Forensic Accounting
Fraud Investigations
Internal Controls
Case Studies – As it Happened
Forensic Accounting for general ledger accounts
“We know one General Ledger Account is out of balance…”
“ABC,” a privately held professional services company, knew that their bank statement for their client deposit account did not match the general ledger balance. Their head accountant recently left the firm and their management did not have confidence in the financial statements.
Beginning with the partners, we looked at each client’s deposit in the partners’ portfolios. To reconcile the client deposit account, we investigated the services provided by each partner and examined the billings to their clients to see if they matched up. Fortunately no fraud was uncovered from my investigation. However, it uncovered a host of problems that went deeper into the accounting process. The billings process was inconsistently applied when there was a balance in the client deposit account. To the firm’s detriment, funds were not transferred from the deposit account to the firm to settle the client’s bill. Having created a trusted relationship, the project scope was broadened to reconcile all general ledger accounts.
In navigating the correct course, the billing procedure was revised to include activities with the client deposit account and the accounting staff was trained on the new procedures. With these changes, the accounting team was able to restore confidence in the financial reporting with the firm’s partners.
Due Diligence Reviews
“Their financial statements are not worth the paper they are written on”
Through an arrangement by a nonprofit agency, the Small Business Administration (SBA) retained my services for due diligence reviews of the largest borrowers. One client’s financial statements were deemed unusable by the SBA and it was suspected that the owners were repaying themselves to the detriment of the SBA.
In meeting with the business owners, I deferred to them that they know their business better than I do and that I was not going to change their operations. After some difficult discussions about the operating cash flows and the financial issues that led to our in-person meeting, we jointly created a repayment priority plan.
This plan satisfied the SBA and allowed the owners to get repaid in a timely manner. On-going quarterly monitoring continued for 18 months, at which point the SBA was satisfied with the loan payment plan and removed this client from the oversight monitoring program.
Embezzlement Detection
“When you don’t record your entries, it creates the perfect environment for employees to help themselves — to the company’s money.”
California-based “BranchCo” was a subsidiary of a Fortune 500 company with headquarters on the east coast. BranchCo’s employee business travel increased heavily due to training at headquarters and increased customer site visits for proposals. The accounting staff did not grow accordingly and unprocessed transactions continued to grow quickly. When employees complained about unreimbursed expenses, the controller authorized travel advances in cash to employees for business travel. These advances were paid out by the CFO’s administrator from the petty cash drawer. The overworked and undertrained accounting team continued to ignore employee expense reports as they were not considered priority tasks. Instead they took a short-cut by booking the cash infusions to petty cash with an offset to the travel expense account.
Once the accounting team grew, the controller brought me in from headquarters to handle transactions and reporting. Additionally the petty cash function was turned over to the accounting department. Working with the IT department, we initiated a process to automate employee travel. This required processing nearly a year’s worth of accounting entries and the creation of a database of travel amounts, cash advances, and returns of unused cash advances. The short-cut accounting entries were reversed and replaced with actual spending amounts.
When rolling out the new system employees were provided with their travel account reconciliations with requests to return travel advances. However, employees came forward with receipts for their travel advances they refunded and it became apparent that $22,738 was not due from the employees. Tracing the documents from the employees and the account reconciliation revealed the cash was missing. The receipts showed a specific date range and numerical sequencing of receipt numbers pointed to the CFO’s administrator time handling petty cash.
This employee was able to embezzle the cash without detection when the accounting team took short-cut methods to record transaction. The employee was immediately terminated and law enforcement was contacted.
The parent company sent out an internal audit team that verified the accounting reconciliation as well as discovering a local bank account previously unknown to the parent company’s treasury department. BranchCo immediately began implementing written procedure for internal controls and expand staff training.
Asset Misappropriation
“It’s the Controller’s job to control”
Every one of us has stories of working at companies where cash was taken from the register, inventory went home with the employees or their friends, or time cards were falsified for personal benefit at the expense of the company.
Control policies need to be implemented beyond the financial department, specifically in operations for inventory, spending ceilings for managers, and travel and procurement card limits for all employees. Managers need to be held to budgets. Gaining their buy-in at the start of the budget process is critical. Ultimately the success in this role depends on the complete backing of the CFO and CEO who need to enforce these policies and controls.
The Controller at the company is the person responsible for implementing procedures and controls to stop asset misappropriation. The controller’s position is the hardest role I ever had in my career. It became easier when I adopted the overall philosophy of “safeguarding the company’s assets and limiting corporate liability” to my decision making. This statement succinctly summarizes the reason and process behind every financial policy.
Financial Statement Fraud Assessment
“Why do you want to unbook our sales?”
“DataCo” was a multi-national start-up that used emerging technology serving the e-commerce market. The vice-president of sales was responsible for sales, marketing, customer service, and operations. I joined DataCo after sales had started and immediately implemented a revenue recognition policy — one of several policies as there were no accounting policies in place.
With new accounting policies in place, the accounting staff was still unable to close the revenue accounts timely. After reviewing the purchase orders and shipping records, I interviewed the operations staff. We uncovered shipments to customers that were still in the manager’s car and improper sales tactics. The CEO agreed to the recommendation to reverse revenue on these ”shipments” and internal controls were implemented for the warehouse and operations staff.
The reversal of revenue led to a high level of friction with the sales team as it caused them to miss the sales target and resulted in a loss of commissions. To correct the situation, the sales personnel went back to their customers and obtained new purchase orders (for higher sales prices), all employees were educated on revenue recognition, customer satisfaction became the new goal and not short-term sales goals, and the operations team was moved to report to finance instead of sales.
Overall employee stress was reduced, DataCo’s books were GAAP compliant, and the average sales price per customer increased.
Contract & Procurement Fraud
“When uncovered, the fraudster flees”
“XYZ” was an independent subsidiary that was growing quickly. After a series of office expansions into subleased suites throughout their building complex, headquarters approved a move to a larger location and to bring together various functional areas in one office suite. I was employed at the corporate office and authorized to oversee the budget and relocation process for XYZ.
After a new location was identified, the landlord solicited construction bids from a competitive process and were delivered sealed to their office. Jointly with the landlord we began negotiations with the contractor from the lowest bid to reduce costs by removing nonessential features or delaying parts of the buildout that were not needed initially.
Separately, negotiations started with the design firm, who insisted on placing firm orders quickly in order to meet the construction schedule. The longest lead item which was carpeting which was a large part of the budget. In reviewing the order, the quantity was nearly twice the square footage of the office suite. The designer explained that the office was not rectangular and the carpeting pattern required excess material. I asked for a new cut pattern given that the scrap material was excessive. A new order was submitted with a 40% reduction in material and the order was placed.
When finalizing the general contractor’s agreement he noticed that his contract did not contain carpeting. I explained the carve-out due to the long lead-time from the manufacturer and that our contract was not in place at the time the materials needed to be ordered. He said this area is known for over-charging clients and kickbacks to the designers. During discussion we concluded that most likely the excess material was never intended to be delivered.
The designer stopped working on this project as it was apparent that costs were being monitored at the line item level and the general contractor finished the project without the designer’s input on materials or suppliers.
Nonprofit Accounting Review
“Why can’t we accept any donation someone wants to give us?”
I have been on several non-profit boards and advised numerous nonprofits at the board level and to their finance committees. Two interrelated areas are not well documented and as a result do not operate effectively. These are a defined Donations Policy and an In-Kind Donations Procedure.
When I quiz a nonprofit board about a donation policy I usually hear back that they accept all donations. “Should a nonprofit accept fifteen cases of bananas?” Yes, if you are holding a walkathon, but not otherwise. “What about appreciated stock?” I hope the nonprofit has a brokerage account to accept this. “Or a restricted donation of $2,000 to create a scholarship fund endowment in which only the interest earnings can be used for a scholarship grants?” You’ll end up with a donation that you cannot use!
A Donations Policy should spell out what types of restricted cash donations and in-kind property donations should be accepted by the Executive Director and when the board should be consulted before accepting any questionable donation. The policy should include the appropriate thank-you level (email, handwritten card, in person visit) and by which level of staff (development director, executive director, board chair).
An In-Kind Donations Procedure should encompass how to value the property, how to record the entry, and alerting appropriate staff so the donor is properly thanked and maybe announcing the donation in its marketing messages. If the non-profit is receiving below-market rent from the landlord due to the non-profit status, you can record the full rent expense as a debit and split the credit into accounts payable and in-kind donation revenue. Including donation property on the books not only makes the financial records more accurate, but it also makes the organization look stronger from a financial perspective.
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