Case Study: How Strong Internal Controls Can Deter Fraud

November 24, 2017

Internal fraud is a growing concern for many businesses today, including dealerships. In fact, dealerships may be especially vulnerable due to their relatively small accounting staffs, large sums of cash kept on hand and their highly marketable inventories, among other reasons.

Experts say that the best defense against fraud is to make sure that strong controls are in place at your dealership. One of the most important internal controls is segregation of financial duties among your accounting staff.

Learn from a recent case

Not long ago, an occurrence of fraud was uncovered at a midsize dealership. And it’s one that illustrates the damage that can take place when too much financial authority is concentrated with one employee. In this instance, a single accounting employee was responsible for collecting accounts receivable, making bank deposits and reconciling the books.

When receivables came into the dealership, instead of depositing them, she used a signature stamp to endorse the checks and then deposited them in a separate account she’d set up for herself. Then she manipulated the accounting records to make it appear that the funds had actually been deposited in the dealership’s account. Or she simply wrote them off as uncollected debt.

In addition, the employee was stealing money out of the cash drawer of the parts department, removing cash before it was ever entered into the system. Since the dealership didn’t reconcile daily parts sales to the bank deposit each day, it had no way of spotting the missing cash.

The employee wasn’t caught until she went away on a two-week European vacation. During this time, the dealership brought in a part-time accountant to handle her work. The part-time employee noticed the manipulation in the accounting records and pointed it out to the owner. He estimates that the embezzling employee stole nearly $100,000 over a five-year period.

This unfortunate situation could have easily been prevented had the dealership segregated accounting duties among more than one employee. For example, at least two different employees should have been collecting receivables, making deposits and entering transactions into the books. If your staff is too small to accommodate this, ask your outside CPA to perform some accounting tasks periodically to keep your employees off guard.

Take other preventive steps

Here are a few more internal controls that can help limit opportunities for employee fraud:

Generate accurate financial information on a timely basis. Having your accounting staff post all transactions daily — from vehicle sales and accounts receivable to repair orders and parts receipts — will make it easier to quickly spot fraudulent activity and stop it. You should be able to view the previous day’s checking account balances and other important accounting information no later than 1 p.m. each day.

Keep an especially close eye on the parts department. Parts inventory is an easy target for dishonest employees to steal from and then resell the parts on the side. Random inventory counts should be performed periodically instead of waiting until the end of the year to conduct an annual parts inventory. Putting cameras in the parts storage area also will make employees think twice before stealing from your company.

Don’t use a signature stamp. The dealership in our example learned this lesson the hard way. The owner or a senior manager should personally endorse all checks for deposit. Also consider having bank statements sent directly to the owner’s home, instead of the dealership’s accounting department.

Require accounting employees to take at least one full week of vacation (or five consecutive days) each year. This makes it harder for dishonest employees to cover their fraud tracks. The dealership in our example could have uncovered the fraud much sooner by taking this step.

Dealerships also need to be on the lookout for kickbacks to some employees. For example, used car managers have been known to buy or sell vehicles at inflated or deflated prices and get kickbacks from wholesalers, while general managers have steered business to certain suppliers in exchange for kickbacks.

Fraud-fighting measure

An effective tool for combating internal fraud is “Positive Pay,” a cash management service widely used by banks today. With this system, you’ll present your bank with a list of all checks issued by your dealership for payment each day.

The bank will then compare checks presented for payment to this check-issued list. It will only make payment on checks that match the list exactly. Any others are flagged as suspect and reported back to you for a final payment decision.

The service also can be used to combat electronic funds transfer (EFT) fraud, which is growing more prevalent as the use of electronic payments grows. You’ll provide the bank with a list of approved vendors who are paid via EFT. Any electronic payments made to vendors not on the list are similarly flagged and sent to you for a payment decision.

Time for action

The time to implement fraud deterrents such as these is now — before your dealership is victimized by fraud. Talk to your CPA about how implementing tight internal controls can help you guard against fraud and embezzlement.

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