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MISSOURI MORTGAGE PROFESSIONAL MAGAZINE JANUARY 2010 O
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honesty as someone taking your lunch out of the refrigerator, or even taking money out of your desk drawer. But what happens when our closest and most trusted employee, the person who makes sure there is money in the bank, takes advantage of us? We all have accounting people who support our businesses, either as an employee or as a bookkeeper or auditor. These people perform essential functions like transferring money and making payroll; functions that we expect to be done correctly and timely without fail. We grow so comfortable with our accounting staff that we are confident they will continue to do what they have always done … move money and make payroll on time every time. We all know there are substantial amounts of money rolling through a mortgage bank. The unthinkable of unthinkable events is when our trusted accountant who manages or money begins to move company money to their own account. At this point, most of you are thinking this is unbelievable. But it has happened. We’ve met with companies where the “always dependable” bookkeeper moved so much money out of the company that the company may not survive … thus the ultimate violation. What if an accountant stole millions from your company by diverting money from loan purchases so they not only took lots of money, but they left you with millions of dollars in unpaid liability? All it takes is five loans to create losses in the millions. CPAs call corporate theft “DEFALCATION” defined as: “To misuse or embezzle funds by a person trusted with its charge.” Defalcation is similar to “DEFICATE” creating an interesting metaphor. I cannot divulge any details, except to assure you that this is a true and recent story. The most disheartening issue of all is that it could have been prevented with just a few common controls mortgage CPAs expect to see in any company’s accounting system. As a side note, before there was an issue with this business, the owner was confident their accounting was fine; when, in fact, it was dangerously compromised. They didn’t know it was compromised because they lacked the knowledge and training necessary to monitor the system and trusted blindly without verification that things were, in fact, “just fine.” All violations of trust are repulsive and end with the gut-wrenching feeling of pervasive violation. The closer the person is to you, if it’s a spouse or a longtime bookkeeper, the deeper the pain and the longer the violation is stained in your memory. No one ever thinks it will happen to them. There is a psychological event that we all fall
victim to and this is denial. We engage this defense mechanism and bury our heads in the sand or state that: “This can’t happen to me nor has it happened to anyone I’ve ever known. This is just something that happens to other people.” And yet, the risk is real, but most business owners tell us their accounting is fine when the reality is they could be at risk and not know it. There is an interesting quote from the Bible that states “Pride Comes Before a Fall.” Basically, if you are so confident in your actions and believe that you are right without exception or counsel, it is likely that you are next to fail. Just ask anyone who has failed. Another saying that speaks to the issue of control is “absolute power corrupts absolutely.” Said another way, someone with unlimited control will use that control to their personal advantage. There are many examples in history of this, from the Caesars through Hitler and on to Saddam Hussein. The lesson learned is without controls or oversight, dictators and those who control money in a business could use their powers to their own benefit.
lations. Many non-certified accountants are excellent bookkeepers and are essential to the accurate record keeping of a company. Just make sure a mortgage CPA helped to set-up the accounting system and reviews the accounting reports on a monthly basis. It is absolutely important to remember that an accounting department is populated by humans, and humans are capable of errors in action or judgment. It is also important for you to pay attention and ask questions about the numbers. If you don’t understand the answer, get someone else to help until the answer makes sense. Never accept the answer, “That’s just how it is,” or “That’s want the auditor said.” Dig deeper and understand the answer. Your first loss is your smallest loss when detecting corporate fraud. Defalcation usually begins in smaller amounts, and then increases in size if the scheme is undetected. Finding corporate theft early will reduce the loss and digging into accounting is the only way to find it.
Check the checkers: Trust but verify
Protecting your company from corporate theft begins with having a good accounting system, along with proper accounting procedures for the posting of loan funding and purchase transactions. No one wants to talk or think about the details of accounting, but this can be the difference between success and failure. Even the Small Business Administration (SBA) has statistics about this. The federal agency that helps small business says that 95 percent of all small businesses fail in the first three to five years because of poor planning and poor financial management. Think about this, out of 1,000 people who started a new business, people who took all of their savings to start the business, people who were all 100 percent confident in their future success, 950 out of 1,000 of them have failed and lost everything. They lost everything because they didn’t have proper financial planning, which includes an accounting system with proper controls over money. So, why didn’t they have good accounting systems? Maybe they didn’t know how to build one. Maybe they didn’t have access to a CPA. The unfortunate reality is almost all of them didn’t know what they needed to know. I heard a college professor comment, “It is better to ask a question and seem a fool than not ask a question and fail.” I think the same holds true when business owners think about their accounting.
So what are the reasonable precautions that are designed to keep honest people honest? The answer to this question is easy. Effective accounting systems require detailed and comprehensive data entry, accurate reporting, thorough breakdowns of where monies are at all times, and finally, absolute transparency. Transparency is not achieved without proper data capture, otherwise reporting can be inaccurate. As I stated previously, no one thinks it will happen to them. Everyone trusts their accountant because generally accounting people are trustworthy. The entire CPA profession is based on providing trust and confidence in the work they perform. CPAs are the only profession in which the Securities & Exchange Commission (SEC) designated as qualified to express an opinion about the presentation of the financial statements of a company. To earn and preserve this trust, CPAs are specifically required to take regular ethics exams and undergo thorough training on how to implement procedures to prevent corporate theft. A very important distinction needs to be made between a noncertified accountant/bookkeeper and a Certified Public Accountant. Although CPAs often do similar work as a non-cert accountant, and a non-cert-accountant may have a degree in accounting, they do not have the same level of continuing education and testing as a CPA. A noncert-accountant is not licensed and is not under regulatory oversight like a CPA. This distinction is important when identifying the path to protect from vio-
Accounting systems prevent failure
From lemonade stand to used car accounting When a lemonade stand buys sugar and lemons they create an asset of the business called raw materials inventory.
When the owner of a car lot buys a car at an auction they can get 100 percent financing from a bank so there is no immediate cash spent. The car lot will record the borrowing from a bank as a liability and the car as an asset held for sale. The fundamental principal here is the moment you borrow money, you have a liability and the moment you close a loan you have an asset. Another important accounting event for a car lot is collecting money from a buyer for the purchase of a new DVD player to be purchased and installed by a specialty auto parts store. The money is a liability of the car lot until they give the money to the auto parts store. When a company receives money from a customer to be held for someone else the money is a fiduciary liability. When we look at mortgage banking, we are surprised to see that many mortgage banks do not follow these basic accounting principals. When they close a loan (buy a car), they do not record the asset. When they borrow money from a warehouse lender (borrow from a bank), they do not record a liability. When they take money from a customer for taxes and insurance, they do not record the money as a liability for escrow impounds. By not implementing these basic accounting principals, the owners of mortgage banks are limiting the accuracy of their financial statement and creating a higher potential for corporate fraud.
Mortgage banking accounting is complicated … get help! The complexity of a mortgage banking operation with warehouse lines and multiple investors can get confusing with many detailed accounting issues. Mortgage banks that hedge or retain servicing create a significantly more sophisticated accounting process. One the basic accounting processes to note is that when a loan is made, it creates an asset of the company and also creates a liability of the company to the warehouse bank. Any funds collected from the borrower at closing for impounds are a liability to the mortgage bank and are subject to the requirements for the segregation of fiduciary funds. When the loan is sold, the asset is removed from the balance sheet, along with the payoff of the warehouse liability and the profit for the specific loan is calculated. When you close a loan it is the same as if you purchased a loan, and as we just discussed when you buy an asset you should immediately record doing so in your books. These are irrefutable and fundamental accounting principals that combine with proper controls to protect a mortgage bank from corporate fraud. Many mortgage banks do not focus on corporate fraud prevention and choose not to implement these funda-