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Kentucky State Auditor Blasts Prison Industries After $377K in Undeposited Payments Found in Manager’s Desk

by Matthew T. Clarke

It is hard to imagine the surprise of Kentucky Correctional Industries (KCI) employees when they discovered $377,751.86 in undeposited payments in a KCI manager’s desk in April, 2004. As a result of the discovery, Kentucky Department of Corrections (DOC) Commissioner John Rees asked the State Auditor to conduct an audit of KCI to “scrutinize the financial integrity of” KCI and “examine existing internal control mechanisms.” The audit revealed “flawed business practices, lack of financial controls, and gross mismanagement by the former branch manager and previous administrators that led to the inability to conclusively account for all KCI receipts.” Meanwhile, state officials expressed shock and anger at the discovery. Kentucky Lt. Governor Pence described the payment hoarding as a “deplorable neglect of duty.”

“This was an extreme example of lack of oversight,” said Rees. “I can certainly understand the surprise and outrage experienced by Lt. Governor Pence and Commissioner Rees when this situation first came to their attention. The fact that an employee would put over $377,000 in payments in a drawer and not deposit them for years is simply unbelievable.”

Of equal concern is that financial controls were not in place to ensure that the employee’s managers would prevent or detect these actions. In short, there appears to have been a complete lack of oversight of cash management at” KCI, said State Auditor Crit Luallen.

On May 4, 2004, Rees asked Luallen to see if the accounting of payments received was reliable, determine the amount of loss caused by the manager’s failure to deposit the payments, evaluate the financial controls in place and report weaknesses in the system. The period audited was July 2000 through May 2004. Without waiting for the auditor’s report, KCI fired the manager and the supervisor of his department, reassigned the manager’s direct supervisor, hired a new fiscal branch employee and put new fiscal and receipt controls in place.

One problem the auditors encountered was an incompatibility between the KCI accounting software and the state’s accounting software that made it impossible to determine whether payments marked paid in the KCI software were also listed as paid by the state. After overcoming this problem, they determined that there was a $177,000 variance between the two systems. An additional $202,000 in transaction discrepancies between the two software systems that was apparently caused by data entry error was also discovered. Additionally, many transactions marked as paid in the KCI system showed unpaid in the state system. Upon further investigation, 35 transactions totaling $63,835.59 appeared improper and were referred to the Kentucky State Police for investigation of possible criminal activities.

The $377,751.86 in undeposited payments were examined and reduced to $342,843.19 in actual undeposited payments because some were duplicate payments while others should have been paid to other state agencies. Of that sum, KCI was able to deposit $338,241.34. It is seeking payment for the remaining $4,618.15 it was unable to deposit because of the time elapsed since payment.

This mess of the undeposited payments was made possible primarily due to three glaring flaws in KCI’s accounting system. The first was that the same person received the payment, receipted the payment, secured the payment and made the data entries showing payment received. These functions should be isolated if possible. The second was that no invoice was generated until goods were shipped to the receiver. This meant that if a payment was received before goods were shipped; the manager had no way to match the payment with the order. In those cases, payments had to be held, often for months, until the ordered goods were shipped. The final glaring error was that KCI sales invoices contained no remittance advice—a portion of the sales invoice that identifies the order and customer and is to be returned with the payment. The only way for managers to identify which payment when with which order was to scour through all of the sales invoices by hand. However, customers often had multiple names (e.g. DOC, Dept. of Corr., Corrections Department) causing confusion even in that process.

The auditor’s report, released on November 15, 2004, made suggestions for improving fiscal controls at KCI, many of which had already been put in place following the discovery of the hoarded payments. The report advised KCI to segregate the authorization, custody, recordkeeping and reconciliation of transactions and operations; restrictively endorse payment checks immediately upon receipt; forward cash receipts to the State Treasury on a daily basis; include a remittance advice on the sales invoice; produce accounts receivable aging reports for management; attempt to reconcile the KCI and state accounting software entries; add a field or sub-field to the KCI and state accounting databases to allow cross-referencing; use a master list of existing customers to avoid duplication of customer listings under different names; update its policies and procedures manual for internal operations and make the manual readily accessible to each employee; pursue payment from customers whose checks have expired; and continue its efforts to deposit payments as quickly as possible.

In short, the hoarding of payments was a big boondoggle that exposed a bigger boondoggle—lack of fiscal controls. Whether KCI can learn from its mistakes remains to be seen. The auditor’s report is available on PLN’s website at

Sources: Kentucky Auditor of Public Accounts, Press Release; Kentucky State Auditors Report (both available online at; New York Times.

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