Embezzlement risk in a retail business

Most organizations are vulnerable to embezzlement from a dishonest or disgruntled employee. A retail establishment is especially vulnerable to embezzlement due to the high volume of cash passing through the business. As the saying goes "Cash is King" and wherever there is cash, there is a risk of embezzlement.

Following are some of the common embezzlement schemes committed against retail operations, along with some simple controls to help prevent the losses.

Theft of Cash. This type of fraud can be committed by any employee in the cash handling process and is fairly easy to cover up if proper internal controls are not in place. A fraud of this nature was recently committed in Northern Michigan resulting in a loss of more than $100,000.

How It's Done: The cashier collects a cash payment from a customer, but does not enter the sale into the cash register. The cashier later skims this cash and the theft is not noticed since the cash in the drawer will balance to the cash register tape. Resorts, restaurants, convenience stores, and bars are especially vulnerable to this type of embezzlement.

How to Prevent It: First, institute a policy specifying that all customers must receive a cash register receipt for their purchase. Second, you may consider instituting a program whereby any customer not receiving a receipt for their purchase will receive a free $5 gift certificate. In this way, you are using your customers to help ensure that all sales are entered into the cash register. National companies, such as Wendy's and Walgreen's, use this control as a theft deterrent. Third, never allow the same person to act as a cashier and also balance or (z-out) their register. Fourth, a separate person should be responsible for depositing the daily cash at the bank. Fifth, actively monitor your product margins; unusual spikes up and down can be an indication of embezzlement.

Write-Off of Friends or Relatives' Receivable Account. A retail business that allows customers to establish credit at their store has an added risk, the potential for abuse of the accounts receivable. I have personally seen this type of embezzlement cost an Illinois car dealership over $300,000. In this case, the controller was writing off amounts that relatives owed on vehicles purchased at the dealership. This type of embezzlement can be a big risk for any retail business that grants significant customer credit, such as a lumber yard.

How It's Done: An individual with access to the accounts receivable ledger and also the accounting records simply writes-off the amounts friends or relatives owe to the business. If necessary, the individual will cover their tracks by posting accounting adjustments to hide the write-off.

How to Prevent It: First, minimize the number of customers to whom you grant credit. Most people should be able to pay your retail business by credit card. Second, limit the number of people with access to customer accounts receivable records. Third, monitor write-offs or adjustments to the accounts receivable very closely with monthly reports detailing all write-offs. The reports should be system generated, not in Excel or manually prepared by the controller. Fourth, implement a monitoring program whereby your CPA or an internal watchdog conducts a periodic surprise inspection of your receivable records. Even if nothing is found during the inspection, everyone is on notice that someone is monitoring the activity.

"Phantom" Merchandise Return. This type of fraud involves processing a bogus merchandise return in the cash register. This fraud is very easy to commit but more difficult to detect than the examples above. The loss potential is equally as great.

How It's Done: The cashier processes a "phantom" merchandise return into the cash register with no cash refund paid out. The excess cash in the register is later stolen or the cashier can process a credit in one of his/her personal credit cards, effectively receiving the cash. Again, the cash in the drawer will balance with the cash register tape, so the embezzlement will not be easily detected.

How to Prevent It: First, institute a policy requiring that all customer refunds over a certain dollar amount be manager approved. Second, monitor the level of merchandise return credits processed. If a certain individual has an unusually high level of returns, this should be scrutinized further. Third, watch your inventory for unexplained inventory write-offs; this can be a sign of bogus merchandise returns. Fourth, actively monitor your product margins; unusual spikes up and down can be an indication of embezzlement.

The examples above are just a few of the many ways embezzlement can occur at your retail business. All retail businesses should consider implementing some of the above controls to help safeguard their cash.

Mike Novik, CPA, is a Manager with Dennis, Gartland and Niergarth in Traverse City. He specializes in fraud prevention and fraud detection services and works extensively with Retail, Manufacturing and Non-Profit entities; 946-1722 or mnovik@dgncpa.com