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Understanding the Three Most Commonly Used Approaches to Valuing a Business

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence programs and forensic accounting services in Philadelphia and the Delaware Valley.

The three most commonly used approaches to valuing a business are: The Income Approach, the Asset-based Approach, and the Market Approach.

Professional business valuators are required to consider all three approaches.  In the end, a business valuation expert must use his or her judgment to determine the best approach or combination of approaches to arrive at a business valuation that is as fair and accurate as possible.

These three most common approaches which a business valuation expert will consider are:

  • The Income Approach, which values a business by using one or more methods to convert anticipated economic benefits (earnings or cash flow) into a single present amount.  There are two primary methods under this approach:
    • Capitalization of Earnings/Cash Flows Method, which is used when there has been a steady level of historical growth; and the
    • Discounted Earnings/Cash Flow Method, which is used when there have been fluctuations in historical growth and when the company can reasonably project earnings for the next five or more years.
  • The Asset-based Approach, which values a business by calculating the value of net assets, (the difference between total assets and total liabilities).  There also are two primary methods under this approach:
    • The Book Value Method, which calculates the net asset value as shown on the books of the business – typically at historical cost, and the
    • Adjusted Net Asset Method, which adjusts the value of assets and liabilities of the fair market value as of the valuation date.
  • The Market Approach, which values a business by comparing it to sales of similar businesses.  There are four primary methods under the Market Approach:
    • Transactions of comparable publicly held companies;
    • Transactions of comparable privately held companies;
    • Prior transactions involving shares of the company itself, and lastly,
    • The ability of the company to pay shareholder dividends as compared to dividends paid by comparable companies.

The specific methods used depend on the facts and circumstances surrounding the business being valued.  For example, if there are no comparable market transactions or an insufficient number to be meaningful, the Market Approach may not be useful.

Once the value of the business has been set under each of the approaches, the business valuation expert must determine whether one of the values is the best representation of the true value of the business or if a weighted blend of the values provides a more accurate final business value, he said.

Typically, the Asset-based Approach yields the lowest value, and is usually relied upon by the valuator to establish a floor value for the business.  However, if the business has had recent operating losses and no comparable market transactions are available, the Asset-based Approach may well be the basis for the valuation.

If the valuation expert is valuing a startup business with little or no operating history and/or profitability, the Income Approach might yield a very low value. However, the Market Approach might result in a considerably higher value based on the sale of comparable businesses.

Under this scenario, some valuators would select the Market Approach as being most indicative of value and others might choose a blend of the Income Approach and Market Approach with a higher weight on the Market Approach.

It all comes down to the professional judgment of the business valuator, based on his or her experience and knowledge about the business being valued.

If you need a business valuation professional in Philadelphia, or if you require any other services of a forensic accounting expert in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.

Bring in Expert Witnesses Early to Enhance Your Litigation Support

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence programs and forensic accounting services in Philadelphia and the Delaware Valley.

Trial attorneys know expert witness testimony from a forensic accounting expert can be critical in determining the outcome of legal proceedings.  Likewise, the timing of when an attorney engages the services of a forensic accountant for litigation support services and, ultimately, expert witness testimony, also has a direct bearing on the success or failure of the case.

“The earlier a forensic accounting expert is called in to consult on a case, the greater the chances the expert will be able to contribute information crucial to winning the case,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides litigation support services and expert witness testimony in Philadelphia and the Delaware Valley.  “Forensic accounting experts who are engaged too late in the process often cannot have the impact on the case that the attorney needs.”

Earlier in his career, Anderson was asked by an attorney to provide expert witness testimony in Philadelphia for ongoing litigation.  The attorney’s client, a minority shareholder in a medium-sized distribution business, was claiming the majority shareholders were taking outsized salaries and benefits; paying significant salaries and benefits to family members who performed little or no work; paying exorbitant office rent to entities owned by the majority shareholders; and running personal expenses through the business.

The attorney said he and his client expected to resolve the litigation without going to trial, but that didn’t happen.  Now, an expert report was due within two weeks.  Discovery had closed several months before, but the attorney had the company’s federal income tax returns for the past five years and believed that would be enough for Anderson to create a comprehensive report detailing the transgressions of the majority shareholders.

Anderson, whose full range of forensic accounting services in Philadelphia and the Delaware Valley includes litigation support services and expert witness testimony in Philadelphia, agreed to examine the tax return and let the attorney know that same day if he would or would not be able to produce the rushed report that was requested.

“Unfortunately, certain schedules were missing from the returns, and the information presented was in summary form – merely totals of overall expense categories with no specifics, said Anderson, a forensic accounting expert in Philadelphia and the Delaware Valley.  “Individual employee wages were not shown and there were no details for benefits, travel, professional fees, meals and entertainment and other categories the minority shareholder suspected were being inappropriately paid by the company.  A $50,000-line item for ‘Miscellaneous Expenses’ appeared on one year’s return, but with no breakdown.”

Absent the complete accounting detail that is often not found in the income tax returns, but instead in the company’s accounting records and detailed financial reports, Anderson was unable to produce the comprehensive report the attorney needed to assure a win in the case.

Engaging a forensic accountant for litigation support services at the very beginning of a case can help attorneys establish the foundation of the case and determine the most effective course for the litigation, said Anderson, whose company offers a full range of forensic accounting services in Philadelphia and the Delaware Valley.  Forensic accounting experts provide litigation support services and expert witness testimony for both plaintiffs and defendants in civil cases, as well as both prosecutors and defense attorneys in criminal cases.

Early involvement allows the expert witness to provide advice in areas such as:

  • Assistance in identifying and formulating arguments for the complaint (if for the plaintiff)
  • Initial evaluation of the plaintiff’s claims and identification of the information or testimony needed to support those claims
  • Analysis of the complaint and assistance with identifying arguments for the response (if for the defendant)
  • Assistance with preparation of discovery requests and interrogatories, including identifying the format(s) for delivery of the requested information (for example, if requesting detailed accounting system information, identifying acceptable formats for the delivered information so that it can be analyzed in a timely and cost-effective manner)
  • Follow-up on information delivered in response to discovery requests and responses to interrogatories to identify either missing information or additional information needed
  • Assistance with identification of individuals to be deposed
  • Assistance with development of questions for the deponents, including for the expert witness’s own deposition
  • Preparation of a report identifying and calculating damages or business value
  • Preparation of rebuttals for opposing expert reports (if necessary)

“Engaging a forensic accountant from the start provides expert analysis of your case before the discovery and deposition phases are closed,” Anderson said.  “In any financial dispute, the insights and advice of a forensic accounting expert can make the difference between winning and losing the case.”

If you require the services of a forensic accounting expert in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.  Anderson also has provided expert witness testimony in the Greater Philadelphia area and served as a forensic consultant on both civil and criminal cases.

Set Up A Tip Hotline to Help Stave Off Business Fraud

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence programs and forensic accounting services in Philadelphia and the Delaware Valley.

Many business owners and executives believe performing a formal financial audit each year is the most effective way of detecting and deterring fraud.

They are wrong.

Less than four percent of all fraud is detected by a formal financial audit.  In fact, nearly twice as many frauds are discovered by accident than by formal audit.

So then, what is the best way to detect and prevent fraud?  You might be surprised.

A recent “Report to the Nations” from the Association of Certified Fraud Examiners (ACFE) shows tips are responsible for uncovering fraud more so than any other method.  More than 39 percent of all frauds were exposed as the result of information provided by tipsters.

And who were the main source of these tips?

By far, it is a company’s own employees. One surprising finding of the ACFE report was that a surprisingly high 52 percent of all frauds reported via tips came from company employees.

“Employees can be your first line of defense against fraud,” said Anderson, of David Anderson & Associates. “Employees may see fraudulent or suspicious activity but may be reluctant to be identified as the source of a tip, either because they fear retribution from other employees or because they’re not absolutely sure that fraud is occurring.”

So how do you encourage employees to come forward?  The best way is using an anonymous tip hotline.

“Employees are far more willing to report illicit activity if their anonymity is protected,” said Anderson, a Certified Fraud Examiner and an ACFE member.  “The anonymous tip hotline provides them with the vehicle they need to do the right thing and bring the fraud to the attention of people in charge.”

Companies do not have to set up the tip hotline themselves, Anderson said. Third-party companies will step into set up and operate the hotline for a reasonable fee and will maintain the employee’s confidentially.  In fact, having an outside party manage the hotline further assures employees their identity will not be revealed by something they say or by speaking with someone who recognizes their voice.

In addition to tip hotlines, the ACFE Report referenced by Anderson shows many companies also are providing mechanisms for receiving tips through e-mail and/or through their websites.

Companies that provide tip hotlines for their employees typically find both the duration of fraudulent activity and amount of the losses are reduced by 50 percent.

A tip hotline is an important component of a comprehensive fraud deterrence program that, Anderson said, can be created by a firm that provides forensic accounting services in Philadelphia and the Delaware Valley. Anderson also said he urges organizations to protect themselves by contacting a Certified Fraud Examiner to conduct a thorough fraud investigation at the first sign of suspicious activity.

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Taking Steps to Prevent Rationalization Can Reduce the Threat of Fraud

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley. 

In this blog, the final of a three-part series on The Fraud Triangle, Certified Fraud Examiner David Anderson of David Anderson and Associates, a firm offering forensic accounting services in Philadelphia, reviews the three factors – Opportunity, Pressure, and Rationalization – that must be present for fraud to occur. 

If even one of these three situations can be eliminated, the potential for fraud and the need for a fraud investigation is either significantly reduced or goes away. After reviewing Opportunity and Pressure in the first two parts of this series, Anderson closes with a closer look at Rationalization. 

Rationalization is the mental process that a potential fraudster goes through to justify committing the fraud.

“Without being able to rationalize to oneself why it is OK to commit the fraud,” said Anderson, who provides forensic accounting services in Philadelphia, “a potential fraudster with the opportunity and pressure will not proceed.”

Anderson said examples of rationalization can include:

  • I’m only temporarily “borrowing” the money to meet my financial obligations, and I intend to pay back the “loan” in full;
  • I’m not being paid what I am worth, so I’m making up the difference through fraud;
  • The company makes a lot of money, so it won’t be missed/ be affected by the small amount I am taking;
  • The owner/management is committing fraud, so why shouldn’t I? and
  • I have been “wronged” by the company/owner/management, so this is how I can get back at them.

Owners/managers can influence the rationalization process and discourage the rationalization to commit fraud by taking several anti-fraud steps:

  • Provide anti-fraud training to all employees which, among other things, includes specific statements that committing fraud is wrong and unacceptable; that management is dedicated to preventing fraud; and that encourages employees to be on the lookout for fraud;
  • Establish a “hotline” which allows employees to confidentially report suspected fraud;
  • Establish a “tone at the top” that demonstrates that management is committed to fighting/preventing fraud (and not merely paying lip service to the fraud);
  • Establish policies and procedures which allow an employee to pursue complaints about being “wronged” (real or imagined);
  • Let employees know management is watching and is implementing such anti-fraud measures as surprise audits and regular management reviews.

Taking these steps as well as steps discussed in the previous two articles (establishing strong internal controls and getting to know one’s employees better) are all part of dismantling the three legs of the fraud triangle.

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Break the Fraud Triangle by Keeping an Eye Out for Pressure Situations

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley. 

In this blog, the second of a three-part series, Certified Fraud Examiner David Anderson of David Anderson and Associates, a firm offering forensic accounting services in Philadelphia, reviews the Fraud Triangle – a combination of three factors – Opportunity, Pressure, and Rationalization – that must be present for a fraud to occur. 

If even one of these three factors can be eliminated, the potential for fraud and the need for a fraud investigation is either significantly reduced or goes away. After reviewing Opportunity in the first entry last week, here Anderson takes a closer look at Pressure. He will discuss Rationalization in next week’s conclusion of this series.

Pressure refers to the personal situation of the potential fraudster that can induce the person to commit the fraud.  Even if the opportunity to commit fraud is present, if the person feels no pressure to commit the fraud, he or she won’t.

“Eliminating such pressures,” said Anderson, who provides forensic accounting services in Philadelphia, “can be key to a successful fraud deterrence program.”

The primary pressure experienced by a potential fraudster is the need for money.  Other potential pressures (which are significantly less likely to occur) include revenge (the fraudster feels wronged by the business, its owners or management) and thrill (the fraudster has no need for money but wants the thrill of committing and getting away with the fraud).

Examples of the need for money include:

  • The potential fraudster’s spouse becomes unemployed or unable to work, and, as a result, the family’s household income has dropped significantly;
  • The potential fraudster has previously lost a higher paying job, and the current job pays significantly less;
  • A member of the potential fraudster’s family has become ill or was injured, and the family is unable to pay the resulting medical bills;
  • The potential fraudster has a drug or gambling problem, and needs additional money to support the problem;
  • The potential fraudster (and/or family) has a lifestyle that requires more money than is currently being earned;
  • The potential fraudster is going through a divorce or other family problems that require more money than is currently being earned.

Although the specific circumstances experienced by the potential fraudster are generally beyond the control of a business’s owners and/or management, the owners and managers should be on the lookout for these types of problems.  It is often as simple as getting to know better the employees who could have the opportunity to commit fraud.

For example:

  • Has the owner or manager noticed whether an employee is driving a more expensive car or wearing more expensive jewelry and/or clothing than would be expected?
  • Has the owner or manager heard (or has it been reported to the owner or manager by another employee) an employee discussing expensive vacations, the purchase of an expensive home or vacation home, or the purchase of an expensive boat that would appear to be more than the employee would be capable of handling?
  • Has the owner or manager heard (or has it been reported to the owner or manager by another employee) the employee discussing family problems, a family member’s illness or injury or a family member’s loss of employment?
  • Has the owner or manager heard (or has it been reported to the owner or manager by another employee) the employee discussing gambling winnings or losses?
  • Has the owner or manager noticed (or has it been reported to the owner or manager by another employee) an employee exhibiting signs of a drug problem?
  • Has the owner or manager heard (or has it been reported to the owner or manager by another employee) the employee complaining about being underpaid or passed up for a deserved raise, bonus, or promotion?
  • If the answer to any of these questions is “yes”, the next step would be to consult with the company’s attorney before taking any action (including confronting the employee or questioning other employees).

By being proactive with getting to know one’s employees better, the owner or manager can help identify when an employee is facing a pressure which could potentially turn the employee into a fraudster.

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Breaking Down the Fraud Triangle – Don’t Let Opportunity Knock

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley. 

In this blog, the first of a three-part series, Certified Fraud Examiner David Anderson of David Anderson and Associates, a firm offering forensic accounting services in Philadelphia, reviews The Fraud Triangle – a combination of three factors – Opportunity, Pressure, and Rationalization – that must be present for a fraud to occur. 

If even one of these three factors can be eliminated, the potential for fraud and the need for a fraud investigation is either significantly reduced or goes away. In this first piece in the series, Anderson takes a closer look at the first leg of the triangle – Opportunity.  In subsequent articles, he will examine the other two legs.

All businesses have, or should have, a set of policies and procedures as part of their fraud deterrence programs that are designed to protect systems and safeguard assets.  These policies and procedures are often referred to as “internal controls”.  If such internal controls are lacking, are poorly designed, or are easily overridden, it presents the potential fraudster with the opportunity to commit fraud.

“Let’s look at two common businesses situations,” said Anderson, who provides forensic accounting services in Philadelphia, “and how internal controls should be designed to prevent or significantly reduce the potential for fraud.”

The first, he said, is for handling payments made by customers.  In a well-designed internal control system structured with fraud deterrence in mind, the person who opens the mail will be different from the person who prepares the deposit slip for the bank.  Furthermore, neither of these people will make the bank deposit or record the receipt of funds and bank deposit in the company’s accounting system.  In addition, the entire process would be overseen by a manager or supervisor.  This step helps in fraud deterrence and lessens the need for a fraud investigation.

However, as this example indicates, these controls require that there be at least five different people involved.  Many smaller businesses don’t have enough staff to separate these functions.  As a result, some employees end up performing more than one of these functions.  This creates an opportunity for the employee to commit fraud.

For example, the employee who opens the mail could also prepare the deposit slip and record the receipt of funds and bank deposit in the company’s accounting system.  If that employee is trusted by the manager/supervisor, the manager/supervisor might not actively review the employee’s activities.  This creates the opportunity for the employee to divert certain customer payments.

A second common business situation is for processing vendor invoices.  In a well-designed internal control system, the person who sets up the vendor in the company’s accounting system is different from the person who approves the vendor invoice.  Furthermore, neither of these people enter the invoice in the company’s accounting system, process the payment or sign the payment check.

As with the previous example, the entire process would be overseen by a manager or supervisor.  If a company is unable to separate these duties, it creates an opportunity to commit fraud.  If the employee who sets up vendor in the company’s accounting system can also enter vendor invoices and process payments, that employee would have the opportunity to create a phony vendor (or change the address of an actual vendor), process phony invoices and produce payments that the employee could divert for his/her own use.

Well-designed internal control systems help prevent the opportunity for the fraudster to commit fraud.  This, in turn, “knocks out” one leg of the fraud triangle, thereby preventing or significantly reducing the potential for fraud.

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Are You Sure Your “Trusted” Employees Can Really Be Trusted?

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

You have them, your competitors have them, every company large or small has them. “Them” are your trusted employees, women and men on your team who have worked with you forever and have, time after time, proven their loyalty to you and your organization.

Despite a spotless track record, though, can you really trust your “trusted” employees?

Certified Fraud Examiner David Anderson of the Philadelphia forensic account services firm of David Anderson & Associates, says you never should forget that these “trusted” employees can pose a significant fraud threat to businesses and organization.

“They may be family members, employees who have worked their way up the management ladder over the years, employees who are hardworking and who put in long hours, and/or employees who have contributed to the past success of the business,” he said.

Because of this “trusted” status, Anderson said, business owners and senior managers tend to exert less oversight over these employees than they do over the typical employee.

Most “trusted” employees are worthy of the trust they have earned.  However, other “trusted” employees have used the trust and lack oversight to commit fraud.  Over the past several years, investigations of “trusted” employees conducted by David Anderson & Associates have identified the following frauds perpetrated on their employers:

  • Use of employers’ business credit cards to charge personal expenses
  • Use of expense reimbursements to have the business pay for personal expenses or non-existent expenses
  • Manipulation of payroll to take improper salaries and bonuses
  • Use of more vacation, personal, and sick days than earned
  • Running purchases for their own personal business through the purchase accounts of their employer, and having the employer pay for these purchases
  • Diverting customer cash payments to themselves, and covering up the diversion by manipulating the employer’s accounting system
  • Removing inventory from the employer’s warehouse, and covering up the diversion by manipulating the employers accounting system
  • Diverting customers and sales from the employer’s business to their own personal or a friend’s business
  • Selling the employer’s fully depreciated assets to a third-party and pocketing the proceeds.

In each case, Anderson said, the employer had no fraud deterrence program in place.  These companies could have significantly reduced the likelihood of fraud occurring if management had instituted such procedures as:

  • Regular top management or third-party consultant review of credit card statements and expense reimbursement requests
  • Regular top management or third-party consultant review of payroll journals
  • Regular top management or third-party consultant review of monthly bank statements and monthly financial statements
  • Regular periodic review of operations by top management or a third-party consultant
  • Instituting an anti-fraud policy, disseminating it to all managers and other employees, and holding periodic training sessions on spotting and report fraud
  • Letting all employees know that top management does not condone fraud, and that supervisors are actively watching out for it.

“Trusted” employees continue to be a problem for employers who provide reduced oversight to them.  However, Anderson said, by instituting relatively simple and relatively inexpensive fraud deterrence procedures, management can significantly reduce the risk of such “trusted” employees becoming untrustworthy.

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Looking to Sell Your Business? Here’s How to Prepare

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence programs, and forensic accounting services in Philadelphia and the Delaware Valley.

Selling a house is an important decision, one that’s not made capriciously but undertaken only after solid research and planning, and consultation with industry experts.

Selling a business is a very similar process. You’ve invested time, money, and sweat equity into your company and you want top dollar when you put it on the market. As you do your research and make your plans, strongly consider working with a forensic accountant experienced in business valuation to maximize the benefits of the transaction.

“Whether selling a house or a business,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm providing business valuation services in Philadelphia and the Delaware Valley, “you must hire a good broker, have your records and physical structure in order, and be prepared to address issues or questions from potential buyers.”

Anderson, a forensic accounting expert in Philadelphia who also is a Certified Valuation Analyst, offers these guidelines to help business owners prepare for a sale:

Find a Good Business Broker

Unless a business owner has extensive industry contacts and experience in selling businesses, Anderson said, sellers should work with a business broker.

“Just as you would do with a real estate broker you hire to sell your home, you’ll want to interview the business broker,” said Anderson, whose company specializes in business valuation services in Philadelphia and the Delaware Valley. “Check references and have the broker analyze your business before you agree to hire them.”

Get Your Books and Records in Order

This is a crucial step in the process, Anderson said, because your business broker and any potential buyers are going to want to examine your books and records as part of their due diligence.

“This is similar to getting your house ready for showings,” he said; “you need to do the same for your books and records.”

Among Anderson’s recommendations:

  • Collect financial statements, general ledgers and income tax returns for the past five years;
  • Secure copies of all leases, contracts and agreements; and
  • Gather organized documentation of any intangible assets or intellectual property.

Business owners also must ensure their books accurately reflect the financial position of the company, he said.  This includes:

  • Writing off old accounts receivable,
  • Adjusting inventory for obsolete and slow-moving items,
  • Removing retired fixed assets from the books,
  • Making sure all liabilities and debt are accurately reflected on the books, and
  • Identifying non-business and/or one-time expenses that have been recorded.

Failure to get books and records in order can result in potential buyers reducing their offers because they question the “quality of earnings” of your business.

It’s often a good idea to have an independent expert, such as a forensic accountant, review your books and records to make sure you haven’t missed anything, said Anderson, a Certified Valuation Analyst and forensic accounting expert in Philadelphia.

Address Key Potential Legal Issues

Review your business with your attorney.  Make sure your attorney (or the attorney’s firm) can address each of the following:  Do you having pending litigation?  If so, be prepared to address this with potential buyers.

Are key employees under contract?  If not, they could leave and take business with them or divulge business secrets.  Have you adequately provided for warranty and return issues?  If not, potential buyers may insist upon you setting up reserves which can lower the sale price.

Are your pension, profit-sharing, and other retirement plans fully funded?  If not, this also can lower the sales price.  Are your trade secrets and intellectual property adequately protected with patents or trademarks or other legal mechanisms? If not, move forward with implementing these protections.

 Get Your Business Premises in Order

Beyond the books and records, Anderson said business owners should take a critical look at their actual business premises.  Among his recommendations:

  • Straighten up and organize;
  • Dispose of obsolete inventory, old furniture, and retired equipment;
  • Make repairs and perform maintenance so the facilities are in working order and look fresh; and be sure you have keys to all locks, and
  • Investigate potential environmental issues, and address them before buyers come calling.

“These are the same things you would do when you are selling a house,” said Anderson, a business valuation expert in Philadelphia who specializes in providing a full range of forensic accounting services in Philadelphia and the Delaware Valley.  “Making sure your physical premises are in top shape will help you get the best possible price for your business.”

Prepare for Questions

Anticipate what buyers will ask and have the answers ready, Anderson said. “This will speed up the due diligence process and impress buyers by showing them you truly know your business,” said Anderson, an expert in business valuation services in Philadelphia.  “Be prepared to discuss employees and key employee retention, customers and customer retention, vendors, products and services, industry trends, and your vision for the future of the business.”

If you require the services of a Certified Valuation Analyst or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Tales of Business “Insecurity” – Part 2

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

In this blog, the second of a two-part series, forensic accounting expert David Anderson of David Anderson & Associates, a Certified Fraud Examiner in Philadelphia, concludes his look at examples of security failures he has observed in his work.

As he noted last week, many businesses implement a wide range of policies and procedures to protect their property, assets, and data. However, even the best of policies and procedures are ineffective if employees don’t adhere to them. Here are several more such “tales:”

The unsecure data center: Anderson was engaged to evaluate the IT security controls at a medium-sized company based in North Carolina.  Their “secure” data center was an unlocked coat closet just off the lobby.  Besides having no air flow, which could have caused the servers to overheat, visitors could have easily entered the closet, and even walked off with the equipment.

Common user IDs and passwords: At the same company as above, each member of the accounting department accessed the company’s accounting system by entering “Accounting” as the user ID and “Accounting” as the password.  Although the company had experienced departmental turnover, including one individual who had embezzled funds, the company had never changed the common user ID and password.

Not changing locks and system access: At a medium-sized Philadelphia-area company, Anderson’s investigation of the IT and facility security controls noted that the firm issued employees an office key when they started their jobs, but never asked for the key back when the employee left.  Additionally, the company never deleted the user ID and password for these employees.

Although Anderson said he was able to persuade the company to remove system access for terminated employees, management did not want to incur the cost of changing locks and issuing new keys.  This problem was resolved several months later after a former employee, who had retained his key, entered the premises one weekend and stole computers and inventory.

Non-secret passwords: This is perhaps the most common “insecurity” Anderson said he has encountered. At many companies, he has seen passwords taped to the monitor, or tacked to a corkboard next to the computer, or taped to the desk underneath the user’s keyboard.  In several of the companies, the company itself was the cause of the “insecurity” because many employees accessed multiple systems which each required a new password every 60 days, and passwords could not be common across systems.

Executives who violate access rules: This is another “insecurity” Anderson said he has seen in multiple companies.  A busy executive provides his/her user ID and password to his/her administrative assistant/executive secretary to facilitate access to his/her e-mail and personal files.  Assuming the administrative assistant/executive secretary is a trusted employee, many companies do not consider this situation to be a problem, even though, as Anderson points out, it usually violates company IT security control procedures.

This situation becomes a problem when that trusted employee is out and must temporarily be replaced. For example, Anderson said he has seen such employees out on vacation, maternity leave, family medical leave, etc. This means one or more new employees – or even temporary employees – are granted access to the executive’s e-mail and personal files.  Now, because the executive does not want to change user IDs and passwords, no such change is made.  This means other employees or temporary employees could continue to access the executive’s e-mails and personal files.

In each of the above cases, the employee’s failure to adhere to the established policies and procedures resulted in security lapses. To avoid the “insecurity” failures Anderson detailed both last week and this week, he makes the following recommendations:

  • Engage an outside expert to review your company’s security/control policies and procedures to identify potential failure points and provide solutions. For example, changing multiple passwords across multiple systems every 60 days is likely excessive. The expert can suggest alternatives, such as using the same password across multiple systems; increasing the number of days between password changes to 120 or 180 or even annually; or providing a password management tool.
  • Ensure all employees are provided with, and acknowledge receipt of, company security/control policies and procedures.
  • Conduct training on a regular basis, at least once a year, to remind to remind employees of the policies and procedures, and why they need to be followed.
  • Encourage employees to follow the guideline “if you see something, say something” with regards to unauthorized visitors and employees who violate company policies and procedures.

If you want to learn how a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley can help you steer clear of such security issues, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Tales of Business “Insecurity” – Part 1

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

Many businesses implement a wide range of policies and procedures to protect their property, assets, and data.  However, according to forensic accounting expert David Anderson of David Anderson & Associates, a Certified Fraud Examiner in Philadelphia, even the best of policies and procedures are ineffective if employees don’t adhere to them.  The following is Part 1 of a two-part series featuring examples of security failures Anderson has observed in his work:

When Security Badges Aren’t Effective:

Many businesses require employees to wear a security badge and “swipe” it to gain access to facilities.  In one case, a just-fired employee returned to the company that had fired him and waited by the security access door. Other employees who had seen him around (and didn’t know he had been fired), held the door open for him (not noticing he didn’t have a security badge).  He then entered the building, proceeded to pull out a hammer, and vandalized several desktop computers until he was stopped by security officers.

In another case, Anderson said he was visiting the IT department of a large Philadelphia business to conduct an evaluation of its IT controls.  He was standing outside the secure data center when an employee with a large cart full of equipment swiped his security badge to enter the data center.  The employee was struggling to hold the door open for his cart and, seeing Anderson, asked him if he would hold the door (neither Anderson nor the employee had seen each other before, and Anderson was wearing a visitor badge).  Anderson helped and continued to hold the door open until the employee entered the data center and out of view. Anderson, now in center himself, went over to one of the terminals, and, if he had been malicious or interested in stealing data, he said he easily could have entered the necessary commands to do so.

When Terminals or Desktop Computers Aren’t “Secure:”

When conducting an IT security evaluation, Anderson wandered into the accounting department of another large Philadelphia business.  He observed an employee tell another he was going to lunch, and then watched him get on the elevator and leave.  Anderson walked over to the now-empty cubicle and noticed the just-departed employee had not logged out of the company’s accounting system.  Anderson said he sat down at the vacant desk and proceeded to access the accounts payable and general ledger applications.  No one challenged him, he said, or even appeared to notice he was there.  Again, had he wanted to, Anderson said he could have caused major damage to the company’s accounting system.

When Confidential Records Aren’t Secure:

When Anderson was a junior auditor (before the days of electronic medical records), his first assignment was on the audit of a large hospital.   One of his assignments was to make sure that selected patient records had been properly entered into the hospital’s accounting system (to facilitate billing).  He said he was unable to locate one patient’s file, and after investigation, learned it was because the patient was still in the hospital (and the records were at the nurse’s station on one of the patient floors).  He said he went up to that floor, and requested the patient’s chart (He said he was not wearing a badge and didn’t identify himself, but was dressed in a business suit).  The nurse handed the requested documents to Anderson, saying, “Here’s the chart, doctor.”

Taking Secured Data Files Home to an Unsecured Computer:

At one medium-sized company, Anderson was called in to investigate when their system became infected with a rather nasty virus.  It turned out the Controller had taken certain budget files home (on a thumb drive) to work on over a holiday weekend.  Unbeknownst to him, his high school son had been using the same family computer, and had unknowingly downloaded a virus.  When the Controller used the computer, the virus was transferred to his thumb drive and then to the company’s system.  What made this worse was that the Controller was responsible for updating the virus protection for the company’s system, but had failed to download three years of updates.

Becoming Victimized by E-Mail Spoofs:

Hackers had obtained confidential names, addresses, social security numbers and other salary information of the employees of a small subsidiary of a larger Philadelphia company.  Anderson said his investigation determined the company’s systems had not been penetrated, but instead, the Accounting Manager of the subsidiary had been victimized by an e-mail spoof.  She had received an e-mail, purportedly from the parent company’s Controller, informing her there was a problem with the subsidiary’s W-2 forms, and requesting she prepare and send to him an Excel spreadsheet of the subsidiary’s W-2 information, allegedly so the home office “can correct the problem.” The local Controller failed to notice the requesting e-mail came from an e-mail address that was similar to but not the same as the corporate Controller’s actual e-mail address.  She prepared the requested spreadsheet and attached the spreadsheet as she replied to the original “spoofed” e-mail.

In each of the above cases, employee failure to adhere to the established policies and procedures resulted in security lapses.  Next week, Anderson will continue with more examples of such failures, and offer some tips for avoiding them.

If you want to learn how a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley can help you steer clear of such security issues, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

When Employees Go Rogue: Tales of Fraud and Fraud Prevention – Part 3

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

In Parts 1 and 2 of this three-part series, forensic accounting expert David Anderson of David Anderson & Associates, a Certified Fraud Examiner in Philadelphia, discussed frauds committed by trusted accounting employees, and how these frauds could have been prevented.  This week, he closes the series with a look at frauds by trusted members of management which he has investigated.

Fraud #1: The President (and 1/3 owner) of a family-owned retail business was a gambler.  He could be found at one or more Atlantic City casinos four or more days a week.  However, he ran short of money to support his gambling habit.  He knew the family business generated a lot of cash sales, so he schemed to use the company’s cash to finance his gambling.  He made sure all cash sales were manually recorded on numbered receipt pads.  He then made sure the pads were used in mixed sequence (of the six pads in use at any one time, no two pads were in sequence), so the receipt numbers could not easily be tracked.

Next, he fired the long-time bookkeeper and installed his new girlfriend as the bookkeeper.  She had no accounting background at all, and therefore depended on him to teach her bookkeeping and how to use the accounting system.   Finally, he made himself responsible for reconciling cash received to the receipts.  Then, each day, he took a handful of receipts and threw them in a desk drawer while simultaneously pocketing the cash amount of those receipts.  He gave the remaining receipts and cash to the bookkeeper for entry into the accounting system and deposit in the bank.

Over time, the business began to experience cash-flow problems (due to his fraud).  He hid this by slowing or even stopping payments to vendors, and then blamed the 2008 recession as the cause of their refusal to ship product to the business.  His scheme was discovered when he was out sick one day.  His brother, another 1/3 owner of the business, was looking for a document and, in searching for the document in the President’s desk, discovered the drawer with the hidden receipts.  By then, the President had taken over $750,000 from the business.

Since senior management can override internal controls, the primary way to prevent such a fraud is to bring in outside oversight.  Also in this case, the other two business owners should have been suspicious of the President firing the long-time bookkeeper.  They should have insisted the company retain an outside accounting or forensic accounting firm to establish internal control procedures, train the bookkeeper, and produce monthly operating reports.  If this had been done, the President would not have been able to perpetrate his fraud scheme.

Fraud #2: The Vice President /General Manager of a family-owned business was the heir-apparent to run the business as the primary owner began to cut back on his involvement in the business.  However, he had only a minor ownership interest, and was supposed to share the profits of the business with other family members.  Instead, he schemed to keep most, if not all, of the profits for himself.  He began by charging significant amounts of personal expenses on his company credit card.  Since he approved credit card purchases, he was able to have these charged as business expenses of the company.

Next, he began to purchase inventory through this company, but for the benefit of his wife’s retail business.  He alone took control of how much the wife’s business was to reimburse the family-owned business for these purchases.  Over the course of several years, he had the wife’s business reimburse only a fraction of the inventory she used, but which was paid for by the family-owned business.  Next, he closed one of the company stores and installed his wife’s business in the store.  Although he stated his wife’s business would reimburse the family-owned business for the rent, he again only had her business reimburse a fraction of the total rent.

Finally, he set up another business to compete with the family-owned business, and began diverting sales to his new business.  His fraud was discovered after the company began to experience significant cashflow problems.  His attempts to cover-up his fraud caused him to have major disagreements with the primary owner.  Due to these disagreements, the primary owner fired the Vice President /General Manager.  After the primary owner stepped back into the business, he discovered the fraud.

As with the previous fraud, since senior management can override internal controls, the primary way to prevent such a fraud is to bring in outside oversight. The primary business owner should have insisted the company retain an outside accounting or forensic accounting firm to establish internal control procedures and produce monthly operating reports.  If this had been done, the Vice President/General Manager would not have been able to perpetrate his fraud scheme.

Fraud #3: The General Manager of an automobile dealership owned only 15 percent of the business, but schemed to keep a greater share of the profits.  He purchased two small nearby businesses – a car wash and a used car lot.  Previously, the automobile dealership had sent each customer car it serviced and each used car it purchased to an auto detailer.  Now, the General Manager started to send each such car to his car wash.  He merely washed each car, but charged the automobile dealership for a full detail.

Next, he schemed to have the automobile dealership sell to his used car lot good quality used cars at large discounts, and to purchase from his used car lot poorer quality used cars at large markups.  His scheme was discovered when an employee overheard the General Manager discussing the huge profits that his car wash and used car lot were making at the expense of the automobile dealership.  The employee reported this to the dealership’s primary owner, and the General Manager was fired.

As with the previous frauds, since senior management can override internal controls, the primary way to prevent such a fraud is to bring in outside oversight.   The primary business owner should have insisted the company retain an outside accounting or forensic accounting firm to establish internal control procedures and produce monthly operating reports.  If this had been done, the General Manager would not have been able to perpetrate his fraud scheme.

As can be seen from the frauds discussed above, when a business owner cedes active oversight to internal senior management, it is critical to employ an outside accounting or forensic accounting firm to provide a measure of oversight and independent reporting to the business owner.

If you want to learn how a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley can help safeguard your company against such fraud schemes, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

(NOTE: David Anderson’s forensic accounting blog will be on hiatus for the holiday season and will return on Monday, January 8.)

When Employees Go Rogue: Tales of Fraud and Fraud Prevention – Part 2

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

Last week, in the first segment of a three-part series, forensic accounting expert David Anderson of David Anderson & Associates, Certified Fraud Examiner in Philadelphia, discussed payroll frauds committed by trusted accounting employees, and how the frauds could have been prevented.  This week, in Part 2, he looks at non-payroll frauds by committed by trusted accounting employees.

Fraud #1: The Controller of a regional retail chain began using the company’s petty cash fund (over which she had total control) to perpetrate her fraud.  Initially, she “borrowed” money from the $1,000 fund and left a personal check in the petty cash box for the amount borrowed.  After receiving her next paycheck, she repaid the “loan” and retrieved her check.  This went on for several months with the “borrowed” amount regularly increasing until she was taking almost the entire $1,000 amount each pay period.  To further her scheme, she persuaded the owner to increase the petty cash fund to $5,000.

As the scheme continued, her “borrowings” increased to the point that the amount borrowed exceeded her entire paycheck, and she was unable to repay the petty cash fund.  No problem, she then launched her next scheme.  She made copies of other employee’s previously reimbursed expense documents, and submitted these as her own (reimbursing herself through petty cash).  This scheme was discovered only when the Controller was away on vacation and the owner went into the petty cash box to pay the person who watered the plants in the office.  He discovered that less than $100 cash was left in petty cash along with over $4,900 in copies of receipts (one of which he recognized was from his most recent expense reimbursement request).

The owner should have initially been suspicious of the request to increase the petty cash fund to $5,000.  He should have demanded written documentation of why it was necessary for such a large increase.  Additionally, he should have conducted regular random surprise audits of petty cash, particularly on the day before a payday and on the day before a long holiday weekend (these are the most likely times to find petty cash fraud).  Had he done so, he could either have prevented the petty cash fraud or stopped it in its early stages.

Fraud #2: The same Controller as in the above fraud also engaged in an additional fraud scheme involving accounts receivable.  The retail chain had its own branded credit card for customer use in making purchases from the chain.  The Controller had previously been issued such a credit card, and the card balance reached a point where she was unable to pay the amount due.  To solve this problem, she simply issued a credit memo which wiped out the credit card balance (obviously the company had no internal controls over credit memos).

The Controller then expanded this scheme by identifying friends, family, and neighbors who also had the chain’s branded credit cards.  She approached these people with an offer to eliminate their credit card balances in return for cash payments (to her) of a percentage of the amount eliminated.  This scheme was discovered as part of the forensic examination Anderson conducted after the owner found the above petty cash fraud.

Because of the possibility of improper use, credit memos should be tightly controlled.  In this case, either the owner’s approval should have been required for issuance of a credit memo or at least approval by two different managers for such issuance.  Additionally, the owner should have required that a monthly analysis of accounts receivable be produced which included identification of all credit memos applied against accounts receivable.  Had such controls/procedures been in place, the fraud could have either been prevented or stopped in its early stages.

Fraud #3: The long-time bookkeeper for a personal liability law firm was responsible for all accounting activities, including writing checks from the firm’s escrow account and recording all transactions on a manual One-Write accounting system.  She began her fraud by writing checks to herself, but recording them on the One-Write system as having been written to various vendors.  Because of the large number of cases, she was able to spread out the improper payments so no one case would have too many vendor payments.

This fraud continued for years until one week when the bookkeeper was on vacation.  The owner received a call from a vendor complaining an invoice had not been paid (such a call would normally have been transferred to the bookkeeper).  Because the escrow account bank statements had arrived the day before, the owner started going through the paid checks to see if any of them were for this vendor’s invoice.  Instead he found multiple checks paid to the bookkeeper.  Our investigation found that this fraud cost the law firm over $500,000.

As with some of the previous frauds, the easiest way to have prevented this fraud or to have caught it in the early stages would have been for the owner to have had the escrow account bank statements sent by the bank directly to him so that he could spend a few minutes each month reviewing the statement and the cancelled checks.

Many business owners believe installing controls to prevent frauds are time-consuming and expensive.  In each of the above cases, installing relatively easy-to-implement and low-cost, or no-cost, controls could have prevented each of the above non-payroll frauds.

Next week, in the final segment of this three-part series, Anderson will discuss fraud executed by trusted members of management.

If you want to learn how a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley can help safeguard your company against such fraud schemes, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

When Employees Go Rogue: Tales of Fraud and Fraud Prevention – Part 1

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

Fraud is most often committed by trusted employees who have “gone rogue.” They are usually able to commit these frauds because their trusted status has caused management to relax its oversight of their activities or because, as members of management, they can override internal controls.

This article is Part 1 of a three-part series addressing frauds investigated by forensic accounting expert David Anderson of David Anderson & Associates, Certified Fraud Examiner in Philadelphia. It will focus on some payroll frauds committed by trusted accounting employees, and how the frauds could have been prevented. 

Payroll Fraud #1: The Controller of a real estate development company noted there was a “bug” in the new payroll software.  The bug caused the cash requirements report (used to determine how much was required to fund the payroll bank account) to show a higher total funding requirement than was necessary.  Rather than reporting the bug to the software company, the Controller funded the payroll bank account with the total shown on the flawed report, and, using out-of-sequence checks, paid himself the overage each pay period.  Because of his trusted status, the company’s owner never noticed the problem until several years later when the company experienced cash flow problems.  The discovered fraud exceeded $3 million.

If the owner had decided to have the payroll bank account statements (and corresponding cancelled checks) delivered directly to him, and spent a few minutes each month reviewing these documents, he would have noticed the large checks written to the Controller and would have discovered the fraud much earlier.  Alternatively, the owner could have required regular analyses of fluctuations in expenses.  In such a case, he would have noticed a sudden and ongoing sizeable jump in payroll costs, and could have investigated the cause.  In either case, the fraud could have either been prevented or discovered in its early stages.

Payroll Fraud #2: The newly hired Director of Finance for a municipal utility learned, among other responsibilities, she was wholly responsible for setting up employees with the utility’s payroll service, and for tracking (via a spreadsheet) employee vacation and sick pay.  Using these trusted capabilities, she started her fraud by informing the payroll service that she had a higher starting salary than she did.  She then based subsequent raises (which were rewarded as percentage increases) on this higher salary.  Additionally, because she alone was responsible for tracking vacations and sick pay, she regularly took additional vacations and sick pay over her actual earned vacation and sick pay.  This was magnified even further because she frequently worked overtime during weeks that she took the unearned vacation and sick pay.  As a result, some of her regular work hours were paid at overtime rates.  This fraud was only discovered when she retired, and, in reconciling her pension entitlement, the new Director of Finance noticed the difference in her original approved starting salary and the salary that was paid to her.

If the municipal utility had instituted certain procedures for handling the payroll, vacation and sick pay for senior executives, this fraud could have been prevented.  Such procedures would require either multiple signoffs for executive salary changes as well as for approvals of vacation and sick pay, or would have designed a specific executive to approve these items for another executive. 

Payroll Fraud #3: The long-time bookkeeper for a small professional services business was given total responsibility for processing payroll.  One of the features of the payroll process was that the company used the payroll system to reimburse employees for business expenses.  The bookkeeper realized this could enable her to receive reimbursements for non-existent expenses.  Experimenting with small amounts at first, she noticed that management was not reviewing payroll, and not picking up on these improper reimbursements.  She eventually increased the reimbursements to herself to many thousands of dollars per pay period (because she was also given total responsibility for the company’s accounting system, she was able to manipulate how the reimbursements were recorded in the company’s system). This fraud encompassed many hundreds of thousands of dollars and was only discovered when the company experienced cash flow problems and hired an outside consultant to help it improve its cash flow.  The outside consultant found the excessive reimbursements and reported them to the company.

Because the company was relatively small, if the owner had taken a few minutes each pay period to review the payroll and payroll funding reports, he would have noticed the increase in payroll costs and the unusual amount of reimbursements going to the bookkeeper.  This would have either prevented the fraud or caught it in its early stages.

You’ll note a common scheme in each of the above frauds.  Because the top executive or owner trusted the accounting employee, he or she failed to take the small amount of time necessary to review payroll activities.  This in turn enabled the perpetrator to execute the fraud.

Next week, Anderson will discuss non-payroll frauds perpetrated by trusted accounting employees who “went rogue”.

If you want to learn how a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley can help safeguard your company against such fraud schemes, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.