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 of the frauds investigated by forensic accounting expert David Anderson of David Anderson & Associates, a Certified Fraud Examiner in Philadelphia, share a common element: The fraudster was able to perpetrate and hide the fraud for an extended period due to the lack of separation of duties.

Separation of duties requires more than one person be involved in the processing and reporting of financial transactions to eliminate the possibility of that person alone committing a fraud. If a fraud were to occur in a situation in which there was adequate separation of duties, it would have to be due to the collusion of two or more people involved in the processing or reporting.

For example, Anderson said, if you look at a sales transaction from start – entry of the customer purchase order/request – to finish – receipt, deposit and recording of the customer’s payment for the sold item(s) or services – you could expect to see the following steps:

• Receipt and entry into the business system of the customer’s purchase order/request
• Fulfillment of the customer purchase order via product shipment/delivery, manufacture and shipment/delivery, or provision of services
• Creation, entry, and sending of customer invoice
• Receipt and entry of payment
• Application of credits, if any – usually for returns or errors in the customer invoice
• Deposit of customer payment
• Periodic reconciliation of an operating bank account into which the deposit is made.

Proper separation of duties would prevent a single person from processing the customer invoice; receiving, entering, and depositing the payment; applying credits; and performing the bank reconciliation.  If those duties are not separated, the person could potentially divert the payment received to a bank account under control of that person or, if the payment is made in cash, to that person’s own pockets, while hiding the diversion by:

• Not recording the sale or customer invoice in the accounting system to hide diversion of the customer’s payment; or
• Recording in the accounting system the receipt of the payment and hiding the failure to deposit the customer payment when performing the bank reconciliation; or
• Applying credits against the customer’s account so that the balance in the bank equals the balance on the books, as adjusted through the bank reconciliation process.

Similarly, if you were to look at a purchase transaction from start – setup of the vendor and entry of purchase order/request – to finish – preparation and recording of vendor check for goods or services purchased – you could expect to see the following steps:

• Receipt and entry into the business system of internal purchase order/request
• Setup of the vendor, if not already in the system)
• Fulfillment by the vendor of the purchase order via product shipment/delivery, manufacture and shipment/delivery, or provision of services
• Receipt and entry of vendor invoice
• Preparation and recording of vendor check
• Sending of vendor check
• Periodic reconciliation of an operating bank account from which the check was written
• Interfacing with the vendor regarding amounts due to the vendor.

Proper separation of duties would prevent a single person from setting up the vendor in the business system, making changes to the vendor information, entry of the internal purchase order/request, receiving and entering the vendor invoice, preparing and recording the vendor check, and sending the vendor check and performing the bank reconciliation.  If those duties are not separated, the person could potentially:

• Divert the vendor’s check to an account under control of that person, in which case the person would tell the vendor that there were problems with processing their payment or would refuse to pay the vendor; or
• Create a phony vendor, or change the mailing address of an existing inactive vendor, and cause payment to be made for non-existent products – typically office supplies and other items that are expensed rather than being recorded as inventory – or services; and
• Hide the diversion when reconciling the operating bank account.

Note that failure to adequately separate duties for payroll could be similarly exploited for payments to either a terminated employee or a non-existent employee.

Based on the description above, it is easy to see the need to properly separate duties as part of a fraud prevention program. However, many businesses and other organizations – including governmental and non-profit entities – do not possess a staff large enough to facilitate adequate separation of duties.  So, what are some alternative steps that can be employed?

In such circumstances, some alternatives these businesses and organizations should consider are:

• Engaging an outside party such as a forensic accountant to provide periodic oversight and review of financial transactions and bank reconciliations;
• Arranging for all bank statements to be sent directly to the owner or a designated executive, at an address outside the business, so the bank statements and cancelled checks can be briefly reviewed for unusual or missing items prior to being given to the person performing the bank reconciliation;
• For deposits, requesting that the bank provides a separate machine-printed deposit receipt matching the in-house prepared deposit slip;
• For checks, requiring two separate approvals and signatures for all checks above a designated amount, or requiring a separate management approval for all checks, i.e. someone separate from the check signer;
• For payroll prepared by a third-party company, arranging for a periodic list of active employees be sent directly to the owner or a designated executive, at an address outside the business, so the list may be scrutinized for unknown employees or terminated employees still receiving pay.

The costs of these alternatives, either financial – for the outside review – or time – for internal review – are low relative to the potential cost of undiscovered fraud.

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, 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.