Forensic Accountants in their bid to successfully fight fraud often falls back to exploring accounting cycles in order to understand how fraud can be perpetrated. This is to say that for one to understand how fraudulent activity is carried out, one must understand the accounting cycles in and out.
This knowledge is acquired both from the classroom and from experience. This article is written to briefly introduce the accounting cycle and then ask questions that would help managers ensure that adequate controls are in place. So let’s get started.
What is accounting cycles?
Accounting cycle is a fancy way of describing the processes that accountants or bookkeepers go through to ensure that all transactions are captured and recorded correctly. It involves collection, collation, analysing and documenting transactions. The trial balance is used at the end of the initial documentation to check the arithmetic accuracy of the transactions from the ledger.
From forensic accounting perspective, we will be discussing the accounting cycles under five headings as follows:
- Sales and accounts receivables
- Purchase or expenses and accounts payables
- Contracts and Capital expenditure
- Human resources and payrolls
- Inventory and warehousing
Now let’s take each heading and explore how it works and what can possibly go wrong under each heading.
Sales and accounts receivables
The whole essence of doing business is o make sales (goods or services). This involves acquiring customers, selling our goods and services to them, bill them and then collect our money from them.
It all starts from approving customers for credit sales and stops with ensuring that cash is collected and reflected in the statement of financial position (aka balance sheet). Safeguards are put in place to ensure for instance that credit a sale is not made to people that are not credit worthy.
A staff with tendencies to commit fraud can for instance create a fictitious business (customer), use the name of the customer to place order for large quantity of goods thereby leaving the business to be chasing breeze all in the name of trying to recover the debt.
How about unauthorized person collecting cash from our debtors? Is there a possibility of diverting cash? Do we have the right separation of duties in place to help deter receivable frauds?
The above paragraph asked some thought provoking questions that will get any business manager thinking. The list of things that can go wrong in the sales and receivables cycle is not exhaustive.
Segregation of duties is the baseline of defence that any business must have in order to prevent receivable fraud. At the very basic, a person authorizing a transaction should not be the one who will record it.
- Authorization to execute transactions
- Recording of the transactions
- Physical custody of assets used in transactions
- Periodic reconciliation of existing records and amount
Credit function has to be distinct from the credit function department. These basic principles of separation of duties apply to all forms of accounting cycles.
Purchase and accounts payables
In most business environment, processes starts with procurements. Majority of these procurements are credit based thereby giving rise to payables in the statement of financial position of the company.
A company can easily pay a non-existing payable or overpay payables. Fraud rate in payables is very high compared to other forms of accounting cycle fraud.
Just like the sales and receivables cycle, segregation of controls is the hub of controls that must be present here. Vendors must be approved after verification and this vendor list must be checked against any payment request made. Special care must be taken to ensure that payments are being made to the right account if an online transfer is being made.
I have seen a case where every other detail on an invoice matched existing record but the bank details that was maliciously changed for personal gain.
The way to go about militating against this kind of fraud is to have approved vendor’s bank details saved and every payment made to that account number when paying via transfer.
For not online payments, the basic separation of duties must be in place and checks done to help prevent fraud. You may want to read this article on using payables to manage working capital.
Human resources and payrolls
This part of the accounting cycle includes the recruitment, training, appraisal, rewards and remuneration and disengagement of staff. A lot of things can go wrong in this regard if adequate controls are not put in place. We always hear about ghost workers, right? Yeah, it’s quite common especially when one person is in charge of more than one key process in the payroll system.
How about the possibility of falsifying hours worked and overtime? How about over paying a staff or still having a staff member that has been dismissed/resigned on the payroll? Ok, what happen to the statutory deductions, are they properly remitted to the right authorities?
I am sure that by now you would have noticed a trend that no control would work well if not laid on the foundation of proper separation of duties.
Proper documentation and the use of time logging system is a must have control in this area. Also, the use of performance review will help uncover any shady business going on.
Inventory and warehousing or storage facility
I was told by my lecturer back then in school that if I wish to steal from my employer for any reason that I should target the inventories as it tends to be a lot easier to do away with. The inventory and storage cycle has to do with how goods are procured, stored in the warehouse and issued out.
Do we have adequate physical and logical security around our warehouse? Who authorises the purchase of inventory? Can anyone raise material requisitions or are there designated officers that do so.
What controls are in place to ensure that items ordered for are supplied completely? Is it possible for orders to be diverted to another destination?
Who does the stock count and verification and how often is it done?
Do we have list of approved suppliers and how often is this list reviewed and updated? Is the stock control system manually kept or automated? Are there bin cards in use? Talk of bin card; I have worked in a modern company that cannot even boast of the simplest form of a bin card.
How are damaged goods disposed of? Can our damaged goods disposal system encourage staff member who might be benefiting from it intentionally damage some inventories?
Contracts and capital expenditures
Contract and capital expenditure cycle can be called different names in different organizations like refinancing cycle, capital acquisition and repayment cycle for example. It involves the approval of capital project, borrowing of funds to finance the project, monitoring the project to ensure that agreed deliverables are indeed delivered, etc.
The question of who approves what must be clearly answered as this forms the basis of other controls in this accounting cycle. Who arranges for the finance and the interest rate? Who can draw from approved loans from bank?
What is the limit that line managers can approve? Who signs off project as being completed?
General internal control
Regardless of what accounting cycle we are looking at, below are controls that must be in place in order to ensure that a giant stride is taken towards achieving organizational goals.
- Separation of duty
- Physical safeguards of assets
- Information processing controls
- Audit trail
- Performance reviews
- Computer check
It is a well established fact that the best way to fight against fraud is by preventing it through the use of robust internal controls. Managers and directors of businesses must in the bid to carry out the management functions familiarise themselves with the tips in this article if they are to effectively protect the assets of the company put in their care.
In as much as internal controls help reduce the prevalence of fraudulent activities in an organization; there are still occasions when internal control no matter how robust it is would not be able to prevent fraud. This happens when people collude to perpetrate fraud.
This takes time to happen as people will usually take some time to familiarise themselves with one another before recruiting gang members. So whatever you do make sure that people do not stay in one position for longer than necessary.
I am sure that this article has opened your eyes to how analysis of accounting cycles can help to significantly reduce fraud in an organization.
Until next time, have a nice day.