Safeguarding Your Business Against Employee Fraud

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West Hartford, CT

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General Business
by Jack Veale

Something seemed wrong at Leo’s Lawncare business. Leo had always trusted his employees, taking great care to screen them before hiring. Lately, however, he noticed money had been disappearing from the company’s petty cash fund. Leo had never suspected any of his employees of acting fraudulently in the past, but now it was something he had to consider.  With the increase in financial fraud over the years, many business owners are encounter-ing situations similar to Leo’s. Whether your employees are new or have worked for your family business for many years, you must be sure to set up a strong internal control system to deter internal fraud.   After discussing the missing cash with his accountant, Leo was advised to keep the petty cash fund separate from records of use. Leo’s CPA also suggested that he use prenumbered usage slips and avoid check cashing from the petty cash fund.   Another internal procedure to control the petty cash fund involved counting cash periodically, and in some instances, counting on two consecutive days. Also, his accounting manager (or someone not in charge of the company’s petty cash) was advised to reconcile and review the used petty cash slips each time the fund was reimbursed.

Stay Aware
As evidenced by Leo’s case, there are a variety of frauds that you should remain alert to. Only then will you be in a position to protect your company’s hard-earned profits from the financial devastation of fraud. In addition to crimes such as the petty cash fraud, be alert to situations where an employee has the ability to divert checks received from customers and then cover up the theft by crediting money received from a different customer to the first customer’s account. This type of fraud is known as lapping.  The best way to prevent lapping is to have proper segregation of duties between your personnel so that the employee handling the checks received from customers has no access to the recording of the accounts receivable records. Also, keep in mind that lapping requires an employee to constantly stay on the scene at work to avoid detection, so be cautious of employees who never express an interest in taking their vacation.

Keep Your Eyes Open
Careful monitoring of your employees is often the key to detecting fraudulent behavior such as kickbacks. When your company experiences a change in personnel, such as the emergence of a new employee in the position to buy goods, look for any vendor changes or unusual buying patterns. In addition, watch for employees who don’t opt to take their insurance benefits. Although some employees may be covered under a spouse’s insurance, ghost payrollers —  or nonexistent employees —  typically don’t elect insurance coverage. One method used to detect ghost payrollers is to periodically have payroll checks distributed by an independent party. Firms frequently have their CPA advisor pass out checks and control and investigate the checks of employees who are not present on payday.  Social Security numbers that don’t check out are good ways of alerting you to the presence of these costly corporate phantoms. Call the Social Security Administration to verify the status of any numbers you suspect were invented by a fraud for personal gain.

How To Discourage Fraud
Other schemes include inventory fraud and accounts payable fraud. Accounts payable fraud occurs when:

  • Bills from legitimate vendors are tampered with, or
  • The employee creates a “pseudo” vendor to do business with.
  • Some ways to discourage accounts payable fraud include:
  • Segregating the bill paying function from the purchase order and invoice approval function. It is difficult for an employee to commit a fraud when he or she doesn’t have access to all of the accounts payable procedures.
  • Making sure that all original invoices are on file. Be wary of photocopied invoices, because they can be falsified to hide any changes made to original versions.
  • Investigating why cashiers’ checks instead of preprinted company checks are used to pay invoices. This can help to distinguish between established businesses and fly-by-night operations that may not be around in the near future.

Another form of fraud, inventory fraud, occurs when an employee purchases goods with the company’s funds that are diverted to the employee’s premises for later sale. To detect and avoid this type of crime you should:

  • Pay bills only when accompanied by proper documentation. This should include approved purchase orders and receiving records.
  • Scrutinize your freight charges. Are they reasonable and correct, or have costs suddenly gone up while your sales have stayed the same? Careful analysis of cost fluctuations may help you detect inventory fraud.

On the Fraud Trail

Employee fraud often leaves a trail of evidence. Disgruntled employees may decide that their time is better spent embezzling money from their employers than resolving their grievances.

Listed below are some suspicious employee behaviors that may be warning signs of a fraud instigator:

  • A noticeable change in employee spending habits,
  • A sudden switch to different vendors or extremely close ties to particular vendors,
  • Unwillingness to take vacation time,
  • Increased


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