Tips to Avoid Embezzlement

BY Bernie Hull

Why does something like this happen to good people—Trust. According to FBI profiles, an embezzler is typically an employee with 5-6 years of experience, often described as good-to-above average, highly desirable, reliable, bright, motivated, trustworthy, and an achiever with good self-control. The typical motive is the need for money caused by a specific problem.”

Potential warning signs:

  • Unusual behaviors—for example, making sure she always gets the mail, intercepts phone calls, never takes vacation—even when on vacation, etc.
  • Lack of timeliness in updating/reconciling the accounting records

Do you have to stop trusting people to avoid such a thing from happening to you? No, but you need to implement good internal controls to reduce the risks. In my opinion, an honest bookkeeper would welcome the fact that controls are put in place—if for no other reason than to avoid the risk of ever being accused of wrongdoing.

Tips to consider:

  • Hire smart—develop accurate job descriptions and MUST do reference checking. During reference checking, make sure you ask former employers, “Would you rehire this person?”
  • Evaluate your internal controls—either on your own, or with the help of your CPA. (IC questionnaire)
  • Remember that as a manager or small business owner you are ultimately responsible for the numbers—so get involved in the process
  • Receive all mail—consider having post office hold mail until you return from vacation, if office is closed in your absence.
  • Review statements from vendors. Many vendors have stopped sending statements, but they will send late notices. Make sure your business is in good standing with vendors. Long overdue invoices may be an indication that a check you thought was going to a vendor actually went in someone else’s pocket, or that an invoice had been overlooked.
  • Receive bank statements directly, unopened. Insist on cancelled checks or check copies. Review cancelled checks for reasonableness of date, payee, amount, authorized signature and endorsement on the back of the check.
  • Review the bank reconciliation every month. This step is particularly important if you have one person doing the bookkeeping, writing checks, posting entries, preparing financial statements. Look closely at any adjustments to the bank accounts. Are there any old outstanding checks/deposits listed on the bank rec.?
  • Scan the check register periodically (every 3-4 months) to verify all payees and amounts paid make sense. Multiple checks written around the same time to the same vendor could be an indication that funds are being diverted—or just an inefficient use of time to write and code multiple checks. Verify check number sequences.
  • Review all credit card statements—are all charges authorized? Look for unusual late fees and finance charges. Pay off credit card balances monthly to avoid late fees. (Financial management point—check into lining up a line of credit with your bank—before you need the money, to manage short term cash flow/seasonal issues—at a lower rate and fees than a credit card.)
  • Review all payroll tax reports—consult with your CPA to verify deadlines and make sure that all reports are filed on time. Consider asking for account transcripts from the IRS and contact WDR at least annually to verify that all taxes were paid on a timely basis and that there are no balances outstanding.
  • Review payroll registers – review frequency of paychecks and amounts paid for reasonableness. Hand out pay checks/ pay stubs.
  • Review your accounts receivable aging summary schedule on a regular basis. This is beneficial not only to determine if you have any slow paying customers. It may also disclose if any customer payments have been misapplied.
  • Evaluate controls over inventory. Establish records to properly and consistently track inventory. Do period physical inventory counts and compare to your perpetual inventory system. Are controls implemented to reduce risk of theft?
  • DON’T EVER pre-sign blank checks. Keep all blank checks in a secured location—with you controlling the key/combination. (Anyone can forge a check.)
  • Make sure employees who can handle cash are bonded. Do you have embezzlement/theft insurance in place? Is it adequate to cover a potential loss and professional fees to determine amounts taken?

A Story About Employee Embezzlement

BY Bernie Hull

(The names in this story have been changed to protect the innocent and allegedly guilty…)

On Saturday, May 17, 2008, I received a call from Jane Victim, a client and a friend. She said, “I need your help.” I just learned that my long-time office manager, Sally Sly, has been stealing from me. “ It was hard to believe—I mean, Sally, was the typical “girl next door”, Jane’s right-hand woman, and someone who was believed to be one of Jane’s best friends. (Heck, I would say that she is one of the nicest people you could ever meet.)

Jane had been contacted by an associate who shared the same office building as Jane. The associate told her that she had heard from their office staff that Sally had been acting strangely, and apparently had been hiding things from Jane. For example, did Jane know that an IRS agent had stopped by the office last December with the threat of a tax lien to be levied against Jane’s business assets? And did Jane know that her business trust account had been overdrawn at one point and that a letter had been received from the state with a warning?

Jane confronted Sally and asked her to tell her what had been happening and why Sally hadn’t told her. Sally started sobbing and saying, “I don’t want to go to jail.” Jane asked, “Why do you think you would go to jail?” Sally admitted, ”…because I stole money from you.”

“How did you do it?” Jane asked.

“You know those checks you would sign and leave with me when you went on vacation? I wrote those checks to myself,” Sally confessed.

“How long have you been doing this?” Jane asked.

“Just a few months in 2007,” Sally replied.

“Any in 2008?” Jane asked. “No.” “Any other year?” “No,” Sally repeated.

So, how much did she take, and how did she do it?

I began the investigation by looking at the accounting records, bank statements and cancelled check copies to look for checks issued to Sally. The more we looked, the more we found. (I was told that the rule of thumb for embezzlement is that you take the amount given by the embezzler and multiply it by 5 or 10 times the amount—that it ALWAYS turns out to be more than you would expect. Unfortunately the rule was on target…

The results of the testing indicated that:

* More than $85,000 was discovered to have been taken by Sally from 2001 to 2008.—via checks issued to Sally or her husband—some as extra paychecks, some as checks actually issued to her, but recorded as to another vendor, etc. Additional amounts could have been taken—potentially through petty cash, cash receipts from clients that were never deposited, etc. The ways that it was covered up was truly masterful, in my opinion—in a nauseating sort of way…

But Jane incurred more losses than the amount determined to have been taken by Sally:

  • Sally transferred money from the trust account to the operating account to fund the amounts she took—they were recorded in the accounting records as “income.” Jane needed to borrow more than $75,000 to cover the accumulated deficit in this account.
  • We discovered that a business charge card that Jane had thought had been cancelled, was still open and accumulating large finance charges and late fees of more than $8.000 from 2006-2008.
  • The accounting records showed that the payroll taxes were being paid in a timely manner. Because she didn’t file all payroll tax reports on time and stopped paying the payroll taxes for a while, interest and penalties had accrued to over $6,000 for 9/30/06 through 2007. (Sally had paid these amounts after the visit from the IRS agent, and coded the checks to “office expense.”)
  • And she lost a “trusted friend”…

So, why does something like this happen to good people—Trust. According to FBI profiles, an embezzler is typically an employee with 5-6 years of experience, often described as good-to-above average, highly desirable, reliable, bright, motivated, trustworthy, and an achiever with good self-control. The typical motive is the need for money caused by a specific problem.”

So, do you have to stop trusting people to avoid such a thing from happening to you? No, but you need to implement good internal controls to reduce the risks. In my opinion, an honest bookkeeper would welcome the fact that controls are put in place—if for no other reason than to avoid the risk of ever being accused of wrongdoing.

Tips to consider:

  • Hire smart—develop accurate job descriptions and MUST do reference checking
  • Evaluate your internal controls—either on your own, or with the help of your CPA
  • Remember that as a manager or small business owner you are ultimately responsible for the numbers—so get involved in the process
  • Receive bank statements directly, unopened. Insist on cancelled checks or check copies. Review cancelled checks for reasonableness of date, payee, amount, authorized signature and endorsement on the back of the check
  • Review all credit card statements—are all charges authorized? Look for unusual late fees and finance charges
  • Review all payroll tax reports—consult with your CPA to verify deadlines and make sure that all reports are filed on time
  • DON’T EVER pre-sign blank checks

There are many more tips, but not enough time to present them today.