MONEY MATTERS
ASSET MISAPPROPRIATION
BY JOHN CHARTIER

Internal controls are essential in any business, especially small businesses where employees are asked to perform many diverse duties. Although implementing controls may seem challenging, small business owners are particularly vulnerable to asset misappropriation.

Mary had been Craig’s office manager from the day he opened his doors. He had known her since high school. She did everything for him — handled personnel issues, ordered materials, collected delinquent accounts and reconciled the bank statements. He couldn’t imagine running the business without her. She was the first person in the office each morning and the last person to leave each night.

As the years passed, Craig’s business had grown dramatically. As each employee was added, Mary had become increasingly difficult to deal with. She was always very direct, but now she was even snapping at Craig on a daily basis. She acted as if she resented his questions regarding the financial affairs of the business.

Craig would never forget that rainy Friday in late October. He had a busy schedule meeting with clients, so he decided to come in early to sign the weekly paychecks. He knew Mary would have the checks ready for his signature, as she always finished payroll on Thursday evenings before leaving.

Craig was surprised to find the office locked when he arrived. He checked his desk for the paycheck folder, but it was nowhere to be found. He walked down the hall to Mary’s office and was shocked to find it unlocked; she was always adamant about keeping people out of her office.

As he switched on the lights, he immediately noticed how clean Mary’s desk was. Not a file or paper in sight. Suddenly, Craig experienced a cold shiver and became very nervous.

Craig never saw Mary again. He transferred money from his personal savings to cover the payroll, and the business survived. His new CPA was able to identify more than $500,000 Mary had embezzled over the years — but suspected the amount was at least five times that sum.

Segregation of duties is a critical aspect of internal control. The typical approach is to separate transaction authorization, record keeping and custody of assets. 

In most small businesses, the owner should retain authority to approve transactions. Tangible evidence of approval should be available, such as signed checks and purchase orders. 

The record keeping function should be segregated from transaction authorization function. Transactions should be accounted for on a timely basis to facilitate detection of errors and preclude falsification. In addition, all items to be recorded must have proper documentation that the transaction was authorized.

Asset custody is particularly challenging in a small business. The owner — as well as many employees — have numerous and diverse responsibilities. Keeping track of inventory, property, equipment — and even cash — makes it difficult to segregate duties effectively. Regular physical inventories and timely account reconciliations are essential to ensure these assets are protected.

The fundamental internal control principle is that no single individual should have control over an entire transaction — either formally or informally.

Why do employees steal from you and your business? Quite simply, because they can. It’s up to you to implement effective safeguards of your assets. 

Ensure orders are recorded in a timely, accurate manner. Account for all cash transactions and ensure timely deposits. Complete billings immediately to avoid collection challenges. Ensure credit authorization procedures are followed. Require authorization for all material purchases. Match materials received to purchase orders daily. Ensure employee hours are authorized and properly recorded. Require proper receipts before monies are disbursed. And limit check signing authority to a single owner.

Your CPA should review your internal control procedures at least annually to safeguard your assets. All transactions should be reviewed prior to producing monthly financial statements, ensuring each transaction was authorized and properly recorded. In addition, your CPA’s timely reconciliation of your banking, receivables, payables and inventory accounts can prevent — or quickly identify and eliminate — misappropriation of your assets. 

Employees are far less likely to misappropriate assets when they know someone outside the organization is watching. LW