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Internal Controls & Fiduciary Responsibilities

How important are separation of duties and strong internal controls in a club environment that does not handle cash and runs on a limited budget?

Occasionally you may hear about fraud at another club. You may even hear a remark that fraud cannot happen at our club because our club does not handle or accept cash. Nothing could be further from the truth! It is an unfortunate reality that there are almost countless ways that one can steal (i.e., check forgery, theft of money, inventory theft, payroll fraud, fictitious vendors, kickbacks, etc.). You never know when or where it will occur until you actually discover it. Most people who start committing fraud will continue. As a noted accounting professor stated years ago, “there are no immaterial frauds, only ones with insufficient time to grow.”

Fraud is a complex phenomenon that has been studied in various fields including accounting, psychology and criminology. These studies have concluded that fraud occurs when the following three factors (sometimes referred to as the “Fraud Triangle”) are present at the same time:

1. Motive – usually a hidden financial need

2. Opportunity – commit fraud without being detected (usually in the presence of weak internal controls)

3. Rationalization – usually done by calling the theft something else (“borrowing”).

A Fiduciary Responsibility

A question that arises from a practical and cost/benefit perspective is whether sufficient controls can be put into place so that the opportunities to commit fraud will be prevented regardless of the level of honesty of a particular employee. Short answer: No system is perfect or foolproof. However, the club’s board has a fiduciary responsibility to ensure that an effective system of internal controls is in place. Such a system should safeguard the assets of the club, record transactions and produce a monthly financial statement in a timely and accurate manner.

The cornerstone of any system of internal controls is segregation of duties—an effective structuring of checks and balances. Fewer people in the accounting office may result in a potential weakening of controls because fewer tasks can be done by different people. Conversely, having more bodies in the accounting office allows for a greater degree of segregation of duties and inherently more checks and balances and improved controls. For those clubs that can’t dedicate the financial resources to the accounting office to accomplish the proper segregation of duties, adequate controls can still be established and maintained using alternatives, which may entail more involvement in—and over- sight of—the accounting and control processes by the general manager and/or treasurer. Another possibility would be to out- source certain accounting and control procedures (payroll processing, lock box systems for cash receipts, etc.) so that limited resources could be devoted to other tasks.

Internal Controls Manual

As a first step in the process of determining whether the club has adequate internal controls, the club should prepare an accounting and internal control procedures manual that details the major financial areas in narratives, including all applicable forms the club uses for sales, payroll, purchasing, cash disbursements and cash receipts.

Once the manual is completed, have it reviewed by persons with an accounting background to ascertain whether the controls are adequate. The controls in the various areas should then be tested to ensure that they are functioning as stated and as intended. To the extent desired and considered necessary, the club should enlist its outside accountants in this process. And, of course, management’s role is critical in this effort to institute and document controls and create an environment of awareness of everyone’s responsibility in carrying out the controls.

Daniel T. Condon is a founding partner in the accounting firm of Condon O’Meara McGinty & Donnelly LLP, which currently serves as auditors, consultants and tax advisors to more than 325 clubs in 14 states. He has practiced in the area of private membership clubs for more than 30 years.