Internal Controls for Governmental Entities

Michigan Association of Municipal Clerks June 25, 2015

Sarah L. Jennings, CPA, CFE

Principal Maner Costerisan

What we will cover…

Trends of fraud schemes Common types of fraud What we can do Other Considerations Case Studies

2014 Report to the Nations on Occupational Fraud and Abuse

Typical organization loses an estimated 5% of annual revenues to occupational fraud

Organizations with < 100 employees had the highest frequency of fraud at 30.8%with a median loss of almost $154,000

2014 Report to the Nations on Occupational Fraud and Abuse

Billing schemes were cited as the most common scheme small organizations, in over 40% of cases Most common detection method in small organizations was tip (over 40%)

Victim Organizations – by Type

Victim Organizations – by Size

Victim Organizations – Scheme Type

Duration of Fraud by Scheme

Victim Organizations – Industry

Frequency of Scheme – Industry

2014 Report to the Nations on Occupational Fraud and Abuse

Most perpetrators (82% of cases) were NEVER charged or convicted

Hind site is 20/20 – there were red flags in over 92% of the cases

Living beyond their means Unusually close relationships with vendors Excessive control issues Financial difficulties

Red Flags

What is going on out there???

Pressure/Need Rationalization

Opportunity

Common Types of Fraud Asset Misappropriation Corruption

Conflicts of Interest Bribery Illegal Gratuities Economic Extortion

Fraudulent Financial Reporting Financial Non-Financial

Common Types of Fraud – Asset Misappropriation

Cash Fraudulent Disbursements

Expense reimbursement and credit cards Purchasing and billing Check tampering Payroll

Larceny Skimming

Non-Cash Misuse Larceny

Corruption

• The wrongful use of influence to procure a benefit for the actor or another person, contrary to the duty or rights of others – Conflicts of interest – Bribery – Kickbacks – Illegal gratuities – Economic extortion

Corruption – conflict of interest

• Investment ownership in a supplier or competitor • Purchasing of goods or services through a broker

or middleman that the purchaser controls • Acceptance of inappropriate gifts • Involvement of other business ventures with

contractors • Purchaser enters into unapproved employment

negotiations with a contractor/supplier

Corruption – bribery

• Inappropriate or excessive gifts • “Loans” (whether repaid or not) or guarantees

of loans • Inappropriate or excessive favors • Personal discounts on items or services • Cash payments

Corruption – kickbacks

• Type of bribery • Personal kickbacks for directing excess

business to vendor • Vendor returning part of purchase price to

influence future purchases

Corruption – illegal gratuities

• Similar to bribery • Difference only in proof that gratuity was

given to influence an official act

Corruption – economic extortion

• The flipside of bribery • Government employee or official demands a

bribe or kickback for payment or contract

Red Flags of Corruption

• Internal • External • Analytical

Purchasing and Billing PROBLEM

False vendors Actual vendor, false charges Mailing address changes Personal purchases

Purchasing and Billing SOLUTION

• Thorough vendor approval process • Review for duplicate vendors • Compare vendor addresses to employee

addresses • Review reports for amounts under specified

threshold • Review year-to-date vendor payment totals

Non Cash Problem

• Theft or misuse of inventory, supplies or property of the Township

Non Cash Solution

• Periodic property verifications (fixed assets) • Supplies restriction and analysis • Periodic machine hour review

Payroll PROBLEM

Ghost employees Unauthorized hours Unauthorized rates

Payroll SOLUTION

• Review payroll register – specifically looking at year to date totals

• Hour approval at the appropriate level • Appropriate authorization and access levels

Expense Reimbursement and Credit/Purchase Card

PROBLEM • Educational books • http://www.salesreceiptstore.com/ • http://www.smileygenerator.us/fake_receipt/

Expense Reimbursement and Credit/Purchase Card

SOLUTION • Require detail receipts for all purchases • Require approval at a reporting level above

the employee • Periodic review of “black hole” accounts • Compare calendar to mileage/conference

Skimming PROBLEM

Theft before the revenue was recorded Fees collected and not received or recorded by the organization Cash collected for sales but the sale not recorded

Skimming SOLUTION

• Budget - have an expectation of revenue • Compare historical results for different time

periods (more than 1 event or period) • Reconcile cash timely • Require multiple individuals to count cash • Count down drawers daily, or at each shift

change if possible • Utilize a numerical sequence of receipts • Require sign off on all receipts

Larceny PROBLEM

Theft after the revenue was recorded Refunds entered Credits to receivables

Larceny SOLUTION

• Budget - have an expectation of revenue • Review refunds and credits issued monthly

(potentially more frequently to begin the process)

• Count down drawers daily, or at each shift change if possible in order to maintain accountability

Check Tampering PROBLEM

Forged authorized signature Altered payee Altered amount

Check Tampering SOLUTION

• Review cancelled checks periodically • Review for unusual check runs or manual

checks

What we can do

Education and communication Internal Fraud Risk Assessment Documented Policies and Considerations

Education

Definitions Tone at the Top Report abuse

Perpetrator to authorities Scheme to colleagues

Repeat annually or with any turnover

Internal Fraud Risk Assessment

Employee Assessment Physical Controls Knowledge and Assessment of the Schemes Vulnerability Assessment

Receipts Disbursements Payroll

Questions to Ask Yourself Receipts

How would you know if something didn’t get there that should have?

Disbursements Who approves? Who signs? Who reviews what cleared the bank?

Reconciliation/Closing Who gets the statements or has access to online activity? Who compares the financial institution statements to the internal reports? Who sees cancelled check images?

Internal Controls - Receipts

Register sales reconciled at each shift change to drawer cash, at minimum on a daily basis Initial cash listing maintained for all cash and checks and reconciled to bank deposits Remote capture deposit utilized Receipts issued in sequential order Reconciliation of receivable aging monthly Accounts receivable clerk - restricted access to create new customer accounts

Internal Controls - Disbursements Established and documented procedures for new vendors

Accounts payable clerk – restricted access to create new vendors

Positive pay solutions with your financial institution Monthly review of vendor totals Dual signature requirements Review of vendor account details and transactions

Disbursements - Concluded After signature, checks not returned to the preparer Cancelled check images returned from the bank or available for review Payments made to employees reviewed for appropriate authorizations, by approved individual Supporting documentation required for all expense reimbursements and Township credit card charges

Internal Controls - Payroll

Payroll clerk - restricted access to HR module Cannot input new employees Cannot input rate changes

All time sheets approved at a level above the employee Review direct deposit listing – including account number

Payroll - Concluded

Review of payroll register Checks distributed by someone other than the payroll clerk Detail review of deductions report Detailed review of payments made on behalf of employees for retirement options

Internal Controls - Reconciliation/Closing

Journal entry control and review Who does them and what can they adjust?

Reconciliations reviewed and approved at an appropriate level and on a timely basis Documentation of all reviews Management should receive financial statements (activity as well as statement of position) monthly

Reconciliation/Closing - Concluded

Bank statements received by and reviewed at an appropriate level monthly (this can be accomplished via online accessibility) Cancelled checks compared to approved check registers Reconciliation of numerical check sequence

Internal Controls - Other

Review exception reports periodically Segregate duties when possible Designate a “watch-dog” over all significant procedures Consider read/view only access to financial information (on-line banking) as well as general ledger detail for management Approve electronic transfers at the appropriate level

Quick Controls that should be in Place

Management review of original financial institution statements; this can be accomplished with online accessibility; cancelled checks should be available Management review of receivable write offs or returns Management review of vendor totals Management review of payroll registers, W-2’s and 1099’s issued

Other Considerations

Check with your financial institution on what fraud prevention services they offer – many products were mentioned in the controls we have covered

Insurance Make sure it is adequate Read the fine print

Hotline Cost benefit analysis Consider access to internal and external stakeholders

Documented Policies • Financial policies and procedures

– Purchasing – Month end close

• Conflicts of interest • Document retention • Fraud prevention • Checklists documenting key controls and

approval

Case Studies

To Wrap it Up

• Educate!

• Segregate!

• Recuperate!

Sarah L. Jennings (517) 886-9502

sjennings@manercpa.com

Questions?