Countering Fraud in small businesses with practical internal control procedures
Small businesses are often faced with the unfortunate occurrence of employee theft. Unlike larger businesses who have the resources to invest in an adequate system of internal control, smaller businesses lack those resources and thus may be more vulnerable to fraudulent activity by their employees.
According to American criminologist, Donald Cressey, there are three factors that are typically present at the same time in order for an ordinary person to commit fraud: financial pressure, rationalization, and opportunity. Although the employer has no control over an individual’s gambling problem or debt and neither an individual’s rationalization for committing fraud, steps can be taken to minimize an individual’s opportunity to commit fraud in the work environment.
Ideally a system of internal control should incorporate six principles: establishment of responsibility, segregation of duties, physical control, documentation procedures, independent internal verification, and human resource control. While integrating all six principles, particularly, segregation of duties and physical controls can be costly to the small business; hiring several employees to satisfy the segregation of duties principle, implementing costly physical controls such as hiring a security guard, purchasing expensive safes, or alarm systems may not be feasible. The benefits of these controls do not outweigh the cost for small businesses. The business owner should consider including independent internal verification and human resource control as essential elements to their internal control system. Incorporating simple procedures as the timely preparation of a bank reconciliation report, spontaneous employee audits, and pre-employment screening will contribute to minimize fraud in small businesses.
Independent Internal Verification
A timely bank reconciliation report, prepared independently, is an excellent procedure which satisfies the principle of independent internal verification. Time after time fraudulent activity in companies would have been prevented or at the very least uncovered sooner had a simple bank reconciliation been prepared. In the case of people v Sheila Seward (Newsday 11/14/2019), a former employee at the Elmont Memorial Library allegedly devised a scheme to manipulate payroll records and stole more than $260,000. The theft was perpetuated for seven years. If applied correctly, a bank reconciliation would have uncovered the theft immediately or prevented Ms. Seward from allegedly committing the fraudulent activity.
The relationship between a business owner and his/her employees may develop into a friendly one. This often makes the office culture a more relaxed and comradely environment. This in and of itself is not a pre cursor to fraud. However, as the business owner, prudent policies should be implemented. The business owner should conduct internal audits on a surprise basis. Procedures should be reviewed to ensure policies in place are in accordance with the business objectives. Business transactions should be reviewed to determine the procedures are followed. In the case of Johnson v West Loop restaurants Blackbird and Avec, the longtime bookkeeper pleaded guilty with stealing $600,000 over a six-year period. This case highlights the abuse of trust the owners placed in their company’s sole bookkeeper. Trust but verify.
Human Resource Control
A simple phone call may make all the difference between hiring and not hiring a thief. One of the basic elements of human resource control is for the business owner to know his/ her potential employee. Applications and resumes should be verified. Background checks screening should be conducted. A conversation with a prior employer may reveal more than what is on the employee application. In the case of Peloton v White, Lawrence White was convicted for stealing more than $500,000 from two previous employers: Peloton and prior to Peloton, Rocketrip. Peloton may have avoided the fraud had a proper candidate screening been performed.
A few internal control procedures in place may mitigate employee fraud in the small business environment. Often, fraudulent practices in small businesses could be prevented or detected sooner if essential internal control procedures are implemented. A timely preparation of a bank reconciliation report, spontaneous employee audits, and pre-employment screening all contribute to minimize fraud in small businesses.
