What Can A Small Business Do As Its First Defense Against Employee Theft?

Demystifying Valuation, Economic Damages + Forensic Accounting

The Association of Certified Fraud Examiners (“ACFE”) reported in its 2012 Report to the Nations on Occupational Fraud and Abuse (“the Report”) that of 1,388 cases of occupational fraud investigated, 87% involved asset misappropriation schemes.  And, it’s not the new employees who are causing the greater fraud losses.  According to the Report the higher fraud losses tend to be committed by employees with ten plus years of experience at the victim organization.  These employees caused a median loss of $229,000 while employees with one or less years of experience caused a median loss of only $25,000.  The Report also indicated that the smallest organizations of the 1,388 cases investigated suffered the largest median losses.  The industries most commonly victimized according to the Report are: a) banking and financial services; b) government and public administration; and, c) manufacturing sectors.

How can small businesses combat employee theft?  There are several processes which a business owner can install to thwart theft from employees.  I’m going to address one of the most basic of these processes: Segregation of Duties.  Segregation of duties means not giving all the accounting functions and all the asset protection duties to the same person.  For example, this means a business owner does not allow one employee to: a) post journal entries to the general ledger; b) post to customer accounts receivable ledgers; c) receive cash directly from customers; d) prepare the daily bank deposit slip; e) deposit cash into the bank; f) prepare the monthly bank reconciliations; and, g) prepare the monthly financial statements.

Ideally, a business operation has enough employees to segregate the duties above.  However, in reality, there are many small businesses which simply are not big enough to have an: a) accounts receivable clerk; b) accounts payable clerk; c) inventory clerk who pays or orders inventory and,  who does not receive the inventory; d) employee in charge of receiving inventory;  e) bank account reconciliation accountant; f) accountant assigned to prepare the monthly financial statements; g) employee not associated with any of the preceding functions who prepares lists of the daily mail cash receipts and the resulting bank deposit slip; and h) another employee not associated with any of the foregoing functions who takes the daily deposit to the bank.

So, what do small businesses – say, the ones that operate with a receptionist and a bookkeeper only as their sole accounting department do? The answer lies in working with what is available.  This means that not only the bookkeeper and receptionist will take part in the accounting functions, but someone else in the business – perhaps the owner/operator.  Following is a possible scenario:  a) the receptionist is in charge of receiving, opening and recording checks received in the daily mail; b) the receptionist gives a copy of her checks received list to the bookkeeper who uses it to post cash receipts to customer accounts and to update the accounts receivable balance in the general ledger (assuming the business is on the accrual basis of accounting); c) the receptionist gives a copy of her list of checks for the day directly to the owner/operator; d) the owner/operator, on random days, will compare the day’s list of checks received to the daily deposit slip prepared by the bookkeeper and, ultimately, to the applicable monthly bank statement’s list of deposits; e) the owner/operator will review the monthly bank reconciliations prepared by the bookkeeper and make note of any outstanding checks or deposits recorded on the business’ balance sheet, but not yet recorded at the bank; f) the owner/operator will also review the monthly financial statements prepared by the bookkeeper, review monthly  accounts receivable and payable aging reports prepared by the bookkeeper; and, g) review the list of vendors with whom the business deals to determine whether the owner/operator recognizes the names listed.

The preceding list of functions is not all-inclusive when it comes to the segregation of duties in a small business.  But, they are a start.  It is not wise for an owner of a business to allow one person to do all the accounting functions.  If a business cannot involve a receptionist in the process it is incumbent on the owner/operator of the business to review, even if periodically, the work of the bookkeeper who does all things accounting.  The thought of the owner/operator reviewing the bookkeeper’s work will help keep the inclination to steal in check.

Don R. Bays, CPA/ABV, CVA, CFF