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Internal Controls to Prevent Employee Fraud in Manufacturing

Posted by Jason Cope, CPA on Nov 4, 2019, 8:20:00 AM

Nearly half of all frauds occur because of weak internal controls. Of those schemes, the lack of simple controls was cited in 30%, and the perpetrator was able to circumvent controls already in place in another 19% of those fraud cases. (ACFE)

A robust system of internal controls and proactive fraud measures is your top line of defense, and those at the highest level of the organization need to be responsible for them. Setting the tone at the top includes understanding the most significant fraud risks, where the opportunities are and where there might be rationalization. It also includes cultivating an ethical culture and evaluating current controls in place.

No matter the size or type of your business, fraud is a real threat and is a challenge for any organization to spot. So how can manufacturers best deter fraud? They must implement a comprehensive system of controls.

According to the ACFE Report to the Nations, frauds detected by IT controls tend to last five months and cause a median loss of $39,000—significantly less than the average median loss of $140,000 among all businesses. That means that manufacturing organizations can significantly reduce the impact of fraud by implementing internal controls that can include surveillance, account reconciliation and management review.

According to the report, the most common anti-fraud controls in the U.S. include:

  1. Code of conduct (73%)
  2. External audit of the financial statement (69%)
  3. Employee support programs (62%)
  4. Management certification of financial statements (61%)

While not as common, other effective controls include surprise audits and employee hotlines. In fact, surprise audits have resulted in a 51% reduction in the cost of losses. On a global basis, 63% of those surveyed had employee hotlines, and fraud losses were 50% less at organizations with hotlines than those without one.

What systems do you have in place when fraud occurs? You will need to have a plan for investigating the alleged fraud, including who should be involved, the roles and responsibilities of each individual – both internal and external – and depending on the magnitude of the fraud, the procedures for disciplinary actions or criminal charges. Based on what you learn, you should be able to determine which preventive measures to take in the future.

Any new internal controls must be clearly documented and reviewed as part of your organization’s overall risk management process, and they must be embedded in your organization’s code of conduct. Together, a strong ethical culture and highly effective internal controls work together to reduce your exposure to fraud and subsequent fina3D-book_Manufacturing-Fraud (ID 142203)ncial losses.

In an upcoming manufacturing blog, we’ll explain how an internal controls assessment can provide your organization with a valuable tool to evaluate your existing controls.

In the meantime, download our free nine-page e-book: How Manufacturers Can Reduce Fraud Through Stronger Internal Controls.

For more information about internal controls for your manufacturing business, please  contact Jason Cope at 214-635-2508 or fill out the form below. Learn more about the Manufacturing and Distribution Services Group at Goldin Peiser & Peiser.

Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.

Topics: Manufacturing, Fraud, Internal Controls