missing money and had falsified the LESSONS LEARNED
physical inventory records to inflate inven- Outsourcing of accounting functions
tory. When queried about anomalies by a doesn’t obviate the need for controls
certified public accountant (CPA) firm dur- consciousness. Dave assumed that using
ing the company’s annual review, Tony a well-known payroll outsourcing com-managed to convince the accountants that pany eliminated embezzlement risks,
it was impossible to retrieve journal trans- and he therefore neglected to imple-actions from a prior year after the year had ment appropriate monitoring controls.
been closed. He kept a file of hard copies Segregation of duties is a must. A con-of what were supposedly all the year’s gen- troller who has both cash recording and
eral ledger transactions. It contained hun- custody functions should not perform
dreds of pages that would have taken bank reconciliations. Further, someone
months to examine, and none of the incrim- without payroll entry/transmission duties
inating journal entries had been retained. should review payroll reports.
After a civil court hearing, Tony sur- Reconciliation procedures must be con-rendered his business, home, and other ducted. Reconciling the payroll journal
assets. Becausehecooperatedwithauthor- data to the amounts charged to the
ities and hired a well-known defense attor- company’s checking account would
ney, the district attorney ultimately accepted have revealed Tony’s advance payments.
a plea bargain for 180 days served on week- Employees with payroll data entry func-ends in county jail, 10 years probation, and tions should not distribute paychecks.
restitution of $80,000 over 10 years. Payroll checks were delivered to Tony,
Dave was relieved to find that his com- who extracted his check and then had
pany’s financial difficulties were due to an administrative person distribute the
theft rather than operational problems. remaining checks.
After a recovery period, the company is Direct payroll deposit and debit
again profitable, and sales have made a systems make payroll controls imper-dramaticturnaround. ative, especially authorization con-
trols. Inadequate controls increase
the likelihood of payroll fraud not
Restricting the external CPA’s reasonable access to people or information
constitutes a fraud warning sign. Tony
dissuaded the CPAs from following up
on issues and limited their ability to
DONALD K. MCCONNELL JR., PHD, CFE, CPA, is
a professor of accounting at the University of
Texas at Arlington. ROBERT L. MONTGOMERY
is the controller at Hayes & Stolz Industrial
Manufacturing Co. Ltd. in Fort Worth, Texas.
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