Most everyone likes to think of their employees as being honest and incapable of fraud or other wrongdoings. Unfortunately, that’s not always the case.
Consider the following example inspired by a real-life event in a nonprofit organization.
The American Do Good Society (ADGS) discovered that its bookkeeper, Heloise, had been writing checks to herself and recording them under an assortment of vendor names. As ADGS dug deeper, it discovered that the employee, who had complete control over disbursements and general ledger entries, had been writing the checks to herself for eight years — to the tune of nearly $500,000.
Nipping Fraud In the Bud
How did such a huge accounting fraud get by the executive director, the board of directors and everyone else? And how could these crimes have been detected much earlier or prevented altogether?
Here are several actions the ADGS could have taken. Any one of them could have caught Heloise in the act.
1. Consider check cosigning
It can be a hassle to implement properly but consider having checks cosigned by either the board treasurer or the president or executive director
2. Require review and reconciliation
The executive director — or another designated employee — should review all checks before they’re dispersed and follow up by reviewing the monthly bank reconciliation. Make sure that no unauthorized checks clear the bank and that all adjustments are explained. Also remember that electronic banking, which eliminates checks, is great for efficiency but increases the need to review transactions that go through the bank account but are not supported on paper.
3. Have bank statements sent directly to someone not maintaining the books
Require that your bank send a copy of the bank statement directly to the executive director or your organization’s treasurer each month for review. The statement should include images of all checks. The treasurer’s independent review helps to ensure that expenses are reasonable and no alterations have been made to returned checks to cover up fraud.
4. Require an annual audit
While having an audit cannot guarantee fraud will be detected it does improve the possibility of detection and also makes a potential perpetrator think twice before committing any fraudulent acts. Hire an external auditor to conduct an annual financial statement audit. If that doesn’t fit into your budget, authorize an “agreed upon procedures” (AUP) engagement, which might be a review of disbursements, for example. You could change the focus of the AUP engagement each year to keep potential fraudsters off guard.
5. Consider a hotline for fraud and employment practice issues
Reporting hotlines have been around for quite a while but they have been more in the spotlight since the Sarbanes-Oxley Act was passed. Reporting hotlines increase the chance of a financial fraud or employment practice issue being reported. These hotlines greatly increase the chance of a fraudulent act being reported and reduces and sometimes eliminates the loss that can be incurred.
The bottom line is that the lack of segregation of duties is often the culprit when fraud occurs. You should not only have different people cosign and review transactions, but also make sure these individuals are from different sides of the organization — the board, the accounting department, the executive director’s office, and so on. Your CPA or auditor can help you set up the right internal controls for your organization.
Two Kinds of Fraud
As you review internal controls at your nonprofit, also bear in mind that you want to deter two types of fraud. The first broad category — theft of assets — involves access to cash or other valuable assets at your organization, such as incoming checks and cash, valuable inventory or computer equipment, as well as the ability to write or deposit checks and cash.
The second fraud category — accounting fraud — gained public attention when Enron defrauded its constituents by misleading shareholders about its earnings. Accounting fraud can happen in much the same way at a nonprofit.
An organization seeking to renew its line of credit with a bank, for example, might purposely exclude accounts payable at year end, in order to look better on paper. Or it might move expenses from one program to another when it hasn’t spent all its funds by the end of a contract period. In both cases, it’s the user of the financial statements, such as a bank or a grantor, who’s being misled by the fraud.
Having committed volunteers on your board is important but it’s also important to have a mix of skill sets on the board. One of those skill sets should include someone with a good background in financial areas such as financial management and reporting.
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