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Stop Calling It Tax ‘Revenue’

Stop Calling It Tax ‘Revenue’

Almost nothing annoys me more than listening to politicians call the inflow of money gained from the involuntary collection of other peoples money – revenue.  Revenue has it’s own definition and by that definition taxes do not qualify, albeit somewhat necessary, taxes are also obligatory and very rarely agreed upon.

If you own a business a revenue is, in its simplest terms, the expected collection of money upon the successful completion of a transaction based on the sale of a good or service.  This means there are two parties involved, both of them willing to consummate the transaction in good faith not under duress.  The nature of taxes does not quite meet this definition, though, because a tax is not a compensatory action, and is not willful exchange.  Instead a tax is a imposition by the government for sometime to contribute funds, willingly or not, to a fund that supports governmental spending.

I am aware the government can do some great things, I currently work for a state governmental agency that I believe serves its constituents extremely well, is not a burden to the tax payers, and is fiscally conscious as to not overspend or spend out of scope.  The problem is that a lot of taxes are arbitrarily imposed and often not well thought out.  In short, they are not at all a willful transaction between two parties, instead they are a forced burden upon people who may or may not benefit from their collection.  In my personal opinion we should focus on reducing what we tax, how much is taxed and what those taxes are spent on, instead of constantly asking for more to be taxed, because you can only bleed a pig so much before it dies.

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Deferred Compensation For Athletes

Deferred Compensation For Athletes

A while ago I discussed a topic near and dear to my heart, contracts for baseball players, more so why they should not give a hometown discount to teams they’ve played their entire careers with.  The topic of this blog post is going to be along the same lines of contracts for professional athletes, but in a different spectrum.

Contracts often differ based on sport, baseball is usually back loaded with little signing bonus money, small amounts of performance bonuses, and a lot of guaranteed money.  Football on the other hand is almost exactly the opposite and basketball is somewhere in the middle, with a heavy emphasis on rookie contracts.  Here’s what all of them are missing, deferred guaranteed earnings after they are no longer playing.  This idea is often referred to as the ‘Bobby Bonilla‘ payout.  Bobby Bonilla negotiated a contract that guaranteed him a certain amount of money over a period of time ($1.19 million over 25 years) after he stopped playing instead of paying him what was owed to him in the final year of his contract ($5.9 million).  This was a historically bad deal for the Mets, who instead of paying Bobby $5.9 million in 2000, would start paying him in 2011 the first of 25 payments that would equal a total near $30 million.  But there are lessons to be taken from this, ones that can prove fruitful for both the team and the player.

Players should insist on deferred compensation, especially if they are nearing their final contract.  It’s no secret that professional athletes are know for going broke after they stop playing, the numbers for the NFL alone are around 80% of all former players.  This highlights the fact that players lack fiscal intelligence and have no clue what to do when the money dries up (side note; roughly 60% of all Americans have less than $1000 in savings, so athletes are not necessarily any less fiscally responsible than the average American, they usually just make more).  What these athletes can do to safeguard, for the most part, against going broke after they finish playing, is to insist on deferred compensation.  What really makes sense about this is that the team will benefit equally from this decision.

In the case of Bobby Bonilla the Mets obviously got the raw end of that deal, but it doesn’t always have to be that way.  If the player insists on deferred compensation the team should give consideration based on the time value of money and build in at least the risk free rate of paying a player beyond his or her service time.  Yes, a lot of contracts in professional sports are for well above $1 million, which means that anything less than that annually will be hard for the player to justify, but for the sake of the argument lets give an example.  If a player is seeking $10 million per season over 5 seasons, and is expecting this to be the last contract of his career, how should he defer the money for financial security?  Instead of negotiating for $10 million/5 years, he should ask for $8 million/5 years with deferred compensation of $500,000 over the twenty years immediately following his retirement from baseball.  This is great for both the player and the team because the team would actually save money, despite it looking like the same amount (5X10=50 million / 5X8= 40 million + 20X.5=50 million) the time value of money tells us that the team would save on the interest of deferring the money over the long term.  This also is beneficial for the player because, well, who is guaranteed to make half of a million dollars for 20 years after they quit their job?

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Government Shutdown? CUT SPENDING!

Government Shutdown? CUT SPENDING!

As we face yet another threat of a government shutdown because the federal government cannot pass funding through legislature I want to share my thoughts on some inherent issues with government budgets.  Lets face it, we have an enormous amount of national debt, and it’s way too late to play the blame game or point fingers, we have to do something about the deficits that we run every year.  During the last years of the Obama administration people were applauding his reduction in deficit, which is a fantastic intentional misrepresentation.  Credit is due that someone can reduce their spending deficit, but any deficit is still an addition to the total debt number, or in other terms, if you make $2000 a month and last month you spent $3000 on your credit card, your deficit was $1000.  Saying you reduced your deficit just means that this month you made $2000 and only spent $2500, yeah you reduced the amount you contributed to your debt, but you still contributed to your debt.  And to be completely fair the last president to operate a budget and end with a surplus was Bill Clinton.

We keep hearing about deficits, spending, revenue, and increasing or decreasing taxes in relationship to the current budget so what is the right answer.  Unequivocally the answer is to control spending, indeed it is the only thing the government truly has control over.  Tax revenues are variable, you can project and change the tax law to try and increase revenue (loosely associated term that I would refute theoretically), but taxation is always a best-case scenario.  Large corporations can lose money, individuals will try to claim every exemption they can, and goods you’ve taxed at a higher rate will most likely move along the demand curve to an equilibrium that equals the same tax revenue as it did before.

Spending, though, is the white whale of conservatism, because they all talk about it but never seem to actually push it.  And it is the true method by which the government can control the deficit.  Back to the analogy of income compared to spending from earlier, if you know that your absolute lowest income level is, say, $1500, then you should control your spending so that it does not exceed $1500 no matter what.  In the best case scenario you could potentially make more than you spend and save money.  This is where the government fails,  because in a governmental budget system not spending whats authorized means that you will not be able to spend as much in future periods.  The problem is that no one in the government is rewarded for saving money, instead they are questioned as to why they didn’t spend every last dollar allocated, otherwise known as ‘use it or lose it’.

My mother always maintained that a slight deficit was better than a surplus because a surplus meant that the government did not live up to their promises some how.  I’d disagree, in my mind budgeting is an estimate, and often you will find that you can do things more efficiently than initially expected, and this should be something we encourage when taking into consideration the fact that we are talking about our tax dollars.  Politicians need to focus on ways to cut spending and not encourage a deficit at the expense of the tax payer just so they can maintain a relatively arbitrary expenditure projection.

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Understanding Your Fraud Risk

Understanding Your Fraud Risk

When thinking about your companies fraud risk there are a number of factors to consider, and understand to mitigate that risk.  One of the first things to consider is the size of your organization; the level of risk will scale with the size of your company.  Secondly, the type of organization you run can also indicate some of your fraud risk, if you are a non-profit or government entity you will have a much higher risk for fraud than all others.  Lastly is the industry you operate in, if you are in financial services or banking you will have a high risk of fraud, same with retail.  In this blog I’ll try to help you understand how to build in fraud protection based on these different factors.

When considering the size of your organization it is best to know that you will need internal controls, and they should be implemented as strong as possible regardless of size.  You should always assume that your company is too large for you to monitor at all times, even if it isn’t, once you operate under this assumption you will need internal controls that can deter even the most creative fraud schemes.  When the size of a company grows, so does the ability for someone to get lost in the weeds so to speak, this means that they are a much smaller part of the team, and the amount of money they are dealing with might be small but over time can become extremely large.  Remember most fraud schemes span well beyond a year before beyond discovered, and the bigger your company is the longer this could be.

Internal controls are a fantastic way to control risk within an organization for all of these factors, but when it comes to type of entity sometimes audits may be equally important for mitigating fraud.  A lot of non-profits and government entities receive external audits, but the scope of these audits are almost always too narrow for finding fraud.  We know from the ACFE that non-profits and government entities have an extremely high rate of fraud and are audited frequently so why would I recommend more audits?  Well, in most situations people know the audits are coming, they know what will typically be looked for, and they know that it will be done pretty quickly.  Asking for a new audit team, or an entirely new firm to conduct the audit could be helpful to deterring fraud.

If your company is in a higher risk industry such as the financial services, banking, or retail industries you are at a higher risk for fraud.  Understanding the fraud du jour, or fraud of the day for your industry can help you understand how to stop fraud before it happens.  One of the best tools in this area is not just understanding and creating internal controls to stop fraud but also having a tip line that is anonymous.  The number one fraud detection method is tipsters and giving your employees the opportunity to anonymously report fraud if they believe it is occurring.

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If It Sounds Too Good to Be True…

If It Sounds Too Good to Be True…

My mother always had a saying that you may have heard, “if it sounds too good to be true it probably is.”  This has been some of the most cogent advice I’ve ever received.  Indeed in many situations we are presented with a deal of a lifetime, something we just cannot pass up with amazing low risk, high reward possibility.  The problem is, unless you were the first investor in microsoft, this is probably a farce at best, and most likely fraud.

This too-good-to-be-true model is the one that most ponzi scheme perpetrators rely on.  They target people who usually already have wealth, or at least funds they’re willing to invest and cajole them into thinking that their higher than usual return on investment model is a once in a lifetime kind of deal.  The initial investors are usually pleased with the returns, they indeed receive the return they were promised, and sometimes more, because they can reinvest now that the confidence is built.  But as the investments come pouring in from people the ability to pay all of them back with interest becomes extremely burdensome and eventually fails, leaving almost nothing for those who were defrauded.

Ponzi schemes are a type of fraud where someone will promise a certain higher than usual return on investment to investors and utilize the funds from new investors to pay off old ones, the problem is sustainability.  Ponzi schemes are an extreme example of the “if it sounds too good to be true,” idea, but it’s not the only one.  There are many ways in which someone can be duped by a fraudster with outlandish, or sometimes just slightly hyperbolic verbiage.  If you’re buying a car with 150,000 miles on it and the owner says its never had an major issues there’s a possibility they’re telling the truth, but if the price is significantly below the average price for a car with no major issues and similar miles then maybe it’s time to either do a little more homework or move on entirely.

This idea of a deal being too good to be true can infiltrate nearly every aspects of business as well, such as a buyer for a large manufacturing plant who begins working with a new distributor who has ridiculously low prices compared to the competition, as well they offer gifts for large purchases.  Once the buyer has made a large purchase, one that looks extremely beneficial for the company, the distributor raises their prices beyond that of the competition, and if the buyer stops purchasing from them they’d be happy to let management know about the gifts the buyer took while using company funds to purchase the product.

Remember, it is easy to get caught up in something that might either put you at risk for fraud, or make you a fraudster yourself, either of which can be (mostly) avoided if you remember the old saying “if it sounds too good to be true it probably is.”

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Adopting Change in the Accounting Department

Adopting Change in the Accounting Department

Change can happen rapidly in a business, especially if your company emphasizes efficiency and effectiveness.  Business means constant change and adaptation, unfortunately accounting departments can be the dinosaur of change.  Some of this is for good reason, you do not want to be constantly revising internal controls or accounting policies, but there are some ways in which the accounting department can adapt along with the rest of the company.

Understanding the needs of the company, and how the changes it has adopted affect the accounting department.  For example, a company could change it’s policy on how they pay for employee travel from reimbursement to prepayment.  This would mean that the accounting department, needing to verify the same exact information in order to pay, may have to change how quickly they process these claims.  Or they may have to change who approves the charges.

In some cases it can be changing how you report to different departments that may have quickly changing needs regarding their ability to purchase materials, or understand what their variable costs are.  This could mean that the accounting department needs to change how, or how quickly they report pertinent information to those departments, or ownership.

Change is obviously extremely important, but it may actually be more important for the accounting department, who is responsible for reporting and working with all of the departments to accomplish a goal.  Always keep in mind that communication if your most powerful tool in creating a system that adapts, it is easy with great communication to understand the needs of your customers, as a member of the accounting department they are your main customer.

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The Fraud Triangle

The Fraud Triangle

My blog spends a lot of time dedicated to fraud, fraud deterrence and fraud detection.  So, in order to really understand all of those things it is best to understand the fraud triangle.  The fraud triangle is the basis of almost all frauds committed and can help shine light on how to either detect, or deter fraud.

First is the motivation, or the factor that causes someone a need to commit fraud.  There can be a number of reasons; gambling debt, marital problems, health problems, a need to uphold an image, or sometimes just plain because they can.  Now, it is important to remember that fraud usually has one of these factors but these factors alone do not make someone a fraudster.  The reasoning can vary but it is often a hardship that is remedied by monetary gain.

Secondly is the opportunity, which is pretty explicit but can mean different things.  Obviously, if a company has weak internal controls or one person filling multiple duties the opportunity is obvious.  There are other cases where an employee can use their position for personal gain by offering unapproved discounts or purchase guarantees to other companies.  And then there are managers who use their position to push through questionable transactions, utilizing their power as an opportunity.

Lastly is rationalization, this is how a person usually makes the act of committing fraud a lesser, not so terrible idea.  In a lot of cases it’s that the company makes so much money they will never miss it, or that they treat the employees so poorly they deserve someone stealing from them.  Another common rationalization is that the fraudster believes they will pay back the outstanding amount and just need to avoid getting caught.

Now that you understand how the fraud triangle affects the majority of fraud it is important to note that there are some, a small amount albeit, fraudsters who are serial fraudsters.  These are fraudsters that are not confined to the fraud triangle and commit fraud just because they can, such as a senior level manager for a large, publicly traded company, making tens of millions of dollars a year selling insider trading information for a couple hundred thousand dollars.  These types of fraudsters are why I always push for pressing charges, because often business’s don’t and the serial fraudster goes on to commit fraud again when a normal background check would have revealed a conviction if it existed.

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What If You Think You’ve Found Fraud?

What If You Think You’ve Found Fraud?

In the course of business there are often times in which someone may act unethically in order to cash in, or utilize their position to receive benefits to the detriment of the company.  So what happens when you think you’ve caught someone committing fraud?

First of all, as mentioned in previous blog posts regarding fraud, you must always assume someone is innocent in order to maintain objectivity.  If you’re the owner of the company this can be extremely difficult to do because if someone is committing fraud it’s with your money.  Objectivity can help stress the need for facts versus hunches, or inuendo, and in order to prove fraud you’ll need objectivity.

Secondly, is to immediately begin treating everything like evidence, preserve as much as you can of transaction logs, check registers, physical checks or anything else you think might be involved in the act of fraud.  Evidence is key to proving fraud, especially if you have evidence of concealment, because at the heart of all fraud is concealment, the act of trying to hide the fraudulent behavior.

Third, hire a qualified professional, not only are they objective and independent, but they know what to look for, what looks like fraud versus incompentence, and if fraud exists they may be able to establish the full pervasiveness and depths

Lastly, and this point is hard to stress, is press charges of theft is discovered.  Unfortunately, for understandable reasons, many business owners decide not to press charges for fear it will look bad on the company.  The problem is that not only do many fraudsters repeat if not punished thoroughly enough, your company appears to be soft on those committing fraud.

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Finding Fraud in Everyday Observations

Finding Fraud in Everyday Observations

I’ve written quite a bit about fraud, here, and here, but one thing that should be pointed out, and something I have not written extensively about yet, is that often fraud can be detected if you know what look for in everyday observations.  First, and something I have pointed out in a previous blog post, is that no business owner, manager, or even auditor should assume that any organization is impervious to fraud.  Every single organization has a risk of fraud.  Why is that?  Because fraudsters are typically normal people who start feeling an external pressure for more money, and they have the opportunity in their position to exploit a system that allows them to commit fraud.  This is also a great reason to submit all potential employees who handle money or accounting functions to a background check, and also a reason to pursue criminal charges against fraudsters you’ve caught, but that’s a topic for another time.

Many business owners or managers are unaware that there are a number of behaviors to look for to identify potential fraudsters, and as written in a previous blog post, professional skepticism and due process are important to note, just because you believe someone is committing fraud you should still take measures to objectively fact find before asserting guilt.  What are some of the behaviors that could give away a potential fraudster?

First is the obvious, someone who is spending well beyond their means, does your contracts manager who makes $60k a year drive a brand new Porsche, and sports a steel and gold Rolex (per Rolex sales people are not permitted to call them two-tone, they are steel and gold, no kidding go to their website).  This is an indication that something is not right, and if you conduct an investigation in the right manner this person will never know unless of course they are committing fraud and you can prove it.  Another situation is that you notice your procurement manager, or a purchaser, continues to get new stuff delivered to the office, this happens often and it usually means that your employee is giving preferential treatment to one vendor in exchange for gifts, sometimes money – see number one.  Does your accounting manager refused to take a vacation or allow someone else to perform a certain duty that is essential to the internal controls?  This one is extremely often for embezzlers because if they take any time off and someone else has to cover their position they know with certainty they will be caught.  Lastly, does one of your employees who handles money often have a personal issue such as a gambling or substance abuse problem, do they have a family member with an illness that requires a large amount of money to cover, or are the possibly going through a divorce that is really contentious about money?

All of the above are indicia of fraud that may suggest fraud exist in your organization.  It is always important to note that indicia, preponderance, and overwhelming evidence that prove fraud are very different things.  The worst thing you can do as a manager or owner is accuse an employee wrongly of fraud.  Every suspicion of fraud should be treated with the most objective and professional mindset.  Often this requires hiring an outside fraud examiner to conduct the investigation, someone who will act as an objective fact finder who is neutral and liable for falsely asserting fraud.

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Asymmetrical Information and Fraud – Part 2

Asymmetrical Information and Fraud – Part 2

In part one I detailed what asymmetrical information and fraud were, and I presented a situation in which asymmetrical information would not constitute fraud.  The question is, are there any situations in which asymmetrical information does constitute fraud?  I believe so, but the truth is it’s most likely extremely difficult to substantiate.  Let’s make a case for it anyway.

Selling almost anything used is an example of asymmetric information, and most times it is not a form of fraud, but what if an agent is involved in the selling.  What if the agents that represent the buyer and seller work for the same company.  Depending on the information that is being conveyed it is possible that there may be a type of fraud happening, especially if the information is used to gain a particular position of bargaining power.  The real question is, how do you prove any sort of fraud in this situation.  Well, if there is a clear detriment, intent to use the information to the detriment of someone else, and the attempt to conceal, then I would say there is absolutely a case for fraud.

The problem with the above example is actually proving that there was intentional, detrimental, and concealed information that was only available to one party.  In most cases, if you have a good enough agent you shouldn’t have to worry about this, but the truth is this probably happens almost every day.  Proving fraud is a very onerous task, and in most cases this type of fraud would not hold up, but it is time we start considering information asymmetry as an area for potential fraud risk.

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