The old saying, “garbage in, garbage out,” in computer programming also applies to accounting fraud.
“Garbage in” means if bad information is entered into a computer the data that comes out is at best worthless, and at worst, harmful. Fraudulent financial reporting (garbage in) is meant to cover up fraud, theft or other criminal acts. Therefore, phony numbers (garbage out) are presented to non-profit boards, contributors, staff and others. As long as the correct information goes undiscovered, so does the fraud.
Typically fraud is used to cover stealing. Sometimes, however, a leader in a struggling non-profit might grasp at the straw that if the books can just look a little better in the short-term, the ship can be righted for the long-term. It never works that way. Fraud is fraud, lying is lying, and a cover-up always makes the situation worse.
There are eight principal variations of fraudulent financial reporting:
- Hiding significant related-party transactions
- Not meeting debt obligations and masking the failure
- Misclassifying restricted donations (contributions by a donor for a specific purpose) to mislead donors and charity regulators
- Artificially inflating revenues by holding records open beyond the end reporting date
- Misclassifying expenses to mislead donors about where funds are directed, or misdirected
- Incorrectly valuing receivables, inventory, donated assets and liabilities under split-interest (shared interest between the non-profit and donor) or gift annuity obligations
- Failing to report trade payables (purchases for physical goods in the organization’s inventory) in the correct period to understate expenses
- Intentionally misreporting obligations for deferred compensation or retirement benefits
Fraud deterrence is an organization-wide imperative. Executives and board leadership must make clear to employees that Big Brother, Big Sister – Big Someone – is watching to ensure that the mission and purpose of the organization will not be subverted, damaged or destroyed through fraud. A few suggestions:
- Have an anti-fraud team in place, including an audit committee and an external auditor.
- Perform a fraud risk assessment and consider ways fraud could be perpetrated; identify what preventive & detective controls would identify that fraud.
- Reconciliation of fundraising accounts, cash, or assets should be conducted by someone who doesn’t have asset custody or transaction authorization; the more that financial responsibility and oversight is concentrated in a single person’s hands, the greater the possibility of fraud.
- Unscheduled (and therefore, surprise) audits.
- Review all adjustments to the general ledger.
- Don’t give one person overall charge of accounting responsibilities or fraud-prevention efforts.
- The more complicated the transaction, the more carefully it must be reviewed; complicated numbers can hide a multitude of sins.
- React quickly and decisively to suspected fraud: no one should be unjustifiably accused, but tip-toeing around a potential problem to spare someone’s feelings or because of friendship can create a universe of problems: the first obligation is to the organization.
Accounting firms with experience in forensic and financial statement audits as well as all aspects of Generally Accepted Accounting Procedures (GAAP) are excellent resources in non-profit anti-fraud efforts. Additionally, the American Institute of Certified Public Accountants (AICPA) and Association of Certified Fraud Examiners (ACFE) examiners have put a great deal of good information on the internet.
A non-profit wants to make fraud as hard to commit as possible. Do it by protecting against garbage information coming in. That way you won’t need to worry about garbage information going out.