Right controls, wrong culture: passed over for a promotion, one employee decides to make a profit on the side and a new auditor learns the value of having someone look over your shoulder

Internal Auditor, April, 2004

IN THE NOT TOO DISTANT past, many of the U.S. military club systems around the globe were rife with theft and mismanagement. Almost daily, the U.S. Congress heard about another scandal plaguing these military facilities. In response, Congress mandated that all club systems be audited annually, and in the Army, that task fell to the enlisted auditors with the U.S. Army Audit Agency.

Standard audit procedures at the time were to review various reports generated by the clubs, including cash count sheets, physical inventory counts, and reconciliation reports. No matter which club was audited, or what time period was selected, there were no exceptions to these audit procedures. When the auditors gathered the club reports from various facilities, they noticed that there was never a variance in the cash reports, never an inventory shortage, and never an unexplained variance in any reconciliation. Even the best-run organizations have an occasional cash overage or shortage in the register or the petty-cash account. In addition, it's not often that physical inventories result in zero missing items; there are always occasional unexplained reconciliation variances.

Because perfection can be just as big a problem as numerous errors, additional testing was conducted. An auditor was stationed at each bar and cash register to observe operations. It was found that, on the day of the observations, sales would increase by 20 percent compared to historical sales for that same day of the week, regardless which club was audited. The auditors also noted that the shot glasses used to measure alcohol for drinks had been rigged. Rather than holding the standard one ounce of alcohol, these glasses held four-fifths of an ounce. The auditors also found that the hamburger meat used for the club's food items had a high degree of cereal filler. It appeared that a portion of the hamburger meat was being stolen and the remaining hamburger was mixed with cereal to cover the theft.

Each club system included about a half dozen clubs that were overseen by one club custodian, which made it difficult for him or her to supervise and monitor the staff. Once the reports were compiled, it became apparent that the staff, with the exception of the club custodians, conspired to skim approximately 20 percent of the sales. In addition to pocketing every fifth sale and not ringing it up in the cash register, they made sure that all cash counts, reconciliation reports, and inventories agreed. If the cash registers were ever short, the staff would replace the missing money with a portion of what was stolen. The auditors recommended more supervision by the club custodian and encouraged better customer awareness of club operations.

CENTRAL FLORIDA

A SLIP IN CONTROLS

A new retail-store manager was reviewing the controls over money and inventory to help familiarize himself with the operations. He was dismayed to find that the former manager's administrative assistant was responsible for reconciling the cash, employee sales, and ordering inventory. Essentially, she had been running the store. In fact, she told him that she thought management was going to promote her to store manager because she assumed they knew how much work she had been doing.

The new manager asked the company's internal auditors to review the operation. Several recommendations on changing controls and processes were made, and the new manager instituted them. A few months later, the manager called internal auditing again. He had not been able to get the administrative assistant to give up handling employee sales and wanted a specific audit on that area. During this inquiry, the auditors found that the selling price to certain employees--and possibly some of the administrative assistant's friends--was less than the cost of the merchandise. In addition, when interviewed, several of the employees told the auditors that sales had occurred without a sales slip being written. They said that when they asked about the sales slips, the administrative assistant told them they had to buy the item with cash and that they wouldn't get a sales slip. If they didn't want to do it that way, then they couldn't buy the item as an employee. A quick review of the items employees had purchased showed inventory was short in those areas. Because the purchases related to large items, considerable revenue was involved.

After numerous denials by the administrative assistant, the police were called in. Eventually they subpoenaed her bank accounts, which revealed checks matching the employees' cancelled checks. She was subsequently arrested. None of this would have been discovered so soon if management hadn't had a solid understanding of control structures and the wherewithal to contact auditing for assistance.

CENTRAL FLORIDA

IN NO ONE WE TRUST

On his first audit, an auditor was assigned to count petty cash at one of the branch locations. As he sat down, the custodian of the fund walked away to do some other work. Being inexperienced, the auditor thought nothing of it and started counting. To the auditor's dismay, the account was short $20. He re-counted--still $20 short. With trepidation, he asked the auditor in charge what to do.