Essential Finance: Preventing fraud – a question of control

The consequences of fraud for an arts organisation (or even an accusation of fraud) can be catastrophic, and not just in terms of cash and any potential legal action against the organisation. Confidence will also be eroded, in the eyes of clients and donors, the public, beneficiaries, and even the organisation’s staff and Board members.

When fraud occurs, one of the most common features found in organisations affected is a weakness or lack of internal controls. People do not usually start off with the intention of committing fraud: a lack of capacity and/or knowledge, too much reliance and trust placed on certain individuals, things being taken at face value, poor formal systems and protocols, and ineffective management all create the environment in which fraud can occur.

An important principle of internal control is segregation or division of duties. This prevents any individual from being able to authorise, record and process a complete transaction. For example, where the same person receives cash for ticket sales, records it in the cash book, pays it into the bank and prepares the bank reconciliation, it would be difficult to detect dishonesty or error. Cash could be misappropriated and hidden by false record keeping (known as teeming and lading).

Internal control systems need to be based on a clear statement of responsibilities. This consists of an organisation chart backed up by job descriptions, and helps staff and management to have a clearer understanding of their duties and to whom they are responsible. All transactions should require advanced authorisation or approval by an ‘appropriate and responsible person’ with backing documentation provided. For example, systems for expense claims are a common area of weakness. No reimbursements should be made without receipts. These should be authorised separately and payments only made for legitimate expenses.

Delegation of responsibility by senior management does not mean abrogation of responsibility, and it is important that transactions are actually checked for accuracy, completeness and legitimacy. For example, arts organisations may receive restricted funds; it is essential to verify that they have been spent in line with the stated purposes. Too often Board members may take a baffled glance at financial reports, give their sweeping approval and then move quickly onto the next item on the agenda (one that they understand better).

Effective internal controls are a necessary part of the management tool kit; they provide additional assurance, protection and clarity to staff, management and the outside world. Arts organisations range in size and complexity, and in an age of contract culture, internal controls need to be adapted and adopted according these factors, as well as funders’ criteria, and areas of high risk. They should not be seen as a straightjacket or be costly to implement; they will never guarantee that fraud will not occur; but they reduce the risk of it occurring and show that the organisation has been proactive and responsible.

Mahmood Reza is Proprietor of the accountancy practice Pro Active Accounting.
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