13 Dec

Detecting Overrides of Internal Controls

Where can employees, outside consultants, and board members look for evidence of override of internal controls? This isn’t a simple list of numbers or documents that must be checked off. Instead, looking for improper override of controls requires looking for red flags that point to something being amiss.

  • Complete an analytical review, looking for unusual changes between periods in terms of dollars and percentages.
  • Look for large, round numbers that enhance the financial position, especially if these numbers just happen to occur at the end of an accounting period
  • Examine reversing entries at the beginning of an accounting period, looking for evidence that these entries relate to an improper entry at the end of the previous period
  • Determine whether transactions have been completed on an arms’ length basis, and with legitimate business partners
  • Look for evidence of undisclosed relationships or agreements
  • Listen carefully to employees who may be reporting wrongdoing or hinting that there is a problem

When examining these things there are three critical items which are the most troublesome:

  • Missing or altered documentation
  • Withholding of information
  • Unexplained variances in numbers

All three of these suggest something is not right. If there is nothing to hide, why are things being hidden? That is often the first clue to a much larger problem.

Trust but Verify
The key reason why employees are able to steal from companies is that the employees are trusted. That trust is obviously inherent to being able to operate a business. If you don’t trust employees to do their jobs, the business cannot accomplish anything.

However, that trust should not be blind trust. Skepticism is an essential element for everyone involved in the process of ensuring that a company’s assets are protected and the financial statements are accurate.

The skepticism must go beyond simply acknowledging that fraud risks are present in every company. Professionals must be alert to the most likely risks and must be willing to ask difficult questions and required support for the answers given. The process of asking questions might be uncomfortable, but it’s necessary to get to the bottom of things.

Remember that if an executive is intent on overriding controls to cover dishonest or unethical behavior, she or he has also likely taken steps to conceal the override. These instances won’t just jump right out at you and announce themselves. Detecting the override of controls and the associated fraud or malfeasance will take a lot of work and a bit of luck. But it is nonetheless important to make the search for the override controls a regular (and important) part of the financial management of a company.

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