Accounts receivable is a thief’s paradise due to the influx of money at all times. Accounts receivable fraudsters take advantage of the trust they’ve built with clients, using their professional position to line their pockets.
Accounts receivable fraud can ruin a company financially. The fraud itself is harmful for the company’s finances, but the negative impact on its reputation and relations with customers is where the real damage lies. Plus, those involved will face civil and criminal penalties.
If faced with fraud in the workplace, do you have the skills to detect it? Prepare yourself for fraud with these tips on how to identify an altered check.
Accounts Receivable Process
The accounts receivable process can facilitate fraud schemes if the right checks and balances aren’t in place. Fraudsters often leave a long, convoluted paper trail to mislead or intimidate auditors and investigators.
An employee committing fraud will use any concealing technique they can to balance the books and hide the fraud: stealing paper statements, applying discounts, applying payments to the wrong accounts and more.
Lapping is a form of accounts receivable fraud. Lapping can easily become an elaborate and complex scheme, and is best explained by example.
Jim works for a company that provides cleaning services to large organizations. He is the sole member of the accounts receivable team for this company and, recently, Jim has been going through a hard time financially. Money is tight for Jim and his family and there doesn’t seem to be a clear solution.
One day, Jim is at work and receives a $100 check from Customer A. With no one around, Jim pockets the check.
A few days later, Customer B sends in a $100 check as well. Jim uses the check from Customer B and credits it to Customer A’s account to replace the missing $100 payment.
So far in the scenario, Jim now has an extra $100 in his pocket and Customer A’s account has balanced out with the payment from Customer B. Customer B’s account is still in the negatives until Customer C’s money arrives.
Jim will continue on with this pattern, continuously recording one customer’s payment to another customer’s account until the scheme is found out (likely) or the employee pays back the money they’ve stolen (unlikely).
The fraudster typically ends up buckling under the pressure of an increasingly complex lapping theft. The sheer volume of transactions will overwhelm the thief. The stress of always being one step behind leads them to eventually slip and expose the scheme on their own.
Lapping is a popular method for concealing skimming fraud.
Skimming fraud usually takes place in either the sales or receivables functions of the accounts receivable process.
An organization that provides goods or services sends out bills to its customers and receives payments as “accounts receivable”. An employee who is skimming receivables is intercepting payments from customers and pocketing the cash.
The fact that skimming fraud is done before the payment enters the company’s accounting system is what separates it from cash larceny. Skimming is “off book” fraud and cash larceny is “on book” fraud, in which funds are stolen after they are recorded in the company’s accounts. Even a well-constructed accounts receivable process isn’t always enough to stop skimming since this happens before the receivables process begins.
There are several ways fraudsters commit skimming fraud.
The first way is through check skimming.
In this scenario, an accounts receivable employee intercepts an incoming check from an account holder.
Before the payment has been recorded, the employee steals the check and cashes it into a private bank account of their own.
Since they’re stealing these checks before they have been recorded, an employee disguises their actions by diverting account statements and late notices.
The second way is called refund skimming fraud.
If a customer of the company has accidentally overpaid, they’ll receive a refund check.
A company with weak controls gives the fraudster an opportunity to pocket the refund check before it’s been recorded in the accounting system and endorse it to themselves.
Once the fraud has been committed, there are several ways that the employee conceals their actions.
How do they do it?
In both scenarios, the skimmer will open up a bank account with a name that’s similar to the company’s bank name. This makes it difficult for the victims or the company to notice the misspelling and uncover the scheme.
For example, if the company’s bank account name is “ABC Co.”, the employee in question might open up a bank account similarly named “ABC Inc.”. Or instead of “i-Sight” they might call it “l-Sight” (with a lowercase L)
The skimmer is usually responsible for the majority of account-related work. This includes being the primary source of communication for the customer, and a main contact for account holders with questions about billing and payment. The circumstances of this relationship work in the schemer’s favor.
Fraudulent write-offs occur when an accounts receivable employee credits a customer’s account for a discount, a return, or some other form of write-off. This technique can be used to cover up a previous theft or be used as a form of fraud in itself.
As a method of concealment, an employee who has been skimming checks over the past couple of weeks might apply discounts to the accounts they’ve stolen from. For example, let’s say Jim has been pocketing payment checks from Debtor A. To hide his fraud, Jim will access the books and apply discounts to hide the “missing” money.
As a form of fraud in itself, a thieving employee will credit old or closed accounts with several discounts. Since these accounts aren’t monitored as closely as an active account, the employee can pocket any payments or divert funds to their own, personal account.
This form of accounts receivable fraud is common in small businesses where there’s only one employee responsible for monitoring receivables in the accounts receivables process. An employee who doesn’t share their duties with a colleague is less likely to get caught.
Would you know how to confront an employee who has been stealing? Check out this cheat sheet with tips on how to confront employee theft.
Fictitious Sales and Fictitious Accounts
Fictitious sales and fictitious accounts are typically set up to disguise one another.
When someone makes a fictitious invoice, accounts receivable becomes inflated and there’s more “money” in the company. And at the end of the day, more money in the company benefits everyone in it.
Once a sale has been booked, the corresponding journal entry is to a payment that’s never collected and eventually written off. So while the payment is never received, the effects and benefits that come from a fictitious sale (booked to a fictitious account) remain.
Company owners might feel compelled to create fictitious sales to make their business seem more profitable to prospective or current clients. Whereas salespersons who are based on commission might want to create fictitious sales to meet daily, weekly, or monthly goals (especially if there is a tempting target bonus). A robust accounts receivables process with strong controls can help to expose this fraud.
The Cost of Workers’ Comp Fraud
Fraud disproportionately affects small companies, says a report by the Association of Certified Fraud Examiners (ACFE).The 2016 Report to the Nations on Occupational Fraud and Abuse concluded that businesses with fewer than 100 employees have the highest number of fraud cases.
The average (median) loss for a victim organization without anti-fraud controls was twice that of their counterparts.
Performing external audits of financial statements, implementing codes of conduct, and forming an internal audit department are a couple ways that larger organizations are able to defend themselves against fraud.
Banamex, Pemex & Oceanografia
Recently, an accounts receivable fraud scam tallied up more than $400 million of fake invoices.
The story goes like this:
- Oceanografia (an oil company) would perform services for Pemex (the Mexican state oil company) and send them a bill.
- Pemex took a while to get around to pay the bills, so Oceanografia would send bills to Banamex (Bank of Mexico) instead.
- Banamex would pay the bill and wait to be paid back when Pemex had time.
- Eventually, Oceanografia began not performing oil services but still sending bills to Banamex anyway.
- Banamex unknowingly paid fake invoices for years, extending millions of dollars in credit.
Detecting AR Fraud
Is your employee constantly debiting the wrong accounts? Are they “accidentally” misplacing or tossing statements, or billing customers at weird intervals?
There are a few things that might be at play: either your employee is really, unbelievable badly at their job, or there’s fraud taking place in your company.
Either way, an investigation is necessary to uncover what’s truly going on.
Sometimes you might get lucky and an employee unintentionally learns about the fraud, other times an audit exposes the truth, or someone reports their suspicions.
In most cases though, someone will witness a warning sign, making them suspicious and prompting action. Keep a watchful eye for these red flags that accounts receivable fraud is happening in the workplace.
Watch for excessive discounts, write-offs, voids, returns, or other modifications to accounts. These might be concealing skimmed payments.
Watch for unauthorized sales or suspicious accounts. This might be a flag that employees are creating fictitious sales and accounts.
Sudden Account Activity or Other Discrepancies
Watch for sudden activity in a slow or otherwise dead account. Abrupt increases in sales, revenue, or AR balances is definitely a sign that something out of the ordinary is going on. Keep an eye out for other forms of discrepancies, too.
Sometimes an audit isn’t possible but a quick look-through of the books might take you down a rabbit hole filled with fraud.
Listen to Your Customers
Most importantly, listen to your customers. Are they receiving wrongful non-payment notices? Did they claim to have paid in September but the payment didn’t show up until November?
Preventing AR Fraud
Every business has a weakness and a really determined fraudster can scope this out with ease.
Beat them to it by identifying your weaknesses and fixing them before it’s too late.
First, Identify Company Weaknesses
One of the biggest mistakes that any company can make is failing to segregate accounting duties.
Hiring only one person to be responsible for finances is good for the budget (especially a small business owners’ budget), but it’s bad for fraud.
An employee who is the sole contact for account holders and the books expert has a much easier time getting away with accounts receivable fraud than someone who splits their role with a colleague.
If Tom is the one-stop-shop for AR needs, no one is around to take a second look at his numbers. No one is around to communicate with the account holders and ask them how they’re doing. No one is around to notice missing checks or missing statements.
Fraud is significantly more difficult to uncover if no one is around to look for it.
Then, Fix Your Weaknesses
Pinpointing weaknesses is half the battle. Successfully preventing fraud is only possible by then correcting these weaknesses.
We recommend a multi-faceted approach to combat AR fraud (and all other types of fraud) by implementing policies, modifying internal procedures, raising awareness, training management to look for warning signs, and more.
A strong anti-fraud program can prevent all forms of company fraud. Check out these ten ways to protect your company from expense fraud.
It’s key to segregate business functions.
Separate accounting functions among multiple employees, if you can. Don’t let one employee have access to every folder, every file, every account.
Relating to AR, HHCPA recommends an adequate segregation of duties among those who: invoice customers, collect accounts receivable, authorize write-offs, independently investigate AR discrepancies, process customer service calls, open the mail, and prepare deposits.
If you have the means, implement a system where two employees must be present during key accounting tasks at all times, such as while opening mail or while invoicing customers.
Be alert to employee problems.
Employees often commit accounts receivable fraud because they’re in a hard place. As you’ll see below in “behavioral red flags” some employees who are committing fraud may be openly discussing their financial issues or relationship struggles.
Being supporting and accommodating with an employee who is going through a tough time can sometimes avoid an issue from happening at all.
An employee will be less inclined to begin stealing if their employer is willing to give them an advance on pay or some extra days off to address personal issues.
Offering a helping hand can sometimes be the solution.
Implement and enforce controls
If employees perceive that they can get away with fraud, they might be more likely to try.
Make it difficult for them. Implement an anti-theft policy, or a company code of conduct that outlines prohibited behavior.
Don’t just implement policies, enforce them. Employees won’t take them seriously if you don’t.
Make employees aware of the zero-tolerance approach to employee misconduct. Explain the consequences of actions.
Stick to careful hiring practices.
Thorough background checks are a good way to uncover the little secrets a potential employee is trying to bury. Background checks might expose a history of committing fraud or an incentive to commit fraud now.
Also, don’t overlook the importance of reaching out to references.
If they’ve given you contact information to a former boss or colleague, this person might have information you’d want to know.
Behavioral red flags
Watch for behavioral red flags.
Employee possessing a new wheeler-dealer attitude, or are they driving a Ferrari on a Civic salary?
Alternatively, have they been openly discussing financial woes or troubles at home?
Refusing to take vacation, unwillingness to share job tasks, or being unusually close with a customer (or two) are also signs that they might not want anyone to find their mess.
Education and training
Embrace awareness and training.
Educate personnel (and especially management) about accounts receivable fraud. Suggest comprehensive internal or online training about AR fraud.
The more educated and aware that employees are about this form of fraud and it’s warning signs, the more likely they’ll feel comfortable reporting any suspicions.
On that same note, let employees know how they can anonymously report fraud in the workplace. A whistleblower hotline is a good option for this, or the open-door policy.
No matter your precautions, fraudsters-to-be will find a way to make it happen.
Insurance can sometimes cover employee misconduct and minimize out-of-pocket expenses needed to right their wrongs.
Criminal Insurance protects company assets from loss due to employee dishonesty, theft, or fraud. This coverage minimizes risk for the company, its clients, and the honest employees.