The Case for Internal Controls: Preventing Fraud in Local Governments

What are Internal Controls and Why Are They Necessary?

Internal controls include policies, procedures, and practices that help ensure the accuracy and integrity of financial and operational information. They safeguard assets, prevent fraud, and ensure compliance with laws and regulations. These checks and balances help organizations reduce mismanagement and prevent day-to-day clerical errors, which can end up saving money and time through improved efficiency and productivity. Simply put, internal controls protect public funds, reduce the risk of loss, and build public trust.

Unfortunately, many local governments are not able to create ideal internal control systems, making the organization susceptible to fraud or errors. Typically, most errors and incidents occur when there is one person handling all financial tasks, leading to a lack of segregation of duties. For example, a financial administrator who is able to write a check, make the payment, and reconcile the bank statements would raise concerns due to lack of oversight, potentially enabling unauthorized or incorrect transactions. Another common weakness is inadequate documentation or approval processes. It is important to show that approval hierarchies are effectively in place and that individuals are not just able to make transactions as they please.

A quick search on the internet will find many fraud cases that have occurred in local governments throughout the country. One of the most popular cases of government fraud occurred in a small town of Dixon, Illinois where the former comptroller embezzled $53.7 million from the city, which was uncovered back in 2012. Fraud cases are identified in governments of all sizes, and the frauds themselves vary in magnitude. The recurring issue that we find in these cases is a lack of internal control. If proper controls and safeguards had been in place – such as independent reviews and approval hierarchies, the fraud may have been caught much earlier, significantly reducing the amount of loss to the government.

It is also important to recognize and remember that a government can suffer a loss even when the act was not intentional, as a result of clerical error or genuine misunderstandings. However, these can still be just as costly to organizations. A school that accidentally misses a filing date for grants could miss out on significant amounts of income, resulting in not only a financial loss, but a loss of time and efficiency where a budget restructure may be required.

Recommended Internal Controls

When our firm conducts an audit, we go beyond the numbers to take a deep dive into these controls to determine whether there are any potential risks that should be brought to the attention of those charged with governance. Our firm looks closely at the standard procedures in place, approval processes, and access available to individuals. From there, we are able to make tailored recommendations for improvements in the structure. Standard internal controls that we tend to recommend include, but are not limited to:

1. Separation of duties including different individuals to make and review transactions
2. Approval processes (and documentation of these approvals) for expenditures, contracts, and budget changes
3. Regularly reconciled bank account statements, ledger accounts, and grant/project balances
4. Restricting access to cash, check inventory and financial information, using both physical controls and digital safeguards such as the use of strong passwords
5. Regular IT training, including a contingency plan and fraud prevention seminars
6. Monitoring and oversight through periodic internal reviews

We encourage local governments to take the time to evaluate these processes on their own, regardless of prior issues, in order to ensure the most efficient and effective structure of their entity.