Basics of Preventing Employee Fraud

As a company grows, the business owner typically will delegate duties to staff.  When delegating duties it is important to realize that how those duties are delegated could result in employee fraud and theft of company assets.

It’s important to understand fraud and what contributes to fraud.  There are three main things to consider when thinking about fraud:

  • Rationalization – Justification for Dishonest Actions
  • Opportunity – Ability to Carry Out Misappropriation of Company Assets
  • Pressure – Motivation or Incentive to Commit Fraud

The first two items can typically not be controlled by the business owner.  You have no control over whether someone else will rationalize doing something dishonest.  You also have no control over whether someone is feeling pressure or wants to commit fraud.

You do however have the ability to control the opportunity.  In order to reduce the risk that someone will have the opportunity to steal from you, you must have strong internal controls over your assets and the use of your assets.

In developing your internal controls, it’s important to remember that the ARC will protect you from employee theft. What is the ARC?

The ARC stands for

  • Authorization
  • Recordkeeping
  • Custody

Each of these functions is incompatible with each other. This means that no one person should be responsible for doing any of the Authorization, Recordkeeping and Custody functions simultaneously. These functions must be properly segregated.

A simple example of separation of duties would be the owner of the company signs checks (Authorization). The accounts payable clerk inputs the transaction into the bookkeeping software (Recordkeeping). The controller keeps custody of the checks in a locked filing cabinet (Custody).

By separating incompatible duties a company can prevent employee theft and other fraud.

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