Element of Surprise a Valuable Asset in Fraud Prevention

There’s nothing quite like the element of surprise when trying to get to the core of an issue. When we’re not expecting something to happen, there’s no time to craft a calculated response based on what we think it should be or what others want us to do.

The same principle can be highly effective when investigating the actions of a member of your internal accounting department. When it comes to preventing fraud and embezzlement, the element of surprise is a rarely used preemptive tactical advantage. Everyone likes to know what is coming, especially those who may be cooking your books or taking advantage of a company with little oversight and deficient internal controls.

Today, business executives must leverage every advantage in their fraud prevention arsenal in the never-ending fight to prevent employee misappropriations. I want to be cautious in using the term “fraud audit” to describe these types of engagements because a surprise review is in no way similar to any sort of financial attestation project. These reviews are consulting engagements that may not even be accompanied by a written report unless one is requested by the client.

Prior to commencing such a proactive fraud prevention program, we meet with the client to assess areas of potential vulnerability and, depending on transactional volume, can even zero in on specific types of transactions. The timing of site visits is coordinated with the company executive to ensure we are not impinging on the affected employees’ busier days, such as payroll or month-end closings.

Management communicates the initiation of such a program to employees beforehand, ensuring that staff are aware of the initiative. While our arrival may still be unexpected, it won’t be a complete surprise when the unfamiliar external accountants show up at their desks asking to see various source documents, files and records.

These engagements are all customized based on the client’s request, needs and overall risk exposure. To maintain an element of unpredictability, we rotate the focus of our reviews on a random basis, keeping the internal accountant guessing what will be examined next.

For instance, one company engaged us to show up unannounced on a quarterly basis. On the first day, the accounting staff were taken aback at the lack of notice but quickly recognized the value of the process. And most important, they were cooperative. In the first quarter, we examined checks greater than $1,000, along with supporting documentation. In the next quarter, we reviewed employee expense reports. Next, we looked at credit card transactions and electronic fund disbursements, then payroll reporting, and so on. The amount of time spent on the respective examination and frequency are both determined by the client. This approach enables the client to control the cost associated with the initiative.

Surprise fraud audits commonly entail a review of:

• • Employee expense reports
  • Credit card expenditures
  • Any disbursements to company employees, spouses or family members
  • Payments to “cash”
  • Check disbursements and the underlying supporting documentation
  • Electronic disbursements
  • Payroll
  • Disbursements based on dollar amount criteria
  • Bank account reconciliations
  • Adjusting journal entries

The impact of having outside professionals regularly onsite to conduct independent reviews of various transactions is immeasurable. If an employee is thinking of perpetrating fraud, the fact that someone is regularly looking at selected transactions usually makes those with questionable morals and ethics think twice. Additionally, this tactic reinforces the company’s anti-fraud tone at the top.

We have had several clients effectively implement quarterly fraud audits. As a result, the success of the program has reduced the scope of their annual attestation engagement from an audit to a review or a review to a compilation. These engagements are a better use of accounting dollars, and the deliverable and peace of mind supersede the perceived value of performing a traditional financial statement project.

A surprise fraud audit is a highly effective yet seldom-used fraud prevention measure. As Charles de Gaulle once said, “A true leader always keeps an element of surprise up his sleeve, which others cannot grasp but which keeps his public excited and breathless.” We could not agree more, General.

 

Contributing Author: Sean T. Daughton, CPA, CFE, is an audit partner with over 29 years of experience specializing in forensic accounting and consulting services. He provides audit and advisory services to a variety of clients, including automotive dealers, manufacturers and retail corporations. For more information on this topic, you may contact Sean at sdaughton@dmcpas.com or (315) 472-9127.