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Taking command of your internal controls

November 18, 2013

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Every dealership is at risk for theft and financial misstatement. These threats are especially high if a store lacks formal, regularly reviewed internal controls. Here are some ways to take command of yours.

Is your accounting accurate?

The first element of a strong internal control system is detailed, current and accurate financial information. Reliable financial statements help dealerships detect fraud early and document the fraud trail, if abuse takes place.

One sign of weak internal controls is an accounting department that fails to generate a balance sheet and income statement until two or more weeks after month’s end. Accounting should post all transactions daily, including new and used vehicle sales, repair orders, invoice payments, and payroll and cash receipts.

By 1 p.m. on any given day, you should have access to real-time checkbook balances and other accounting information effective as of 5 p.m. the day before. That way, you might be able to catch the first signs of fraud.

Conventional safeguards

Conventional safeguards, such as passwords, alarms and locks, are obvious elements of internal controls. But sometimes these fall by the wayside.

To illustrate: A dealership’s general manager forgot the parts storeroom key at home on audit day. When touring the facility, the CPA was shocked that the GM was able to enter the parts area through the exterior shipping door without being detected by anyone. So much for security!

Periodically review your safeguards and reinforce them, if necessary. Require employees to change their passwords quarterly and replace the locks when a manager terminates employment.

Operational controls

Operational safeguards mitigate the opportunity to commit fraud. Here are some real-world scams and ways that operational controls might have reduced or prevented losses from spiraling:

Checks and balances. Consider the parts manager who stole $70,000 by selling parts on the side and pocketing the cash. The loss could have been significantly reduced if the owner or CFO had thought like an internal auditor and performed random inventory counts throughout the year, rather than waiting for the CPA to physically verify inventories at year end.

Segregation of duties. Another dealership lost nearly $16,000 when its cashier was caught stealing cash by voiding service orders and falsifying deposit slips. The cashier’s responsibilities included collecting cash, issuing receipts to customers, preparing the daily deposit slip and reconciling the daily cash report. The loss might have been prevented if the dealership had separated these jobs. As a rule of thumb, employees who record and reconcile transactions should never have access to those assets (including being a signer on any bank accounts, and so on).

Background checks and dealer involvement. Another dealer was shocked to discover that the general manager was routinely wholesaling used cars at a loss to the dealership, because he owned a 50% interest in the wholesaler. A better pre-employment screening process could have helped detect such conflicts of interest as well as any criminal history. It also can identify people with poor credit histories, who might have a financial incentive to commit fraud.

The dealer-owner could have further prevented the scheme mentioned by reviewing wholesale transactions that incur a loss and by personally meeting all wholesalers and vendors. An involved, informed dealer who sets an ethical “tone at the top” is the surest sign of a strong internal control environment.

How does an audit help?

External audits provide no guarantee against fraud, but it’s often helpful to have an objective, experienced outsider verify and analyze your accounting records. CPAs are trained to spot anomalies and will recommend ways to improve internal control weaknesses. Moreover, employees are less likely to commit dishonest behavior if they know someone will be asking questions about their actions.

Regular reviews

Even if your dealership already has a formal internal control system in place, be sure to review it periodically. You never know when you might discover new vulnerabilities that could enable dishonest employees to steal from you.

Sidebar: 5 easy fraud prevention tips

Talk to your employees about internal controls and let them know that you’re proactive about preventing and detecting fraud. Make it known that you:

1.    Receive a copy of bank and credit card statements at your personal address. Don’t rely only on the accounting department to reconcile cash and approve charges. Duplicate their reconciliations and investigate questionable items.

2.    Track inventory and fixed assets. Periodically ask accounting to run an inventory or fixed asset register; then locate or test count a few items. Inaccuracies or missing items should raise a red flag.

3.    Review adjusting journal entries. Normal accounting entries should accurately record financial transactions. Adjusting entries — those that correct normal accounting entries — should be rare.

4.    Require annual vacations. Some diligent workers legitimately forgo a vacation, but fraudsters also need to be in the office every day to hide their improprieties. Implement a mandatory vacation policy, to be on the safe side.

5.    Have a zero tolerance policy. Terminate and prosecute employees caught stealing, cooking the books or “borrowing” dealership assets for personal use. Exceptions set a bad precedent.
Frank Panzeca is a Shareholder at Clark Schaefer Hackett and the Chair of the Firm’s Auto Dealerships Group. Please contact him at [email protected] with any questions or for more information on this topic.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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