Are You a Victim of Fraud

Are you a Victim of Fraud?

By John Dupree, CPA, CFE, FCPA, MBA
Audit Supervisor

If the vendor you buy most of your inventory from shares the same address with your accounts payable clerk, then your clerk might be a fraudster.

If your accounts payable clerk drives up in Ferrari, then he might be a fraudster.

If your human resource manager spends a lot of time in grave yards writing down the names on the tombstones, then he might be a fraudster.

Unfortunately, for the owners of businesses who have experienced fraud, it is no laughing matter. According to the Association of Certified Fraud Examiners 2006 Report to the nation, it is estimated that U.S. organizations lose approximately 5% of their total revenues every year due to fraud. Thus if your business has gross revenue of $1,000,000 a year, fraud may be costing you $50,000.

Many business owners will read that statistic and think, “It’s not happening to me, I have honest employees.” Let’s hope that is true, but realistically any employee given the proper motive and opportunity can turn into a fraudster. Furthermore, you never know what outside factors might cause a person to take desperate action. Consider a parent with a sick child in need of care without the means to pay for treatment. When people get desperate, even honest people will do desperate things. Furthermore, it may not be your employees that are committing fraud. Today’s businesses outsource many of their functions including payroll and accounting. This gives strangers access to businesses’ most vital records and with that access, they get the opportunity to commit fraud.

So how does a business owner tell if fraud is occurring? Unfortunately, it is not easy to tell. Today’s employees are generally more educated, and thus are more astute when it comes to covering up fraud. In addition, modern computer technology makes generating fictitious invoices extremely simple. These factors combine to make fraud a major threat to today’s businesses.

It’s a trite but true cliché that it takes a thief to catch a thief. In this case, you don’t actually have to become a thief; you just need to learn to THINK like a thief. Therefore, we need to learn the three general types of fraud that occurs in a small business. This is not meant to be an all inclusive list, but to present the three kinds that are the most common: larceny, skimming and fraudulent disbursements.

The classic legal definition of larceny is the unlawful taking and removing of another’s property with the intent of permanently depriving the owner. Typically this involves taking the property after it is recorded on the books of the organization. An example would be taking inventory home for his or her personal use. Another example would be the personal use of company assets such automobiles and computers for personal use.

Generally, theft by larceny occurs in small individual amounts, but it can add up over time.

Skimming differs from larceny in that it involves the taking of property before it is recorded on the books. One famous example involved a grocery store where the manager set up another cash register in the store. Any sales that were recorded in that register never were recorded on the company’s books and went directly into the manager’s pocket.

A Fraudulent disbursement scheme is defined as a scheme where the organization is caused to disburse funds under false pretences. This type of scheme can take many forms including check tampering, false register disbursements, billing schemes, payroll schemes and expense reimbursement schemes.

Check tampering occurs when a valid check is altered after it is prepared in order to convert the check to another use. This type of scheme is usually easily detected because the proper vender will not receive the intended payment and will generally send another bill.

False register disbursement occurs when an employee will make false entries in a cash register in order to cover up a theft. For example, an employee at a company cafeteria kept loose change on her register. She would move the change from one side of the register to another when she would overcharge a customer. She would record the sale for the correct amount on the register. At the end of the day, she would count the change on the register and determine how much cash needed to be taken out.

Billing schemes involve payments for fictitious invoices. An example is an employee with approval authority generating an invoice to a fictitious vender, and sending the invoice to the company where he or she approves it for payment.

Payroll schemes can take many forms. Examples can range from recording time on time sheets for hours not worked to paying non-existent employees.

Expense reimbursement schemes are one of the most common. They are usually related to employee travel. In one example, an employee when traveling on company business would buy two airline tickets. One ticket would be purchased at the cheapest rate available. The other ticket would be purchased at the last minute for the most expensive fair available. The employee would then travel on the cheap ticket. When he submitted his request for reimbursement, he would turn in the receipt for the expensive ticket. He would then request a refund from the airline for the expensive ticket and pocket the difference between the expensive fair and the cheap fair.

Once an understanding of the way fraud can occur, ways of detecting it can be developed.

Here are some indications that skimming may be occurring:

1 Decreasing cash to total assets ratio. If skimming is occurring, the fraudsters are more than likely going to be taking cash; therefore, cash will make up less of your total assets.

2 Decreasing ratio of cash to credit sales. Again, since the fraudsters like cash, they will take the cash and try to obscure the theft with credit sales.

3 Flat or declining sales with increasing cost of sales. If sales are not being recorded, this will cause downward pressure on sales, yet since inventory is still going down, costs of sales will continue to increase.

4 Increasing accounts receivable compared with cash. If customer’s cash payments are being stolen, cash will go down, but the receivable balances will not.

5 Delayed posting of accounts receivable payments. In order to cover up theft of cash from accounts receivable payments, a clerk may use other payments made by check to cover the stolen cash payments.

Some indications that larceny is occurring are:

1 Unexplained cash discrepancies. When cash is stolen, it will show up in the balancing process which cannot be explained.

2 Altered or forged deposit slips. In order to cover up the theft, the fraudster might alter financial documents.

3 Customer billing and payment complaints. If a customer’s account is not properly credited with a payment, it may indicate that the payment was used to cover up a theft.

4 Rising in transit deposits during bank reconciliation process. In order to cover a theft of cash, in transit items might be used to obscure the theft

Finally, indications of fraudulent disbursements include:

1 Increasing “soft” expenses (for example consulting or advertising). Expenses for services are often used for fraudulent disbursements since there is no receiving report or other documentation that the service was received.

2 Employee home address matches vendor’s address. This way the fraudulent payments are delivered right to the fraudsters home.

3 Vendor’s name consists of initials or the employees last name. Some fraudsters really are not very creative and use their last names or initials in the business name.

4 Disbursements for a vague business purpose. Since the disbursements are fictitious, employees will have a hard time describing why they are needed.

5 Excessive voided, missing or destroyed checks. Many times, fraudsters will try to eliminate as much evidence as possible.

Now that you are armed with a little knowledge, you are better equipped to identify potential fraud schemes. If you suspect that you may have a problem, consider hiring an expert to investigate the situation so you can be certain. Remember, the only thing worse for a business than dealing with fraud is to deal with a lawsuit for falsely accusing an employee of theft.