Internal controls are processes related to forensic accounting which consist of procedures, and mechanisms put in place by an organization to ensure the integrity of its operations, reliability of financial reporting, and compliance with laws and regulations. These controls are crucial for safeguarding assets, preventing fraud, and promoting efficiency and effectiveness within the organization.

Three examples of violation of internal controls and their impacts:

Embezzlement through Cash Manipulation

Violation

In the case of the farming equipment company, the controller violated internal controls by separating cash from cash receipts documents and depositing it into the bank account without proper documentation.

Impact

The forensic accounting led to a misstatement of cash balances and financial records, which eventually led to the embezzlement of over nine hundred thousand dollars. Additionally, customer complaints about incorrect account balances signaled operational inefficiencies and potential mistrust in the company.

Fictitious Customers and Incorrect Payments

Violation:

Lack of internal control procedures for setting up new customers allowed fictitious customers to be created in the accounting records, leading to incorrect payments.

Impact

The forensic accounting discovered Tens of thousands of dollars were lost due to erroneous payments, impacting the company’s financial performance and potentially tarnishing its reputation with suppliers and creditors due to payment discrepancies.

Management Collusion in Fraudulent Credit Applications 

Violation

Management colluded with employees to create fraudulent credit applications for high-end product purchases, falsifying down payments and deceiving banks into approving loans.

Impact

The forensic accounting led to the financing institution suffered significant losses as many of the fraudulent loans defaulted, leading to financial strain and potential legal repercussions. This also eroded trust with financial institutions and customers.  This also created the issues of bank and mail fraud.

Preventing management collusion and fraudulent activities

Segregation of Duties

Implementing a system where no single individual has control over all aspects of a transaction can prevent collusion.  For example, separating the duties of approving credit applications, processing payments, and reconciling accounts.

Regular Monitoring and Auditing

Conducting regular internal audits and reviews can help detect anomalies or suspicious activities, discouraging collusion among employees and management.

Establishing a Whistleblower System

Encouraging employees to report any unethical behavior or suspicious activities anonymously can deter collusion and provide early detection of fraudulent activities.

Ethical Training and Code of Conduct

Promoting a culture of ethics and integrity through training programs and a clear code of conduct can instill a sense of accountability and discourage fraudulent behavior among employees and management.

By implementing these preventive measures, organizations can strengthen their internal controls and mitigate the risk of management collusion and fraudulent activities.

Conclusion

I have earned a Master’s Degree in Business Valuations and apply those skills to my everyday business valuations.

 

Richard Claywell has been valuing closely held companies since 1985.  He has earned two of the highest designations in the business valuation field, the Certified Business Appraiser (“CBA”) and Accredited Senior Appraiser (“ASA”). Richard is a Certified Public Accountant, has a Master’s in Business Valuation (MBV), and holds ASA, CBA, ABV, ICVS, CVA, MAFF, CFD, ABAR, CVGA, and ICVS-A credentials.

I hold the Master Analyst in Financial Forensics and the Certified in Fraud Deterrence.  I have taught forensic accounting/fraud courses in the United States, China, and Taiwan.

I welcome and encourage comments and feedback. If you benefit from this series, please recommend it to your friends and colleagues and suggest they sign up to receive posts regularly.

© 2024 J. Richard Claywell, CPA, ABV, ASA, CBA, CVA, ICVS,  MAFF, CFD, ABAR, ICVS-A, MBV – all rights reserved

 

Richard Claywell is the co-author of Capitalization and Discount Rates: The Value of Risk and contributing author of the NACVA Fundamentals Theory & Techniques training materials. Richard is also the Chairman of the International Certified Valuation Specialist Association. Richard has made presentations on business valuation topics in Germany, China, Korea, and Taiwan. Richard is also a contributing editor to Practitioners Publishing Company’s Guide to Practical Estate Planning (2008). Richard is the chief architect for the Business Valuation Manager Pro business valuation software program and the accompanying Professional Report Writer and contributing author of Financial Valuation: Application and Models.

Richard can be reached at 281.488.7531 or richard@biz-valuation.com