Are Your Managers Riding Roughshod Over Internal Controls?

According to the latest Association of Certified Fraud Examiners’ Report to the Nations on Occupational Fraud & Abuse, override of internal controls is the primary facilitator of fraud in 19% of cases. Most of these frauds are uncovered only because an employee or other source brings them to light.

As these findings suggest, anyone is capable of committing fraud — even trusted managers. You don’t want to think it could happen, but need to protect against it just the same.

Managers Feel the Pain

Fictitious or premature revenue recognition, overstated assets, and understated expenses or liabilities are among the most common types of management fraud. Managers can, by overriding internal controls designed to detect fraud, record nonexistent or improper sales, undervalue bad debt allowances or inventory reserves, or simply not accrue liabilities.

Your managers, of course, must have some flexibility to override financial reporting internal controls. However, these should be rare occurrences, and your company should require the employee to obtain subsequent approval from you or another authorized manager. Unusual and unsupported entries made to these accounts should raise red flags.

Besides unusual entries that may suggest managers are taking advantage of their override privileges, look for unexpected activity in financial records. If an account is posted through a journal entry, rather than as a normal transaction, dig a little deeper to learn why. Similarly, if transactions are initiated by unexpected parties, or adjustments made without required approvals, get to the bottom of them.

Such activities aren’t definitive indications of fraud, but they are warning signs. If nothing else, they signal a need to overhaul your accepted accounting procedures before a thief finds a way to manipulate your current system.

Avoiding Unrealistic Goals

Even trusted managers are subject to the same “fraud triangle” of influences that cause rank-and-file employees to commit fraud: incentives or pressure, opportunity, and rationalization. Managers also may feel pressured to meet your company’s challenging financial performance targets. So in examining the strength of your fraud control procedures, consider whether your managers’ performance goals are realistic.

Despite your best efforts, management fraud can still be difficult to anticipate and detect. Manager- and owner-perpetrated fraud schemes tend to last much longer than those perpetrated by lower-level employees — possibly because managers intimidate their subordinates into silence.

Still, the people just below managers often are the first to know that something is amiss. To help combat managerial fraud, cultivate a comfortable relationship with employees a level or two lower than your managers.

Raise Your Standards

You trust your managers and don’t want to alienate them or feel compelled to monitor their every move. But that doesn’t mean you should take everything they say at face value, or that you don’t need to understand and test your financial reporting and accounting processes.