When a troubled New York-based manufacturer called in its auditor for a look at its books last year, the firm got more than it had bargained for.
Checking to make sure that a number of transactions close to year-end had been credited to the right period, accountants at Mahoney Cohen & Co. discovered something much more serious than a bit of innocent confusion.
“We discovered that dates and invoice amounts on bills of lading were altered to overstate revenues and accounts receivable to increase their bank collateral,” recalls Kenneth I. Steckler, an audit partner at the Manhattan-based accounting firm.
In the future, small firms will likely see more such scrutiny, courtesy of a new auditing standard that requires auditors to identify the factors that may lead to fraud.
Auditors have always been charged with responsibility for providing a reasonable assurance that financial statements are not materially misstated, whether by fraud or by error.
The new standard, officially known as SAS82 (Statement on Accounting Standards) requires auditors to go further, to review the risk factors related to fraud and assess the risk that fraud may have occurred.
Many welcome the broadened reach as an attempt to prevent fraud before it occurs. “Anything that focuses accountants’ attention on the potential for fraud is beneficial” says Harold Monk, chairman of the Private Company Practice Section, an arm of the American Institute of Certified Public Accountants. “SAS82 was written to resensitize auditors to the potential for fraud.”
Beyond conditions that could make it easier to cook the books, the other main concern of auditors is the potential for a misappropriation of assets.
“On the one hand, you’re misstating amounts in financial statements, and on the other, assets are being stolen,” explains Edward Morton, a partner at accountants Richard A. Eisner & Co. in Manhattan.
Reducing Business Failures
The reason for the new focus on fraud is clear. No fewer than 30% of business failures are in some way tied to fraud, according to the Association of Certified Fraud Examiners.
“Because of the prevalence of fraud, small businesses should be concerned that their control systems are appropriate and that the system is enforced,” says Mr. Monk.
Under the new standard, accountants will help small businesses prevent fraud by evaluating their clients’ control systems. Audits now promise to give companies a better understanding of the conditions and organizational structures that can lead to fraud, so they can better arm themselves against it.
“We look at a company’s internal controls and if the same person is handling too many functions, that’s a red flag,” said Fred Shapos, managing partner of accountants Rosen Seymour Shapos Martin & Co. in Manhattan.
Auditors caution that they will be looking not just the most obvious controls – the ones surrounding the receipt and disbursement of cash. They will also closely scrutinize controls related to the safeguarding of assets employed in the company’s production cycle.
Nonprofits Don't Have Special Status
The potential for fraud is not limited to public or private companies. It can also crop up in nonprofit organizations.
Edward Morton, a partner specializing in nonprofits at Manhattan-based accounting firm Edward A. Eisner & Co., says he is concerned about potential fraud in the preparation of financial statements and its potential impact on nonprofits’ assets.
Unlike commercial enterprises, nonprofits tend not to have inventories and do not as a rule strictly divide up employee duties, says Mr. Morton.
‘They’re trying to hold down administrative costs and spend funds on their mission, so they become susceptible to intentional or unintentional fraud,” he says.
“They say, ‘This can’t happen to us because we’re a church or a charity or a school,’ but recent history on the national level has shown that major misappropriation of funds can occur.”
The recent scandal involving fraud at the United Way is a painful reminder of that.