Management overrides of internal controls can make your company more vulnerable to fraud. This is true even when managers have innocent intentions — for example, they don’t feel they have time to follow proper accounts payable procedures because a vendor is requesting immediate payment. Your company is at even higher risk of fraud losses . . . controls are ineffective . . . if a senior manager intentionally ignores the rules to manipulate financial statements.

Warning signs

Management overrides of financial controls can be difficult to detect. However, there are several warning signs that a manager isn’t fully adhering to the policies and procedures your organization has adopted. For instance, a manager may fail to call attention to business risks or dispute an auditor’s findings regarding his or her department. A senior manager may be unwilling to discuss issues that could require financial adjustments or insist on releasing overly optimistic reports on current or future performance.

Such behavior doesn’t prove that fraud is occurring. However, it suggests that you need to improve or open new paths of communication and consider retraining managers on the importance of internal controls. If you do suspect fraud, you must be willing to investigate — regardless of whom it might implicate.

Encouraging honesty

To prevent management overrides, build a culture that encourages honesty and supports employees who speak up when they suspect something’s wrong. Think about whether your managers experience pressure that unwittingly encourages fraud. For example, if your industry has seen increased business failures, some employees may think they need to keep profits at specified levels. They might also feel stressed if their compensation depends on achieving stretch goals for cash flow or operating results.

Employees a level or two below senior managers are most likely to observe management overrides. Give them access to a confidential hotline and they’re more likely to report fraud before it seriously harms your business. And if you extend your hotline to vendors and customers, you’ll increase your chances for learning of improprieties early.

A difficult year

This year has been challenging for businesses of every size and in every sector. With many employees working from home and some companies downsizing, managers may be tempted to take short cuts they wouldn’t under ordinary circumstances. Or worse, managers with access to financial statements may feel pressure to fudge numbers to improve your company’s public profile or boost their own compensation.

(This is Blog Post #932)