How to Prevent Accounting Fraud

Bad accounting habits seem to be cropping up everywhere these days. New information surfaces almost daily about Enron, Adelphia, WorldCom, ImClone and other companies accused of fraud or cooking the books. You may even read accounts in your local newspaper about a bookkeeper stealing money.

Poorly advised or dishonest people in large companies can find numerous ways to misrepresent the financial condition of a business, including accounting for stock options, pension plans, derivatives and more. Just because small businesses such as screen printing or embroidery shops don't face these technical accounting challenges doesn't mean there's no potential for fraud. With this in mind, it's a good time to ask yourself, "What's protecting my business?"

Systems Check

You can protect your business from both innocent error and intentional fraud by documenting fundamental disbursement and revenue procedures and identifying the number of people that have to be involved for a loss to occur.

First, the CEO and auditor of your business should review documentation of how your accounting systems work, and identify what controls are in place and who has responsibility to exercise those controls.

A simple audit verifies all the assets and liabilities. Inventory is counted. Accounts receivable are confirmed with customers. Cash is counted, and all liabilities are confirmed. The difference between assets and liabilities is stockholders' equity and capital stock. Any increase or decrease in the equity since the last audit is profit or loss.

This is an easy way to account for profitability, but doesn't protect against fraud or innocent mistakes. The balance sheet audit approach simply tells you the company's financial condition after the fraud or innocent error has occurred. Many small business audits are conducted using this method because the company does not have systems controls in place, and because this audit method is inexpensive.

A systems approach requires documenting the company's revenue and disbursement procedures, and the separation of duties or other procedures such that collusion would be required for an error or embezzlement to occur. People do make mistakes that can cost an organization substantial amounts if the errors aren't caught. That's what makes the systems approach essential.

Spending Habits

When an organization spends money, the quantity, description, price and authorization for expenditure should be documented (usually via a purchase order). In large organizations, the person preparing the purchase order and the person authorizing the expenditure are different people. Industry statistics show, however, that 85% of screen printing and