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Fraud - key control weakness

Levon Helm was a kind of one-man mortgage broker. He would drive around Tennessee looking for homes that had second mortgages, and if the criteria were favorable, he would offer to buy the second mortgage for "cash on the barrelhead." Helm bought low and sold high, making sizable profits. Being a small operation, he employed one person, Cindy Patterson, who did all his bookkeeping. Patterson was an old family friend, and he trusted her so implicitly that he never checked up on the ledgers or the bank reconciliations. At some point, Patterson started "borrowing" from the business and concealing her transactions by booking phony expenses. She intended to pay it back someday, but she got used to the extra cash and couldn't stop. By the time the scam was discovered, she had drained the company of funds that it owed to many of its investors. The company went bankrupt, Patterson did some jail time, and Helm lost everything.

What was the key control weakness in this case?
Many small businesses cannot afford to hire enough people for adequate separation of duties. What can they do to compensate for this?

Solution Preview

Two key internal control weaknesses that have occurred are a lack of oversight through continuous automated monitoring of journal entries, and lack of separation of duties. Patterson has committed General Ledger fraud. General ledger fraud occurs when employees have exclusive access to accounts payable or suspense accounts and unbeknown to the employer, are able to move funds between accounts. This allows for employees to set up fictitious companies or venders, as was the case of Patterson, which may ultimately take employers years to realize.

The second control weakness is a lack of separation of duties. Because Patterson had sole responsibilities for all the ...

Solution Summary

Too often in small businesses, the employer is so busy that they leave most of the paperwork to their office staff, which is usually one person. This is not a good strategy in preventing fraud. There are various ways to resolve cases such as this. First, in order...