Connect with us

Business Operations

Planning for Fraud: Using Forensic Accounting to Protect Your Business

On average, more than 20% of corporate profits are lost due to fraud each year.

Advertisement

Advertisement
Click Here to Read More
Advertisement

On average, more than 20% of corporate profits are lost due to fraud each year. That number is even higher among small companies, where there is usually more trust and owners often turn a blind eye, thinking it will never happen to them.

If you assume the only times you need an accountant are for tax preparation and year-end financial statements, think again. In recent years, a new breed of accountant has proven popular – the forensic accountant. Part financial expert and part detective, forensic accountants investigate trends in your business in order to uncover potential problems, including overbilling, inaccurate rent or lease contracts and fraud, among others.

While forensic accountants have been around for quite a while, they only recently have become more formalized. The American Institute of Certified Public Accountants (AICPA) issues a Certified in Financial Forensics (CFF) credential to CPAs who meet specific requirements. Only 1% of CPAs have qualified for the designation of CFF. I am proud to say that my firm is in that top 1%.

As senior partner and founder of Richard L. Lipton CPA & Associates LLC, I have many tire dealers as my clients, which makes sense as my roots are in the tire business. I was a stockholder and manager of family-owned Sam’s Tire Co. in New Jersey for about a decade.

Advertisement

Here’s how a forensic accountant is different from a typical CPA. With traditional accounting, a dealer meets with an accountant and gives them the business’ books and records. The accountant puts a financial statement and tax return together based upon what is provided to them – and that’s it. If the business owner does not give something to the accountant, it’s not recorded in the tax or financial statements. In many cases, accountants are trained to look “at” numbers. Forensic accounting, on the other hand, is investigative and accountants are trained to look “into” the numbers. The forensic accountant takes a detailed look at the books in addition to interviewing employees, suppliers and landlords if necessary to protect the client.

The first step a forensic accountant takes when investigating a business is to benchmark the numbers of financial statements in order to look for discrepancies. This includes looking for any numbers that stand out from the others to help identify which areas to target for further research.

A forensic accountant starts by talking to the dealer to find out whether there are any suspicions or concerns, in addition to getting an idea of how the business is run. This includes finding out which employees serve which roles – from bookkeeper, shop foreman and warehouse manager to service truck driver – and how much the business owner trusts them.

Advertisement

It’s important to communicate to your accountant if you’re suspicious of anything. But often, fraud occurs in the least likely place a dealer would think to look: with that trusted employee who has worked at the business for many years. When dealers trust someone completely and give full control, that’s where fraud has the potential to occur.

The owner of the business will often say, “That person is the most honest person,” and “They’ve been with me for the first day and I trust them with everything.” Generally that’s the person we look at first. The reason is simple – if they trust them so much, they let them get away with everything because they’re not watching them. In most cases fraudsters are good – so good they can convince anybody how honest they are.

Another sign my firm looks for when tracking down fraud is employees who work overly hard to maintain control of their particular job. Often, they have built a sense of trust with the owner and won’t let anyone else touch their department.

One example was of a sales manager for a larger organization. The individual did their job well and was highly regarded so they left him alone. He also traveled quite a bit for his job, so much so that it seemed a bit excessive. When we looked into it further, we uncovered that he was taking his wife on all of his business trips without the company’s permission.

Advertisement

When exploring business-related expenses like travel, it’s important to identify the reason for the trip and any relevant details behind the money spent. What seems like a necessary business trip might actually be a vacation. Things like hotels, food, side trips, and rental cars should also be justified and traced back to specific meetings or events.

In one case, we found that an employee started his own company and was using my client’s employees to handle things for his side business while he was away. His peers knew it was wrong but wanted to protect him so they didn’t say anything to the owner about it.

When looking into your own books, major red flags typically include unusually low cash flow but not knowing why, staffing issues with employees unable to keep up with the workflow, inventory shortages, and not meeting sales goals when things seem to be running well enough to do so.

A common example: a mechanic is doing an alignment, but the car also needs ball joints or an additional repair, so the mechanic decides to go ahead and put them in without approval or accounting for the extra service. Maybe they make a deal “under the table” with the customer or they do it as a quiet favor. That adds up to a little extra labor time, and the dealer will also see an inventory shortage because the technician didn’t go through the computer system to take the replacement parts out of inventory. When they need that ball joint that’s now missing from inventory, they can say that they don’t have it stocked or blame the computer system. But it’s fraud.

Advertisement

Three things must be present in order for someone to commit fraud: Need, Greed and Entitlement. Now­adays people need the money because their hours or salary have been cut or not increased to their liking. Greed is present because they want the extra cash now more than ever. And if the money is there for the taking, without any controls, they think they’re entitled to it.

Often, forensic accounting can uncover other problem areas, such as overbilling by a supplier or inaccurate rent or lease contracts. If a tire dealer trusts their landlord, he or she might not realize that individual is passing along costs that are unjustified – or higher than they should be – in each month’s rent.

Lately, we have seen employees disguising their personal expenses as business expenses, which the company winds up paying for. Once our firm determines the extent of the fraud, the business owner is surprised how long this was actually happening – and the fact that they let it happen. The best time to catch a fraud is before it builds. If left unaddressed, it can potentially bankrupt the business.

Warning Signs

Some common warning signs of fraud include rising expenses, declining revenue, and abnormally high inventory shrinkage. Other more specific indicators include missing purchase orders, dramatic increases in labor costs or overtime not justified by a sales increase, increased payments to a vendor without reason, consistent cash shortages, an excessive number of voided sales transactions and excessive inventory write-offs.

Advertisement

In tandem with fraud being on the upswing, many companies that feel they need to cut expenses, choosing to remove proper internal controls as a way to decrease costs. While a lot of businesses think they can’t afford a quality accountant or forensic consultant, it can actually be more costly for them not to bring someone from the outside in. The reality is that you can’t necessarily ask your bookkeeper about this since that person could actually be the problem. We recommend sourcing outside help.

Another warning sign is body language when we interview people about the financial numbers. Those responses – words, body language and facial expressions – of employees during the interviews can also help uncover fraud.

We start by talking with the employees, observing how they answer specific questions. There are certain methods of asking and certain ways of listening that can tell us are they telling the truth or are they covering it up. Are they being overly defensive or are they being overly helpful?

Solutions

In addition to audits and interviews, forensic accounting firms work with business owners to put controls in place as a deterrent for future incidents. These deterrents are tailored for each client and can include things like division of duties, monthly bank reconciliations, the owner reviewing the credits or a periodic review by an outside forensic accountant.

Advertisement

Some examples of fraud we’ve uncovered include a bookkeeper that takes a customer’s check and diverts it to his or her own bank account. I’ve also seen a service truck driver who goes out on a service call, changes the tire and bills the customer for it, but on the way back to the shop the driver sees another car stuck on the road, provides service using the company’s tools and equipment, then accepts a cash payment which he pockets for himself.

Despite the benefits and security that hiring a forensic accountant can bring, many business owners may question the need (and the expense) to go through the process. But when things get tight, the risk can increase. When companies cut expenses, they’re doing several things: eliminating some controls, reducing workforce and hurting employee morale – all of which are incentives for fraud. If as an owner you look at your cash flow and know the shop should be doing better, you can’t always blame everything on the economy.

Bringing in a forensic accountant also helps keep employees honest, especially if they know that things will be under closer scrutiny. And even if there is no fraud or other problems found in a business, that dealer has the peace of mind of knowing his business is in good hands with his team. TR

Advertisement

Rich Lipton is a Certified Public Accountant and has earned his CFF credential. He can be reached at [email protected] or by calling 973-520-8123. For more information visit Lipton CPA Associates online at www.liptoncpa.com.

Advertisement
Click to comment

Loading Post...

Loading Post...

Loading Post...

Advertisement

POPULAR POSTS

Back to Basics: Step-by-Step Tire/Wheel Balancing

Business Operations

Back to Basics 3: Rotating Vehicle Tires

Legislative Update

Business Operations

Back to Basics 1: Basic Tire Repair

Connect