Simple steps to detect and deter employee theft
and fraud

Many small businesses share a common characteristic—an exposure to loss caused by employee theft and fraud. An employee theft can be a devastating loss to a small business. The business not only sustains the monetary loss associated with the misappropriation but also often loses a key employee or employees. In addition, it incurs substantial legal and accounting fees investigating and cleaning up the mess. Although insurance may provide some coverage, it will not compensate for all the damage sustained. The loss of employees and associated expenses are normally not insured. The best approach is for management to work aggressively to prevent the theft or embezzlement through internal controls and segregation of duties.

For small businesses, this can present a problem. Frequently, the trusty bookkeeper does it all. He or she opens the mail (including the monthly bank statements); reconciles the bank accounts; prepares company purchase orders; matches receiving reports to invoices; prepares, signs and releases checks; and inputs expenditures into the general ledger. Reliance on an outside accountant to detect irregularities by the bookkeeper is misplaced. Financial statement audits, reviews, compilations and tax return preparation services provided by a certified public accountant are not designed to detect fraud and irregularities and should not be relied on for that purpose.

To reduce the risk of internal fraud, management must take the initiative and demonstrate a commitment to ethical behavior by establishing a code of ethics and ensuring compliance with it. In addition, a small business can easily implement a few controls that will dramatically reduce the risk of loss:

  • Bank statements should be opened and reviewed by the primary check signer to ensure that only authorized checks have cleared the bank.
  • Bank accounts should be reconciled by an employee who has no involvement with the payment of bills and the deposit of revenues.
  • Purchase orders should be sequentially numbered and required for accounts payable disbursements.
  • Checks should be signed by an officer of the company only after a review of authorization for purchase and receipt of the goods or services.
  • Blank checks should be maintained under lock and key and sequentially controlled to prevent misuse.
  • Approved vendors should be added to the accounts payable system only after verification of propriety by an independent employee.

If employee embezzlement or fraud is suspected, it is imperative for the company to conduct a thorough and confidential investigation before making any allegations and/or terminating an employee. The investigation should be coordinated with legal counsel; the bonding company, if any; and the company's outside accountant. To prevent disclosure of the investigation and its findings, legal counsel should conduct the investigation and/or retain a forensic accountant. If the forensic accountant is engaged through legal counsel, his or her reports will constitute work product and will be shielded from discovery.

—Richard G. Witkowski