Most small businesses that are under 30 million dollars in revenue, only perform audits when its required by a lending institution or an investor. Most of these small businesses also only use an accounting firm to conduct their monthly or quarterly reviews and to prepare their taxes.
When audits are conducted, it is important to understand the purpose of a financial audit; namely, to express an opinion as to the fairness and accuracy of the company’s financial position as of a certain date. The financial auditor is generally responsible for performing audit procedures to discover financial statement fraud, he or she is not expected to uncover asset theft fraud. At the end of the day the intent and results of financial auditing and fraud auditing are completely different and, often, financial auditors refer us to their clients if it appears that they may have a potential fraud loss…
Not long ago, we were referred to a growing medical practice by their own accountants. This practice was doing very well, they had multiple locations around town and over 100 employees. The accountants had their suspicions that the manager of the practice may have misappropriated $10,000 to $15,000 over a three-year period. Once we came in and completed a full review and fraud audit, we discovered that the manager had in fact embezzled more than $250,000! Shortly after, the manager was arrested and a partner in the practice was implicated.
The practice generated millions of dollars of revenue every year and, you guessed it, the manager had almost sole responsibility for managing all finances, paying invoices, managing supply contracts and, at one time, even overseeing the construction and outfitting of a new facility.
Many medical practices use bespoke software packages to manage patient scheduling, insurance billing, purchasing and collections. Many of these software packages do a great job at what they are supposed to do but have a downfall when it comes to some accounting functions. For this reason, many practices also work with a separate accounting software such as QuickBooks, unfortunately the two do not always integrate well, leaving a lot of room for things to fall through cracks.
Now, if you have cracked the case on how the manager got away with this for so long, then you, my friend have what we like to call Strategic Intelligence!
The manager would pay all the vendors through QuickBooks but their products and services were billed on a patient basis, with the other software. He would regularly use QuickBooks to print checks naming himself as the payee and then go back into QuickBooks and change the payee to a regular supplier of the practice.
When their accounting firm would conduct monthly review they simply picked the embezzled funds as expenses to suppliers. The manager also paid a number of vendor bills with his personal credit card (so he could earn points) he would simply just inflate the amounts and pocket the difference.
There are a number of lessons here...
1) While it is important to have an accounting firm conduct regular reviews, plan and prepare tax returns, it is equally important to conduct a fraud risk assessment review and develop a fraud deterrence program, even for a small business. We emphasize “deterrence” because it is virtually impossible to prevent all fraud and, if possible, would certainly not be cost-effective.
2) A good fraud risk assessment should include risk from internal as well as external factors, assessment of internal controls, employee responsibilities and access, financial reporting and asset control. The purpose of the assessment is to identify vulnerabilities and develop a program to address the issues by corrective actions, new controls or insurance.
3) One of the keys to fraud deterrence is having a fraud prevention program in place and ensuring that all employees are aware of the program both from a deterrence point of view as well as from a reporting standpoint assuring that all employees know how to address suspect issues within the Company. Employees need to understand that fraud not only affects the company but their own jobs and income and will not be tolerated on any level.
4) We would be happy to provide a free telephone consultation to any of our readers who want to learn more about developing such a program.
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