The Hidden Cost of Materiality Thresholds
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By Marilou Vroman, CPA
As you may know firsthand, many automotive dealers are required to have regular financial statement audits or reviews performed to meet lender requirements, or at times, for piece of mind. While audits and reviews are important for third parties relying on the financial statements, all too often we find some dealers believe an external financial statement audit or review is also designed to detect fraud. While certain procedures may lead an auditor to detect fraud, procedurally, there are limitations such as materiality thresholds that may prevent inappropriate activities from being detected.
For those familiar with fraudster’s tendencies, embezzlements typically begin at small dollar amounts to “test the waters” and to identify if a scheme can be perpetrated without detection. Once the perpetrator has been successful with their initial scheme, the tendency is to increase the reward while the perceived level of risk declines. For example, a salesperson may collect $500 cash from a customer and divert $100, while altering the terms of a vehicle sale. If the first theft is successful, the next may be $500 of a $1,000 deposit, and so on. This pattern may continue over the course of weeks, months or years without detection since the dollar amounts are very small.
A financial statement audit will have a materiality threshold (the dollar amount below which transactions are not typically considered) set at tens to hundreds of thousands of dollars, depending on the size of the business and the dealership’s risk assessment by the auditor. This contrasts with internal audits, which typically are behavioral in nature and rely significantly less materiality. If relying solely on a financial statement audit or review for a level of comfort or assurance, an embezzlement perpetrated in small amounts over the course of time could go undetected.
Therefore, it is so important for dealers to ensure implementation and enforcement of strong internal controls at all levels. Keep open lines of communication for fraud tips, and inspect what you expect.