internal controls
Design procedures to protect a business’s assets
Safeguard what cash is on hand 8.2 How to make a checking
account work for a business
Monitor and protect the cash that fl ows into and out of a business 8.3 How to work with cash registers
Think about how careful you are with your personal cash. You fi nd various ways to pro- tect how you carry it around, you dole it out carefully to your family members, and you may even hide cash in a safe place just in case you need it for unexpected purposes. If you’re
that protective of your cash when you’re the only one who handles it, consider the vulner- ability of business cash if you have employees. In this chapter you will learn how to protect cash and other business assets.
INTRODUCTION
Many business people start their operations by carefully hiring people they can trust, thinking “We’re family—they’ll never steal from me.” Unfortu- nately, those who have learned the truth are the ones who put too much trust in just one employee.
Too often a business owner fi nds out too late that an employee may steal from the company if the opportunity arises and the temptation be- comes too great—or if the employee becomes caught up in a serious per- sonal fi nancial dilemma and needs fast cash. In fact, according to the American Management Association, at least 20 percent of all business fail- ures are the direct result of employee theft.
Businesses protect themselves by setting up internal controls. As de- fi ned in Chapter 1, internal controls are procedures that protect assets and provide reliable records. Given the importance of these twin goals of inter- nal control, consider the following:
• Safeguard assets: To achieve this goal means more than simply keeping assets from being stolen; it also includes the idea of using assets well and not wasting them.
• Provide reliable records: This goal is related to the simple defi nition of accounting as an information system: Input → Process → Output. The output does not have utility if it is not accurate. For example, if John pre- pares an accounting report and says, “Well, this report is about 80 percent accurate,” then that report has little credibility.
8.1.1 Types of Internal Fraud
The four basic types of internal fraud are: • Embezzlement.• Internal theft.
8.1 PROTECTING AGAINST
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• Payoffs and kickbacks. • Skimming.
Embezzlement is the illegal use of funds by a person who controls those funds. For example, a bookkeeper may use company money for his or her own personal needs. To put it another way, embezzlement is the wrong- ful use, for one’s own selfi sh needs, of the property of another when that property has been legally entrusted to one.
Internal theft is the stealing of company assets by employees, such as taking offi ce supplies or products the company sells without paying for them. Internal theft is often the culprit behind inventory shrinkage.
Payoffs and kickbacks are situations in which employees accept cash or other benefi ts in exchange for access to the company’s business. A payoff is paid before the sale is made, essentially saying “please.” A kickback is paid after the sale is made, essentially saying “thank you.” In these situa- tions the company that the employee works for often pays more for the goods or services than necessary. The extra money fi nds its way into the pocket of the employee who facilitated the access.
For example, say Widget Wholesale wants to sell its products to The Chain Store. An employee in The Chain Store helps Widget Wholesale get in the door. Widget Wholesale prices its product a bit higher and gives the employee of The Chain Store that extra profi t in the form of a kickback for helping it out. In reality, payoffs and kickbacks are a form of bribery.
Skimming occurs when employees take money from customers and don’t record the revenue on the books.
Although any of these fi nancial crimes can happen in a small business, the one that hits small businesses the hardest is embezzlement. Embezzle- ment happens most frequently in small businesses when one person has ac- cess or control over most of the company’s fi nancial activities. For example, a bookkeeper may write checks, make deposits, and balance the monthly bank statement—talk about having your fi ngers in a very big cookie jar. Embezzlement:
The illegal use of funds by a person who controls those funds.
Embezzlement:
The illegal use of funds by a person who controls those funds.
Internal theft:
Stealing of company assets (such as inventory) by employees.
Payoffs:
A payment made before the fact to an employee who will provide a supplier with access to the company’s business, often to the detriment of the employer.
Kickback:
A payment made after the fact to an employee who provided a supplier with access to the company’s business, often to the detriment of the employer.
Skimming:
Taking money from customers and not recording revenue on the books.
Internal theft:
Stealing of company assets (such as inventory) by employees.
Payoffs:
A payment made before the fact to an employee who will provide a supplier with access to the company’s business, often to the detriment of the employer.
Kickback:
A payment made after the fact to an employee who provided a supplier with access to the company’s business, often to the detriment of the employer.
Skimming:
Taking money from customers and not recording revenue on the books.
Section 8.1:Protecting against Internal Fraud
Criminal Words of Wisdom
Sam E. Antar is a convicted criminal and the former Chief Financial Offi cer of Crazy Eddie, the notorious New York City–area consumer elec- tronics chain of the 1970s and 1980s. Sam E. Antar, the cousin of the real “Crazy Eddie” Antar, was convicted of crimes associated with the fi nancial scandal, which cost investors about $145 million and involved frauds such as receipt skimming and money laundering. These days,
IN THE REAL WORLD
8.1.2 Dividing Staff Responsibilities
Your primary protection against internal fraud is properly separating staff responsibilities when the fl ow of cash is involved. Basically, you should never have one person handle more than one of the following tasks: • Bookkeeping.
• Authorization. • Money-handling.
• Financial report preparation and analysis.
Bookkeeping
Bookkeeping involves reviewing and entering all transactions into the company’s books. The bookkeeper makes sure that transactions are accu- rate, valid, appropriate, and have the proper authorization. For example, if a transaction requires paying a vendor, the bookkeeper makes sure the charges are accurate and that someone with proper authority has approved the payment.
The bookkeeper can review documentation of cash receipts and the overnight deposits taken to the bank, but he or she shouldn’t be the person who actually makes the deposit. Also, if the bookkeeper is responsible for handling payments from external parties, such as customers or vendors, he or she shouldn’t be the one to enter those transactions in the books.
Authorization
Each manager usually has the authority to approve expenditures for his or her department. You may decide that transactions over a certain amount must have two or more authorizations before the checks can be issued.
Authorization levels should be clearly spelled out and followed by all, even the owner or president of the company. (Remember, the owner sets the Small Business
Accounting in Action
Design procedures to protect your business assets.
IN THE REAL WORLD
(continued)Sam E. Antar is making a second career out of teaching others how to spot fraud in public companies, acknowledging that he “helped master- mind the fraud by giving advice to Eddie Antar on accounting aspects of the fraud.” He speaks to law-enforcement, accounting, and student groups about Crazy Eddie and what it can tell them about spotting ac- counting fraud. He tells his audiences that most accountants “don’t even get any training in fraud,” and that one way to safeguard against accounting fraud is to train auditors better.
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tone for how the rest of the offi ce operates. If the owner takes shortcuts, it sets a bad example and undermines the system.)