Internal Controls Help Reduce Embezzlement


Over the holidays, I received a telephone call from an old friend of mine. After we exchanged the usual pleasantries, he shared with me a concern he had regarding his business. He is a general contractor in Beverly Hills, specializing in large custom homes. Like most entrepreneurs in his position, he spends most of his time at the various jobsites, supervising his many construction employees. Typically, he spends about an hour a day in the office, where his bookkeeper/receptionist manages the company’s business department. In fact, she is the business department. My friend shared his concern that his bookkeeper might be embezzling cash from the company.


After a brief discussion on the company’s accounting procedures, specifically the handling of cash receipt and cash payment transactions, it was easy to see that cash was vulnerable. I learned the bookkeeper was responsible for all of the company’s accounting functions. Her responsibilities include receiving and depositing payments from customers, writing checks to suppliers, maintaining the accounting records, preparing payroll, and reconciling the monthly bank statements. When I asked my friend if he reviewed the financial records on a frequent basis, his response in an uncomfortable voice was “define ‘frequent.’” The word “scary” escaped from my lips before I could bite my tongue.

Obviously, I couldn’t tell him for sure if his bookkeeper was embezzling; but I did try to explain a theory known to many in the accounting profession:


Opportunity + Motivation = Theft

The first factor in this equation—opportunity—would be defined as a work environment where an employee can steal cash or other assets with little chance of discovery. The great thing about this factor is that the employer can reduce it by implementing one or more internal controls. Internal controls are accounting policies or procedures designed to eliminate or reduce the chance of theft. While there is a wide variety of internal controls available, I believe the most important is the separation of accounting tasks.


Specifically, the task of handling cash (or other assets) should be performed by a person other than the person in charge of maintaining the accounting records. For example, the person handling the checkbook should not be the one recording cash transactions into the accounting records. This internal control can be fairly simple to implement in a company with a sizable accounting staff. However, many small companies, like my friend’s, only have one person in the accounting department. This makes the task separation difficult—but not impossible. I explained to him that this separation was so important that he should consider hiring a part-time bookkeeper to handle one of the tasks. He acknowledged the need for task separation, but declared that he didn’t want to hire another employee. I then suggested that he contact his CPA to see if they could send one of their bookkeepers to help out a few hours a month.


As he began to verbally calculate how much this alternative would cost him a month, I knew he was beginning to understand that implementing internal controls comes at a price. I explained to him that this was one of those instances where you “pay now or pay later.” I also told him of another important internal control: have the monthly bank statements reconciled by someone outside of the accounting department. “Who could I get to do that boring job?” he asked. “What about you?” I replied. Having the owners do the reconciliation is a great way for them to better understand the flow of the company’s most liquid resource, cash. Having the owner get more involved in the accounting function, from reconciling the bank statements to doing frequent reviews of the accounting records will go a long way in reducing and detecting embezzlement. As a practicing CPA, this has certainly been my experience in working with companies.


The second factor in the equation, motivation, is related directly to the employee. So why do employees steal? It would probably serve an employer well to understand a thief’s motivations. I encouraged my friend to read a book by James W. Coleman entitled The Criminal Elite: The Sociology of White Collar Crime. In the book, the author has developed a list of rationalizations that thieves use to commit their crimes. The list includes:


  • I’m just borrowing the money
  • It doesn’t hurt anyone (most often used)
  • Everyone else is doing it
  • I deserve the money

The third factor in the equation is theft. Internal controls should be in place to reduce the chance of theft. Their function is to keep dishonest people honest. But they are also there to keep honest people honest. I guess the big question is, “Does that mean an employer who doesn’t have any internal controls in place, thereby providing ‘opportunity,’ has created a work environment where honest people could become dishonest?” I guess your answer might depend on how strongly you accept as true the equation



Opportunity + Motivation = Fraud.

Before my friend and I said our goodbyes, I gave him one final piece of advice: have your CPA get more active in your business. After a comprehensive review of the accounting records, the CPA will be able to determine whether or not cash is missing, to develop internal controls tailored to the business, and to craft a plan to implement the controls. I hope the next time he calls he’ll have good news.


M. Scott Hays isan assistant professor of business administration at Central Oregon Community College and can be reached at 383-7715.


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