Front page of the Newspaper Test

When management or the board of any non profit makes a decision, they need to consider a number of issues - eg. what will it cost the organisation, what benefits will the organisation receive.

However, another issue needs to be considered when making decisions - how would others view your decision if it made the front page of the newspaper?  Would you lose donations?  Would there be agreement with your decision?  Every decision should be considered to this extent.  Those decision can very from how do you spend funds raised to should you report fraud to the police.

Of course, some non profits are at greater risk of hitting the front page of a newspaper than other non profits (eg. a charity would be a reasonably high risk as a significant portion of funds are publically raised).  However, this one question is a good test of if the decision is in the best interests of the organisation.

Educating Donors

How many times have you had questions raised about what percentage of funds donated actually goes directly to the mission of the organisation? It is difficult to achieve and then maintain an appropriate balance between the expectations of donors of funds where they want every cent of every dollar donated to go to the mission of the organisation and having sufficient funds to be able to develop and maintain appropriate controls.

With demands from donors wanting all funds donated going to the mission, how does the organisation pay expenses, such as market rates of salary / wages to employees and having the resources to maintain controls.

If an employee is not paid at market rates and controls are not maintained appropriately, the risk of fraud will increase.

So what is the answer? It is not an easy question to answer considering the amount of media that is regularly given to the percentage of donated funds that are used for the organisation’s mission. Ultimately it is a longer term education process so that donors of funds understand that a reasonable percentage of funds are needed to administer the organisation.

Auditor Management Letters

In a previous fraud tip we discussed how it is not the primary role of the auditor to detect fraud. They are engaged to provide an opinion as to the reasonableness of the financial statements. To be able to provide that opinion, one thing that the auditor needs to do is to consider the reasonableness of internal controls.

Issues that the auditor finds, such as weaknesses in internal controls, are provided to the organisation by way of a management letter. The following should be considered in relation to the management letter:

• If there are a number of issues or if the issues are complex in nature, the auditor should meet with the board to discuss the issues;
• The board needs to understand the issues raised;
• The board should consider each of the issues and prioritise the list in order of importance so as to ensure the issues raised are corrected;
• The board should work with management to ensure issues raised are corrected within a reasonable time frame.

It should also be noted by correcting issues raised in the management letter, problems with internal controls can be corrected which should result in a reduced risk of fraud. Correcting the issues may also save funds by reducing the time needed by the auditor to undertake the audit, thus reducing the audit fee.

Bad Debt Policy

Policies are an important part of any organisation. One of the policies needed is a Bad Debt Policy which provides details of when a debt should be written off. It also provides details of how the write off process needs to be authorised. So how does this help with fraud prevention?

A common method to hide a fraud is to take funds as they are received and to record them in the accounts as a debtor. As the debtor gets larger and is seen not to be being collected, it is written off, thereby reducing the risk of the fraud being discovered. This is especially a problem for organisations that are regularly owed funds from clients or other customers which do not pay and there is a history of writing off the debt.

When preparing a Bad Debt Policy, you need to clearly set out the criteria of when a debt is to be written off as well as how the write off is to be authorised. It is the authorisation process that should pick up potential fraud.

Budgeting as a tool to reduce fraud

Budgets should be a part of any organisations.  What a lot of people do not realise is that the budgeting process is a useful tool in the fight against fraud.  For example, the comparison of actual results to budgets may show discrepancies in spending which when investigated may show significant over spending which has not been approved.
But to enable reliable comparisons of actual results to budgets, the preparation of budgets need to be undertaken with care. Hints on developing budgets are:

• It doesn’t matter how big or small your organisation is. It should still have a budget;
• Go back to last year’s budget (if there is one) and see how accurate it was compared to actual results;
• Go back to last year’s actual results and determine when income was received (eg. was it seasonal) and when expenses were incurred (eg. are there a number of expenses that are paid once a year?);
• If there are new programs or expenditures that are to be included, have that relevant person or department prepare a detailed “mini budget” to be included in the budget;
• Determine if there are new events that may affect the budget (eg. capital expenditure);
• Make sure the board sign off on the budget after having thoroughly reviewed the budget.

To reduce fraud, the budget needs to be accurate. If you find that the budget is starting to have significant variances from the budget, it may be necessary to restate the budget. It is these variances that may show fraud is occurring and if variances are common place, fraud may be missed.

Good Culture = Reduced Fraud

An organisation can never underestimate the value a good culture within the organisation plays in reducing the risk of fraud. Having a good culture includes management and the board leading by example as well as employees and volunteers enjoying working for the organisation and believing in the organisation’s mission.

A poor culture where employees and volunteers feel that they are not part of the organisation, feel ignored and have low morale have less loyalty to the organisation and do not have the same, if any, feel of guilt at committing fraud against the organisation.

But how do you know if you have a good culture within your organisation. Using employee/volunteer surveys is one way to determine if the organisation has a good culture. Another way is to review retention rates and sick leave rates. If rates are increasing it may indicate a slide in the organisation’s culture.

The following are some issues that may detract from the culture within the organisation and therefore lead to an increase in fraud:

• Management and the Board not leading by example, being autocratic, do not take action against inappropriate action and do not reward good behaviour;
• Actual or perceived inequalities in the way staff and volunteers and managed;
• Not being recognised either with appropriate promotion and/or market rates of pay;
• Unrealistic budget expectations, both reducing costs and increasing funding or a combination of both; and
• Poor training and lack of other employee benefits.

Trust

Something that I hear all the time when I talk to nonprofit organisations is that they trust their employees. It is also interesting that in many instances, the organisation trusts employees more than volunteers.
While the majority of employees and volunteers are honest, there will always be some that are not. So what do you do? Here are some tips to help:

• Don’t be concerned about implementing new controls. You are doing this for two reasons. Firstly to protect the organisation from fraud and secondly to protect employees and volunteers that do follow the rules.
• If you can’t segregate duties, put other controls in place that will act as detection controls.
• If someone has been doing the same role for a long time and it is difficult to suggest you need to change the way it is done, explain the risks – for example an employee would regularly take the cash takings to the bank in their her car every day. She was not concerned when we suggested a change to make sure the organisation was covered by insurance and she would not at risk of potentially being robbed.

While all organisations will ultimately have to place some level of trust in employees and volunteers, don’t ever be afraid to implement new controls or change controls already in place. You can’t put all of your trust in a person without the back up of some form of control. This is simply not acceptable.

What is the true cost of fraud?

The following, while not an exhaustive list, need to be considered:

• Of course the actual value of the fraud needs to be taken into account.
• How much does it cost to investigate the fraud? This could be the cost to bring in someone externally to conduct the investigation or the time cost of people within the organisation to investigate the fraud.
• Who will liaise with law enforcement and take the necessary time to work with them and potentially ultimately attend court to give evidence?
• Fraud comes straight off the bottom line – consider this: if your organisation runs with a 1% surplus, a $50,000 (off the bottom line) fraud means that you need to raise $5,000,000 (top line) to replace that $50,000. This is a very difficult task to do.
• Would the fraud mean your organisation would need to either need to arrange an overdraft or extend the overdraft to maintain the cashflow? The additional interest becomes a cost of the fraud for the length of time it takes to no longer need the overdraft or extended overdraft.
• It is very difficult if not impossible to determine the cost of the fraud on the reputation of the organisation. What effect would the fraud have if it made the front page of the newspaper?
• Could the organisation be at risk of losing funding such as grants?
• Losses can be offset by any insurance, but it needs to be remembered that an insurance payout is “after the fact” and cashflow can be significantly affected before the payout is received.

Does Your Board Hinder Your Fraud Prevention?

I am often asked the question of how does the person charged with fraud prevention in an organisation, get buy in from the board and in some instances from management.

There is no easy answer, but the following are some ideas that may help:

• Remind the board of their duties to the organisation – eg. duty of care;
• Have the board consider what they organisation could do with an amount that could easily be lost to fraud, say $50,000 (eg. run a specific program, provide a service to 250 clients);
• Step the board through the true cost of fraud (eg. the loss of funds to the fraud, extra interest on an increased overdraft facility, cost to investigate the fraud, legal costs);
• Explain that employees and volunteers should not be concerned with the introduction of a fraud control program – the program is important to protect those employees and volunteers that are honest and find those that are not.

How do you deal with the media?

There are a number of issues you need to deal with when fraud is discovered. One of those is how do you deal with the media. The following are suggestions on issues that need to be considered:

• The first thing you need to consider, and pre-plan for, is the potential risk to your organisation of media attention, should it become publich that it has suffered a fraud. For example, a charity is likely to be at a higher risk as funds it relies on are from public donations and it would therefore potentially make newsworthy reading.
• The organisation then needs to be prepared. Does the organisation have a media policy? If yes, part of that policy should be who has authority to speak to the media. This person should be the person authorised to speak to the media if enquiries are made about the fraud. It also needs to be determined who authorises what can be said to the media.
• The organisation needs to consider how they will address the issue if they are contacted by the media. It is the reputation of the organisation that is at risk if a report that is not favourable to the organisation is published.