the less vacation time they take, the greater your risk for fraud.

Spreading accounting and banking duties across multiple employees — or shouldering some of the review processes yourself — provides segregation and oversight that are essential to deterring fraud.

Regularly review organizational charts to ensure constant segregation of duties.

Other issues to consider include:

Key performance indicators. Entitywide fraud can show up in the performance of sales goals or inventory management. It’s important to take fraud risk into account when establishing key performance indicators, as well as to review them regularly with an eye to the unexpected.

Fraud-risk management budget. Compliance training, internal controls monitoring and ongoing risk reviews take time and money. The extent and cost of such activities will vary among companies, but they should be included in your business’s budget.

Strategy updates. Risks change, and you need to change with them. Evaluate your risk management practices regularly — annually, if possible — to identify and address any new weaknesses.

Focus where it matters

When analyzing your findings, remember that your company’s processes, procedures, programs and policies make you unique. Your results aren’t likely to be the same as those of other companies — even in the same industry. That shouldn’t keep you from benchmarking against best practices, but you should concentrate on your own areas of greatest risk. A manufacturer that regularly purchases parts inventory may have more risk of procurement fraud, for example, than a small publishing firm that buys only office supplies.

The fewer employees involved in financial functions, and the less vacation time they take, the greater your risk for fraud.

Next, consider less-critical areas. Typically, you should have one key control for each risk. If payment authorization is a risk area, for example, you could require multiple approvals for expenditures over a certain amount. Alternatively, if the risk is great enough, you may decide to alter a business process to remove the risk rather than attempting to control it. If you determine that a manual checkwriting control is inadequate, for example, you might choose to automate check payments rather than add more controls to the manual system.

Be sure to assess all the risks associated with a process, too. For example, you’ve probably surrounded your IT system with firewalls, intrusion detection alarms, virus protection and other guards against outside invaders. But are you guarding against intrusion from inside the fence? Keep activity logs for company data servers, as well as itemized logs of calls made from office phones and corporate cell phones. Require employees to password-protect sensitive files, and monitor to make sure that passwords are in place and that they aren’t being written down or shared freely.

Finally, if you don’t have a fraud hotline, consider establishing one. Time and again, research has found that tips from employees are one of the most effective ways to expose fraud. To be successful, though, hotlines must be convenient and confidential. You may also want to establish a hotline for customers and vendors, or give them access to the employee tip hotline.

Cultural commitment

Regardless of what your fraud risk assessment reveals, you need a strong antifraud policy — which you can create with a forensic accountant’s assistance — and you must communicate it regularly and emphatically. One of the best deterrents to fraud is a company culture in which fraud is absolutely not tolerated. If you and your senior management are visibly committed to honesty, integrity, fairness and equity in all your operations, your employees will follow suit.

(Reprinted with permission McGovern & Greene)