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What Happens When Companies Don’t Have Internal Controls

While we never aim to scare our clients and readers, we have a huge plethora of war stories about what happens when companies don’t have internal controls. Just in my 18+ years of experience, I’ve compiled all the crazy stories for you today. 

What Happens When Companies Don’t Have Internal Controls 

So, what happens when companies don’t have internal controls? They open themselves up for theft, embezzlement, and liability. If there are no controls over what’s going on inside, then there is no control over cash flow, profitability, etc. It also “gives permission” to your team to do as they please and when it pleases them.  They may or may not be making decisions in the best interest of the company.  But without internal controls, they are likely less careful with the decisions they make.  Have you ever noticed how easy it is for a child to spend their parent’s money, but if it was their own money they are less likely to spend frivolously?

War Stories | What Happens When There Are NO Internal Controls 

In my experience, I have gathered so many war stories on what happens when there are no internal controls. Read about some of my most unforgettable below.  

My Most Trusted Accountant and Advisor 

Many years ago, while I was part of the audit team, I had a client who had the same accountant for 20+ years – we’ll call her Sheila. She has been with the company since it opened its doors and was the owner’s most trusted confidant and advisor. Sheila was in complete control of the receivable and payables.  There was no oversight over Sheila’s position. When I started to look at their accounting records, there were several red flags…

Sheila was very defensive and abrasive when I came into the office and during the review phase of the engagement.  She mentioned several times it was okay for me to work remotely.  She wanted me to sit outside of her office, even though her office was large and had a meeting table and several chairs. Intuitively, I knew something was off with her.

I also noticed that the company cut thousands of checks every month to different companies. Sheila cut them and signed them herself.  The business owner trusted Sheila and gave her access to manage the bank account and accounting records.

The biggest red flag was discovered during the audit of the transactions.  There were several inconsistencies with who the checks were being written to and how they were recorded in the accounting system.  It appeared Sheila would have the checks payable to herself and immediately go back into the system and change the name to a made-up vendor.  After months of due diligence and investigation, it was discovered that she had stolen at least a quarter of a million dollars in just the last 10 years of her employment. While this hurts the owner, the owner gave less trust at face value and implemented internal controls to regain trust in accountants.

Creating Checks and Balances with Internal Controls

In another instance, the Chief Operating Officer of a company approved several supplier invoices.  The accounts payable department processed the invoice and paid the supplier without further questioning. It took at least a year before the company learned that the COO created this false company, approved the invoices and received payments for personal gain.

Therefore, it is critical to have internal control at all levels of the company with different teams in place to create the check and balances it needs.  Internal control would the purchasing group validate the supplier, approve the purchase order before submitting the order to accounts payable.  Generally, operations would have received a receiving document once goods/services have been provided with a signature of the person receiving the goods/services.  Accounts payable would receive the final invoice and match it against the approved purchase order and receiving document.

 

What I Learned About Internal Controls 

There are several things I learned about internal controls when I was in audit and now even as a CFO 

Trust Your Gut 

If your gut is telling you something is wrong or off, it is worth investigating. When I have followed my gut, I have either found something wrong or found comfort that everything is okay. But those few times I did not trust my intuition, I missed steps to prevent fraud, etc.  

Never Do Anything Without Oversight 

As a CFO, business owner, entrepreneur, and accountant, I have learned that no one is too high not to have oversight. If I cut all the checks and sign them, that leaves it all up to me. Thankfully, I know myself and I would never do anything criminal! However, not all people are like me. There are, unfortunately, individuals that are motivated by rationalization, pressure, and/or opportunity. Oversight helps protect all parties – even yourself.  

So that is what happens when companies don’t have internal controls – lack of control.

what happens when companies don't have internal controls, When Companies Don't Have Internal Controls

what happens when companies don't have internal controls, When Companies Don't Have Internal Controls

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Audit Scope Example

Audit Scope Example

Ely is an auditor for the IRS. His work, some of the most technical for any forensic accountant, involves looking deeply into a company to find errors which may lead to prosecution. By doing this, Ely is preventing the company from any financial foul-ups that could lead to fraudulent information being shared. He is now tasked with finding the reason for recent tax payments.

The company Ely is auditing is a major food processing plant. This food company has had a history in the past of financial record “mistakes,” which explains the reason for the IRS being quick to investigate a discrepancy. This company, paying much less than IRS estimated taxes, may face a penalty. Thus the company sends Ely to see the reason for this discrepancy.

As Ely is working he takes on massive amounts of documents. He will have to sift through countless financial statements, as well as procedural documents in order to draw a conclusion on a large auditing matter. For this project he will have a very deep audit scope: he must find the reason through almost any means necessary. Because federal taxes are taken very seriously in the United States, Ely is given the authority by the IRS to request any documents or evidence that could make his decision making process run more smoothly in a legal way.

Ely Finds Something

As he is working, one of Ely’s assistants finds something; an account which should have more money than it does. With large company’s this is not uncommon because large sums of money must be moved and transferred at a moment’s notice in order to retain balance in the company’s ledgers. However, Ely is not completely convinced that unintentional error is the cause for the discrepancy. Ely scales deeper to find the cause: a company employee has been stealing funds. Though the company itself is proven to be fully compliant their records have been altered by this corrupt worker. Ely is able to help the company recover the funds and see that the employee pays for his crime. Each party is pleased with the audit, except for the employee who caused the problem.

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audit scope example
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audit scope example

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Audit Scope

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