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FRAUD
What's Your Fraud IQ?
BY ANDI MCNEAL, CPA, CFE
SEPTEMBER 2009
Placing a sizable amount of trust in staff members is part of the cost of doing business. Trusting workers
with access to information, products, vendors and funds is necessary to run an effective and efficient
operation. But some employees—when faced with sufficient pressure, a perceived opportunity, and the
ability to rationalize a criminal act—will take advantage of that trust and defraud their employers.
How well do you know the signs and symptoms of employee embezzlement? Do you know what to do
when you suspect an employee is stealing? Take this quiz to gauge your knowledge of the red flags and
investigative methods for internal fraud.
1. Which of the following fraud schemes generally does not leave an audit trail and, consequently, is
among the hardest to detect?
a. Sales skimming
b. False billing
c. Check tampering
d. Inventory theft
2. The employee hotline for Aspiring Inc. received an anonymous call alleging that several employees are
receiving kickbacks from a local vendor. Management has decided to launch a formal investigation into
the allegations. Who should be primarily responsible for directing the fraud examination?
a. The head of the company’s security department
b. The partner of the company’s external audit firm
c. The company’s legal counsel
d. The company’s human resources manager
3. Charlotte Grey, CPA, is conducting the annual audit of XYZ Corp.’s financial statements. While
performing the yearend inventory procedures, she notices that several inventory items are regularly
purchased at prices above the industry standard. These same items are also frequently purchased well
before the typical reorder point and are, therefore, consistently overstocked. She notes that XYZ has
recently changed vendors for these items, and she can’t locate the new vendor on the company’s
approved vendor list. Which of the following fraud schemes might these findings indicate is occurring?
a. Inventory theft
b. Asset overvaluation
c. Bribery
d. Lapping
4. Thoroughly examining canceled checks that are returned with the bank statement and reviewing
vendor complaints regarding nonpayment are both proactive tests that can help detect:
a. Shell company schemes
b. Forged endorsement schemes
c. Skimming schemes
d. Fictitious refund schemes
5. Lincoln Bartuska is investigating some suspicious activity at ZX & Co., a regional office supply store. As
part of his investigation, Bartuska compared inventory adjustments to refund transactions by employees.
He also looked for any sales transactions where the sale was posted to one credit card and a refund was
posted to another credit card. What type of scheme is Bartuska most likely looking for?
a. Cash larceny
b. Inventory theft
c. Credit card skimming
d. Fictitious refunds
6. Which of the following may be a sign that an organization is being victimized by a falsified hours
scheme?
a. Several employees appear on the personnel employee roster but are not on the most recent payroll
check list.
b. The payroll expenses for the company unexpectedly exceed budgeted projections and prior years’
totals.
c. One employee consistently submits more requests for expense reimbursements than all other
employees within the department.
d. The FICA tax withheld on several employees’ paychecks does not equal 7.65% of the employees’
gross pay.
7. When returning a stapler he borrowed from a co-worker, Johannes Kiebler noticed a notebook on the
coworker’s desk that contained what appeared to be a second set of accounts receivable records. Kiebler
managed to quickly read among the scribbles: “Sept. 2, Customer Q, $3,200,” “Sept. 3, Customer R,
$2,900,” and “Sept. 5, Customer S, $2,650—need $2,400.” What type of scheme did Kiebler most likely
catch the co-worker perpetrating?
a. Lapping
b. Kiting
c. Altered payee
d. Falsified billing
8. An unexplained increase in bad debt expense can be a red flag that an employee is stealing inventory
from the company warehouse.
a. True
b. False
9. Which of the following might be a warning sign of a shell company scheme?
a. A vendor that is not listed in the phone book
b. An unexpected and significant increase in “consulting expenses”
c. Invoices lacking details of the items purchased
d. All of the above
10. Gerri Alderman is an internal auditor for Steen Corp. She ran a report that listed payments to
employees for business expenses that occurred while the employee was on vacation. What type of fraud
scheme is Alderman most likely to find?
a. Petty cash larceny
b. Concealed expenses
c. Mischaracterized expense reimbursement
d. Falsified salary
ANSWERS
1. (a) Skimming is the theft of an organization’s cash receipts before they are entered into the accounting
system. In a sales skimming scheme, the fraudster collects the customer’s payment at the point of sale,
but simply pockets the money without recording the sale or the payment. Because no entry is made on
the victim organization’s books, there is no direct audit trail of the transaction. In many cases, indirect
evidence—such as inventory shortages or lower-than-expected sales—provides the only indication that
the fraud has occurred.
2. (c) An investigation into alleged employee theft is a minefield of legal pitfalls. Without proper guidance,
investigators can run afoul of issues such as employee privacy and wrongful termination. Therefore, in
most situations, investigations should be headed up by legal counsel who can provide clear professional
guidance on these issues. Additionally, allowing an attorney to direct the investigation may allow any
collected evidence to be protected under the attorney-client privilege.
3. (c) The combination of findings that Charlotte Grey discovered could indicate that a bribery scheme is
occurring. For example, one of XYZ’s purchasing agents may be accepting bribes for diverting orders for
these inventory items to a new vendor—one that has not been through the company’s usual vetting
process. The vendor would likely charge an inflated price for the items to cover the amount of the
kickbacks paid to the purchasing agent. Additionally, the bribery scheme might explain the overstocked
quantity of the goods on hand, as both the purchasing agent and the vendor may push through excessive
purchases to increase their take from the scam.
4. (b) Forged endorsement schemes are a form of check tampering in which an employee intercepts a
company check intended for another party, fraudulently endorses the check, and uses it for his or her own
benefit. Checks that have been pilfered as part of a forged endorsement scheme may have dual
endorsements or obviously forged endorsements on the back. Consequently, the employee who
reconciles the bank statement should be required to thoroughly examine and compare the front and back
of canceled checks for any signs of manipulation or forgery. Additionally, if a fraudster misappropriates a
check payable to a vendor, the vendor will likely complain about the company’s nonpayment. Reviewing
complaints of this nature from vendors may help uncover a forged endorsement scheme.
5. (d) Fictitious refund schemes occur when an employee processes a fake refund transaction as if a
customer were returning previously purchased merchandise and then pockets the amount of the refund.
Several tests can be used to detect this type of scheme, including:
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Searching for a large number of refunds just below the management review amount.
Searching for customer sales and related refunds that occurred on the same day.
Comparing inventory adjustments to refund transactions by employee.
Identifying sales posted to one credit card with related refunds posted to another card.
Extracting the names of all employees who can post both refunds and inventory adjustments.
Placing random customer service calls to customers who have returned merchandise to verify
that the return transaction was valid.
6. (b) The most common method of payroll abuse involves submitting claims for excess compensation.
Without attentive oversight, hourly employees can simply falsify the amount of hours reported to increase
the size of their paycheck. One of the biggest resulting red flags is payroll expenses—for an employee, a
department, or the company as a whole—that are higher than expected. Other warning signs of such
schemes include excessive overtime claims for an employee or department, inconsistent net payroll
check amounts for salaried employees, and timecards that contain unexplained alterations, errors or
discrepancies.
7. (a) During a lapping scheme, the perpetrator embezzles money from one customer’s incoming
payment, then attempts to cover that payment with later receipts from other customers. The misapplied
payments must then be covered with other subsequent receipts, creating a snowball effect. As Kiebler
observed, lapping schemes can become so onerous to keep up with that the perpetrator may create a
second set of books to maintain the fraud. To end the escalating confusion, the perpetrator must
eventually either make restitution or create a journal entry to adjust the affected accounts receivable
balances for the shortfall.
8. (a) To cover the theft of inventory from the company’s warehouse, some perpetrators will record
fictitious sales of the missing merchandise on the company books. Of course, this results in accounts
receivable due from customers who did not receive any goods, and who will therefore not pay for these
transactions. To keep the fake sales from coming to light, the perpetrator must then either cancel the fake
sales or write them off as bad debts.
9. (d) A shell company is a fictitious vendor created by a fraudster for the sole purpose of generating false
payments from the victim organization. Many shell company schemes are perpetrated using nothing more
than a company name and a printed invoice template. Red flags that an employee is using a shell
company to defraud the organization include vendor invoices lacking details—such as phone number,
invoice number or information about the items purchased—and invoices from a vendor that is not on the
approved vendor list, has no record of a physical address, or is not listed in the phone book.
Additionally, shell company schemes frequently involve the purchase of fictitious services, such as
consulting or administrative services, as these purchases are less verifiable than purchases of goods.
Consequently, unexpected and significant increases in these types of expense accounts may be
indicative of a fraudulent billing scheme.
10. (c) Most companies reimburse employees for business-related travel expenses, such as
transportation, lodging and meals. Dishonest employees may take advantage of this policy by requesting
reimbursement for expenses that were incurred during a personal trip and claiming that the travel was for
a business purpose. However, searching expense reimbursement claims for costs incurred during the
same period an employee was on vacation can help identify mischaracterized expense reimbursement
schemes.
Andi McNeal (amcneal@acfe.com) is research manager for the Association of Certified Fraud
Examiners.
AICPA RESOURCES
JofA articles
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“What’s Your Fraud IQ?” May 09, page 52
“What Is Your Fraud IQ?” Dec. 07, page 56
“What Is Your Fraud IQ?” May 07, page 64
“What’s Your Fraud IQ?” July 06, page 86
Past articles are available at journalofaccountancy.com. In the search box, click “Open Advanced Search”
and then search by title.
OTHER RESOURCES
Association of Certified Fraud Examiners
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Association of Certified Fraud Examiners Fraud Resources, acfe.com/resources/resources.asp
2008 Report to the Nation on Occupational Fraud & Abuse, acfe.com/documents/2008-rttn.pdf
Occupational Fraud: A Study of the Impact of an Economic Recession,
acfe.com/documents/occupational-fraud.pdf