Fight Internal Fraud with 8 Precautions

When you read in the paper that a "trusted employee" has been charged with embezzlement, it can be shocking. But then, of course, it makes sense because the theft involved a trusted employee. An employee who isn't trusted doesn't have much of a chance to commit fraud.

The Fraud Triangle

Research by Dr. Donald Cressey (of the Association of Certified Fraud Examiners) led him to develop a concept called the "fraud triangle." Basically, most fraud has three elements:

 A financial problem. The person committing fraud needs help with a pressing problem, which can't be solved by ordinary financial resources.

The employee has access to funds.

Rationalization. The thief has an excuse or reason for the fraud.

Steps to help identify a fraud triangle:

  • Pay attention to employees so you know when they have financial problems.
  • Encourage honesty so employees find it harder to rationalize theft. This also prompts other employees to report unusual behavior.
  • Be fair and consistent when disciplining employees and make sure they know the consequences of committing fraud.

How can you ensure that internal fraud doesn't happen in your business? Distrusting everyone certainly isn't the answer. You need to implement and monitor internal controls and procedures to make sure that employees don't have an opportunity to steal. Duties should be segregated so that no one employee is able to commit fraud and then cover his or her tracks without anyone else noticing.

Internal controls generally involve common sense and paying attention -- not elaborate systems. Although there are countless ways fraud can occur, here are eight precautions that can help prevent it:

1. Enforce vacations. Make sure employees take some annual leave. Have other employees cover them during the time off. Many sophisticated fraud schemes can be uncovered with this simple step.

2. Check references. This is often overlooked. When hiring new employees, check references in detail and run background checks. Run a credit report on applicants and employees when making promotions. Statistically, employees with pressing debts or bad credit histories are more likely to commit fraud.

3. Minimize access to cash, inventory, and building entry. Make sure as few people as possible have key and alarm codes -- ideally, just the owners and top executives. Change locks every year or two and change alarm codes often (Don't use birthdays or other easily guessed combinations).

4. Take inventory regularly. Supervise the process closely. Have spoiled goods set aside for your inspection. Someone other than the person who orders, ships or receives goods should do the counts.

5. Watch cashiers. Don't let them void transactions without approval and watch to ensure they ring everything into the register at the right price. Approve discounts or markdowns.

6. Verify cash totals. Clerks should count and total the cash in the register at the end of their shifts. Then, designate a trusted person to recount the cash and compare it to supporting, detailed records. Bank deposits should also be compared with supporting documents. Bank statements should be opened and reviewed by a person of trust who reports discrepancies and unusual items to upper management.

7. Use a dedicated payroll bank account. Deposit the exact amount every period so you can recognize amounts that are fraudulently changed. However, this requires paying close attention to details like overtime and withholding so that the account doesn't fall below minimum balances due to legitimate changes in payroll.

8. Safeguard check handling. Use a "for deposit only" stamp on incoming checks, which can prevent employees from cashing them personally. A designated individual should open mail and list all checks with the date, amount, and payer information. Spot check the dates when checks in a bank deposit actually came in - they should be listed as received after the last deposit. Other safeguards involving checks:

  • Consider accepting electronic payments or a implementing a bank lockbox system to prevent employees from cashing incoming checks.
  • Monitor receivables and payables. Investigate discrepancies.
  • Don't let the same person who handles cash or other receipts take care of disbursements. When feasible, rotate the duties of employees with these duties.
  • Reconcile accounts at least monthly and follow up on items that don't reconcile with supporting documentation. Compare checks with the company ledger. Make certain that payees on checks match payees shown on the ledger.
  • Confirm that payees and amounts on checks are consistent with your company's practices.

These are just some of the controls your business can implement to minimize the chances of internal theft. Consult with your accountant for more safety measures.

Employee or independent contractor?


The federal government is always on the lookout for businesses that improperly classify workers as independent contractors rather than employees. But the heat was recently turned up even more.The issue of worker classification has many tax and benefit implications. And it continues to be problematic for employers.

Your Responsibilities

If a worker is an employee, you generally must withhold federal income tax and the employee's share of Social Security and Medicare taxes from his or her wages. Your business must then pay the employer's share of Social Security and Medicare taxes, pay federal unemployment tax, file federal payroll tax returns and follow lots of other burdensome IRS and DOL rules.

You may also have to pay state and local unemployment and worker compensation taxes and comply with more rules and regulations.

In addition, employees may be eligible for fringe benefits such as health insurance, retirement plans and paid vacations.

If a worker is an independent contractor and you pay him or her $600 or more during the year, you must issue a Form 1099-MISC to the individual and the IRS to report what you paid.

If you incorrectly treat a worker who is actually an employee as an independent contractor, your company could be assessed unpaid payroll taxes plus interest and penalties. It also could be liable for employee benefits that should have been provided but weren't, including significant penalties under federal laws. In addition, businesses with misclassified workers also generally owe taxes and penalties to their states.

During 2015, both the IRS and the U.S. Department of Labor's Wage and Hour Division (WHD) issued communications to employers about employee classification.

The IRS issued a Fact Sheet reminding employers "to correctly determine whether workers are employees or independent contractors." The tax agency and courts generally take the stand that workers are independent contractors if they meet specific criteria focusing on the amount of control they have over their jobs.

The WHD, on the other hand, issued an "Administrator's Interpretation" stating that worker classification isn't just about control. Rather, the focus is "whether the worker is economically dependent on the employer or in business for him or herself."

The WHD added that "most workers are employees" under the broad definitions of the Fair Labor Standards Act (FLSA).

The two federal agencies are working together and with states to tackle misclassification.

Many businesses prefer to classify workers as independent contractors to lower costs, even if it means having less control over workers' day-to-day activities. Federal and state government agencies have always cracked down on businesses that classify workers as independent contractors to evade taxes or sidestep providing benefits. Now there's another reason to focus on worker classifications: Employers may treat individuals as independent contractors to avoid health insurance obligations that involve employee headcounts under the Affordable Care Act.

Note: Be aware that a worker or a business can file a form with the IRS to ask for a determination about classification. Disgruntled former workers may file the form to show that a business improperly denied employee benefits by classifying them as independent contractors. Businesses should consult with their tax advisers before filing this form because it may alert the IRS to worker classification issues — and inadvertently trigger an employment tax audit.

Here's the rub for your business: If you incorrectly classify an employee as an independent contractor, your company could be assessed unpaid payroll taxes plus interest and penalties. You also could be liable for employee benefits that should have been provided but weren't, including significant penalties under federal laws.

That doesn't mean that you shouldn't use independent contractors. You just have to be careful to handle the relationships properly. A written contract can help support a worker's independent contractor status. But that's no guarantee.

The determination traditionally boils down to this: A worker is an independent contractor if you have little or no control over the way he or she gets the job done. For example, do you set the hours, provide equipment and require the worker to come to your facilities? These are only some of the questions that need to be asked. The bottom line is that if you provide substantial day-to-day supervision, the worker is probably an employee.

Worker classification is a complex issue. Contact us if you have questions about the status of an individual or the filing of 1099 forms. We can help.

How to avoid hiring the wrong person


Ever hired the wrong person?   I've made plenty of bad hires over the years.  Many times I simply rushed through the decision process to get a position filled rather than taking time and working through a well thought out hiring plan. As Chris Hogan of EntreLeadership shares below, every hire you make should build your team and not set you back.

Along with saving significant cost and resources, now having a solid hiring process in place has made a big difference in our employee retention and satisfaction.