Church Fraud Prevention Service at Weeds in the Garden – Why We Care

Weeding out church fraud, and embezzlement.

Why do we care about church fraud protection at Weeds In The Garden?

To be honest, well, we love honesty. Church Fraud Prevention is one way to combat a hurtful, damaging form of dishonesty. Why, though, do we love honesty?

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Fraud Prevention Programs, part 2

Our Fraud Awareness in the Church series continues with part 2 on Fraud Prevention Programs – Fraud ReportingWe asked churches to respond to this statement:

“Our church has established appropriate channels for reporting and resolving sensitive issues like fraud and illegal acts. (Examples include establishing an anonymous fraud hotline, posting notices, etc.)”

Survey Results: Only 40% of the respondents have established any form of fraud reporting mechanism.

KEY: Key Point: Statistics make it clear that the most common method of fraud detection is anonymous tips!

Few churches have the stomach or the nerve to do what businesses and local governments are increasingly doing.  For example, A “Report Fraud” link on a school district’s or city’s website gives comfort to most taxpayers.  But, the same people would choke if they saw a fraud tip hotline on their church’s website!

One solution I have seen:

A church contracted with an HR services firm to take care of all of their payroll compliance issues such as wage and hour laws, discrimination, workmen’s comp, immigration, etc.  The HR company also drafted the church’s personnel manual which included an 800 number hotline.  The HR professionals maintain the hotline assuring that all fraud reporting remains confidential.

Ingredient Four – Managing Your Cash

Monthly cash receipts seldom match what was budgeted and it is not unusual that during some months, cash outflow will exceed inflow. (Like July and August…)

Not preparing for this may force a church to:

  • Dip into savings or investment accounts
  • Pay bills late
  • Borrow money.
  • Dip into designated accounts (AKA – World War III!)

One way to avoid having to resort to these measures is using a monthly cash budget. This is a fairly simple process of developing a “budget within a budget”.  Using historical data:

  • Estimate the next month’s receipts
  • Estimate the next month’s expenses
  • Compare the net amount to cash on hand
  • Make adjustments as necessary based on the shortfall amount

Fraud Prevention Programs

Our Fraud Awareness in the Church series continues with a two-part series on Fraud Prevention ProgramsPSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent of fraud awareness in the church environment. We asked churches to respond to these statements:

“Our church has established a formal program for managing fraud risk.”

“Our church has developed an anti-fraud team consisting of members from the leadership team, ministerial staff, congregation and professionals such as CPAs, CFEs, or attorneys.            “

“Our fraud risk program includes a routine assessment (at least annually) of the vulnerability of the church to fraudulent activity.”

“Our church has created “ownership” of fraud risk management by assigning the responsibility of managing fraud risks to a member of senior ministerial staff or the leadership team.”

Survey Results: Approximately 40% of respondents stated that they had a formal fraud prevention program in place.  Although I wished the number would be higher, it settled in about where I expected.  What I didn’t expect were the low compliance rates for the next three questions.

These responses indicated a very low compliance rate in three elements that SHOULD be included in a fraud prevention program.  The low numbers also indicated that the formal fraud prevention programs in place are probably not very thorough and as a result, not a very strong defense against fraud occurring in the church.

Only 10% reported having an anti-fraud team in place.  This begs the question, “Is the Administrator having to do this all alone?”

Only 25% reported conducting an annual assessment of their church’s fraud preparedness.  This begs the question, “How do you know your prevention measures are effective, if you really don’t know what they are to begin with?”

Finally, only 25% of the churches reported had actually assigned responsibility of fraud management to an accountable staff member.  This begs the question, “Who’s in charge here?”

KEY: Fraud prevention does not happen by accident!

Ingredient Three – Controlling Expenses

Even though we started with keeping an eye on receipts, most of the budget busts I have seen have been in this area.  Stories are legendary about ministers with little regard to the budget process and some of the budget bypassing techniques they employ can be quite creative.  Many of these situations I have helped churches work through if the church has simply understood this: A formal bill paying and approval system is a must!   

A strong bill-paying system must clearly document:

  • Who authorized the purchase of goods or services
  • Who received the goods and compared them to the original order
  • Who compares the invoice with the authorization?
  • Who prepared the check
  • Who signed the check
  • Who mailed the check
  • Who recorded the transaction in the general ledger

 

Preventing Church Fraud: Individual Payments

Our Fraud Awareness in the Church series continues as we look at Individual Payments: Contractors and BenevolenceWe asked churches to respond to these statements:

“Before paying an individual as an independent contractor, our church applies IRS compliant tests to determine if the payee qualifies as an independent contractor.”

“Our church has written a policy to direct benevolence payment activity.”

With two notable exceptions, tax-exempt organizations are not to transfer assets or make payments to individuals.  The two exceptions are Contractor payments — reasonable compensation for services provided the organization, and Benevolence payments — to individuals who are the target of the organization’s exempt purpose (rent assistance, etc.).  Outside of these two exceptions, all other payments are looked upon with a degree of skepticism by the IRS.

Survey Results: Surprisingly, 40% of the respondents do not go through a formal employee vs. contractor test.

Key: Embezzlers tend to shy away from reporting their theft to the Government. If ALL payments to contractors are screened and a 1099 prepared, a fraud loophole is closed.

Another area particularly vulnerable to fraud is benevolence.  Again, 40% of the churches do not operate under a written benevolence policy.

Key: Benevolence funds are one of the few accounts where payments to individuals are not suspicious.  (Fraudsters are very aware of this fact.)

Double Key: Part of the benevolence policy should be to NEVER give funds directly to the people being helped.  Make payments directly to 3rd parties. (Utility company, landlord ,etc.)

 

Ingredient Two – Keeping an Eye on Receipts

Tithes and offerings are the financial life-blood of a church.  Changes in the flow of a church’s resource stream need to be regularly monitored.  This is not something that is only to be done during the budget development process.  By waiting until then, it may be too late.  By keeping an eye on receipts, churches can move quickly to address shortfalls.

First thing is to make sure you are identifying all kinds of revenues such as:

  • Tithes and offerings
  • Service revenues (Day care, school, book store, etc.)
  • Special events
  • Investments/Endowments

Once this has been done the goal is to be on the alert for trends.  The earlier a church spots a new trend in giving, the easier it is for making mid-course corrections.  Just like driving a car, it is much safer to ease over into the next lane than jerking suddenly on the steering wheel!

Here are a few questions a church should ask in order to identify trends:

  • Is income increasing, decreasing, or plateaued?
  • Are a significant number of members joining or leaving the congregation?
  • How is the local economy doing?  Are any layoffs on the horizon?
  • What is the demographic make-up of your church?  What did it look like three years ago?

Information Technology

Our Fraud Awareness in the Church series continues as we look at Information Technology SecurityWe asked churches to respond to these statements:

“Our church has a formal information technology security plan.”

“Our church financial secretary or accountant/bookkeeper has access to all modules of the church’s software system.”

Churches struggle to keep up with the challenges of the rapid change in information technology.  Even when they want to address the issues in the two questions above, the workload crush of most churches makes it very difficult to stop the train long enough to develop a good IT plan. This is clearly (to me) reflected in the:

Survey Results: Only 50% of the participants have implemented a formal information technology security plan.

In another indicator of the impact workload pressure has on fraud protection, a whopping 80% of the churches surveyed confessed that their accountant/bookkeeper had access to ALL of their church’s software applications.

In the vast majority of churches this large degree of “trust” is placed in the hands of very good people and a problem never arises.  But if, just once, a church employs an individual given to theft and gives him or her this much access…trouble is probably just around the corner.

In PSK’s Faith Based Accounting Blog I posted an article titled “Taking IT for Granted”, where I addressed this issue.  The following are a few questions each church should ask itself when developing strong IT controls:

  • Does our church have a formal Information Technology security plan?
  • Do any individuals at our church have access to all modules of the church’s software system?
  • Does our church partition its computer applications so that employees and volunteers have access only to files necessary to perform their duties?
  • Does computer access require passwords that are confidential and unique?
  • Are our passwords changed periodically?
  • Are passwords complex including alpha, numeric and case sensitive characters?
  • Do we have backup procedures that are performed regularly that include off-campus storage?
  • Do we have measures in place to protect the church from malware?
  • Do we train our employees to avoid accepting email from unknown locations?
  • Do we have a download policy?
  • Do we maintain separate public and private wireless networks?

Ingredient One – A Strong Platform

A strong platform for managing the church budget begins with the chart of accounts.  For any non-accountants reading this, a chart of accounts is simply a list of the church’s general ledger accounts used to generate financial statements.  The accounts are listed according to where they appear in the church’s financial statements beginning with the balance sheet and running through the income statement.  The accounts as they appear in the church’s income statement should be an exact replica of the church budget.  Frequently this can be a problem with churches using financial software designed for businesses.  Because the financial statements generated by the software system look like a business, the church will resort to spread sheets to develop a budget.  Unfortunately, this makes mid-stream budget analysis difficult.

A financial reporting system that keeps the church truly informed is the next requirement.  A church should generate timely financial statements (usually monthly) that generate not only results of activities but also a meaningful budget vs. actual comparison.  To be meaningful, the budget must be broken down by month but NOT simply by dividing the annual budget into 12 equal amounts.  Annualize the budget by incorporating the natural trends in all accounting years.  (For example, receipts will be much higher in December than July…)  Also, hardly anyone does this but try to include designated/restricted gift activity in reports.  It’s perfectly permissible to budget for these types of gifts.   

Payroll Fraud, Phantom Employees

Our Fraud Awareness in the Church series continues as we look at Payroll Fraud and Phantom EmployeesWe asked churches to respond to these statements:

“Someone not involved in the payroll preparation process distributes paychecks or direct deposit stubs.”

“We review direct deposit account information for duplicate accounts.”

Survey Results – Very few churches do any kind of employee verification once the employee has been hired.  According to our survey only 25% of the churches engage in any form of paycheck verification (check stubs in the case of direct deposit).  A little higher percentage, particularly among NACBA members, perform periodic reviews of direct deposit data (Social Security numbers, addresses, duplicate accounts, names of relatives, etc.)

KEY: To avoid phantom employees and payroll fraud, a church must KNOW who their employees are.

The term “phantom employee” refers to situations like this:

An employee is terminated but a supervisor continues to submit hours so that the “employee” continues to receive a check for months, sometimes years, after the employee left.  The supervisor either colludes with the phantom in order to have the check endorsed and cashed or resorts to forgery.

A payroll clerk creates fictitious employees.  These often are friends and relatives and once again, the fraudster will collude or forge.

I suspect the compliance is low regarding these questions because most “church” employees are easy to identify due to the relatively small staff size of most churches (25 to 50) and turnover is relatively low.  HOWEVER, this is not the case with satellite operations such as a daycare program.  Many, if not most, daycare programs are staffed by low paid, low hour, often temporary employees.  Almost by definition, the turnover rate of a daycare program will be volatile compared to the parent organization, the church.  With so many people coming and going, it is almost impossible to know each and every employee – an ideal place to breed “phantom employees.”

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