Non profit organization fraud. Financial audit or forensic investigation?

Accountants perform a variety of services for non-profit organizations. Sometimes the services will go outside the standard audit service and entail the investigative accounting realm.

Many professionals whether they are engineers, accountants, or writers, belong to their related trade organizations.

Trade organizations are designed to help promote a respective profession’s trade. As a member of the organization, you will usually pay yearly dues and conference fees, if you attend their annual trade conference. You personally get the benefit of belonging to the organization and the ability to network with others in the same industry. As the organization reflects upon the membership, you want to belong to one with a solid reputation.

How the money is managed and what your funds go toward is generally handled by the executive director of the organization.

The executive director will take the direction of the board of directors and, with the assistance of staff, map out where to spend the funds to best benefit the members. I often hear from trade organization members that their organization is reputable, from a financial standpoint, because they “get an audit” ever year. They think that because they “get an audit,” there couldn’t possibly be any theft of funds.

This is a common misconception.

What is the goal of a financial statement audit?

Under the rules and regulations the auditor must follow, the three most common goals of a financial statement audit are to:

1. 1. Issue an opinion that the issued financial statements are materially correct.

What does “materially correct” mean?

Well, assume you have $1,000 in $1 bills on your desk. Now let’s say you lose one of those dollars and you know have $999. Would losing the $1 make you upset? Probably not, because in the scheme of things it is immaterial to the overall amount.

This is how auditor approaches financial statements. They only look at the items that are determined to be material. If they did evaluate the entirety of the financials, the cost of the audit would be astronomical.

1. 2. Document any internal control weaknesses.

The auditor is required to document and communicate internal control weaknesses. They are only required to make sure the weakness didn’t cause the financial statement balance to be ‘materially’ misstated. In other words, the difference of what is report and what the balance should be is so large it would change the mind of the end user.

1. 3. Review management’s assertions.

This is a fancy way of saying that the auditors will ensure that if management is recording something in the books based on an estimate, then the estimate is reasonable.

As you can see, at no time does the auditor develop their audits to test for any fraud or theft. While they may occasionally stumble upon fraud or theft, many times fraud isn’t caught. Especially, in this type of a financial audit. Rarely will a non profit organization fraud be caught.

 

How often have you heard the saying ‘where were the auditors’ when a fraud happens?

It isn’t that the auditors don’t know how to find fraud. It is simply that their tests are not designed to detect fraud. Their tests are only designed to make sure the balance reported is within a material tolerance of what the balance should be.

Enter the role of a forensic accountant.

In the forensic accounting world, we are hired to perform forensic investigations that specifically hone in on theft and fraud.

We don’t issue financial statements (e.g. balance sheet, income statement, cash flow) but rather a report on the testing of specific transactions.

What is the goal of a forensic investigation?

The three main goals of a forensic investigation are:

1. 1. Determine all the parties involved with a possible fraud or theft.

We develop what is called a genogram. Think of it as a flow chart that maps out all of the people in and out of an organization. We do this because if we just focus on the primary people involved, we may miss the larger picture of fraud outside of the immediate area.

1. 2. Test all transactions related to the area of suspicion, regardless of dollar value.

Even if an invoice is $1, if it falls in the area we have concerns about then we will test that area. There have been famous cases that unraveled because of the examination of a small amount.

1. 3. Report the findings.

The report will be detailed enough that it will break out everything examined and any fraud that has taken place. Additionally, the report can be used in litigation proceedings and, in some cases, criminal proceedings.

So to recap, an audit is more concerned about the material presentation of the financial statements. The forensic investigation is concerned about reviewing every transaction that is specifically related to the area of concern.

Indicating you have no concern about theft from an organization when they ‘get an audit’ is misguided.

What are red flags you should be concerned about?

Most trade organizations are set up a non profit organization. Non profit organization fraud red flags you should be aware of are:

• • • Expense reports are not reviewed by an employee or someone a level above the person submitting.
    • People who get overly defensive when asked about an account or the state of the financials.
    • Significant change in leadership.

Many times non profit organizations will bury a fraud and not prosecute. This is done to avoid negative publicity. It is important, regardless of whether an individual will be prosecuted, to report nonprofit fraud.

Steven D Hovland is a Certified Public Accountant and a Certified Forensic Accountant. He has 20+ years experience in auditing, accounting, and forensic investigations. He is the founder of Hovland Forensic and Financial, a virtual CFO service company as well as forensic litigation services.