Sound Internal Control Needed To Safeguard Your Business Assets
By: Richard L. Goldstein, MBA, CPA

Each year many business owners discover that their assets are not as well protected as they thought when they become victims to employee theft. This is particularly true in small-business environments where a single employee manages all the finances. Often there are no "checks and balances" to verify that transactions are accurate. Most employee thefts are perpetrated by highly trusted employees in key positions, involving substantial sums of money.

When proper, consistent procedures are not in place, employees can learn to manipulate the accounting system to their benefit. Whether they take money from the company or their mistakes are undiscovered, the end result can greatly impact your company’s management discussions, financial reports, and tax filings.

Unfortunately, once year financial records have been altered, discovering problems is extremely difficult. Most standard accounting practices are not designed to uncover internal problems such as embezzlement.

Depending on your CPA to protect against acts of one employee is a dependence that is false comfort. A review or compilation engagement is not designed nor intended to uncover or search for defalcations. In conducting a review or compilation the CPA does not gather evidence that may be necessary to uncover a defalcation. Also, the CPA concentrates on large transactions and major accounts that, if in error, could have a material effect on the company’s financial statements. For this reason, an employee who tampers with a number of small accounts over an extended period will usually escape detection.

Many people holding key financial positions may have gained an understanding of the review and compilation process and its inherent limitations. Therefore, they are in a position to access the company’s assets by methods not subject to detection.

The odds are that you will probably never experience a major defalcation. Yet, statistics are high that at least one of our clients will be victimized every few years.

Therefore, the best way to safeguard your agency's assets is to recognize and improve weakness in your internal procedures. Defalcations are more likely to be discovered when there is an appropriate separation of duties between asset handling and recording functions. It is also critical that you exercise managerial oversight. The following business practices can help you minimize potential internal control problems.

1. Related duties should be assigned to different people: Certain accounting functions are designed to cross-reference each other for accuracy, writing/signing checks, ordering/paying/receiving materials, handling cash/recording cash, etc. These procedures can reveal inconsistencies in your records in a timely manner.

2. Reconcile and scrutinize your bank statements every month. A bank statement can tell you a lot about your business if you review the information in a timely manner. Actions you should do on a monthly basis include the following:
a. Receive the unopened bank statement directly and open it up personally.
b. Scan the front and back of all canceled checks.
c. Question the purpose of all transfers.
d. Compare payroll checks with employee records, and ask questions.

3. Signing checks:
a. Never sign a check without inspecting original supporting documentation including the invoice, shipping documents and the purchase order.
b. Cancel all supporting documentation after signing a check.
c. Never sign a check that is not completely filled in.
d. Verify the names of your vendors.

4. Protection of Valuables
a. Keep blank checks and the signature stamp secure. (Better yet, do not use a signature stamp.)
b. Deposit all cash and checks daily.
c. Get fidelity bond insurance for all accounting and key employees.
d. Backup all computer files on a regular basis and store the backup at a secure, remote location.
e. Periodically, change computer system passwords.

5. Watch out for changes in employee behavior:
a. Always verify employee references before hiring.
b. Be aware of substance abuse, changes in lifestyle, living beyond means, possessiveness of work.

These are some of the internal controls that can help you reveal many discrepancies. Your CPA can help you develop and implement any of these important internal controls.

Client Internal Control/Defalcation Checklist

1. Segregation of Duties
a. Is the person who handles cash also responsible for recording cash?
b. Does the person who pays or orders inventory also receive materials?
c. Are two or fewer people responsible for reviewing financial statements each month?
d. Is your review of financial journals sporadic?

2. Bank Reconciliations:
a. Do you reconcile the bank statement on a timely basis, at least once a month?
b. Do you review any adjustments and verify reconciling items?
c. Are reconciliations performed by one person and reviewed by another?
d. Is the person who writes checks restricted from signature authority?
e. Do you review canceled checks and endorsements on a monthly basis?
f. Do you compare payroll checks with your current employee records?
g. Do you question funds transferred between bank accounts?
h. Do you track the number of credit card bills you sign each month?

3. Supporting Documentation:
a. Do you ever sign blank checks?
b. Do you ever sign checks without original supporting documentation?
c. Have funds ever been transferred between accounts without review or verification?
d. Do you ever sign checks for new business vendors without knowing or verifying their name and association with your company?

4. Employees: [Know your employees and be aware of changes in their behavior.]
a. Are any employees extremely possessive of their work records and reluctant to share their tasks?
b. Are any employees apprehensive about taking a vacation and time off, and are also the first one in the office and last one out?
c. Have you noticed a substantial change in the lifestyle of any employee?
d. Do any of your employees have a possible substance abuse problem?
e. Are any of your employees living beyond their means?
f. Have you ever hired an employee without checking references?
g. Do you permit accounting personnel to work longer than a year without taking a vacation?
h. Do you have any accounting staff that has not been bonded?

5. Safeguard Assets: Are blank checks and signature stamps locked up?
a. Do you restrictively endorse all checks?
b. Do you deposit all cash and checks daily?
c. Do you maintain a list of office furniture, equipment, and vehicles?
d. Do you back up all computer files on a regular basis and store the backup in a remote location?
e. Do you have password restrictions for your systems?
f. Do you maintain adequate insurance coverage on all assets including business interruption insurance?

Analytical Procedures in a Review Engagement

In conducting a review engagement, the accountant performs procedures consisting of inquiries of company personnel and analytical procedures applied to financial statement data. Generally, the accountant does not gather evidence as he or she does in an audit.

Analytical procedures include evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. A basic premise underlying the application of analytical procedures is that plausible relationships among data exist. Analytical procedures may help identify potential material misstatements. The results of such procedures should be used as a basis for making additional inquiries and obtaining additional information. Using analytical procedures includes not only calculating ratios and trends, but also analyzing the results and identifying fluctuations and their cause.

The rules for applying analytical procedures are found in SSARS No. 1 and include the following:
a) Compare financial statements from year to year, for comparable periods.
b) Compare financial statements with budgeted/forecasted information for comparable periods.
c) Study relationships of the elements of the financial statements that would be expected to conform to a predictable pattern based on an entity’s experience.
There are three (3) types of analytical procedures:
a) Trend analysis: Study the change in accounts over time.
b) Reasonableness tests: estimating a financial statement amount or the change in an amount from the prior year and comparing it to the existing financial statement amount.
c) Ratio analysis: Studying the relationship between two financial statement amounts.

When the analytical procedures identify significant fluctuations and lead the accountant to believe that information may be incorrect, incomplete or otherwise unsatisfactory,

SSARS No. 1 requires the accountant to perform the additional procedures he or she deems necessary to achieve limited assurance that no material modifications should be made to the financial statements.

In applying analytical procedures in a review engagement, the accountant may achieve both effectiveness and efficiency by using the following decision approach:

Types of account balances Procedures to Apply
Immaterial account balances: Apply no analytical procedures if the risk of understatement is low.

Material account balances:

a. Significant other accounting procedures have already been applied.


Consider whether the existing evidence is adequate and whether any material errors are likely to occur. Analytical procedures are usually not needed.

b. Significant other procedures have not been applied. Analytical procedures should be applied:
Analytical procedures should be applied:
a. Develop expectations using historical trends.
b. Compare the actual balance to the expected balance. If the result is close, no additional procedures are applied.
c. If the result is a large difference, material errors could exist. Inquiry about valid business reasons for the difference should be made.
d. Other analytical procedures should be applied if needed.

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