Why Internal Controls Are Crucial

Allen Friedman, Partner
Kleiman & Weinshank

The Lay of the Land

As auditors, we’re required by professional standards to make certain inquiries of the boards in connection with our audit. One of the topics we discuss is their internal control procedures. We assess the risk of material misstatements in the financial statements and consider the co-op or condo’s internal controls as we plan our audit. We do not, however, express an opinion on the effectiveness of those controls.

The audit is designed to provide that the financials are free from material misstatement. Some boards misunderstand this and often rely too much on the audit to detect any fraud. While the audit can most certainly do that, in my experience the most effective deterrent is board involvement or board oversight. Remember, the audit is done once a year, but the board is there every day.

Here are some frauds we have encountered over the years. In one situation, a property manager created invoices for a nonexistent company called “American.” He would then alter the checks paid by the co-op to “American” to read “American Express,” and he then paid his own American Express bills with that money! In another instance, a property manager was giving a large amount of work to one particular vendor. Nobody seemed to think much of it until this vendor’s poor workmanship caused extensive flood damage. It was then discovered that the company was owned by the manager’s spouse. While the relationship itself is not fraudulent, it should have been disclosed to the board.

Now What?

At the planning stage of the audit, we will ask a board representative various questions regarding the invoice approval process and the internal control procedures that are in place at both the board and management levels that could reduce the risk of fraud. Board responses to us can indicate how well they understand our role as auditors, what their current involvement is, and how much they rely on management. We can then make suggestions on how they can improve matters. Some responses I’ve received indicate to me that the respective boards need to be much more involved in overseeing operations.

However, most boards get it right. For instance, one of our clients is very involved with the oversight of management, and the practices that this board has in place would decrease the risk of fraud. The board reviews the monthly management reports in detail. They examine cash receipts, cash disbursements, and invoices. They’re comparing actual versus budgeted expenditures every month and questioning any variance. They are looking at everything even after it was paid. In the interim between these monthly meetings, they’re also communicating with management on financial matters.

Such attention to detail is important because, at the end of the day, it’s the property’s money, and the board should be very involved in safeguarding it.