Fraud triangle

The improving economy has led more dealerships to recently fall victim to fraud. Dealers need to know how to improve their internal controls to reverse this trend.

Recovering Economy Leads to Increase in Dealership Fraud

  • 9/20/2012

Recovering Economy Leads to Increase in Dealership Fraud

A recent court case involving a controller who embezzled millions from an Acura dealership highlights one of the few negative side effects of the improving economy — an upsurge in dealerships falling victim to fraud.

“As the automotive market is getting stronger and dealerships have a growing influx of cash, we’re starting to see more cases of fraud in dealerships,” says Mrudul Sharma, a manager in the dealership practice with CliftonLarsonAllen. “However, a lot of dealerships have to make major changes to their internal processes to reduce their risk of fraud. Many do not have sophisticated internal control systems, because they believe the time and cost to implement them outweigh the benefit.”

Dealerships have been particularly susceptible to fraud for years, due to a combination of the generally small number of staff and large sums of money they handle. This recent rash of cases raises the question of what dealerships can do differently to minimize their chances of fraud exposure.

Although the Acura case is an extreme example of the effects of fraud, it occurred partially because of a lack of oversight — an issue that is widespread among dealerships.

“Failures in key controls over cash, a general lack of segregation of duties, inadequate computer systems, and unusual general journal entries seem to be a common thread in many of these recent cases of fraud,” says Sharma.

Electronic transfers

A growing number of people committing fraud are using wire transfers, since it leaves no paper trail, thus making it easier to hide activity.

Therefore, dealers should review these transactions on a regular basis, and ensure payments are supported by an invoice or other documentation directly from the vendor. Dealers should also review electronic funds transfer (EFT) and automated clearing house (ACH) transactions on monthly bank statements for unusual payments.

Segregating accounting tasks

In the Acura case, the controller was solely in charge of the accounts for many years. During that time, she electronically transferred over $10 million to her personal bank account, and then altered bank statements to cover her crime.

“This may have been avoided if the dealership had a proper segregation of duties, so one person wasn’t in charge of all the bookkeeping and accounting activities,” says Sharma. “Functions such as approving transactions, daily accounting, and asset custody should be divided among employees, and reviewed by the dealer or manager.”

Monthly bank reconciliations should be prepared by someone who is not involved in any banking duties or does not have access to accounting records. The dealer should scan the monthly bank reconciliations and inquire about unusual items. In addition, the employee who opens the mail should not maintain the checks or online accounts, and the employee who prepares the floor plan reconciliations should not pay for the vehicles. Supporting documentation should always be reviewed by check signers and invoices should be approved by appropriate department managers.

General journal entries

In addition to segregating accounting and bookkeeping activities, dealers should also review general journal entries each month. The entries should be analyzed for large and unusual amounts, entries to cash, entries impacting profit and loss accounts, and entries to parts inventory. General journal entries should also have complete descriptions and supporting documentation, and be approved before posting.

Fraud triangle

It is also helpful to understand why people commit fraud. Sociologist Donald R. Cressey devised the “fraud triangle,” a concept which describes the factors present in every fraud situation:

  • Incentive or pressure. The circumstances in someone’s life that leads them to fraud.
  • Ability to rationalize. The mindset that lets them justify committing fraud.
  • Opportunity. The situation or environment that allows fraud to occur.

Of the three fraud factors, controlling opportunity is the most effective way for management to deter fraud. This can be done by establishing a strong internal control environment where policies and procedures are documented, internal controls are implemented, and employees are educated about fraud.

Dealers should also be vigilant to some general characteristics of employees who commit fraud. They are usually a trusted employee and are able to exploit the internal controls to cover up their fraud. They also tend to work long hours or never take vacations in order to protect their fraud scheme. Other red flags could be noticeable changes in lifestyle or spending beyond their means, or an addiction to gambling, alcohol, or drugs.

How we can help

As the economy continues to improve along with the financial performance of most dealerships, the strength of a dealership’s internal controls become more important. Dealers need to improve their internal controls and manage their fraud exposure now to ensure they are safe in the future. It is much cheaper to implement a good series of controls and external reviews than to deal with lost revenues and high costs related to fraud.

Auto Team America, a group of CPA firms (including CliftonLarsonAllen) that focus on serving dealerships, has developed an internal control program in response to dealers’ concerns about potential fraud. The Control of Operating Procedures and Systems (COPS) product is a simple, cost-effective way to evaluate the operating effectiveness of dealership controls and identify internal control weaknesses.

COPS is a versatile modular system that can be tailored to address specific areas of concern or analyze the entire dealership operation. We will identify and address areas of risk, inspect specific key operations for compliance with established policies and procedures, highlight opportunities on how the dealership can be more profitable and increase efficiency in operations, and suggest best practices on internal controls and operations.

Mrudul Sharma, Manager, Dealerships or 612-376-4513