How Nonprofits Can Reduce Opportunities for Fraud

Mitigating risks of fraud with proper internal controls

As many not-for-profit entities are entering their annual audit season, concerns of fraud are often top of mind for those charged with governance. However, based on studies by the Association of Certified Fraud Examiners, only a small percentage of fraud is caught by external audits while the majority is caught through internal tips and management review. That is why the implementation of internal controls within an organization is so important to help mitigate the risk of fraud.

The three elements of fraud, often referred to as the “Fraud Triangle,” are motivation, rationalization, and opportunity. Motivation may come from heavy financial burdens or living beyond one’s means, and rationalization often comes from a feeling that one is underpaid or underappreciated or that any diverted funds are “just a loan.” The third element, opportunity, occurs when there are not proper internal controls in place or internal controls are not implemented properly.

To reduce the opportunity for fraud, nonprofits should do the following:

Implement segregation of duties

To ensure the same individual isn’t performing key functions such as recording transactions in the general ledger and approving invoices and processing payments or collecting cash receipts and making cash deposits. Complete segregation of duties within the accounting/finance team is not always possible at smaller organizations so utilizing others within the Organization such as an administrative staff member or a part-time outsourced accountant can help maintain segregation of duties.

Conduct regular reviews

Review your nonprofit’s financial information such as budget to actual, expense reimbursements, credit card usage, collections of contributions and related receivables. It is important that those performing the reviews have the necessary expertise or have been properly trained so that the reviews conducted are effective. Regular reviews of the organization’s processes should also be completed to ensure the prescribed policies are being followed. Reviews by those charged with governance, such as an audit or finance committee are even more critical when full segregation of duties is not possible.

Foster a culture of transparency and accountability at all levels of the organization

Ensure there is a way for employees to report any concerns over internal controls and for those concerns to be reviewed by an appropriate member of management or the Board of Directors. Written policies should be enforced. For example, if there is a policy that expense reimbursement forms will not be approved and paid without proper support, then there should be no instances where a report is being approved without supporting documentation. If the policy is not being followed consistently, those performing the review should be held accountable by a member of management or the Board of Directors. Monitoring and regular reviews of processes will help quickly identify gaps in the implementation of controls.

While controls are not often tested during the annual audit, your audit teams are required to understand your organization’s processes and conclude whether certain identified controls have been designed and implemented. Based on those reviews, there may be observations or suggestions for improving the internal control environment. By ensuring there are proper segregation of duties, regular reviews, and a culture of transparency and accountability within the organization, the opportunity for fraud can potentially be minimized.

Questions on improving internal controls for your nonprofit organization? Contact your Keiter Opportunity Advisor or Email | Call 804.747.0000