Fraud – Prevention, Policies and Procedures

Roselli, Clark and Associates

Certified Public Accountants

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Introduction

Presenters: Tony Roselli, CPA, Partner Chad Clark, CPA, Partner

Cash handling

Frequency of fraud

Detection of occupational fraud

Case studies

Auditors’ responsibility to detect fraud

Introduction

Typical deficiencies

Implementation of procedures

Obtaining a fraud policy template

Conclusion

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Cash Handling

Cash handling = actual receipt of funds by a government Takes on several forms: cash, currency, checks, credit

cards and on-line payments Of these, cash is most susceptible to misappropriation Treasurer maintains legal custodial responsibility In most instances however, the Treasurer does not

handle the cash Cash is typically handled at the department level by

clerks

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Frequency of Fraud

Inverse relationship between frequency of fraud and level of economy

Vibrant economy = lower existence of fraud Struggling economy = higher existence of fraud Due to spousal layoffs, lack of pay raises, market

deterioration of portfolios and other financial related situations

Fraud Triangle Current fraud climate reaching historic levels due to

adverse conditions in the economy

Frequency of Fraud - continued

Struggling economy Vibrant economy0%

25%

50%

75%

100%

Level of Fraud

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Frequency of Fraud - continued

Approximately 40% of our clients have been exposed to some manner of fraud in the last 3 years

Mostly at the clerk level Range from $2,000 to over $500,000 Lack of controls Lack of policies Lack of training Easily preventable Taxpayer is ultimately the victim

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Frequency of Fraud - Fraud Triangle

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Frequency of Fraud - Types

Building permits – 2 situations Vending machine – 1 situation Council on Aging – 2 situations Transfer station – 2 situations Recreation receipts – 1 situation School lunch receipts – 1 situation School lunch inventory – 1 situation Petty cash reimbursements – 1 situation Athletic receipts – 1 situation Real estate tax refunds – 1 situation Contract kickbacks – 1 situation

Detection of Occupational FraudStatistics per Journal of Accountancy – June 2010

Tip - Whistleblower

Management Review

Internal Audit

By Accident

Account Reconciliation

Document Exam

External Audit

Surveillance

Notified by Police

Confession

IT Control

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0%

40.2%

15.4%

13.9%

8.3%

6.1%

5.2%

4.6%

2.6%

1.8%

1.0%

0.8%

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Case Studies

Building permits (both cases) Cash collected was reduced and the reduced amount was

placed on Treasurer turnover report. Amount reduced was misappropriated. Treasurer and Accountant reconciled since they both agreed to

reduced amount. No independent reconciliation was performed to the

department detail. This would have detected the theft. Employee resigned in both situations, with no charges filed.

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Case Studies - continued

Real estate refunds case Collector allowed unpaid real estate refunds to accumulate into

the millions of dollars Collector Clerk created fictitious refund requests in the name of

acquaintances; in some instances, numerous times The control in the system for refunds was bypassed and Clerk

was allowed to process requests manually Collector did not reconcile with Accountant until year end Over $500,000 was stolen over a 15 month period Clerk is serving two years in jail and was ordered retribution

Case Studies - continued

Recreation receipts case Recreation Director created a separate bank account, with

Town’s name but without Treasurer approval Cash received for activities was deposited partially to the

separate bank account and partially to the Town Money was misappropriated from bank account Over $100,000 was stolen Director went to jail for one year with retribution Off the books cash accounts are very common and should be

abolished

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Case Studies - continued

Petty cash reimbursements Director for senior activities had created separate bank account

for seniors Director incurred cost in administering the activity Director reimbursed himself from separate bank account and

submitted reimbursement request to Town In effect a double reimbursement Was not discovered until Director was vacated and someone

else tried to reconcile separate account About $80,000 was taken over a 10-year period

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Case Studies - continued

Vending machine Same Director operated a soda machine Town was unaware of the soda machine Director kept funds and paid for supplies from cash receipts Approximately $40,000 was taken over 10 years Was not discovered until Director vacated position

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Case Studies - continued

School Lunch receipts School lunch turnover manipulated prior to turnover to

Treasurer No independent verification of turnover back to cashier register

performed, unknowing staff instructed to destroy records Accountant and Treasurer reconcile since reduced amount is

reported amount Deposits turned over infrequently thereby allowing manipulation

more easily Director was relieved of their employment Director was awarded unemployment benefits at hearing

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Case Studies - continued

School Lunch inventory Cafeteria Director took turkeys to supplement catering business Was caught through video surveillance Claimed to be only be borrowing turkeys Arbitrator sided with Director since there was no policy

prohibiting the unauthorized borrowing and assumed subsequent payback of items

Director was awarded back pay for time since firing School was required to give Director their job back

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Case Studies - continued

Transfer station Patrons paid cash at gate to dump trash Not all cash was recorded on turnovers to Treasurer Scheme was discovered when Transfer Station Agent was

replaced and revenue spiked significantly Difficult to prove if cash was in fact stolen so no charges were

filed

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Auditor’s Responsibility To Detect Fraud

Statement on Auditing Standards (SAS) #99 – Consideration of Fraud in a Financial Statement Audit

Issued in 2002 and effective 2003 This was a major change for audit firms Due to fraud at World Com, Enron and other large SEC firms,

this SAS required auditors to focus on the risk that the financial statements may be misstated due to fraud

However, the responsibility of preventing fraud was and continues to be Management’s responsibility

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Auditor’s Responsibility To Detect Fraud – continued

SAS 99 specifically states it’s Management’s responsibility to:o Understand the risks of fraudo Set the proper philosophical toneo Create and maintain a culture of honesty and ethicso Develop and implement controls to prevent, deter and detect fraudo Develop procedures to monitor internal controlso Follow up with identified fraud risk areas communicated from your

auditors

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Auditor’s Responsibility To Detect Fraud – continued

Numerous audits typically result in findings related to Management’s risk of preventing or detecting fraud

These are communicated via a Management Letter

It is Management’s responsibility to correct these findings

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Typical Deficiencies

Inadequate departmental receipts policy Lack of internal audits Lack of segregation of duties Receipt trends not monitored No formally accepted fraud policy No student activity policies Lack of adequate training Lack of background checks

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Implementation of Procedures - Departmental Receipts Policy

Cash handlers are bonded Use of pre-numbered receipt forms Mandatory vacations for cash handlers Reasonable turnover period, especially for

large amounts of cash Secure, on-site storage between turnovers Internal reconciliations of cash handler’s

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Implementation of Procedures - Internal Audits

Internal audits by accounting or Treasury personnelo Unannouncedo Reconcile cash reported per turnover back to source document

such as number of permits issuedo Cycle departments, so that all cash handling activities are

internally audited at least twice during the yearo Add departmental reviews to annual audit process, such that

the independent auditor will audit 1 or 2 departments per year

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Implementation of Procedures - Segregation of Duties

Where practical, assure that cash handlers are independent of the cash recording and cash reconciliation function

Always have reconciliations reviewed independently

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Implementation of Procedures - Monitor Receipt Trends

Establish a spreadsheet that includes historical receipt data (up to 5 years)

Determine revenue trends and create expectations based on known facts

Investigate where revenue trends deviate from the expectation

Expectations for Transfer Station could be comparing the amount of trash produced from tipping fee invoices to prior years and developing a revenue ratio

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Implementation of Procedures - Formal Fraud Policy

Create a policy that communicates the City/Town understanding of fraud to its employees

Designate a fraud officer Emphasize the whistleblower statute within the policy Review policy with Legal Counsel Assure no contradiction with collective bargaining agreements Formally accept policy through Selectmen or City/Town Council Disseminate policy to all employees Conduct training to assure understanding of policy

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Implementation of Procedures - Formal Fraud Policy

Fraud policy template in a downloadable and customizable form, available at:

www.roselliclark.com

From home page, click on “Industries” Then click on “Municipalities” Go to bottom of page under caption “Key Note

Presentations”

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Implementation of Procedures - Student Activity Policies

Develop policies to comply with MGL Require reconciliations monthly Train secretaries to assure proper cash

handling and cash disbursement procedures Conduct independent audits every three

years

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Implementation of Procedures - Institute Formal Training

Many times, departmental cash handlers are not sophisticated bookkeepers

These cash handlers should undergo adequate training procedures on a periodic basis

This will help eliminate careless errors Even we CPAs are required to take 80 hours

of training every two years

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Implementation of Procedures – Formal Background Checks

Implement a policy of performing background checks when hiring employees

Consider using CORI; which is required if working with minors

Consider performing credit check as studies show that there is a correlation between bad credit and fraud

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Conclusion

The pressure and motivation to steal money is at historic highs

City/Town officials need to understand this Put policies in place to mitigate these risks Once its happened its too late to say I should have

done something about it End fraud and protect the taxpayer

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