6 of the best internal control procedures for auto dealers

Taking on a new client several years ago that engaged our firm for a review, I heard about Bob, who had been a trusted employee for more than 30 years and managed the financial reporting process with precision and efficiency. “You won’t find much wrong with the schedules Bob puts together” and “he will get you what you need ASAP,” I recall the owner telling me. At the time, the owner’s biggest concern was replacing Bob, who was 71 at the time. He mused about finding someone as dedicated, trustworthy and accurate—“he is just old school, they don’t make them like him anymore.” Of course, the readers of this article know where this story is headed—I found out three years later that Bob had embezzled $300,000 from that dealer over a 5-year period.

Anyone close to the retail automobile industry has probably heard a similar story. It is unfortunate, but in many small businesses, the major reason fraudsters can commit their crimes is because management trusts them so much; they are family members or longtime friends, or they have proven work records and years of service that allow them to hide their activities. In my experience, the fraud perpetrated by the trusted long­time employee seems to be particularly prevalent with auto dealers.

Given all the moving parts in an auto dealership, it is easy to overlook internal controls. Yet maintaining effective internal controls is crucial to protecting the business and its assets.

Through consulting services and agreed upon procedures, there are many ways an accountant can help dealerships adapt to the significant changes happening in the auto dealership industry. They can review the internal controls over financial reporting and operations to make an assessment on the design of the internal controls and perform checks on whether the controls are appropriately implemented. Additionally, they can provide documentation that clearly describes the processes, key controls, and their recommendations for improvements.

Internal control is not just about preventing or detecting a misstatement. Accountants can also focus on controls that improve the efficiency and profitability of a dealership’s operations. Some areas that a dealership can focus on include:     

• Reviewing contracts in transits, vehicle accounts receivable, warranty receivables and manufacturer receivables.
• Managing new inventory by reviewing the composition and age of new-vehicle inventory. Monitoring floor plan payoffs and performing reconciliations is also critical to reduce floor plan interest and ensure that a dealer is not in an out-of-trust situation.
• Managing used vehicle inventory by reviewing the controls over acquiring, recondition­ing and appraising used vehicles.

The following is a summary of the best internal control procedures for auto dealers:

• Segregation of Duties – There should be an adequate division of the following duties: approval, accounting/reconciling and asset custody. For example, in the finance department, there should be separation of assignments for accounts payable, bank reconciliations, receivables, titling and customer refunds.
• Purchase Orders – All purchases should be approved by a managerial-level staff member. The purchase order should be attached to a vendor invoice for verification before payment.
• Check Signing – It is important to ensure that check-signing responsibility is left to a senior manager or owner. In addition, carefully review all check details to ensure that the payee is an approved vendor. Many businesses are utilizing ERP (enterprise resource planning) systems that provide electronic signing on blank check stock and an audit trail for authorizations. The business can set a certain threshold and secure the computers that have access to print the checks. Another way businesses are cutting costs is by transitioning to using ACH (automated clearing house) payments over credit cards. ACH is one of the largest, safest and most reliable payment systems in the world.
• Conduct a Vendor Audit – Sometimes fraudsters will create phony vendors to make small payments to on a regular basis. This allows them to pay themselves large sums of money over an extended period without being noticed. It is important to regularly review a list of the dealerships’ vendors to verify data about the companies being paid. Call the vendor to ensure the details are accurate and that the business is legitimate, or hire a company that will manage vendors for the dealership.
• Reconciliation Process – Reconcile all key accounts, preferably monthly. Informing employees that accounts will be reviewed and reconciled and that differences will be investigated can be a preventive measure.
• Mandatory Vacations – Be sure to require mandatory vacations for all members of the dealership. This will ensure the opportunity for others to review fellow employees’ work, observe processes, create an opportunity for any inappropriate behavior to be discovered, and cross-train staff on different accounting functions. It is a red flag when an employee refuses to take a vacation or time away from the office; it can signal that they are concealing inappropriate activity. Another benefit of mandatory vacations is that it forces the dealership to cross-train staff on different accounting functions.

Annual reviews or audits are important, but it’s also valuable to throw in some consulting or agreed upon procedures to really get into the nuts and bolts of the operations to identify potential issues. Feel free to discuss any of these matters with us.