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How to Detect and Prevent Fraud in Your Accounts Receivable Department

Segregation of duties and employee monitoring reduce your risk of skimming and other AR fraud schemes

Posted by Ann Snook on January 4th, 2021

According to the Securities and Exchange Commission, improper revenue recognition (inflating or delaying revenue) is the most common type of accounting fraud. While this and other types of accounts receivable fraud can result in huge financial losses, your company can suffer in other ways, too.

Customers could lose faith in your company and take their business elsewhere. Your accounting system could need an overhaul with new fraud controls, costing even more money.

Quick detection is key to preventing fraud in your accounts receivable department. Use these detection and prevention tips to protect your organization.

 

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Employee theft and fraud can shake up the entire company, but a poor investigation can make the situation worse. Download our free cheat sheet to learn tips for documenting your investigation, keeping the workplace safe and disciplining a fraudster.

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What are Common Accounts Receivable Fraud Schemes?

 

Accounts receivable fraud schemes are often complex and usually involve creative accounting on the fraudster’s part. Learn the signs of these four common types of AR fraud to prevent losses in your organization.

 

Lapping

 

Lapping “involves taking a subsequent receivables payment from a transaction (for example, a sale) and using that to cover the theft. The receivable from the second transaction is covered by money from the third transaction, and so on,” according to Investopedia.

In practice, a lapping scheme looks like this:

Bob works in AR at an auto garage. Carol pays $120 for her car inspection, and Bob steals her payment. Then, Mike pays $120 for his inspection. In the books, Bob credits Mike’s payment to cover the lost funds in Carol’s account.

However, now Mike’s account is missing $120, so Bob has to apply the next customer’s money to balance that account, and so on. Lapping can grow rapidly and be difficult for the fraudster to keep up with, leading them to eventually slip up in their scheme or pay back the money they’ve stolen.

 

Skimming

 

Skimming is an “off-book” fraud, meaning the employee swipes the funds before they’re entered into your accounting system. Types of skimming include:

  • Refund skimming: A customer has overpaid on their bill (or made a complaint) and your company owes them a refund. The fraudster pockets the refund before it can be sent out.
  • Check skimming: The fraudster takes a customer’s payment check and deposits it into their own bank account. To avoid suspicion, their account is probably under a similar name to your company (e.g. Cool Candles, Inc. instead of Cool Candles Co. or Joe Snith and Associates instead of Joe Smith and Associates).

 

Fake Sales/Accounts

 

When a salesperson or company wants to appear more successful, they might inflate their sales records. This helps salespeople earn more commission and meet sales targets and helps companies get more money from investors.

For example:

Chinese coffee chain Luckin Coffee opened stores rapidly starting in 2017 with the goal of outpacing Starbucks. To make the company appear more successful when it debuted on the American public market in 2019, its executives inflated sales by about $300 million to boost the stock price.

Following an internal investigation and fraud disclosure, the company now must pay a $180 million penalty to the Securities and Exchange Commission.

On a smaller scale, a salesperson might create invoices for fake sales, then intercept late notices to the “customer” when they don’t pay their bill. After awhile, the account will be either sent to a bill collector or forgotten about.

 

Fraudulent Write-Offs

 

Finally, a fraudster might take advantage of a customer’s return, discount or other type of write-off.

For instance, if Judy is running a lapping scheme, she could apply a customer’s refund to an account she’s stolen money from to cover up the loss.

She could also credit the write-off to an inactive account in your system and pocket the cash. To achieve this, Judy could change the customer’s contact information to her own or skim the check meant for the customer.

 

RELATED: The Definitive Guide to Accounts Receivable Fraud

 

Tips for Detecting and Preventing Fraud in Your Accounts Receivable Department

 

Audit for Known Concealment Methods

 

Most AR fraudsters use the same tactics to hide their fraud:

  • Stealing or falsifying documents and statements
  • Crediting payments to the wrong accounts
  • Applying excessive write-offs or discounts
  • Applying discounts to old or inactive accounts

 

Joseph R. Dervaes, CFE, CIA suggests that you can successfully detect AR fraud by focusing your audits on these methods. Unless the fraudster is really creative, you’ll probably catch their scheme.

 

Separate Your Customer Service

 

If an employee is running an accounts receivable scheme, customers will start to notice. They might wonder why their payment hasn’t gone through even though months have passed. Or why they’re getting delinquent notices when they paid their bill on time.

Consider dedicating some customer service staff to accounts receivable complaints. They can investigate customer concerns about their accounts and other unusual account activity for faster fraud detection.

 

RELATED: 41 Types of Employee Fraud and How to Detect and Prevent Them

 

Implement Internal Controls

 

“The key issue is control of the work environment,” says Dervaes.

To detect and prevent accounts receivable fraud, study your organization’s weaknesses. Then, address your areas of risk by:

  • Segregating accounts receivable duties (e.g. bank deposits, editing accounts, accessing revenue)
  • Rotating duties for staff every few months
  • Forbidding AR employees from conducting their duties on personal devices
  • Requiring AR staff to work reasonable hours (not too much overtime) and take time off

 

Monitor Employees at Every Level

 

Many anti-fraud controls focus on the work of what Dervaes calls “doers” or lower-level employees. However, he says, there are “few or no controls where managers monitor the work of supervisors in the same way their review the work of their subordinates.”

Make sure to implement controls at all levels, not just for the junior staff in your accounts receivable department.

 

If you do uncover fraud in your workplace, what are your next steps? Prepare your employees before disaster strikes with a thorough fraud response plan. Download our free template to get started.


Ann Snook
Ann Snook

Marketing Writer

Ann is a marketing writer at i-Sight Software. She writes about issues related to investigations of fraud, employee misconduct, corporate security, Title IX, ethics & compliance and more.

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