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Five Types of Fraud Dealerships Can Prevent With Better Internal Controls

September 22, 2014

By Anthony J. Allison, CPA

The U.S. District Court for the Western District of Pennsylvania recently indicted the former controller of a car dealership, who subsequently pleaded guilty to the charges. The indictment details several ways in which the controller stole $10.2 million over a six-year-period and highlights the importance of proper internal controls in a dealership. Many dealers are likely wondering whether something like this could happen in their dealership.

In the Pennsylvania case the controller siphoned $10.2 million over a six-year period by shifting money between accounts, creating fictitious journal entries and making fraudulent automated clearinghouse (ACH) transfers to the controller’s personal account. The fraud involved more than 800 such transactions that could have easily been discovered, or, better yet, prevented, had some basic internal control policies and procedures been in place and monitored. Below are five specific types of fraud committed in this case and what dealerships can do to help prevent the same thing from happening to them.

1. Electronic Transfers

The controller in this case transferred funds electronically via ACH transactions from the dealership’s payroll bank account into the controller’s personal bank account.

Related Controls:
To address fraudulent ACH transactions, dealerships should have a call-back procedure in place with their bank for all ACH transactions. In a call-back procedure, when one person in the dealership authorizes and initiates an ACH transaction, the bank calls back another individual at the dealership to confirm the ACH transaction is proper.

Another control is to have someone other than the person initiating the ACH transaction independently review the payroll amounts submitted for payment. Individual department heads typically review and approve the payroll for their departments, but a different individual should then review all of the departments’ payrolls to verify they’ve been reviewed and appear to be reasonable.

A third control is to complete an independent review for reasonableness of year-to-date wages in the payroll register. A dealer can look at the year-to-date wages on a periodic basis to reconcile the employees in the payroll register and the amount of wages those individuals are receiving.

2. Bank Statements

The controller altered the dealership’s bank statements to eliminate references to the fraudulent ACH transfers from the dealership’s payroll account.

Related Controls:
If a dealership is still receiving hard copies of its bank statements, the statements should be received unopened by someone independent of the bank reconciliation process. Bank statements could be mailed directly to the dealer’s home so that the dealer has the opportunity to review the bank statement unaltered. Many dealerships access their bank statements online and should have someone independent of the bank reconciliation process review the statements for reasonableness.

Another basic control is to segregate the functions of writing checks or initiating ACH transfers from the duties of preparing the bank reconciliation. An independent preparation of the bank reconciliation provides the opportunity to raise questions and investigate unusual items.

Finally, the monthly bank reconciliation should be a part of the monthly reporting package that the accounting office provides to the dealer for review. The dealer can then ask questions about items that he or she does not understand.

3. General Ledger

The controller inflated the general ledger inventory account via journal entries and added previously sold vehicles back to the dealership’s inventory database.

Related Controls:
Journal entries are commonly used to hide fraud. Someone other than the preparer of the journal entry should review all general journal entries. Each general journal entry should include a detailed description of the reason for the entry and a reference to supporting documentation so the reviewer can confirm the accuracy and purpose of the journal entry.

Another inventory control is for a dealership to take a monthly physical inventory of its new and used vehicles.

The inventory should be taken by someone independent of the new and used vehicle inventory departments and can be done at any time during the month.

4. Floor Plan Loan

The controller fraudulently reduced the general ledger floor plan loan amount and altered the floor plan loan documents.

Related Controls:
Dealerships should reconcile the floor plan bank statement with the general ledger on a monthly basis. This reconciliation should be prepared by someone independent of the bank reconciliation and inventory functions. A copy of the reconciliation and the floor plan statement should be a part of the monthly reporting package the accounting office provides to the dealer.

5. Reserve Accounts

To conceal the fraud, the controller made false and fictitious increases in reserve accounts as well as fraudulent expense offsets.

Related Controls:
Controlling journal entries by having separate individuals perform the preparation and review of each entry will also help prevent this type of fraud. In addition, a month-end summary of all reserve accounts explaining what the reserve is for and how it was determined should be a part of the monthly reporting package submitted to the dealer each month. Another control to address this type of fraud is reviewing financial statements. Looking for month-to-month trends and fluctuations in the detailed financial statements might help a dealer identify unusual items that require further investigation.

Prevention Is Key

The Pennsylvania case should remind dealers to periodically review and monitor their internal control policies to ensure they are being followed and are working. Having a good internal control policy that incorporates “inspect what you expect” can help dealerships prevent costly fraud.

 

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