Upload
duongquynh
View
230
Download
1
Embed Size (px)
Citation preview
GUIDE TO ETHICAL GOVERNMENT SPENDING Living in a Glass House Michael A. Crawford, CPA
2
GUIDE TO ETHICAL COVERNMENT SPENDING
A publication by Michael A. Crawford, CPA of Crawford & Associates, P.C., designed to promote ethics, transparency and
accountability in government spending
Crawford & Associates, P.C. 10308 Greenbriar Place
Oklahoma City, OK 73159 T 405-691-5550 F 405-691-5646
W www.crawfordcpas.com E [email protected]
3
GUIDE TO ETHICAL GOVERNMENT SPENDING
Table of Contents PREFACE........................................................................................................................................... 5
ABOUT THE AUTHOR ....................................................................................................................... 7
CHAPTER 1 – SETTING THE RIGHT ETHICAL CLIMATE ..................................................................... 8
Establishing and Maintaining the Right Ethical Environment ..................................................... 8
Establishing a Proper Code of Conduct ....................................................................................... 9
Principles of Government Ethics ........................................................................................... 10
Stressing the Importance of Integrity in Public Service......................................................... 10
Addressing Ethical Dilemmas .................................................................................................... 12
Steps to Resolving Ethical Dilemmas ..................................................................................... 13
CHAPTER 2 - DEFINING AND RECOGNIZING WRONGFUL SPENDING ............................................ 17
Illegal Acts .................................................................................................................................. 17
Fraud .......................................................................................................................................... 21
Abuse ......................................................................................................................................... 22
Waste ......................................................................................................................................... 23
CHAPTER 3 - PREVENTING AND DETECTING WRONGFUL SPENDING ........................................... 25
Establishing and Implementing Internal Controls ..................................................................... 25
What Internal Control Is ........................................................................................................ 25
What Internal Control Is Not ................................................................................................. 25
Designing an Effective System of Internal Control ................................................................ 26
Establishing Key Controls over Wrongful Spending .............................................................. 28
Identifying and Addressing Fraud Risks ..................................................................................... 29
Identifying Red Flags in Fraudulent Spending ....................................................................... 31
Tips for Preventing or Detecting Fraud ................................................................................. 32
Applying Professional Skepticism .............................................................................................. 34
CHAPTER 4 - REPORTING INDICATIONS OF WRONGFUL SPENDING ............................................. 37
4
Exercising Moral Conviction and Courage ................................................................................. 37
Providing for Effective Lines of Communication ....................................................................... 37
Establishing an Ethics Hot Line .............................................................................................. 38
Establishing a Whistleblower Policy ...................................................................................... 40
Establishing an Ethics Board or Committee .......................................................................... 41
Establishing an Effective Audit Committee ........................................................................... 42
CONCLUSION ................................................................................................................................. 44
5
PREFACE Spending government resources is like “living in a glass house.” All your actions and
activities are open to and scrutinized by others as evidenced by the laws and regulations
related to open meetings, open records, and freedom of information. The use of
“involuntary” public resources demands a transparent approach to accountability. These
principles of transparency and accountability for the use of public resources are
essential to our nation’s governing processes and to maintaining public trust. A 1978
Oklahoma Supreme Court ruling maybe said it best by stating that
“If an informed citizenry is to meaningfully participate in government or at least
understand why government actions that affect their daily lives are taken, the
process of decision making as well as the end results must be conducted in full
view of the governed.”
Government officials are entrusted with public resources and are responsible for
carrying out public functions efficiently, effectively, economically, and ethically, while
achieving desired program objectives and providing public services. Those who govern
and those who are governed need to be assured that (1) the government manages its
public resources and uses its authority properly and in compliance with laws and
regulations; (2) the government’s programs and services are achieving their objectives
and desired outcomes; (3) the government’s services are provided effectively,
efficiently, economically, and ethically; and (4) government managers are held
accountable for their use of public resources. Therefore, it is essential that government
officials and employees embrace the concepts of transparency and accountability for
their use of public resources.
Wrongful spending or the perception of wrongful spending through lack of transparency
can be the downfall of public trust. In this document, we will explore the concepts
associated with promoting ethical government spending including (1) how to establish
6
the right ethical climate within the government organization (2) how to define and
recognize wrongful spending, including illegal acts, fraud, abuse, and waste, (3) how to
prevent or detect wrongful spending through a system of internal control and
organizational fraud awareness, and (4) how to effectively report or communicate
indications of wrongful spending.
7
ABOUT THE AUTHOR
Michael A. Crawford is a Certified Public Accountant and Chairman Emeritus of Crawford & Associates, P.C., a CPA firm headquartered in Oklahoma City, Oklahoma, that specializes in providing professional services exclusively in the practice area of state and local governments. Mr. Crawford is a former auditor and consultant for an international accounting firm, a former finance director for a municipal government and has over 32 years of experience working with governmental entities. He is a past president of the Oklahoma Society of CPAs, an inductee into the Oklahoma Accounting Hall of Fame, and a past Vice Chairman of the Governmental Accounting Standards Advisory Council (GASAC), and Chair of the GASAC Technical Agenda Committee. Mr. Crawford is a nationally recognized author and public speaker, and is responsible for the development of a number of CPA publications and practice aids on governmental accounting, auditing and ethics.
8
CHAPTER 1 – SETTING THE RIGHT ETHICAL CLIMATE
Establishing and Maintaining the Right Ethical Environment
The “tone at the top” of an organization generally establishes the overall attitude
toward ethics (ethical climate) within that organization. In other words, if you expect
employees and others within the government to behave ethically, then the governing
body, management and other government leadership must “walk the talk”, and set the
right example for others to follow.
Creating the right ethical climate is not the same as having a documented code of ethics
or conduct within the government. Many of governments and other organizations that
have been victimized by scandal and ethical lapses, have had well documented codes of
ethics and conduct. However, in these governments or organizations, management, the
governing body, or both of these groups have failed to incorporate the elements of
these codes into their overall organizational culture. To create a positive ethical climate,
a government organization must understand the ethics-based risks associated with its
activities, and provide for an environment that encourages the proper behavior and
decision-making in response to these risks. An ethics-based risk can be defined as the
risk that the governing body, management, or staff will not know how to respond when
faced with a specific ethical dilemma. It is not sufficient to merely have a documented
code of conduct. The government’s leadership must foster a culture that can withstand
the ethics-based risk pressures it is likely to face and uphold the principle of integrity
when dealing with the challenges posed by those pressures.
Setting the right ethical climate involves such actions as:
• Conducting open meetings with transparency, integrity, fairness and respect and
honoring the form and spirit of open records requirements
9
• Creating a positive and open work environment that encourages moral behavior
and communication of inappropriate behavior, including providing hot lines for
anonymous tips and whistleblower protection
• Hiring employees committed to maintaining the right ethical environment
• Establishing, communicating, and enforcing a comprehensive code of conduct
• Developing an anti-fraud policy that includes fraud awareness and prevention
training, reporting and investigative processes, and resolution or results of
confirmed fraud
• Guiding employees in navigating through the “gray” areas where no specific
laws, regulations, policies, or guidelines exist
• Providing employee counseling and assistance programs for employees
experiencing work or personal problems
• Enforcing the code of conduct by rewarding demonstrations of moral courage,
and by effectively punishing instances of unethical behavior
Without the governing body and management setting the right ethical example for the
entire government through their own actions and through creating the right
organizational environment, employees will be less likely to follow the appropriate
ethical path when faced with moral dilemmas. The governing body and management’s
actions are more powerful than words!
Establishing a Proper Code of Conduct Every government entity or agency should have a formal code of conduct in place and
take the steps necessary to ensure it is well communicated to and reinforced with its
governing body, management, and staff. Ideally the code of conduct should be
introduced to all new officials and employees upon joining the organization and then
reinforced through period training and staff meetings.
10
Principles of Government Ethics
In establishing and maintaining a proper ethical environment within the government,
the following ten principles should form the cornerstone of the code of conduct and
expected behavior:
1. Public service is about public trust, not about private gain
2. Avoid conflicts of interest in fact and appearance
3. Don’t misuse or misappropriate government information, funds or property
4. Don’t accept or solicit gifts or items of value
5. Put forth honest effort in duties
6. Make no unauthorized or unfulfillable promises or commitments
7. Be impartial and avoid giving preferential treatment
8. Exercise civility and respect others opinions and beliefs
9. Comply with laws and meet all obligations as any other citizen
10. Expose corruption and report fraud, waste and abuse
These principles should be included and defined in understandable detail within a
formal written code of conduct that is provided to all government officials and
employees and reinforced through periodic training and application.
Stressing the Importance of Integrity in Public Service
Integrity is an essential element of character fundamental to the government or public
service. It directly affects the level of public trust afforded the government and elected
or appointed representatives and should be the benchmark against which a government
official or employee must perform. Integrity requires an individual to be, among other
things, honest and candid within the constraints of required confidentiality. Service and
the public trust should not be subordinated to personal gain and advantage. Integrity
can accommodate the inadvertent error and the honest difference of opinion, but it
cannot accommodate deceit or subordination of principle. Integrity is measured in
11
terms of ethical decision making or what is morally right and just. In the absence of
specific laws, rules, policies, or guidance or in the face of conflicting opinions, an
individual should apply ethics by questioning his or her own actions based on the
public’s expectations (i.e. what does the public deserve and expect). Integrity requires
an individual to observe both the form and spirit of laws, rules, policies, or guidance. In
observing both the form and the spirit of laws or other legal requirements, it is
important to understand that simply because an action may not be illegal, this does not
mean that the action is ethical or the right thing to do. The fact that it is possible or legal
to do something does not mean that it ought to be done. Laws establish a minimum level
of prudent behavior that must be followed in society. However, applying ethics involves
moral considerations, beyond the laws, and requires consideration of a higher level of
prudent behavior. The application of appropriate moral behavior takes into
consideration not only the legal requirements or ramifications related to an action, but
also the individual’s moral obligation to the public and others in determining the proper
action to take.
PRACTICAL EXAMPLE: Assume that a president of state university has
just recently been hired and is in the process of renovating the university-
owned president’s house on campus. The president’s house currently has
three televisions that average being five years old. During the renovation,
the president determines that these televisions are not large or new
enough, and that more televisions are needed. The president then directs
staff to purchase seven new high-definition flat screen televisions for the
house, essentially one for each room of the house, including the master
bathroom. These televisions are purchased with university resources and
will become university property. As a result, these purchases are not
considered in violation of any constitutional provision, statute, or
regulation. However, while acquiring all these new high-definition flat
12
screen televisions for the president’s house may not represent an illegal
act, the action lacks sufficient ethical consideration for the appropriate
use of the institution’s public resources. While it may be legal to make
these purchases, it is not appropriate behavior from a moral perspective
because the end result of the action is to detract or divert resources from
the primary educational objectives of the institution for the personal
benefit of the university president and family.
Addressing Ethical Dilemmas
Trying to understand and predict human behavior is complex at best and involves a wide
range of philosophical theories and concepts upon which even professional
psychologists often disagree. However, one thing is for certain, certain decisions in work
and life are difficult to make. Quite often, these decisions involve ethical dilemmas. An
ethical dilemma can be described as a situation that calls for some type of action, where
an individual may be simultaneously compelled and pressured to take different
alternative actions. These compelling reasons or pressures to take different actions
compete against one another, thereby creating the ethical dilemma.
For example, assume you are a member of the governing body of a local government
and are made aware of a group of citizens who are in desperate need of funds to
provide financial help for a family that has recently lost their home in a fire. This group
has approached you as a local government official and asked for a donation of public
funds to assist in their efforts for the immediate and long-term benefit to the family (a
compelling reason to make the donation). However, you are informed by the
government’s legal counsel that such a donation could be considered a violation of the
state constitution on the use of public funds (a compelling reason to not make the
donation). Hence an ethical dilemma - compelling reasons or pressures to take different
actions that compete against one another.
13
Steps to Resolving Ethical Dilemmas
When faced with an ethical dilemma, morally poor choices are usually made for one of
three reasons:
1. Individuals do what is most convenient.
2. Individuals do what they must to succeed.
3. Individuals rationalize their choices with situational ethics.
Government officials and employees must avoid the temptation of giving into these
three reasons when faced with ethical dilemmas, and instead must demonstrate the
moral courage and bravery to stand up for what is right.
Individuals should be provided the proper training and guidance in ethical decision
making to overcome the temptations that surround making morally poor choices. In
facing tough ethical dilemmas, you should consider the following five-step approach or
process:
1. Gather all the relevant facts regarding the situation or circumstance.
2. Consider what alternative actions are available.
3. Consider the applicable external laws, regulations, principles, rules and internal
policies and procedures (justice considerations - what is the right thing to do
from a legal, rules or principles perspective).
4. Consider the results or consequences in terms of good versus harm that may
result from the alternative actions (care considerations - what is the right thing
to do in terms of helping others or benefiting the most people).
5. Select the course of action that upholds the core values of honesty, respect,
responsibility, fairness, and compassion, and takes into account both justice and
care considerations; reflect on that decision; and exercise moral courage to face
and endure the challenges or dangers that may be associated with your decision.
14
PRACTICAL EXAMPLE:
Step 1 - Gather the Facts: An elected state audit official is responsible for
auditing health agencies within the state that receive state funding. One
such group of health agencies are owned and operated by a prominent
citizen who has been a long-time friend of the state audit official. The
health agencies’ owner and the state audit official have both a personal
and professional relationship, although the professional relationship is
relatively new and only began when the state audit official was elected.
For years, they have been friends and played golf together, belonged to
the same country club, and frequently gone on vacations together. In
regards to business and audit matters, they serve as the primary contacts
between their two entities on all matters of significance. The state audit
official has not yet performed any audits over his friend’s health agencies,
but such audits are planned for later in the year. In an expression of
appreciation of his continued friendship, the health agencies’ owner has
offered to take the state audit official and spouse on an all-expense paid
five-day trip to Las Vegas. Under these circumstances, what actions
should the state audit official take?
Step 2 – Consider Alternative Actions: Alternative actions could include
1. Accept the trip as offered.
2. Go on the trip provided the state audit official pays for his or her share
of the costs.
3. Decline to go on the trip under any circumstances.
Step 3 – Consider Applicable Laws, Principles, Rules, and Policies:
Assume, that the professional ethics standards applicable to the state
audit official requires the auditor to maintain objectivity and integrity,
and be free of conflicts of interest, and that his or her objectivity would
15
be considered impaired by accepting or offering gifts or entertainment
from or to a client, unless the gift or entertainment was “reasonable” in
the circumstances. In determining “reasonableness in the
circumstances,” the auditor should consider such factors as: (1) the
nature of the gift or entertainment, its cost or value, and the occasion
giving rise to the gift or entertainment, (2) the nature, frequency, and
value of other gifts offered or accepted, (3) whether the entertainment
was associated with the active conduct of business either directly before,
during, or after the entertainment, (4) whether other clients, customers,
vendors, or employees of the company or firm also participated in the
entertainment. In addition, assume that applicable state laws and
regulations prohibit the receipt of gifts or “things of value” in excess of
$100 in any one year from any lobbyist or individual in a position to
exercise influence over the elected official.
Step 4 – Consider the Results and Consequences in Terms of Good
versus Harm: From a personal perspective, in accepting the all-expense-
paid trip, the state audit official and spouse would be the recipients of a
potentially enjoyable cost-free vacation. However, from a negative
consequences perspective, the state audit official could be placed in a
position where his friend would expect a professional favor in return in
the future, including a finding-free audit. It is likely that if the state audit
official paid for all his or her expenses on such a trip, that it would not be
a violation of the applicable state laws. However, if the public were to
merely perceive a conflict of interest in this relationship, the credibility
and reliability of the future audit results could be reasonably questioned
and damage could be done to the public’s trust in the state audit office.
16
Step 5 - Select the Most Ethical Course of Action: All too often, gifts
and entertainment of this nature and value involve the perception of
giver expectations of receiving something in return. The pressure from
these expectations, when coming from auditees, could be of such
magnitude to negatively affect the objectivity of the audit official.
Although, this trip may be similar to previous trips taken together by the
health agency owner and the state audit official before the audit official
was elected, there still exists the danger associated with the perception
of a conflict of interest, and such a perception would damage the
credibility of the auditor and the public’s trust in the audit office.
Therefore, under these circumstances, it would be in the best interest of
the state audit official, the health agency owner, and the public for the
state audit official to decline the trip entirely.
17
CHAPTER 2 - DEFINING AND RECOGNIZING WRONGFUL SPENDING
Wrongful spending in government can be defined as spending that involves elements of
any of the following:
• Illegal Acts
• Fraud
• Abuse
• Waste
These elements are defined below, including examples of improper spending or
inappropriate behavior.
Illegal Acts
From the perspective of government spending, illegal acts can be defined as acts related
to purchasing, contracting, and paying for goods and services that are in violation of
governmental laws and regulations, including provisions of constitutions, charters,
legislative acts (laws), resolutions, and other regulatory requirements.
Examples of Illegal Acts:
With regards to government spending, the following are examples of potential illegal
acts, depending on the facts and circumstances:
a. Using government property or resources for personal or non-public purposes
b. Gifting, donating, or loaning public resources to private individuals,
organizations, or corporations without a contract for service
c. Failing to follow competitive bidding requirements when required, or splitting
purchases to avoid competitive bidding requirements
d. Accepting gifts or kickbacks for providing favors or special considerations
18
e. Authorizing purchase commitments or contracts in excess of available
appropriation or other legal spending limit
f. Failing to pay overtime and other compensation to employees in accordance
with the requirements of the federal Fair Labor Standards Act, where applicable
g. Using legally restricted resources for purposes other than the restricted
purposes specified in the legal requirement
h. Failing to account for and spend certain restricted resources in separate funds as
may be required by law
Each state or local government entity may have differing legal requirements in regards
to spending and use of public resources. For example, at a very high level, the State of
Oklahoma Constitution contains the following provisions regarding the use of public
resources:
• Public Purpose Limitation (Article 10, § 14 A.) - Except as otherwise provided by
this section, taxes shall be levied and collected by general laws and for public
purposes only…
• State Prohibition on Aid to Others (Article 10, § 15 A.) - Except as provided by
this section, the credit of the State shall not be given, pledged, or loaned to any
individual, company, corporation, or association, municipality, or political
subdivision of the State, nor shall the State become an owner or stockholder in,
nor make donation by gift, subscription to stock, by tax, or otherwise, to any
company, association, or corporation.
• Local Government Prohibition on Aid to Others (Article 10, § 17) - The
Legislature shall not authorize any county or subdivision thereof, city, town, or
incorporated district, to become a stockholder in any company, association, or
19
corporation, or to obtain or appropriate money for, or levy any tax for, or to loan
its credit to any corporation, association, or individual.
PRACTICAL EXAMPLES: In regards to the above noted Oklahoma State
Constitutional provisions on use of public resources, the following
actions could be considered a constitutional violation:
• Spending public resources on improvements to a personal
residence or vehicle of a government official or employee (a non-
public purpose)
• Spending public resources or using public employees to improve
private property (a non-public purpose)
• Donating public resources to a local non-profit organization
without a contract for services (donating or gifting of public
resources)
• Using public resources to purchase the capital stock of a local
emerging business (becoming a stockholder in a company or
corporation)
• Loaning public resources to a local chamber of commerce to be
repaid when the chamber receives anticipated grant funding
(loaning the credit of the government to a corporation or
association)
• Advancing paid sick leave to an employee prior to the employee
earning the leave or being entitled to it (loaning the credit of the
government to an individual)
(Note: Whether these examples are in fact an illegal act, is a matter of
legal determination by a court of law. They are listed here as possible
illegal acts for purposes of demonstrating the application of
constitutional limitations to governmental spending. For example, a
20
government might legally provide tax incentives, or otherwise commit or
use public resources in a manner that will ultimately benefit a private
individual, association, or corporation under the theory that it is
benefiting the public as a whole in terms of community development or
economic development. Therefore, legal counsel should always be
consulted on matters that involve the potential to be perceived as an
illegal use of public resources.)
A word of caution though…In addition to the overriding constitutional constraints on
spending, each individual government or government agency may have more specific
laws and regulations that should be followed that may be more restrictive or provide
additional spending constraints. These other legal requirements could be in the form of
state laws, state regulations, local charters, and local ordinances or resolutions.
PRACTICAL EXAMPLE: While a municipal government may be subject to
the broad spending restrictions contained in a state constitution to which
it is subject, the municipality may also be governed by a local charter that
contains a specific provision that limits contracting to only local vendors
when the desired goods or services are available locally. Furthermore,
the municipal governing body may have also adopted an ordinance (local
law) that requires all purchases over a specific dollar amount to be
approved in advance by the governing body prior to the purchase
commitment. Therefore, the municipality must be familiar with and
comply with all applicable legal requirements.
A significant amount of legal research may be needed to develop a complete and
comprehensive list of spending laws and regulations to which the government is subject.
Such as listing should become a permanent part of the government’s purchasing and
21
spending policies and procedures and should be continuously updated as new laws and
regulations are established or existing ones are modified.
Fraud
Fraud can be broadly defined as an intentional deception or perversion of the truth
made for personal gain or to damage another individual. Fraud from the perspective of
government spending can be defined as the spending activities or actions that are
intentionally designed to deceive another party, and can involve embezzlement of
government monies, filing false claims, and contract fraud.
Fraudulent activities can be categorized by type of perpetrator as:
• Internal fraud – activities perpetrated within the organization (e.g. employee
theft or embezzlement, misappropriation of resources, intentional
misstatements in financial reports)
• External fraud – activities perpetrated by individuals outside the organization
(e.g. false claims or statements provided to the government, fraud by
beneficiaries of government benefits, contract or procurement fraud by vendors
or contractors)
• Internal and external fraud – activities perpetrated by government employees
and outsiders in collusion (e.g. kickbacks to employees from vendors or
contractors for preferential treatment)
Examples of Fraud:
With regards to government spending, the following are examples of fraud, depending
on the facts and circumstances:
a. Splitting contracts or purchases in an effort to avoid competitive bidding
requirements
22
b. Awarding a contract to someone other than the lowest and best bidder for
reasons of personal gain or to do damage to another party
c. Falsifying purchasing, receiving, or payment documents to conceal the
misappropriating or embezzling of public resources for personal gain
d. Approving purchase documents or contracts with knowledge that no
appropriation is available for that purpose or that it will exceed available
appropriation
e. Miscoding a purchase order or invoice for the purposes of avoiding budget
overages or the exceeding of legal appropriations
f. Falsifying or omitting key information in employment applications or
employment tax documents
g. Falsifying time worked or leave earned/taken in payroll time records
h. Submitting a false request for paid sick leave when the employee is not actually
sick
Abuse
Abuse involves behavior that is deficient or improper when compared with behavior
that a prudent person would consider reasonable and necessary business practice given
the facts and circumstances. Abuse includes misuse of authority or position for personal
financial interests or those of an immediate or close family member or business
associate. From the perspective of government spending, abuse can involve
unreasonable or unnecessary spending or purchases that are unnecessarily extravagant
or expensive. Actions and activities do not need to be illegal or fraudulent to be
considered abusive.
Examples of Abuse:
With regards to government spending, the following are examples of abuse, depending
on the facts and circumstances:
23
a. Creating and paying for unneeded overtime
b. Requesting staff to perform personal errands or personal work tasks for a
supervisor or manager
c. Misusing the official’s position for personal gain, including actions that could be
perceived by an objective and knowledgeable third party as improperly benefiting an
official’s personal financial interests or those of an immediate or close family
member, or that of an organization owned by or other benefitting the official
d. Making travel choices that are contrary to existing travel policies or are
unnecessarily extravagant or expensive
e. Making procurement or vendor selections that are contrary to existing policies or
are unnecessarily extravagant or expensive
Waste
Waste in government spending is much more difficult to define that illegal acts, fraud,
and abuse. Identifying wasteful spending involves the application of significantly more
judgment than in cases of illegal acts, fraud, and abuse. Often different individuals will
have varying perspectives on defining what is wasteful. However, generally speaking
government spending waste can be defined as “the inefficient or ineffective use of
public resources.”
Examples of Waste:
The following are examples of waste, depending on the facts and circumstances:
a. Spending public resources on pork-barrel projects
b. Spending on ineffective projects
c. Spending on duplicate projects or activities
d. Spending on payroll where duties are neglected or excessive unproductive work
hours are charged
24
With an understanding of the types of wrongful spending that can occur in government,
an individual is better prepared to determine “what can be done to better prevent, or
detect and report such actions or activities” in achieving the ultimate goal of protecting
public resources and maintaining public trust. The remaining chapters of this guide will
deal with the issues of prevention, detection, and reporting or potential wrongful
spending.
25
CHAPTER 3 - PREVENTING AND DETECTING WRONGFUL SPENDING
Establishing and Implementing Internal Controls
The key to preventing and detecting wrongful spending lies in the proper design and
implementation of a system of internal control. A system of internal control is put in
place to keep the organization on course toward its goals and achievement of its
mission, and to minimize surprises along the way.
What Internal Control Is
Internal control is broadly defined as an entity’s process, affected by the entity’s board,
management, and personnel, designed to provide reasonable assurance regarding the
achievement of certain objectives. In the context of financial management, these
control processes should provide reasonable assurance that reliable and fairly presented
financial statements will be prepared, financial-related laws and regulations will be
complied with, and assets will be adequately safeguarded. In the specific context of
government spending, internal control processes should provide reasonable assurance
that spending-related laws and regulations will be complied with, and public resources
are used efficiently and adequately safeguarded against misuse and misappropriation.
What Internal Control Is Not
Internal control is not a panacea. The internal control process can help an entity achieve
its objectives. However, no matter how well designed and implemented it can only
provide reasonable, not absolute, assurance of achieving those objectives. For example,
although controls may be adequately designed and in place, control objectives may still
be unachieved resulting from: (1) simple errors and mistakes, (2) faulty judgments in
decision making, (3) circumvention by collusion, and (4) management override of
26
controls. Finally, the design of internal controls must be considered within the context
of resource constraints and cost effectiveness.
Designing an Effective System of Internal Control
Internal control processes can generally be classified into one of the following five
components of an integrated internal control framework:
1. Control environment - the tone of the organization influencing the control
consciousness of its people, such as a well-communicated and understood code
of conduct, an effective management style, and a demonstrated interest in
controls by the governing body
2. Risk assessment - the identification and analysis of relevant risks to achieving the
control objectives, such as risks of noncompliance with legal spending
requirements, and risks of misappropriation of assets for personal use
3. Control activities - policies and procedures that help ensure actions are taken to
address the identified risks, such as effective policies and procedures related to
the authorization and processing of purchase orders, invoices, and payments for
goods and services
4. Information and communication - the information and communication systems,
both manual and automated, that make it possible to operate, control, and
report the entity’s activities, such as an effective information technology system,
sufficient internal and external reporting systems, and proper channels of
internal and external communications
5. Monitoring - the on-going monitoring and evaluation of the effectiveness of the
other four components of the internal control framework through internal and
external audit activities and governing body and management oversight; a well
recognized system of monitoring can also be an effective deterrent to wrongful
spending
27
For internal controls to be properly designed and operating effectively, each of these
five integrated elements must be working together. The evaluation of the effectiveness
of the design and operation of internal controls should be focused on the identification
of control objectives, the specific risks associated with achieving those objectives, and
the internal controls designed to minimize those risks. In other words, you should define
(1) “what we want to accomplish”, (2) “what could go wrong”, and (3) “what we should
do about it”.
PRACTICAL EXAMPLE: One of the objectives of internal control over
wrongful spending (what we want to accomplish) is to ensure that
purchase commitments and contracts are made in conformance with
applicable laws and regulations, such as competitive bidding laws and
public-purpose laws. When evaluating the effectiveness of internals with
regards to this control objective, you could consider what specific risks
exist that could result in not achieving the compliance objective (what
could go wrong) and then identify the internal controls needed to
minimize those risks (what we should do about it). This process is
illustrated in the table below.
Control Objective (what we want to accomplish): Ensure that purchase
commitments and contracts are made in conformance with applicable laws and
regulations.
Specific Risks (what could go wrong) Controls to Minimize the Risks (what we
should do about it)
Laws and regulations are
unintentionally violated because
Individuals involved in the purchasing
process are not aware of the applicable
laws and regulations.
1. Up-to-date policies and procedures,
including reference to laws and
regulations, are written and provided to
purchasing staff.
2. Entity management and staff are
provided periodic training on laws and
regulations and related policies and
28
procedures.
Laws and regulations are intentionally
violated or policies and procedures are
circumvented for personal gain.
1. Duties are segregated between
purchase authorization, receiving, and
payment approval.
2. Entity management and governing
body provide oversight of purchases in
excess of a specific dollar amount in an
effort to monitor compliance.
Employees with knowledge or suspicion
of laws and regulation violations do not
communicate or report such concerns.
1. Entity has a code of conduct and
related policies and procedures in place
to encourage the reporting of
noncompliance with laws and regulations
to appropriate persons, and provides for
whistleblower protection.
2. Entity has an effective internal audit
function or similar internal investigative
unit that follows up on such reported
concerns.
It is important to note that in the above example, risks of not achieving the control
objective of laws and regulations compliance are addressed with internal control
processes that “specifically respond to each risk.” This approach to identifying and
addressing specific risks is the most effective way to prevent and detect wrongful
spending in government from the perspective of the design of internal controls.
Establishing Key Controls over Wrongful Spending
While the design and implementation of an effective system of internal control requires
a thorough evaluation of control objectives and risks, there are certain broad types of
29
controls (key controls) that should be considered over wrongful spending. These key
controls include:
• Authorization and Approval – controls over spending that involve delegation of
authority with specified limitations and approval requirements (e.g. identifying
who is authorized to make certain purchases, setting limits where advance
approval is needed, indicating who must review and sign documents for
evidence of approval)
• Security over Access – controls over access to purchase authorization documents,
signature stamps, cash, checks, and computer system processes that safeguard
assets from loss or misappropriation (e.g. maintaining locked safes, cash
drawers, and frequently changing computer access codes)
• Segregation of Duties – controls that do not put a single individual in a position
to be able to commit a fraud or misappropriate resources and then be able to
conceal it (e.g. preventing the same individual from placing an order for goods or
services, acknowledging the receipt of those goods, and authorizing payment)
• Review and Oversight – controls that provide sufficient monitoring over spending
activities, the reconciliation and investigation of unresolved questions or
differences, and the ultimate resolution of those questions or differences (e.g. a
timely comparison of budget and actual amounts to look for unexplained
variances, and periodic internal audits over spending activities)
Identifying and Addressing Fraud Risks
Identifying fraud is difficult because unlike identifying errors in judgment or application,
fraud involves an attempt to conceal. Therefore, it is important to be alert to certain
conditions that may be present in your organization that could heighten the risk of
30
fraudulent activity. Popular guidance in the area of fraud awareness indicates that most
frauds contain all of the following three elements:
1. Motive or Pressure – the reason an individual decides to engage in fraudulent
behavior
Examples:
• Unmanageable personal financial obligations
• Excessive gambling or other addictive vices
• Adverse employment relationships
• Living beyond one’s means
2. Opportunity – the condition that provides an individual the ability to perpetrate
the fraud
Examples:
• Unrestricted access to cash or other assets
• Inadequate segregation of incompatible duties
• Inadequate monitoring or oversight
• Records are in disarray and difficult to follow or trace
3. Rationalization – the mindset of the individual that allows him or her to justify
fraudulent actions
Examples:
• Employee displeasure or dissatisfaction with job or compensation, or
revenge for unfair treatment
• Just a temporary borrowing that will be paid back
• Everyone does it, it is no big deal
• No harm, no foul
31
To enhance your ability to identify fraud in your organization, you must understand
these three elements and constantly be alert for evidence of their existence and watch
for warning signs (red flags) of potential fraud.
Identifying Red Flags in Fraudulent Spending Indicators of heightened risk of government spending fraud could include the following
red flags that should not be discounted or overlooked:
• Employees are scared of superiors and there is evidence of management
override, in other words management bypassing controls or overriding lower-
level decisions for personal gain
• Employees do not take or refuse to take vacations or extended periods of time
off
• Employees with fraud opportunities exhibit evidence of fraud motives or
pressures, such as unusual behavior, personal financial problems, excessive
gambling, living beyond their means
• Payments are made to unfamiliar employees or terminated employees
• Employees carry unusually high unused leave balances
• IRS notices for untimely tax deposits or failure to make required deposits
• Non-existing or unapproved employee time records or leave requests
• Unsupported expense reports or reports with excessive or unreasonable
expenses reported
• Travel and training expenditures are significantly increased or in excess of
budget
• Key purchasing or payment documentation is lacking or does not exist, such as
no evidence of receiving advices
• Invoices are faxed, only in photocopy form, or appear altered
• Vendors have only post office box addresses
32
• Contracts or invoices are in amounts just under the dollar threshold that would
require bidding or pre-approval
• Invoice numbers are in broken sequence from the same vendor
• Vendor names are similar to each other, or may have the same address or phone
number
• Certain purchasing or payment documents or transactions are subjected to
“special” handling outside the normal policies and procedures
• Excessive use of sole source purchases
• Certain vendors appear to consistently obtain all or an extraordinary share of the
business
• Certain purchases appear to contain unreasonably high prices or significantly
lower quality when compared to other competition
• Vendors and government employees with purchasing authority have close
personal relationships or frequently dine together or otherwise socialize
• There is a pattern of large procurements in any budget line with remaining funds
at year end, in order to “use up all of the funds available”
• Tips or complaints regarding wrongful spending or fraud are ignored or not
followed up on
When any of these fraud red flags are present, they must not be ignored or overlooked.
Appropriate follow up is needed to ensure they are not indicators of an actual fraud.
Tips for Preventing or Detecting Fraud
Even the best of internal controls may not be sufficient to prevent or detect fraudulent
activities because the individual(s) perpetrating the fraud are also doing their best to
conceal the fraud. Therefore, it is especially important to be alert to identify potential
fraudulent activities. The following guidance will help you be more alert to potential
fraud and enhance your ability to prevent or detect fraud.
33
1. Just Going through the Motions – avoid the work mentality of just doing the
steps in a process without thinking about what you are doing; supervisors should
reinforce with employees the need to pay attention to their tasks and the
consequences for failure to be responsible in carrying out those tasks
2. See No Evil, Hear No Evil – avoid putting blind trust in any individual, thereby
failing to recognize or acknowledge fraud warning signs or red flags; realize that
anyone can commit fraud, and when faced with warning signs prove to yourself
that it is not fraud
3. It’s Good to be the King – look out for positional immunity, or in other words,
upper level management or the governing body rationalizing that rules or
controls don’t apply to them because of their position; these conditions
generally present themselves as management override of existing processes or
controls; identify someone within or outside the organization to whom you can
report such activities with jeopardizing your job
4. New Kid on the Block – don’t give in to the thinking that new employees are not
yet competent in their position and therefore not in a position to question why
certain things are happening; new employees are generally not prejudiced by
past policies, procedures, and practices; supervisors should take all employees
questions seriously, and employees doing the questioning should address their
question to more than just a single individual
5. Where’s All the Time Gone – beware of the pitfalls of excessive workload and do
not use this excuse to rationalize why designed internal controls cannot be
followed; for example, it may take more time to reconcile differences noted in
purchase documents, but that reconciliation is essential to managing fraud risks;
when faced with an excessive workload, reevaluate assignment of duties, and if
necessary demand more resources by explaining the consequences of fraud
6. Don’t Invade my Space – beware of employees who do not want any other
individual performing their tasks or learning what they do; encourage cross-
34
training, periodic rotation of duties, and mandatory vacations for all employees
and positions
7. Must Not Be for my Eyes – be concerned when you are denied access to
requested records that support the work to which you are assigned; report such
activities and lack of openness to appropriate supervisors and do not give up on
the unfulfilled request
8. It’s None of my Business – don’t look the other way when faced with signs of
fraudulent or unethical behavior by rationalizing that the activities are none of
your business; work to create an environment within the organization that
fosters ethical and responsible behavior and the reporting of lapses in such
behavior
9. It’s Over my Head – avoid the failure to question activities, events, or
transactions that appear unusual because you feel you do not fully understand
the situation or circumstances; individuals involved in fraudulent activities often
rely on the complexity of the circumstances to help them conceal such fraud;
continue to educate yourself, and ask for simplification in reports and
explanations
10. Just a Bad Apple in the Bunch – realize that even with the best of internal
controls, some people are just “ethically challenged” and are looking for ways to
commit fraud or improperly benefit themselves or gain an advantage; do your
due diligence in hiring employees and learning as much as possible about their
background and ethics
Applying Professional Skepticism
An important aspect of identifying wrongful spending is maintaining and applying a
sense of professional skepticism throughout the spending process. Professional
skepticism is an attitude that includes a questioning mind and a critical assessment of
motives and documentation/evidence. In applying professional skepticism, you should
35
have a mindset that recognizes the possibility that a fraud could be always present,
regardless of your past experience with the individuals involved and regardless of your
belief about their honesty and integrity. Professional skepticism further requires an
ongoing questioning of whether the information and evidence obtained suggests that a
fraud has occurred. In exercising professional skepticism while gathering and evaluating
evidence, you cannot rely on your belief that the individual is honest, and should not be
satisfied with less-than-persuasive evidence.
PRACTICAL EXAMPLE: Assume you are processing a purchase order
presented by a department head for the purchase of normal office
supplies from an out-of-state vendor. You are curious as to why relatively
normal supplies are being purchased from an out-of-state vendor when a
local vendor can provide the same supplies. Upon inquiry, the
department head states that the out-of-state vendor was selected
because they provided a lower quote, even considering shipping costs.
The application of professional skepticism demands both an unbiased
questioning of the motives behind this purchase and a critical assessment
of persuasive evidence. Merely accepting the department head’s
response to your inquiry does not provide persuasive evidence of the
absence of fraud in regards to this purchase. This purchase order could
be evidence of the department head arranging payment to a fictitious
company for goods that will not be received, or be evidence of a
purchase where the department head may be receiving a kickback.
Therefore, you should not be satisfied with the department head’s
response and should obtain further evidence of the appropriateness of
this purchase by checking out the valid existence of the vendor, the
reasonableness of the prices for the supplies, and the ultimate delivery of
the goods ordered.
36
To apply professional skepticism, you must (1) understand the normal purchasing and
spending process, requirements and limitations, (2) being alert to exceptions from the
normal process, and (3) take a proactive approach to investigating and reporting
indications of wrongful spending, rather than merely looking the other way.
37
CHAPTER 4 - REPORTING INDICATIONS OF WRONGFUL SPENDING
Exercising Moral Conviction and Courage
It is one thing to possess a proper set of values and know the difference between right
and wrong; it is another thing to actually exercise the moral conviction and courage to
“do what is right” and report indications of wrongful spending. Moral courage can be
described as responding to ethical dilemmas with bravery and courage in the face of
mental and physical challenges or danger that could harm us (e.g. harm our family, job,
self-esteem, reputation, bank account, livelihood, or health). It is the courage to stand
up for the core values of honesty, respect, responsibility, fairness, and compassion in the
face of these dangers. These challenges or dangers may subject you to enormous
pressure; however, when faced with an ethical dilemma involving whether or not to
report indications of wrongful spending or other inappropriate behavior, you must
exercise moral courage and stand up for these core values and focus on your ultimate
responsibilities as a government official or employee to serve the interests of the public
and uphold public trust.
Providing for Effective Lines of Communication
Many employees struggle with the dilemma of whether or not to report potential
wrongdoing. They often find it difficult to balance the perceived conflicting pressures of
“remaining loyal” to the employer versus “blowing the whistle”. A recent study
sponsored by an international accounting firm concludes that one in five American
workers possess personal knowledge of workplace fraud or wrongdoing. However, these
same studies indicate that less than half of these employees report such concerns or
knowledge. Considering these findings, it is essential that the employer provide the
38
proper reporting mechanisms and channels of communication and encourage the
reporting of indications of wrongful spending and other unethical behavior. If an
individual is to exercise the moral conviction and courage to report indications of
wrongful spending, the government organization must make it easy for such
communication to occur and with little fear of retaliation or other negative
consequences to the reporting individual. To facilitate these communications, the
government organization and its leadership should consider establishing effective
communication tools such as:
• An Ethics Hot Line
• A Whistleblower Policy
• An Ethics Board or Committee
• An Effective Audit Committee
Establishing an Ethics Hot Line Despite the best efforts of government organizations and their system of internal
control, they are not immune from illegal acts, fraud, abuse, and waste, and will face
challenges in being made aware of such conditions. However, government organizations
can take a proactive approach to this challenge, by promoting an ethical workplace and
providing opportunities for stakeholders (employees, vendors, contractors, citizens,
constituents, and the general public) to get involved and report concerns.
Anonymous ethics hotlines have proven to be one of the most powerful methods for
reporting concerns. Recent studies indicate that organizations without anonymous
hotlines suffer average losses that are twice as high as organizations with established
reporting mechanisms. While some anonymous complaints or reported concerns turn
out to be frivolous and without merit, these studies indicate that the majority of
complaints or concerns received by organizations with ethics hotlines are serious
enough to warrant an investigation. Therefore, collecting the initial report or tip is a
39
critical first step to becoming aware of potential illegal acts, fraud, abuse, or waste.
Studies have also shown that people are generally more likely to report complaints or
concerns if they can remain anonymous.
To facilitate the hotline communication, the government organization should provide
simple, straightforward instructions for the hotline process and identify the information
that will be requested. In essence, the government will need the reporting individual to
provide the “who, what, when, where, why, how, and how often” factual information
regarding the complaint or concern. Generally, the following information should be
requested from the reporting individual:
• The nature of the complaint or concern and the circumstances of the incident(s);
• The agency, department, location, and the subject(s) involved;
• Any documentary or testimonial evidence that is available;
• Dates, times, names, and places; and
• The identification of any credible witnesses.
Not all ethics hot lines are effective. For ethics hotlines to work well, they must be
appropriately designed and implemented. The Antifraud Programs and Controls Task
Force of the American Institute of Certified Public Accountants offers the following
advice for establishing an effective ethics hotline:
• Hotlines should have a dedicated phone number, fax number, web site, email
address, and regular mail address to facilitate reporting of complaints or
concerns
• Hotlines should be made available 24 hours a day, seven days a week, and if
possible staffed by a live interviewer (voicemail systems often prove to be
ineffective)
40
• Assign a unique identification number to each complaint or concern received to
facilitate continued follow up; a case management log should be maintained to
track all reported incidents and the resolution of the case
• Hotlines should provide for anonymous reporting and protection of the
confidentiality of the informant; consideration should be given to using a third
party (i.e. outsourcing) to receive and process the reported information to
improve the perception of confidentiality
• Hotlines should automatically and immediately route the concern or compliant
information to the appropriate investigators or recipients for follow up; a dual
(two or more people) routing can also be effective in serving as a protective
mechanism to avoid possible conflicts on interest
• Interview processes should be standardized and interviewers should be trained
to gather the information in a clear and complete manner while calming the
fears of the individual reporting the concern
• The hotline communication process should promote continued dialogue
between the interviewer and the reporting individual in order for details to be
clarified and understood
• The existence, purpose, and process of the hotline should be well communicated
through an effective communications campaign, including hotline posters
displayed in prominent places, reinforcement through periodic training,
prominent display on the organization’s web site, and inclusion of reporting
information on pay stubs, customer invoices or bills, newsletters, purchase
orders, checks, and even government vehicles
Establishing a Whistleblower Policy
One of the most common reasons employees do not report observed indications of
inappropriate behavior or wrongdoing in the workplace is because of the fear of
retaliation. To encourage the reporting of complaints or indications of inappropriate
41
behavior including indications of wrongful spending, without fear of retaliation, the
government entity should establish a formal whistleblower policy. Such policy should
accomplish the following objectives:
• Provide specific guidance, instructions, and training to employees on what types
of behavior or actions are to be reported, how and to whom the reporting
should be made, and their rights under the whistleblower policy;
• Prohibit interference with the right of an employee to report or blow the whistle,
and provide legal protection for the reporting employee;
• Prohibit retaliation against an employee for having made a complaint or
reported the concern;
• Provide procedures for filing and addressing complaints of retaliation for blowing
the whistle; and
• Provide substantive rewards that encourage constructive whistle blowing.
Whistleblower policies should be crafted within the framework of any federal, state, or
local laws or regulations governing such activities. Such laws and regulations may
include specific procedures for the confidential receipt, retention, and follow up on
complaints or concerns received, and the legal protections for the whistleblower.
Establishing an Ethics Board or Committee While it is important for an organization to have communication channels for reporting
concerns over potential illegal acts, fraud, abuse, and waste, there must also be a
mechanism in place to properly deal with and address these complaints or reported
concerns when received. A formal ethics board or committee can serve such a purpose.
In addition to overseeing the development and implementation of a governments’
formal ethics policy or code of conduct, an ethics board or committee can serve the
following functions in regards to handling ethics complaints or concerns:
42
• Provide advice to employees and others on ethical dilemmas and code of
conduct questions or uncertainties
• Serve as the initial point of contact or designate and oversee an individual to be
the contact point for the communication of complaints or concerns
• Conduct or oversee the conduct of investigations into valid complaints and
concerns
• Hear employee complaints regarding alleged retaliation for blowing the whistle
• Make recommendations to management and the governing body regarding what
actions to take in response to investigation results
• Conduct due process hearings in the final resolution of ethics matters
The presence of a formal ethics board or committee can serve as a positive
reinforcement to employees that their complaints or concerns will be handled in a
professional and independent manner.
Establishing an Effective Audit Committee While a government’s governing body is ultimately responsible for the organization’s
accountability and stewardship or resources, an effective audit committee can play a
significant role in promoting a culture of honesty and integrity. The audit committee can
help ensure the government has anti-fraud policies and programs and a strong system
of internal controls in place to prevent, or detect and report illegal acts, fraud, abuse,
and waste. An audit committee should have a broad range of fiduciary responsibility
including:
• Monitoring the entity’s code of conduct and internal control system
• Overseeing the external and internal audit functions
• Instituting and monitoring special investigations
• Reporting audit or investigative findings to the governing body
• Following up on corrective actions
43
A properly formed and empowered audit committee is in a unique position to provide
the necessary guidance and oversight of investigations of ethical concerns or complaints
by ensuring that appropriate resources and skills are assigned to gather and evaluate
the necessary evidence associated with the investigation, including resources and skills
of internal or external auditors, appropriate law enforcement agencies, and legal
counsel.
The following are some practical suggestions for establishing an effective government
audit committee:
1. Consider formally establishing the audit committee and its powers and duties by
law or regulation (e.g. constitution, charter, statute, ordinance or resolution).
2. Ensure the qualifications for committee membership provide that the members
of the audit committee collectively possess the technical accounting, auditing,
and financial management expertise needed to understand and address
technical issues.
3. Consider appointing the majority of the audit committee members as qualified
individuals from outside the government, but also include at least one
representative from the governing body or board. The government’s
management should not be represented on the audit committee but may be
present in an advisory role.
4. Ensure audit committee members are provided education and training as to
their role and responsibilities; and that their terms of service last longer than
one year and are staggered to provide continuity.
5. Encourage audit committees to meet as frequently as needed, but at least more
than once a year and maintain minutes of audit committee meetings while being
careful to protect confidential information.
6. Provide for appropriate reporting processes and channels of communication
between the audit committee and governing body.
44
CONCLUSION
Government officials are entrusted with public resources and are responsible for
carrying out public functions efficiently, economically, effectively, and ethically, while
achieving desired program objectives and providing public services. An actual
misappropriation of assets from embezzlement or instance of wrongful spending or the
mere perception of such acts through lack of transparency can be the downfall of public
trust. Therefore, it is essential that government officials and employees embrace the
concepts of transparency and accountability for their use of public resources and
promote ethical government spending by (1) establishing the right ethical climate within
the government organization (2) understanding how to define and recognize wrongful
spending, including illegal acts, fraud, abuse, and waste, (3) preventing and detecting
wrongful spending through an effective system of internal control and organizational
fraud awareness, and (4) effectively reporting and communicating indications of
wrongful spending.