Ever been to a teen gathering where the icebreaker activity is untangling your 30-foot strand of twine from the 40 others that have been woven into a gigantic web? Figuring out the losses, timeframe, and methods of embezzlement can be a similarly complicated task. Without accurate forensic accounting, claims can be under- or over-paid.
Employee fraud is most likely to occur in a workplace environment where office and accounting duties are not segregated or are “siloed”—delegated to only one person. While embezzlers have myriad maneuvers to cook the books—paying for services that were never rendered, compensating phony travel, deleting accounting records—nothing lines pockets like cash. Claims professionals who are dealing with hard-to-track money like cash or with complex payment schemes involving stocks or multiple fraudsters need to get accounting experts involved with the investigation.
Drilling for Dollars
The owner of a successful water well drilling and pump installation company had suspicions that an employee was stealing cash. The company had annual revenues of approximately $10 million. Under suspicion was a longtime, trusted employee who served as the company’s office manager and bookkeeper. The employee’s office responsibilities included managing the accounts receivable and depositing receipts (cash and checks) into the company’s bank account when received from customers. In addition, he performed the reconciliations of the company’s cash balances on the books to that of the bank accounts.
The owner of the company observed a customer paying with cash (hard currency) and became concerned about how cash receipts were being handled. The owner also noticed that the employee who accepted the cash payment provided that cash to the office manager/bookkeeper to post the payment on the company’s books. Now the owner needed to determine whether or not the cash had been placed into the cash drawer or the petty cash box prior to its deposit.
Fortunately for the owner, the office manager/bookkeeper was out the following day, and while he was away, the owner searched his office for the cash but was unable to locate it. The owner then contacted his bank to see if the cash had been deposited. The bank advised that no cash had been deposited into the account since it had been opened two years earlier.
A review of the books and records of the company, including all of the business bank accounts, was performed. Bank deposit slips were analyzed and compared with entries in the general ledger, and it was determined that several general ledger entries identified as cash receipts from customers were not deposited into the bank account. Fortunately for the owner, his company’s business insurance policy had recently been renewed and included coverage for employee theft.
The office manager/bookkeeper ended up confessing to the misappropriation of cash and further admitted to writing himself extra payroll checks that he cashed and subsequently voided from the company’s accounting system. The amount of loss was determined for the period covered by the insurance policy as well as the period prior to the policy renewal date, which is also covered under certain conditions.
What to Look For
Fraud experts agree that three components are typically present when a fraud of this type occurs: motive, opportunity and rationalization. Investigation of the suspected thief may reveal information about incident dates and amounts that are needed for establishing accurate claims payments. What may also be present are disqualifying factors—circumstances that nullify insurance coverage.
Claims investigators can start with motives when trying to expose information to aid data collection. Living beyond one’s means, poor credit or unexpected need can not only motivate someone to embezzle, but can also provide a chronology and a series of data on the suspect’s expenditures that can often be tagged to dates of theft.
The insurance adjuster should ask to review the subject employee’s personnel file to determine if any prior misconduct has taken place. If the subject employee has been involved in prior criminal activity or was suspected of theft or other dishonesty, it often is sufficient reason for the claim to be denied.
Reducing the Take
Understanding motive, opportunity and rationalization aids in prevention and early discovery of fraud. The opportunities mentioned above—non-segregated accounting duties or a “siloed” bookkeeper—can be exacerbated by negative employee workplace issues, such as a lack of motivation, a lack of recognition, or the sense they are underpaid. Thieves will even rationalize that they are not hurting anyone because the company is covered by insurance! Combine all that with an employee with motive, and you have a business tailor-made for pocket-lining.
The following list of bookkeeping procedures may help prevent employee fraud. Management should ensure that:
- Mail is opened by an employee who does not perform bookkeeping functions.
- Cash receipts are not handled or recorded by employees having access to accounts receivable or general ledger.
- Cash receipts are deposited daily.
- Sales staff and/or drivers do not handle or accept cash receipts.
- Bank accounts are reconciled independent of cash receipts, accounts receivable, and general ledger functions.
- Employees responsible for posting receivable accounts have no access to cash receipts.
- Cash receipts are applied to specific invoices rather than current balances.
- Delinquent accounts are followed up independently of the cashier.
Education is key for the small-business owner as well as the insurance adjuster. With the implementation of some basic loss prevention internal control procedures and the proper insurance coverage, small-business owners can prevent or significantly impair employee theft. Employee dishonesty insurance protects the employer from financial loss due to the fraudulent activities of employees that result in the employees’ personal financial gain. Most employee dishonesty insurance policies are written on a blanket basis so that all employees are covered, and the loss can be the result of the employee's theft of money, securities, or other property of the insured.
Insurance adjusters must be aggressive in their investigation of losses. An understanding of the underlying motives to commit fraud provides adjusters with background knowledge that may assist them in their investigations. When necessary, adjusters should seek the assistance of forensic financial consultants in investigating and verifying loss amounts.
The Forensic Accountant’s Role
Forensic accountants wear many hats and can assist the claims professional in fraud investigations in a variety of ways. Often, they are certified public accountants, certified fraud examiners, and sometimes private investigators. They are independent and impartial, taking into account both the financial records and employee behavior.
Because fraudsters work hard at hiding their crimes, forensic accountants must look beyond the numbers. For example, a public record search may reveal the subject owns numerous residences, cars, boats, and investment land. This will be a red flag to a forensic accountant—especially if the wealth was accumulated on a moderate salary. Conversely, the information related to the tangible assets of the suspected fraudster can be helpful to the insurance company and the defrauded business for potential monetary restitution for the amount of stolen money.
A typical fraud engagement includes an in-depth review of the books and records of the defrauded business and an analysis of its internal control system. The method of defalcation is then determined, and the financial quantification of the loss is calculated. Beyond calculating damages, personnel files may be reviewed and employee interviews may be conducted in the search for clues and factual evidence. The reports generated by the forensic accountant are often useful in mediation or arbitration, or they provide the basis for the forensic accountant’s expert witness testimony in court.
In summary, forensic accountants are more than just number crunchers. They know how to conduct investigations, navigate various computer programs, and communicate well. They exist to solve problems and help the insurance, legal and corporate communities.
Robert D. Jones, a partner with
RGL Forensics, is a certified fraud examiner, certified business manager and licensed private investigator. He can be reached at (213) 996-0900 or
bjones@us.rgl.com.