What you always wanted know about fraud and embezzlement but were afraid to ask
Following are excerpts from Polices & Procedures to Prevent Fraud and Embezzlement – Guidance, Internal Controls, and Investigation, a book published by John Wiley & Sons, Inc. in 2006 written by Edward J. McMillan, CPA, CAE
1. Who Embezzlers rarely fit a stereotypical image and almost always someone above suspicion.
2. Why Despite the appearance of honesty in their personal life they are desperate people capable of taking desperate action and have a gambling issue, alcoholic and/or substance abuse problem or are experiencing financial difficulties.
3. The Fraud Triangle From the “Statement of Auditing Standards Number 99” of the American Institute of Certified Public Accountants, for fraud to occur the Fraud Triangle of incentive, opportunity and rationalization is present. Incentive (See why above with an employee experiencing financial difficulties), Opportunity (To much trust, poor internal controls, lack of supervision by supervisors, no financial audit by independent CPAs). The basis purpose of effective controls is to remove the opportunity for fraud. Rationalization (Over time the embezzlers are convinced they are not stealing, but rather self-correcting a perceived wrong such as a pay discrepancy or the like.
4. How They Get Caught Despite belief to the contrary, most fraud is discovered by accident and due to unanticipated work interruptions. CPAs financial audit 2% - The embezzler knows the auditors routines and what its supervisors look for and do not look for. The auditor engagement is to render an opinion on fairness and accuracy of the financial statements and not to uncover fraud.
Results of internal audit 18% - A good internal audit program is very effective if effective established procedures and internal controls are followed between annual audits.
Whistle blowing 30%
Luck of by accident 50% - Stumbling into something or the thief’s careless accounts.
5. The Financial Services and Accounting Department Most internal embezzlement schemes and other financial related difficulties involve someone assigned to an accounting function such as handling checks, cash, deposits, bank statements and reconciliation, payroll preparation, payroll tax deposits and employees with sole custodian of accounting records. Also the incidents of accounting irregularities are greatly increased if the person assigned to these function is not an accounting specialist by training, education and certification.
6. When Most embezzlements take place during the “window of opportunity” that is open between the time the CPA has concluded the audit field work for one year and the time the auditor starts the subsequent annual audit.
In the case of the MVF “misdirected- suspicious transfer” All 6 conditions excerpted from Mr. Mc Millan’s book were present creating a perfect storm for financial disaster, a trusted long term accounting department employee, with financial problems, apparently solely responsible for “managing its benefits program” embezzling funds after the audit field work for 2004 was completed.
What we know about the MVF employee retirement and saving plan
Note 8 B (Employee benefit plans – Retirement and Savings Plan) to the “Notes to Financial Statement of the audit of the financial statement of Montgomery Village Foundation, Inc. for the year ending December 31, 2001 states “ The foundation makes a fixed contribution fo 2% of salaries and wages to the retirement savings plan. In addition, if the employee elects to defer a percentage of their pay the Foundation will make matching contributions as follows:
Employee Elective Deferral 2%, 3%, 4%
Employer Matching Contribution 3%, 4%,5%
The maximum employer match is 5%. Employer contributions to the plan were $94,537 in 2001.”
How do these plans work?
The administration of “retirement and saving plans” is normally a function of the payroll accounting and record keeping department of a large scale community association such as MVF using a payroll service company and/or the payroll module of its in-house accounting program. The benefit program, the savings funds and individual retirement and saving accounts are normally maintained and managed under contract by a benefit or investment management firm as the fund manager.
It is common practice to establish a payroll transfer bank account as the depository of the gross payroll including the employer’s cost of payroll taxes and fixed and matching employer contributions to the retirement and saving funds are deposited each payroll period. Logging on to a web based computer program of the fund manager the total of the current employee withholding retirement fund contribution and the employer’s fixed and matching contributions are posted to each individual employee’s account balance and simultaneously wire transferred to the fund manager. For larger employers federal and state income fax employee withholding and employer social security contributions are paid as a function of the withholding tax reporting system by electronic transfer knows as “impoundment”. Any payroll or tax and benefit expenses not paid at the end of the monthly accounting period is usually recorded on the books and records as a current liability.
So what do you think happened?
The 2007 payroll budget for salary and wages is $3,011,092. If the assumption that the total of the payment to benefit and saving fund is 6% of salaries and wages, the annual contribution would be approximately $180,000 or $15,000 a month. Remember the employer pays a 2 % fixed contribution for eligible employees. Each employee can elect a deferral amount from 2 to 4% and MVF contribution a matching contribution from 3 to 5%. In 2001 MVF contributed $94,537 so it would be reasonable to assume that the total employer-employee contributions to for 2001 would be $150,000 to $160,000. If we assume MVF electronically transmitted the contributions monthly to the benefit and retirement fund, it is a good possibility that the “fraudulently transfer of $13,684 from the MVF retirement fund” was the March 2005 “retirement and saving” transfer normally electronically transferred to the benefit manager.
Such a misdirected transfer could go unnoticed even if others employees were responsible for balancing the bank statements, producing the financial reports and performing other balancing and internal control procedures. All bank, payroll and general ledger accounts would appear in order until the 2005 audit is conducted in the spring of 2006.
On page 15 of the 2004 MVF Annual Report in the section on Finance and Administration it is written “The department underwent several changes during 2004. The financial affairs supervisor served as interim director until the new director (Geraldine Barber) was hired in December 2004. During the transition, staff readily assumed additional responsibilities to keep the department running. Fixed asset, payroll and COBRA software was upgraded.” There were plenty of changes, distractions and stress on the remaining and new staff to assume the “unauthorized transfer” would probably go undetected for at least a year.
Normally the benefit manager provides a variety of paper and on-line monthly, quarter and annual reports to its clients and employee enrollees to the benefit and savings plan. During the annual audit payroll transactions and balances from the fund including individual employee transacts and balances would be examined to ensure all payments from MVF accounts were received and properly transmitted and posted.
If the audit uncovered the "unauthorized transfer" why wasn't it disclosed?
If the “suspicious and unauthorized transfer” was discovered during the course of the 2005 audit, should this have been reported and prominently noted as part of or during the audit process? Should it have been included as an employee receivable; as part of the “Notices to Financial Statement” Note 8 B, Employee benefit plans – Retirement and Savings Plan”; Note 10 “Concentrations of credit risk”? Should it have been a reported condition in the Management Letter as a concern or weakness of the internal controls when the draft audit was first presented to the board of directors?
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