A Real Case of Fraud (#281)
/In this podcast episode, we discuss how to recover from fraud. Key points made are noted below.
Details of a Fraud Case
The topic of this episode comes from a listener, and it involves an actual case of fraud. It appears that criminal charges were filed, so I decided to let this one sit for a year before putting it on the podcast. I’m also not going to mention any names. What you hear next is going to be a mix of the listener’s e-mail to me, and a few comments I have on the situation.
His email begins as follows: “Good morning, I’m a young business owner who made a terrible decision with a woman I hired last year, and it’s erupted into total chaos trying to clean up the mess I was left in. While trying to rebuild the books and payroll system, I figured what I’ve been going through could be a good podcast for your listeners. A quick background on the company, I founded it while in college working toward a degree in finance, working in electrical contracting. By the end of 2017, we grossed $330,000 in revenue and around $100,000 in profit. At the end of 2018, I decided to sign a lease on office space to expand operations. I knew I’d have my hands full running the business and starting my junior year of college, so I decided to hire a contracted controller who would also oversee all of our human resources. What came to follow blows my mind to this day. I later found out that she lied on her resume, had limited accounting experience, and the list goes on. Since her removal from the company in May of 2018, I’ve been doing my best to keep everything together, but the challenges are ongoing and I’m surprised the business hasn’t folded yet. Here are the highlights of what happened:
She set up a Quickbooks accounting system and locked everyone else out of the system.
She set up a Paychex account and locked everyone else out of the system.
She took out a $15,000 loan and forged my signature on the application.
She wrote over $33,000 in checks to herself.
She threw out 90 percent of the receipts for all purchases.
She paid “reimbursements” to her brother, who also worked for the company, that were actually wages.
She stole proprietary information from the company and then started a competing company, and solicited all of my employees to work for her.
It looks like the district attorney will end up sending her to jail, but that doesn’t help me in putting the finances back together. After being a victim of fraud, having to let go all but two employees, and needing to get the books in order with limited source documents and little money to find professional help, I’ve been having to do it all myself. Based on my situation, I have a few questions that I, and your listeners, might find useful in a similar situation. First question: How do you book a transaction when there’s no supporting documentation?”
Booking Transactions Without Documentation
Before I respond to that, let me just say, holy crap! Talk about being taken. This was a case of both massive incompetence by the controller and a comprehensive lack of ethics. Anyways, when there’s no supporting documentation, I wish I could give you a magic solution, but there just isn’t. When all you know is that cash has been withdrawn from the business, then all you can do is charge it to an expense account. I suggest setting up an account with a name like “Undocumented expenses,” just to clarify the situation, but in this company’s case, there’s no way to be more refined about it.
Forensic Best Practices
Second question: “Are there any best practices for doing forensic work to isolate questionable transactions?” The point of this question was for the owner to save time in cleaning up the books by focusing on specific transactions. The answer is, not really. When one person has total control over the books, as was the case here, anything and everything could be screwed up, so there’s no way to reduce the amount of investigative work. To go into a bit more detail here, you can either keep things at a high level and just write off every outgoing payment as an expense, or go into lots of detail and try to track down check recipients and company suppliers and try to get their side of each transaction. Which can take a long time, and it may not be worth the effort.
Wages Paid as Reimbursements
Third question: “How to treat reimbursements paid to employees that were actually wages.” This one is not too difficult. In this company’s case, the owner could notify Paychex of the situation and record the payments in the payroll system after the fact, paying payroll taxes a few months late. This also means that the government will be notified of the increased compensation on the employees’ year-end Form W-2.
Recording Cash Receipts Without Paperwork
Fourth question: “How do you book a cash receipt when there’s no supporting paperwork?” Same answer as for question one, except that now we’re talking about revenue. You can either record these receipts in an undocumented revenue account, or call it a revenue suspense account, if you think you can figure it out at a later date, and then move the money from the suspense account to a more specific revenue account.
Penalties for Engaging in Fraud
Final question: “To what extent of liability or jail time can an accounting professional face by doing these things, and what level of detail should they be concerned about to keep them in the clear?” That is the most interesting question of all. So in essence, what is the difference between someone acting in a fraudulent manner, and someone who’s just royally incompetent? There’s no legal answer that I’m aware of, but I would say that if the person screwing up the books is not personally benefiting from doing so, then it would be difficult to prove fraudulent behavior. I would say that if you’re not too certain of your accounting skills just yet, then rely on the company auditors for advice or use their connections to find someone more competent than you, and ask for help. And always, always document every accounting transaction, so that you can prove why you did what you did.
Getting back to the case that started off this episode. I can totally see why the circumstances led to the hiring of this controller. The owner was desperate for support, needed it right now, and so probably hired her without spending enough time on background checks. When bringing in a new controller, this is the one position where you absolutely, positively have to be sure that the person is a professional, so if there’s any question about a candidate, keep looking for someone else.