Team Member Or Criminal Offender

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According to the United States Chamber of Commerce, one-third of all businesses fail due to employee theft. The problem? Business owners fail to identify the villains stealing their profits.

Perhaps owners fail to identify the thieves because they don’t have unshaven faces and approach them with a firearm yelling, “Stick ‘em up!” Rather, they appear with clean criminal records, often as star employees who rarely take vacations. They disguise themselves as “the son you never had,” employees who always work late and skip lunch.

Motivation of theft

Why would such trusted employees pilfer? Though all reasons necessitate dishonesty, other reasons include low work morale, lack of adequate compensation, no consequences for broken policies, general lack of internal controls, revenge, peer pressure, work hazing and work culture. Some wrongdoers actually have no reason, as evidenced by the following letter submitted to Human Resources by an employee who had never even taken a sick day (taken from “Employee Theft” by Bob Mather).

“To whom it may concern. I must admit that I have been part of the problem with the missing inventory. Three other people and I. (I do not want to name names.) I have been taking items from here for the past couple years. At first we did it because it was easy and I figured no one would miss anything.” The letter continued on for pages, documenting over tens of thousands of items. In the end, it read, “I really want to say I am sorry and that I will not do it again. This is completely out of character for me. I am a wife and a mother and a grandmother and do not need the money.”

How do they do it?

Aside from inventory, supplies and tools, probably the most deadly threat to a business is monetary misappropriation. In order to successfully steal money from the business, an employee must steal cash directly from a register when it is handed from a client and fail to book the sale. In a non-retail business, funds must be misappropriated from the company to the employee. Then, in many cases, the books and records must be adjusted to cover the theft.

If the embezzlement is significant enough to threaten the business over the long run, it is an employee who has access to the books, so the villain is most likely the bookkeeper. Each theft strategy will be discussed in turn, as well as how the cash is extracted and how the books are adjusted, if necessary.

That sweet bookkeeper holding the abacus cannot simply write a check to cash and run away. For those readers who are not accountants, debits must always equal credits, and assets must always equal liabilities plus owner’s equity. (For those of you who tuned that out and instead heard the adult voices from the Peanuts cartoons, the bank statements would not match the internal books.)

The first theft strategy involves establishing a phony receivable. Cash would decrease (because the fiend has it), and accounts receivable would increase. The flaw in this strategy is the aging receivable now on the books. The aging receivable, however, could eventually be written off.

A second strategy involves decreasing debt. The thief writes himself or herself a check and lowers the vendor’s account balance as if the employer has paid the vendor. The books stay constant because cash decreases and debt decreases, as if the cash was used to pay off the vendor. However, if the vendor is legitimate, they will eventually want their money. If the crook is more advanced, he or she may set up a dba checking account with the same name as a popular vendor and pay a phony invoice to himself or herself. This way, it would be more difficult to detect, as the check would be cut to the same name as a legitimate vendor.

A third strategy involves phony expenses, which do not directly impact the balance sheet. The theft would not impact beyond the income statement, as the income sheet is wiped clean from year to year. Cost of goods sold (COGS) is a popular area to impact because many small areas impact COGS. However, any single item in one of these areas may trigger suspicion; therefore, many offenders lose interest in this strategy.

Bamboozling is much easier if, as the perpetrator, you have complete control over the mail, the books and the checking process. It is almost as easy if the interloper does not have total control, but forms a relationship with a party who has control and together they dupe the boss. The bandit may also form a relationship with a vendor or a vendor’s bookkeeper to steal. The vendor may agree to mark up the goods in exchange for an exclusive contract with the employee’s company. The vendor will then issue the employee a check or cash directly for the difference between the price of the goods and the markup (otherwise known as a “kickback”).

Petty cash is also a frequent area of abuse and theft. Though petty cash is typically not a significant amount of money, it can serve as a gateway to greater theft. A bookkeeping thug can get his or her thieving feet wet by taking a few bucks from the petty cash fund and then move on to some bigger and better purloins. Company credit cards may also serve this same purpose. Business owners will entrust several stellar employees with company credit cards to make business purchases for ease of operations. (Owners have their reasons—remember, credit cards give cash rewards or other benefits.) While owners may review statements, they fail to check individual receipts, so employees add personal items, even cash at the register, onto their purchases.

Non-monetary theft is also a way in which employees can steal. This does not have to involve a bookkeeper. For example, a certain amount of inventory theft is expected by customers. However, employees contribute to this as well and know the opportune time, the location of the cameras and, in small retail operations, are left alone to close up shop.

Rogue employees prepared to leave may steal tax submissions. The reason this type of offender would be labeled “rogue” is because this offense would eventually be caught, even if years later, when the taxing authority reports the tax deficiency to the employer. In the most severe case, the payroll tax dollars would be collected and not submitted to the government. Instead, the criminal establishes the dba account and submits the money into his or her own account (or uses a money order, etc).

Alternatively, the bookkeeper could prepare more than one tax return. The business owner would be told the true tax liability, but then a tax return would be submitted for a smaller amount and the fiend would keep the difference. This is an extremely dangerous dupe because the employer is still liable to the taxing authority for the full amount.

Why aren’t the fiends caught?

Simply, most of the offenders are “trusted” employees. Owners believe their employees are good people and that one person would not steal from another. Beyond this, they believe fairly compensated employees would not “bite the hand that feeds them” by doing anything that would threaten their employment. Lastly, employers feel their workers have loyalty or a feeling of friendship towards them and would therefore never swindle.

Amplifying the employer’s reliance on the wolf in sheep’s clothing is the owner’s own onerous and demanding responsibly of operating the business. Owners have little time to review the journal, the checkbook, the ledger, the financial statements, the bank statements, the invoices or bills and other important documents within the business. In addition to putting out everyday “fires,” the day-to-day operations cause a small business owner to wear many hats, and finding a “trusted” employee to take one of the hats off the hat rack removes some of the burden from the owner by allowing him or her to explore more worthwhile endeavors, such as searching for more contracts and infusing more revenue into the business. What owners fail to realize is by giving up that hat, the profits are dripping out of the business like a leaky bucket!

These wolves smocked in sheep’s wear cover their tracks fairly well. These strategies do not leave an obvious paper trail and are difficult to catch in a single bookkeeping type of operation. Owners often feel audited or reviewed financials will reveal this type of theft. However, the types of services received by small business owners will not reveal the types of theft previously discussed. Audits and reviews of financial statements are done to ensure that the statements were prepared in accordance with Generally Accepted Accounting Principles (GAAP). Deeper, forensictype audits check the internal controls of the business to assess risk. However, the professional service fees for these types of studies are substantially higher, and owners typically do not want these forensic auditors at their headquarters for long periods of time to run the audit tests. Hence, many small business owners believe that a reviewed financial statement will uncover theft, which it will not.

A recent example of this false sense of security was revealed in a case involving Koss Corporation. A top executive at the $38-million (2009 revenue) headphone manufacturer had used the company as her own personal piggy bank by wiring more than $31 million over four years to her American Express card—approximately $400,000 per month. Profits in 2009 were approximately $2 million, but would have been about $7 million if not for her embezzlement. The Milwaukee-area executive Sujata “Sue” Sachdeva’s compensation was approximately $170,000 a year, and it was later revealed she used the stolen money for expensive clothes and jewelry. Case in point—Koss Corporation had audited financial statements; however, they would not turn up a theft, but rather comment on Koss Corporation’s ability to follow GAAP. (Though Grant Thornton, the auditing firm, was fired by Koss Corporation, they defend they were retained by the company to conduct a financial statement audit, which rarely uncovers fraud. Many industry experts have defended Grant Thornton.)

How have employee thugs been caught absent systems and controls?

Dishonest employees are caught a number of ways. Sue Sachdeva was caught when the fraud division of American Express contacted Koss Corporation. If other employees turn in a crook, this is often referred to as “whistleblowing.” Sometimes an accomplice can turn in another accomplice in exchange for immunity or forgiveness. Some employers are fortunate enough to catch an employee “redhanded” in the act of theft or, if a vendor is involved directly or indirectly, they may turn on the employee.

How can employers protect themselves?

Required vacations. At first glance, an employer may believe an employee who refuses to take vacation signifies a stellar worker, particularly a salaried employee. However, this may be a sign of an employee whose patchwork quilt may unravel if anyone else were there to try and baste it together for a week or two while the employee took a short sabbatical. After all, certain scheming requires careful timing. Asking, insisting and then requiring employees to take their vacation may not only expose theft (or conspiracy if you require multiple employees simultaneously), but may also deter employees from the behavior.

Division of duties. Most of the slippery tactics require a single bookkeeper in the company. However, some can be executed with only certain duties performed by a single person. These duties include the receipt of checks, the adjustment of receivables, the preparation of deposits, actual deposits, the recording of payables, the “cutting” of checks, the signing of checks and the mailing of checks. The division of duties forbids a single employee or group of employees from possessing both the power to perpetrate and to conceal theft or fraud. Therefore, this would prevent a tremendous number of monetary thefts from occurring.

In non-accounting language, if the same person receiving the mail (or cash directly, if the company is a retail operation) was also entrusted to record and make deposits, you can see how this person could easily steal a check because who would know it was missing? However, if these duties were divided (for instance, a person opening the mail recorded the check, but the check was never deposited in the bank), internal controls would aid in exposing the theft.

The same can be said regarding the purchasing side of the business. If a person has control over purchasing, the same person or group of people should not be in control of receiving. Why? Because they then can alter the records stating they never received certain items! These ordering villains can then pocket the goods, supplies, equipment or parts on your (or your supplier’s) dime and claim they were never received.

Strict company policy. Enact strict company policies regarding employee theft. Consequences of theft should include criminal prosecution, and you must be willing to act on these policies. Consult an attorney about a well-written policy to include rewards and reprimands for co-workers reporting other employee thefts. Once policies have been established, communicate them to employees. Conduct an orientation for current employees with legal counsel, and obtain signatures upon completion. When new employees are hired, learn what legal steps need to be taken to verify they are aware and understand the theft policies. Remember, it is estimated that one-third of businesses ultimately fail due to employee theft; therefore, such policies are well worth the investment.

Keep in mind, no policy is anything more than paper if it is not enforced. Police pull over vehicles on well-traveled roads during busy hours for a reason—not only do they catch one person, but their actions also serve as deterrents for certain behaviors (i.e., don’t speed here). Your policy could do the same. Further, your employees become operatives when you add a clause that requires them to turn each other in.

Inventory and supply controls. From flashlights to hammers and tile, inventory and supplies that end up in Agnes’ purse or Ziggy’s personal truck can eventually drain the boss’ checking account or leave him asking, “How could I have incorrectly bid this last project?” Or perhaps he is thinking, “All the tools must be at the other job site, at the shop or in the garage.” Eventually, these thieves will steal the profits and threaten the livelihood of their own jobs by terrorizing the business.

Both routine and unannounced inventory audits can help uncover shrinkage, as well as dissuade associates from having “sticky fingers.” Division of duties in the area of inventory may prove to be beneficial, as the likelihood of catching the shrinkage increases, and villains are more likely to be discouraged from their thieving ways.

Easy ways to decrease shrinkage include having a coat room, which can help keep large coats from serving as beautiful gift wrap for stolen inventory, tools, supplies, etc. Having a coat room provides a central location in which a trusted supervisor can watch for crooks.

Another simple way to deter theft is to use only clear trash bags throughout the workplace. Even with the division of duties or unannounced changes in garbage routes, the use of clear bags prevents employees from using the garbage bags as holding tanks to move merchandise or supplies.

Sign your own checks, insist on having paper copies sent and review all checks returned in hard copy format (or at least review them online). Have your bank statements sent to your home address instead of to the business. At a minimum, learn how to reconcile the bank statement.

For what third party expenses is an employer responsible?

After apprehending the wrongdoer, one would hope the worst-case scenario is the employer suffers the loss of certain supplies, but recovers some equipment with the help of legal enforcement and the judicial system. The hope of recovering cash from an employee by the time the theft is discovered is like getting blood from a stone, and the cost of chasing the money may greatly exceed any recovery. In any respect, the loss is limited to the actual cost of the money/goods pilfered. Hopefully, the employer also learns a thing or two about trusting people simply because they have gray hair, a stellar smile or good manners.

Certain types of theft can leave the employer paying for the theft twice, plus interest, literally. With employment tax theft, courts have found that even though the tax has already been withheld from employee paychecks and paid out of the employer’s fund, if it does not hit the taxing authority, the employer remains liable for the payment. (Pediatric Affiliates, P.A. v. U.S. 3rd Cir., No. 06-1979, 2007). The Internal Revenue Service warns business owners on its Web site that penalties and interest will be assessed for past due payments, as the employer is ultimately the responsible party, regardless of a third party’s delegation to make the payroll tax deposits.

Some closure.

Reading about the abundant methods of thievery is understandably overwhelming for a business owner. However, knowing how a “team member” is ripping you off is half the battle. Now, it’s up to you to put in the measures to protect your profits, the livelihood of your family and your other employees by establishing internal controls and measures, and by enforcing these policies to ensure your business prospers and increases in ownership value. “Sticky fingers” in your business should only be due to the donuts you buy your employees on Fridays!

Perhaps owners fail to identify
the thieves because they
don’t have unshaven faces and
approach them with a firearm
yelling, “Stick ‘em up!”
Rather, they appear with clean
criminal records, often as star
employees who rarely take
vacations. They disguise themselves
as “the son you never
had,” employees who always
work late and skip lunch.
About Elizabeth Fullington 5 Articles
Elizabeth Fullington is the Business Development Manager for STA. She is a CPA and JD, obtaining her undergraduate degree from Truman State University in Kirksville, Missouri, and law degree from the DePaul University College of Law In addition, Elizabeth has her Certificate in Taxation form the DePaul University College of Law.

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