I have many years of experience with audits, reviews and compilations for both business and non-profit entities. Audits require significant planning in order to achieve a successful engagement. I also have extensive experience helping business and non-profit clients detect employee fraud and theft and take corrective actions to strengthen their accounting systems and internal controls.
Employee dishonesty costs businesses, non-profits and town governments staggering amounts of money. According to the US Department of Commerce $50 billion is stolen annually by dishonest employees. A US Chamber of Commerce study estimated that 75% of all employees steal at least once.
See: EMPLOYEE DISHONESTY
These losses are made worse because most cases of employee fraud and theft occur over a prolonged period of time before they are caught. Recovering money after it has been stolen is extremely difficult or impossible.
What is an Audit?
An audit is the highest level of attestation service provided by CPA’s. Few people request an audit unless a third party (such as a bank) requires one. Auditing standards for non-public companies are established by the Financial Accounting Standards Board and the American Institute of Certified Public Accountants. The primary goal of an audit is to obtain assurance that your financial statements conform to generally accepted accounting principles applicable in the U.S.
Audits are expensive, time consuming and require CPA’s to satisfy many professional standards and regulations. Financial scandals including Enron, WorldCom and other notorious business failures have resulted in increased regulation of the accounting profession. Fewer and fewer CPA’s are willing to accept the professional risk and burdens associated with an audit.
Many people believe the primary goal of an audit is to detect fraud, theft and other cases of financial malfeasance. This is wrong. The primary goal of an audit, as stated above, is to obtain assurance that your financial statements conform to generally accepted accounting principles.
You cannot count on an audit to catch fraud or theft because this is not its primary purpose.
I will perform an audit if I am satisfied regarding certain criteria relating to your system of internal controls, the quality of your management and accounting personnel, and the quality of your accounting records.
I may recommend considering a review instead of an audit in cases where a review satisfies your needs. Reviews involve less work than an audit, can be completed more quickly, at less cost, and in most cases will satisfy the requirements of third parties including banks.
What is a Review?
A review of financial statements involves substantially less work and less cost than an audit. In most cases a review will satisfy the requirements of banks and other third parties who seek assurance that your financial statements conform to generally accepted accounting principles.
A review consists of analytical procedures and inquiries of management with limited assurance that your financial statements conform with generally accepted accounting principles.
As is the case with audits, you cannot count on a review to catch theft or fraud.
What is a Compilation?
A compilation is the lowest level of service provided by CPA’s. Compilations merely take your financial data and present them in the form of financial statements. Compilations provide no assurance of any kind that your financial statements conform to generally accepted accounting principles, nor can you count on a compilation to catch fraud and theft.
Detecting Fraud and Theft
We live in a harsh time with tough economic conditions and an uncertain future. Theft and fraud by employees are at an all-time high and there is no good reason to think this situation will improve anytime soon. Employee theft and fraud affect both business and non-profit entities and can be especially devastating when town government is impacted. Fraud and theft destroy trust and impair credibility.
Is your company, non-profit or town being harmed by theft and fraud? How do you know? How can you be sure? Most instances of employee malfeasance go undetected for years, sometimes decades, resulting in a staggering cumulative cost. And it is very difficult to recover money once it has been misappropriated. Prevention and swift detection are wise policies.
According to a 2010 report by the Association of Certified Fraud Examiners, small business is 31% more likely to be hurt by fraud. And as many as 40% of small business owners are victims of theft and fraud by their own employees. Many bankruptcies are specifically caused by employee theft and fraud. Even worse, many employees who commit fraud and theft are not prosecuted and move on to work for other unsuspecting business owners.
As discussed above, you CANNOT rely on financial audits, reviews, or compilations to catch theft or fraud. You must use specialized tools which specifically focus on these crimes.
I have helped many clients over the years who were impacted by employee fraud and theft. For firms that are concerned with these issues I offer to perform certain agreed-upon procedures to systematically search for theft, fraud, and misappropriation of funds. Mathematical analysis is one of the most effective tools available to detect fraud and theft. In the 1990's, years before notorious fraudster Bernie Maddoff was caught, Harry Markopolos working with mathematician Dan diBartolomeo warned the SEC that Maddoff's numbers were too good to be true. See:
Agreed-upon procedures is a limited engagement consisting of providing defined services and reporting the findings. Although there can be no guarantee of results, the procedures used are generally effective at detecting many times of fraud and theft. In most cases these procedures can be applied in a discreet manner.
If you are interested in this type of engagement it is very important that you contact me privately, with no “tip-off” of any kind to the employees whose work will be subject to such procedures.
A Powerful Fraud Detection Tool
One especially effective forensic accounting tool is Benford Analysis. This technique is used when there is suspicion that financial accounting records have been fabricated or falsified. Benford Analysis makes use of the so-called First Digit Phenomenon: Many types of numbers in the real world are distributed in a way that defies and conflicts with common sense expectations. Here is great YouTube summary:
Most types of financial accounting information can be subjected to Benford Analysis. Consider all check payments in the month of April. Assume there are 100 such check payments. The dollar amounts of these payments must begin with one of nine possible digits, i.e., from 1 to 9. (It’s not possible to have zero as the first digit.)
Most people simplistically assume that because there are nine possibilities then the chance that any one particular digit will appear must be one divided by nine or 1/9 = 11.11%.
THIS IS WRONG. The world does not work this way.
What does this mean?
It means that statistically significant discrepancies between the observed distribution of check payments versus the standard Benford Distribution are grounds for further investigation. In other words, big discrepancies potentially mean big trouble. If I find such discrepancies I will be able to say that I am 99% confident that something is wrong and needs to be checked further.
Benford Analysis is a powerful tool that has emerged in forensic accounting only recently. Its proper use requires specialized expertise and software. And there are many other effective analytical tools and procedures available to detect theft and fraud. A further benefit is that the publicized use of such procedures will go a very long way in deterring theft and fraud.
If you would like to read more on Benford Analysis here are two excellent articles. The first is general in nature while the second is a more technical and detailed discussion:
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