"Internal controls" refers to a system of checks and balances designed to ensure reliable financial reporting, and safeguard the association's assets against error, fraud and embezzlement.

Segregate Duties. The most important control is segregating duties, i.e., financial tasks are performed by different personnel. This makes fraud more difficult because it requires collusion of two or more persons; and it makes innocent errors easier to find. The following duties should be performed by different people:

1.  Approve Transactions. Approving purchases, writing off bad debt, authorizing salary increases, selecting vendors (functions typically held by the board of directors).

• Boards need to establish a check signing policy. 

• Never makes checks payable to "cash."

• Disbursements should be based on original invoices. Monthly statements and photocopied invoices open the door to fraud.

• Bank signature cards should be updated whenever new directors are added to the board.

2.  Carry Out Transactions. Someone other than a check signer should:

• Prepare checks.

• Make bank deposits (in FDIC insured accounts in the association's name).

• Control petty cash

3.  Record Transactions. Someone who does not sign checks or make deposits should Post transactions to the general ledger, record payables and receivables, handle payroll, and make bank account reconciliations.

• Bank reconciliations should be done on a monthly basis and reviewed by the board.

• Missing checks and gaps in check numbers must be accounted for.

• Conduct an independent year-end financial review.

Late Financial Statements. Red flags should go up if the board starts receiving late and confusing financial statements from the person in control of preparing those statements. Statements that are 2 to 3 months late and require verbal explanations for confusing or contradictory accounting entries are a good sign of either mismanagement or embezzlement.

Additional Protections. In addition, boards should:

• Adopt a conflict of interest policy, and

• Establish and follow strong collection policies.

RECOMMENDATION: Boards should work with the association's auditor to develop and implement internal controls.