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In a reflection about life on planet Earth, C.S. Lewis once wrote “We live in enemy-occupied territory.” Given a combination of perfect storms during moments of our lives on this planet even the most honest of us is capable of succumbing to the enemy and committing defalcation. (Go look up that word.)

My friend and mentor Dennis Osterdock, a longtime Fairbanksan now consulting in Idaho, was sharing with me some of his experiences uncovering defalcation (there’s that word again) in some of his clients’ businesses. During his career, he has exposed 10 cases of employee “fraudulent appropriation of funds or property entrusted to their care but actually owned by someone else” (the definition of defalcation in case you hadn’t looked it up yet). Five of those cases amounted to more than $150,000 and from a recent client, more than $1 million.

Dennis remarked that the scenarios are always the same. “When internal controls around cash are weak, there are always temptations to take.” Another interesting observation was that in the biggest thefts, “the people taking are always long-term, trusted employees.” As a young CPA, he uncovered a $32,000 theft by a trusted 32 year secretary/bookkeeper who had been giving herself an unauthorized $1,000 per year bonus. When Dennis casually asked her about an invoice during a routine audit, she broke down sobbing in remorse. There had been no system in place to stop her, and once started, she could not stop herself. When we live in enemy-occupied territory, the enemy wins if we don’t have our guard up all of the time.

The death blow always hits a business when the person who signs the checks also reconciles the bank statements. Further, if your business allows the one who opens the mail to prepare and make the bank deposits and access the accounts, then you have created the opportunity to corrupt an otherwise honest employee. Owners magnify their lack of controls risk when they aren’t brave enough to question, confront and challenge their bookkeepers.

With his most recent client, Dennis reflected that though the firm was very profitable, it was behind in producing current financial statements. Upon further audit, he discovered that the 941 payroll taxes were late, as were bank reconciliations and tax returns. The vice president of finance had been a very old and trusted friend of the owner for more than 18 years. Though the vice president was only paid $48,000 a year, he was living a high roller lifestyle having defalcated more than $1 million from 2006-08. Fortunately, this firm has a great cash flow and so the additional $2 million in back taxes and penalties won’t bankrupt the business.

Here is a test: Which of these actions are the top 10 ways to set employees up for corruption?

• Do let the person who opens the mail, prepare and reconcile the bank deposits and statements.

• Don’t, as the owner, try to understand your accounting system, or even look at the bank statement.

• Don’t hold employees accountable for getting work in on time.

• Don’t audit employee credit cards.

• Do let employees have accounts receivable and charge to the business.

• Do let your inventory system be lax and let inventory go in and out without controls.

• Do let people dip into the cash register.

• Do let employees use the cash register for petty cash payments.

• Don’t balance cash daily.

• Do let the controller open the mail.

The correct answer is all of the above create opportunities for the enemy to corrupt your employees and No. 10 has cost an Idaho firm $3 million, so far. We need to understand defalcation and put systems in place to discourage our teams from going down the slippery slope of corruption.

Charlie Dexter is a professor of applied business at the University of Alaska Fairbanks Tanana Valley Campus. He can be reached at 455-2837 or ffcnd@uaf.edu. This column is provided as a public service of the TVC Applied Business Department. Copies of this column can be found at www.CharlieDexter.com.