Susceptibility of Small Businesses to Fraud
There
are at least three reasons that small businesses are considered to be the most
vulnerable to fraud. First, the very size of a small organization limits its
ability to separate functions related to the authorization, record keeping and
physical safeguarding of assets. Without this segregation of duties, internal
control functions are weakened or susceptible to circumvention, and the
opportunity to commit fraud is increased. Second, smaller organizations tend to
disregard or subordinate the importance of monthly accounting functions such as
account reconciliations and analyses. In other cases, the preparation of the
financial statements are outsourced; therefore, the independent transactions
are never scrutinized by anyone within the organization who has knowledge of
the appropriateness of the transactions. Third, the management and employees of
the company may not have adequate fraud awareness. That is, they may not
realize the areas in which the company is vulnerable to the risk of fraud and
therefore d o not take the appropriate measures to prevent it. Along these same
lines, it is very common for the management of smaller businesses to believe
that the close relationships that exist among a smaller group of people prevent
fraud from being committed. In reality, these feelings of absolute trust may
create an environment of perceived opportunity to commit acts of fraud.
Recognition
of the value of information provided by the company's accounting records will
also assist in preventing fraud. Assuring that monthly reconciliations of the
businesses' balance sheet accounts are prepared and reviewed will make it more
difficult to process fraudulent transactions. In addition, performing a monthly
comparison of detailed sales and expenses accounts to budgeted amounts or to
prior months' amounts will help detect irregularities that maybe the result of
fraudulent transactions. Finally, developing a system of internal controls that
will minimize small businesses' exposure to asset misappropriation is of utmost
importance. The overall objective of the internal control system should be to
prevent any one person from having authorization, record keeping and physical
safeguarding functions over the same asset.
Although
small companies have a limited number of human resources available to perform
transaction processing, it may not be difficult to segregate these duties. A
common misconception of management is that accounting personnel must perform
all internal control functions. In reality, this is not the case. While the
recording of accounting transactions should be performed by individuals
experienced and/or educated in this area, authorizing the use of and
safeguarding assets can be performed by personnel outside of the accounting
department. For instance, the safeguarding of inventory should be made the
responsibility of the warehouse manager or someone with similar responsibility.
Utilizing the company's receptionist to perform simple accounting tasks, such
as running a total on checks when they are received in the day's mail, is a
means of segregating accounting functions.
In
addition, the small business has resources available outside of the company
that can assist it in maintaining a segregation of duties. These resources
include the businesses' banking institution and public accounting firms. To
illustrate, establishing a lock-box at the bank serves to minimize the risk
that cash receipts will be altered and removed from the organization. Also,
using a lock-box benefits the company by reducing the time between receiving
the customers check and depositing it in the bank. A public accounting firm can
assist a small business in maintaining a segregation of duties in many ways.
Any one or a combination of the following services outsourced to an accounting
firm will help ensure a segregation of duties:
*
Preparation of bank and accounts receivable reconciliations to be reviewed by
company management
*
Preparation of other balance sheet and expense account reconciliations to be
reviewed by company management
*
Performance of physical inventory counts Compilation of monthly financial statements
to be reviewed by company management
*
Development or review of internal controls for proper segregation of duties
Thus,
the small business has many resources available to ensure an adequate system of
internal controls. A list of some of the key elements of a strong system of
internal control include the following:
* Utilize pre-numbered checks, invoices, credit slips, and any other document
used regularly in the operations of the business
*
Lock up check stock in a secured area
*
Prompt review of account reconciiations and journal entries by management
*
Tag fixed assets and perform inspections of them
*
Conduct cycle counts of inventory to maintain integrity of reporting system
*
Physically secure inventory by fencing in product or securing warehousing
facility
*
Change locks on a periodic basis to ensure access by authorized employees only
*
Pay vendors based on original invoices only
*
Disbursement of payroll checks by management to employees on periodic basis
*
Review of payroll register by management on a periodic basis
Conclusion
Small
businesses are particularly vulnerable to fraud; however, businesses can take
various steps to prevent fraud. Some of these steps can be performed inexpensively,
while others may require a major commitment of resources. If the business does
not have the resources internally, it can use the services of outsiders to
create fraud awareness and prevention.
Colleen
A. Lavery, CPA, MBA, is a manager in litigation support services at Gleeson,
Sklar, Sawyers & Cumpata LLP.
Deborah
L. Lindberg, CPA, MBA, DBA, is an assistant professor of accounting at Illinois
State University.
Khalid
A. Razaki, Ph.D., is a professor of accounting at Illinois State University.
eposit checks received on a daily basis
