"Millie" totally controlled all cash disbursements in two small organizations. She enjoyed complete freedom as the treasurer of a small state advisory board and as the executive director of another small, private nonprofit organization. Millie prepared and signed checks, reconciled the bank statements, and maintained all the accounting records for both organizations -- certainly a recipe for disaster. So she was able to issue unauthorized checks totaling $144,422 over three years to herself from the treasuries of these two organizations. The members of the private nonprofit governing body initially hired Millie as their executive director. However, she subsequently took control of the organization and began appointing all future board members instead -- certainly an undesirable condition. Sadly, no one on the governing body or oversight board protected the assets of these organizations because they failed to monitor Millie's work. This is a recurring problem in many small organizations.
Today's regulations require an entity's governing body or board of directors to install internal controls. To meet this obligation, small organizations should consider recruiting a responsible volunteer such as an accountant, bookkeeper, or a school teacher to monitor employees in key fiscal positions. After you've identified volunteers, give them specific directions about their responsibilities. They must understand they're performing these tasks to protect the entity's assets and to ensure that it meets its financial goals. And employers need to tell the volunteers how much time a task will take and if they're allowed to complete the work in the office or at home.
I've designed the steps here to combat the internal control weaknesses I've found in the cash disbursement function while dealing with employee embezzlement in the workplace.
THE BASICS
An independent volunteer, or anyone charged with monitoring financial activities, must ensure that funds are properly safeguarded from loss, that expenditures are promptly reimbursed, and that the organization's accounting records are accurate.
The highest fraud-risk employee in the disbursement system is the individual preparing general expenditure documents for approval by the governing body or oversight board. This employee has the opportunity to manipulate accounts often without detection by managers. The independent volunteer should:
- Ensure all check stock is appropriately safeguarded and controlled and that all checks are issued sequentially and listed on the log of all disbursement transactions approved by the governing body or oversight board
- Ensure there are no gaps in the sequence of check numbers listed from one payment period to the next or from one disbursement log to the next
- Ensure checks aren't pre-signed by the designated signatory official
- Ensure checks aren't issued prior to approval by the governing body or oversight board (If they are, the designated signatory official's actions should be bonded by insurance for an amount specified in the organization's policies and procedures manual or in the governing body's meeting minutes.)
- Ensure all issued checks are recorded accurately in the organization's accounting records
- Verify critical information from the accounting copy of all disbursement transactions (such as payee, date, amount, coding of expense, etc.) agrees with the check register, the accounting records, the log of disbursement transactions approved by the governing body or oversight board, and the actual redeemed checks
- Review check endorsements for irregularities such as for any disagreement between the endorsement and the original payee on the check
- Examine check endorsements for dual signatures (particularly on payroll checks), endorsements made payable to third parties, and endorsements for multiple vendors with unexplained similarities such as deposits of the checks issued to multiple vendors that have been deposited into the same bank account
- Review checks for other anomalies including out-of-town checks cashed or deposited at a local bank; voided checks that subsequently clear the bank; checks issued to individuals for large, even amounts (because these payments are rarely routine); and abbreviated payee names such as IBM and UPS that easily can be altered by unscrupulous employees
- Review a sample of disbursement transactions for propriety by scanning the check register and log of disbursement transactions approved by the governing body or oversight board for any unusual or non-routine items
TRAVELING ON
Employees might take unauthorized trips for personal benefit and even make claims for travel expenses that violate the organization's policies and procedures. The highest fraud-risk employees are governing body or oversight board members, department heads, and any other trusted employees who prepare expenditure documents for the organization's approval. These individuals have the opportunity to manipulate the documents supporting each transaction for personal benefit. Because of their positions in the organization, other officials might not even review or approve their travel vouchers.
The independent volunteer should ensure that all travel vouchers have been approved by the governing body or oversight board, all reimbursements have been made at rates specified in the organization's policies and procedure manual, all expenses are reasonable and properly supported by receipts, and all expenditures are for legitimate business purposes (for example, no personal trips, no dependent travel expenses, and normally no first-class airline tickets).
The independent volunteer also should review travel vouchers for employees who attend formal conferences. Organizations should require each employee to file a copy of the conference brochure with the travel voucher. The organization should verify that meals and lodging provided to this employee while attending the conference and other direct billings to the organization for the individual's hotel costs are excluded from employee requests for travel reimbursement to ensure that the employee hasn't claimed duplicate travel expenses.
Determine if any governing body or oversight board member performs official travel and seeks reimbursement for expenses from more than one organization. Designate one of the organizations to pay this individual's travel expenses to prevent duplicate payments. This organization should then bill the secondary organization for its appropriate share of total travel expenses, which eliminates the need for the individual to submit duplicate copies of documents to one of the organizations -- an undesirable condition.
Ensure that all vicinity travel mileage is reasonable and reimbursed at the rate authorized in the organization's policies and procedures manual. This rate should also be the same as the federal mileage rate to eliminate tax problems for employees. Compare travel vouchers to employee time sheets for any obvious irregularities such as listed travel on days when the individual was absent from the workplace after claiming sick or annual leave or was performing other formal travel at destinations out of town. In other words, the employee can't be in two places at once.
PHONY PHONING
An employee might use an organization mobile phone for personal or unauthorized purposes. Obviously, the highest fraud-risk employees are those who have been given the organization's mobile phones or those who prepare expenditure documents for the organization's approval. The independent volunteer should:
- Ensure that all mobile phones are approved by the governing body or oversight board, used according to the organization's policy and procedures, and for official business purposes
- Ensure that access has been blocked for international mobile phone calls by all employees except for those executives who make international calls as part of their normal jobs
- Verify that all employees have certified in their monthly mobile phone statements that they have made all calls for official business purposes and that supervisors have approved them
- Scan telephone statements for any unusual activity such as calls made before or after normal duty hours and for out-of-state calls
- Verify that employees use the least costly phone plans for the amount and types of calls they make
FIXED ASSETS AND INVENTORIES
Every organization must account for its fixed assets and other accountable inventories. The highest fraud-risk employee is the custodian of these assets, but any employee could misappropriate them. The independent volunteer should ensure that accurate inventory records are maintained for (1) fixed assets, all of which have property tags affixed for accountability purposes, and (2) all other accountable inventories, which are properly secured in locked facilities with limited access.
The independent volunteer should analyze life-to-date maintenance records maintained for all vehicles in the inventory to discover any inappropriate purchasing of parts. That person should also analyze vehicle mileage and gasoline records for all vehicles in the inventory, discover if the organization uses these records to make vehicle replacement decisions for the fleet, and decide if managers periodically review these records to determine if all gasoline has been used for official purposes. (The volunteer could do this by comparing the number of purchased gallons of gasoline to the mileage over a period of time.)
Ideally, these records should include the date of each transaction, the amount of fuel purchased, the mileage of the vehicle, and the name of the employee making the purchase. Investigate any significantly low amount of miles per gallon of gasoline for any vehicle.
The volunteer can also verify that annual inventories have been conducted, that all items are properly accounted for and controlled, plus document and explain significant variances. Additionally, that person can review fixed asset and inventory write-offs for propriety.
BACK TO MILLIE'S FRAUD SCHEME
Millie violated her position of trust at two small and very vulnerable organizations by processing false disbursement transactions for her own benefit. For example, as the treasurer of the state advisory board, she reimbursed herself for fictitious expenses, purchased personal items on the board's credit card, transferred funds to the private nonprofit organization without authority, and issued checks to "cash" and a financial institution for unauthorized purposes.
As the executive director of the private nonprofit organization, she issued checks for personal or unauthorized expenses, took payroll advances and didn't deduct them from her end-of-month payroll check, and paid herself twice for the same vacation benefits.
The governing body and oversight board of these two organizations didn't properly monitor Millie's work to ensure that all cash disbursements were made for legitimate business purposes. However, the external auditor eventually detected these irregular disbursements during a routine audit of the state advisory board. Because Millie transferred state funds to the private nonprofit organization, the external auditor was able to follow the money and audit the records of this second entity -- a capability that would normally be outside its authority.
Millie plea bargained an agreement with the county prosecutor to pay $144,422 to the two organizations plus audit costs. She was sentenced to 18 months in the state penitentiary.
LESSONS LEARNED
Let's review some of the finer points of fraud and reasons small organizations not only need internal controls for cash disbursements but also volunteers to monitor those controls:
- As I've mentioned in previous columns, the organization must first segregate the duties of key trusted employees, if practical.
- The governing body or an oversight board should recruit an individual who's independent of the organization to periodically monitor the work of key employees to ensure that no fraud is being committed and that the organization's financial goals are being met.
- To have an effective monitoring program, the governing body or oversight board must give clear direction to volunteers by telling them exactly the tasks they want to be accomplished, and more importantly, why they should complete them.
SAVORING ALL THE SIGHTS AND SOUNDS
But wait, there's more! We'll conclude our discussion about guidance for volunteer professionals who monitor the cash disbursement function of small organizations in the next column to savor all the sights and sounds of this most interesting area.
Regent Emeritus Joseph R. Dervaes, CFE, CIA, ACFE Fellow, has retired after more than 42 years of government service. He remains the vice chair of the ACFE Foundation Board of Directors.
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