The Best Ways to Detect and Protect Your Contracting Business from Employee Theft and Fraud

April 25, 2019
Category: Be a Highly Effective Owner,Eliminate Problems and Fires,Hiring

Over the years several of my clients have experienced employee fraud or theft in their businesses. It’s not a pleasant experience.

I read a troubling statistic recently from a 2018 study by the Association of Certified Fraud Examiners, that 28% of businesses with less than 100 employees experience fraud or theft by employees each year and that the average company will lose 5% of their revenue due to fraud. The report says that biggest contributing factor to fraud and theft is the lack of internal controls.

So, how do you know if fraud is taking place in your business and how can you protect your business?

To find out, I asked my colleague and friend Diane Gilson owner of Info Plus Accounting. Diane’s firm provides job-cost and management accounting training, consulting, and support products for construction and contracting companies. She’s great!

Diane has written a series of 12 brief but informative articles on different aspects of fraud detection and prevention that I want to share with you.The first two intro articles are below. To access the remaining 10 articles in Diane’s fraud series CLICK HERE.

This is must read material, if you want to avoid being part of the 28% who experience fraud and theft each year!

Protecting Yourself from Fraud: An Introduction

By Diane C.O. Gilson, CPA, CIA, President, Info Plus(+) AccountingSM PC

The first in a series of articles on preventing fraud from affecting your business.

Theft doesn’t have to happen with a gun. You can be robbed in broad daylight while you’re out working on a job site, as you sit at your desk talking to a vendor or while you’re on vacation. And you won’t even know it happened until well after the fact — if ever!

Through my years of experience as a certified public accountant, certified internal auditor and QuickBooks® ProAdvisor, I have seen a surprisingly high rate of significant internal frauds. I have investigated instances of embezzlement and have studied various documented fraud cases, specifics and fraud warning signals.

When I help my clients develop management and cost accounting systems, I typically advise them about implementing basic, cost-effective controls to help minimize, prevent or detect fraud. When I work with owners of small businesses, I normally find that, unless they’ve personally experienced prior theft, they have little or no knowledge about:

• How they may be at risk
• How simple frauds are easily perpetrated
• Warning signals (“red flags”) of fraud
• Basic anti-fraud controls
• How to proceed if they suspect or discover fraud in their company

Without this information, small business owners (and particularly those in the construction industry) are exceptionally vulnerable to major loss. Fraud is a quiet, insidious form of theft that can rob you, your employees and your family of your financial security and everything you’ve worked for over the years. It is not uncommon for a major fraud to cause a company to fail. And the criminal seldom makes restitution or goes to jail.

It’s a darn shame — and it needn’t happen to you.
I’ve developed this series of business management articles, to brief you in the following areas:

• Assessing your knowledge of fraud
• Why construction businesses are at increased risk for fraudulent activity
• The power of self-defense strategies (awareness, preparation and action)
• Warning signs and what to do if you suspect or discover a problem
• Analyzing and recognizing the specific risks that your company faces
• The importance and impact of environmental controls
• Preventative and detective controls for bank accounts, credit cards, payroll and employees, purchasing and company costs and computer and accounting systems
• Avoiding identity theft

I’ll include real-life examples of actual frauds and discuss controls that could have prevented the fraud or detected it in its early stages.

A Quiz to Get You Started

The following quiz will get you thinking about your areas of risk (answers are at the end of the article). This actually is the first half of the quiz. The second half will be provided in the next article of this series.

1. Most frauds are committed by (choose one):

a. Smooth-talking, deceptive con artists

b.Long-term, trusted management level employees

c. Sharp, young employees who are new to the job

d. Front-line or field employees with access to assets

1. Which of the following scenarios might encourage the bookkeeper for a small company to “temporarily borrow” some funds from the company (choose all that apply)?

a. The job duties include:

• Posting deposits and checks to the accounting records
• Creating checks for the owner to approve and sign
• Mailing checks after the owner signs them
• Promptly reconciling the checking account at the end of the month after you receive the bank statement
• The boss doesn’t understand the accounting reports and seldom reviews the financial statements.

b. The company owner has a clearly posted “immediate dismissal and report to the authorities” policy for theft within the company.

c. As a part-timer, the bookkeeper is paid at a very modest hourly amount, doesn’t qualify for benefits and has some high expenses and several large credit card balances.

3. True or False: The bank will only clear checks that show the name(s) of authorized signers.

4. True or False: The bank checks authorized signatures on checks exceeding $10,000.

5. Your blank checks are stored in a drawer in your bookkeeper’s desk. Without your knowledge, several checks are removed from the bottom of the box and made payable to “Pam Wilson.” Your name is forged and the checks are cashed. They clear for a total of $14,500. Your actual loss is (choose one):

a. $0; because the bank is responsible for any forged checks.

b. $0; because you discovered the forgery two months later while performing your bank reconciliations and promptly reported it to the bank.

c. $0; because your employee bonding insurance will cover the loss.

d. $14,500; because you were negligent. The checks were not properly secured, you did not report the theft to the bank within 30 days of receiving your statement and your insurance deductible is $50,000.

Answers:

1. b. Why? Because they are in a position to do so and the work of trusted employees is seldom reviewed or questioned.

2. a. The bookkeeper controls all accounting activities so there is minimal opportunity to spot fraudulent transactions. And if owners don’t understand or review work, it’s like announcing that they are putting a large sum of money in a drawer but will never check to see that it’s all there.

c. Underpaid employees can develop a “they owe it to me” attitude.

3. False. Although a sharp teller might catch a bad signature at the teller window, most checks are processed by the thousands in batch mode and signatures aren’t checked.

4. False. See number 3. Banks may check signatures on a small percentage of checks written for large amounts (e.g., more than $5,000 to $25,000, depending on the bank), but you should always assume that the authorized signature “control” is nearly non-existent.

d. Self-explanatory answer. Banks can require you to notify them of discrepancies within 14 to 30 days. You’ll probably want to check your bank to see how much notification time you are allowed and then be sure to reconcile within that time frame.

Re-printed from Nation’s Building News, December 15, 2003

Diane C.O. Gilson, CPA, CIA, is a Certified QuickBooks ProAdvisor
and author, trainer, and construction accounting coach,
as well as a frequent speaker at The International Builders’ Show and The Remodelers’ Show.
Her firm, Info Plus Accounting, provides job-cost and management accounting training,
consulting, and support products for construction and contracting companies.

Contact Diane at 734-544- 7620 or Help@InfoPlusAcct.com

To access the more articles by Diane, CLICK HERE.

Are You at Risk? Protecting Yourself from Fraud

By Diane C.O. Gilson, CPA, CIA, President, Info Plus(+) AccountingSM PC

The second in a series about preventing fraud from affecting your business.

There are many scrupulously honest, dedicated and loyal employees who would never dream of defrauding their employers. But, unfortunately, there are far too many frauds committed against innocent business owners by employees who are “wolves in sheep’s clothing.” The following information will help you become more knowledgeable so that you can begin to protect yourself.

Why Are Small Businesses So Vulnerable?

Lack of financial expertise. Individuals typically start new businesses by converting years of advanced skills and industry expertise into marketable products and services. A small business owner generally has abundant technical skills (to provide a product/service) and people skills (to sell the product or service). But rarely does he or she have the financial expertise to run a business.

Most business owners are happiest when they are producing or selling and would prefer to have someone else handle the financial side of the business. Many owners are uncomfortable working with numbers, or are not interested in investing valuable time to learn how to understand or structure their financial information.

Lack of risk awareness. Business owners are usually hard working, honest, positive and upbeat individuals who project the same attributes on others. Because they are risk-takers with a certain sense of invulnerability, they are not typically suspicious and often fail to create even the most basic financial controls or safeguards for their companies.

To heighten your risk awareness, you should periodically remind yourself that there are others who may:

• Be less honest and straightforward than you
• Feel they deserve a paycheck every week regardless of work delivered
• Think that they deserve to earn far more than you pay them
• Feel entitled to “adjust” their incoming funds to higher levels
• Perceive that, because you are a business owner, you are a wealthy person
• Believe they deserve some of your money
• Believe that if you don’t have strong controls in place, that you are inviting them to help themselves
• Expertly conceal debt, alcohol or drug issues for extended periods of time.
• Initially intend to “borrow” some funds for a short time but then can’t pay it back. As their cash needs continue, they continue to “borrow” from you.

Limited information and resources. Information about fraud risks and controls is not common knowledge or readily available. CPAs, internal auditors and security officers are trained in common risks and controls, but this specialized information is not regularly distributed to the public.

Because small-business fraud is seldom prosecuted and because small businesses don’t have human resources departments to properly investigate applicants, embezzlers are often free to move from business to business.

Business owners often believe that fraud can’t happen at their companies or that the additional work required to implement the controls is too costly or time-consuming, given their current staff. (Too often, they implement fraud controls only after a large fraud has been discovered.)

Additional Construction Industry Stressors

More than most businesses, the construction industry is susceptible to financial control weaknesses. On the financial and accounting side, home builders:

• Experience high-dollar flow-through situations. Even if your bottom line is extremely modest, funds coming in and funds going out are much higher than in other small business environments. These large amounts and numerous transactions can create a high-temptation environment for individuals with access to assets.

• Many companies undervalue the importance of timely, accurate financial information. However, business owners cannot be confident about the numbers they see in their financial reports when records are messy or non-existent and the financial environment lacks control. They are unable to spot financial problems when they occur.

• Financial transactions are complex (e.g., job costing, various allocations, percentage of completion and completed contract entries) and can be difficult to follow or understand. This makes it easy to hide or “bury” fraudulent transactions, especially when financial controls are weak or non-existent.

On the operational side, owners are exceptionally busy handling the numerous phases of construction projects. Extra-busy owners have little time to dedicate to the financial side of their business. They also have a tendency to delegate heavily (especially on the financial side), and may also spend a great deal of time in the field away from the office. All of these factors contribute to a loose financial control environment and higher risk of fraud.

Fraud Quiz ― Part 2

Here is the second half of the quiz initiated in this series’ introductory article. Ask yourself the following questions to assess your knowledge of fraud risk areas (answers are at the end):

1. Employees who commit fraud often do so because (choose all that apply):

a. They need a short-term loan and intend to pay the money back.

b. They observe that small errors or obvious discrepancies are not challenged or corrected.

c. Their lifestyle (or other financial circumstances) requires additional funds.

d. The opportunity consistently presents itself.

e. They have a drug or alcohol problem.

f. They have a criminal background.

g. Additional funds will allow them to take more time away from work.

h. They want to “get even” with the boss.

   2. Small business owners who discover that an employee has committed a relatively small fraudulent act are likely to (choose the best answer):

a. Confront the employee, deliver a stern warning and keep a close watch on the employee until they are sure the person has “learned his or her lesson.”

b. Immediately dismiss the employee.

c. Contact their attorney and accountant for advice on how to proceed.

d. Report the fraudulent act to authorities.

e. Prosecute the employee.

f. Receive full restitution from the employee.

3. When hiring bookkeepers or internal accountants, most small business owners make their hiring decision after:

a. Performing in-depth background and credit checks, discussing the candidate’s skills, work habits and honesty with former employers, and testing the person’s software and accounting skills

b. Conducting several interviews, reviewing the candidate’s educational  background, formal credentials and resumes, and satisfying themselves that the individual appears to be hard working and honest

c. Learning that the individual is the most reasonably-priced applicant available, that he or she seems to be reasonably intelligent, has “bookkeeping experience,” has worked with the existing accounting software and that the person is “willing to work hard and to learn.”

Answers:

1. a.   Most employees who commit fraud truly intend to pay the money back.

b. If small errors or obvious discrepancies in the books are undetected by owners or management, it quickly becomes apparent to the bookkeeping staff that no one is paying attention to the financial records. It’s like announcing to the staff that you’re leaving your finances unattended.

c.In today’s society it is very easy to live (or aspire to live) well beyond one’s means. And a variety of other financial stresses (e.g., medical costs, divorce, emergencies, family demands, peer pressure) can motivate anyone who is easily tempted.

d.When employees are consistently given unmonitored access to assets, only a person of true integrity would not be tempted to “borrow — just a little.”

e.Drug and alcohol problems are abundant, and unfortunately, many of the people with those issues are also skilled people-pleasers and masters at hiding their situations. Unless you screen out these individuals during the hiring process, you end up with an employee who is an expert at subterfuge and is also likely suffering from money problems.

f. Chances are that only a small proportion of the people who apply to work for you have any kind of criminal background. But if they did, how would you know? How thorough are your background checks?

Answer “g” is unlikely because an effective fraud requires continual close monitoring, so perpetrators may actually take far less time away from work than other employees.

Answer “h” is generally not the primary motivating factor for embezzlement.

2.  a. Many employers choose this “parental” approach. You should exercise caution with this as keeping an employee who has committed fraud on staff may void your bonding insurance.

b. through e. Although some business owners choose one or more of these options, they are not the typical responses to discovering internal fraud. Why don’t people report fraud? Some of the reasons may include:

• • Shock and denial
  • Parental forgiveness of employee
  • Feeling sorry for the perpetrator
  • The potential for unfavorable publicity
  • Personal embarrassment about being fooled or being a victim
  • Cost/time related to prosecution
  • Easiest route is to just ignore and “go on”

f.Although I have seen fraud cases taken to court, court-ordered restitution and fraud perpetrators begin to make restitution, the chance of receiving the lion’s share of embezzled funds is rare.

3. c.  The answer should be “a,” but the real answer, based on my experience, is “c.”

Re-printed from Nation’s Building News, January 26, 2004

To access the remaining 10 articles in Diane’s fraud series
CLICK HERE

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