Using Cash Control to Prevent and Detect Fraud

In all business entities, cash is a high-risk asset and vulnerable to fraud. Having controls in place and ensuring employees their compliancey with them is of top priority.

April 2012

By Elina Chu, J.D., CFE, CPA

A former Major League Baseball team payroll manager pleading guilty to embezzlement makes the news; so does the investigation of a political campaign treasurer embezzling millions, undetected, for a number of years. These revelations may be shocking, but they are not surprising.

Having control over a large amount of cash is tempting; knowing there is no oversight is inviting. These factors add up to a fraud-in-the-making. All it needs is a spark.

According Dr. Donald Cressey’s Fraud Triangle, the elements necessary for a fraud to occur are pressure, opportunity and rationalization. Faced with personal financial needs and wants, these individuals exploited the opportunity and rationalized their actions.

Such stories emphasize the importance of cash control and the function of oversight. In all business entities, cash is a high-risk asset and vulnerable to fraud. Having controls in place and ensuring employees comply with them is of top priority.

 

The Cash Processes 

To begin with, there must be robust processes in place for cash receipts and disbursements. All cash processes, manual or automated, must meet their objectives to (1) safeguard the asset and (2) prevent, deter, and detect errors and fraud. To achieve these objectives, the organization must ensure receipts and disbursements are appropriately directed and recorded.

Key Controls 

The key controls in cash processes are segregation of duties and independent verification.

Segregation of duties is a preventive and detective control. The division of responsibilities serves to cross-check the work of each function, thereby increasing the chance of detection, while reducing the chance of concealment without collusion. The custodial duties direct the actual asset flow and must be separated from the cash recording duties.

Custodial duties include cash counting, check endorsement, bank deposits, blank check stock custody, check printing, and check signing. The electronic fund transfer application operator who processes and submits the fund transfer request is a cash custodian.

The independent verification control in a cash process is verifying internal records of receipts and disbursements against externally sourced records. This is commonly known as the bank accounts reconciliation. Obviously, there must be accurate and reliable internal records to begin with; and that is why the recording duties need to be separated from the custodial duties.

While all controls are preventive in design, some are put in place as detective measures. This is particularly true for controls deployed at the later stages of a process. The bank accounts reconciliation is a detective control and stop loss procedure.

Underutilized and Underappreciated 

In my experience, the bank accounts reconciliation has been totally underutilized and underappreciated as a control mechanism. It has become a mere bookkeeping routine and mathematical exercise to make book balance equal to bank balance.

I have seen bank account reconciliations performed by individuals having access and control over the records -- as well as custodial duties over the cash. I have seen publicly traded companies with over 20 bank accounts and cash boxes all over the country that had not reconciled their bank accounts for more than six months.

The Proper Steps 

To verify information independently, there must be separation of duties. The person who performs the verification should not be the same person who has access and control over the assets. In performing bank accounts reconciliation, the verification procedures must include: (1) tracing all cash receipts to the bank record; (2) supporting all bank debits with approved internal records; and (3) examining all cancelled checks for signs of alteration.

As internal control director for a non-profit organization, I instituted a two-person team in the cash receipts process. This is absolutely necessary in protecting cash donations, and contributions not previously pledged.

In the disbursement process, I implemented an independent verification step to be taken before the checks are sent. It is performed by a person removed from custodial, recording and approval duties. This control step addresses the issue of fraudulent supporting documents, which can easily be produced and inserted into the invoice processing and check preparation stages.

There are some important takeaways for anti-fraud professionals in learning about the importance of cash control: 

 

Having control over a large amount of cash is tempting; knowing there is no oversight is inviting. It is fraud in the making. All it needs is a spark.

In all business entities, cash is a high risk asset and vulnerable to fraud. Having controls in place and ensuring their compliance is of top priority.

All cash processes, manual or automated, must meet the objectives (1) to safeguard the asset against risk of loss, and (2) to prevent, deter, and detect errors and fraud.

The key controls are segregation of duties and independent verification.

Separating the custodial duties from the recording duties is the key.

The bank accounts reconciliation is an independent verification control which has been underutilized and underappreciated as a detective and deterrent control.

It has become a mere bookkeeping routine and mathematical exercise to make book balance = bank balance.

The person who performs the bank accounts reconciliation should not be the same person who has access to, and control over, the cash.

Verification procedures must include (1) tracing all cash receipts to the bank record, (2) supporting all bank debits with approved internal records, and (3) examining all cancelled checks for signs of alteration.

The deployment of a two-person team in the cash receipts process is recommended.

The implementation of an independent verification step prior to disbursing cash, or transferring funds, is recommended.

Cash will remain as a high risk area and vulnerable to fraud. Stringent controls must be in place and deployed to mitigate the risk of loss.

For controls to be effective, there must be diligent oversight.

 

Cash will always be a high-risk area of vulnerability when it comes to fraud. Temptations are great, and controls are often insufficient — leading to an abundance of opportunity for would-be fraudsters. Stringent controls must be in place and deployed to mitigate the risk of loss. However, there must be diligent oversight for controls to be effective. It is imperative for today’s anti-fraud professional to understand how to implement a proper cash control system and monitor its success.

 

Elina Chu is a process & control specialist forMetro Accounting Solutions in San Francisco, Calif. Contact Ms. Chu at elinachucpa@gmail.com.