Fraud & Cost Management
Fraud (as defined by Black’s Law Dictionary)
A generic term, embracing all of the various means which human
ingenuity can devise, and which are resorted to by one individual to
get advantage over another by false suggestions or by suppression
of truth, and includes all surprise, trickery, cunning, dissembling,
and any unfair way by which another is cheated.
Fraud categories in a business environment:
• Employee fraud:
Asset misappropriation (i.e. theft)
• Management fraud:
Fraudulent financial reporting
The Fraud Triangle
Perceived Pressure
Rationalization
(Personal integrity)
Opportunity
Perceived Pressures
Financial pressures:
•
•
Overextended on personal debt (loans, credit cards, etc.)
Divorce
•
Greed
Personal habits pressures:
•
•
Alcohol, drugs, etc.
Gambling addictions
•
Expensive relationships (i.e. extra-marital affairs)
Work-related feelings pressures:
•
•
Alcohol, drugs, etc.
Gambling addictions
•
Expensive relationships (i.e. affairs)
Integrity and Rationalization
Perhaps the most important factor in keeping a person from misappropriating assets or
committing management fraud. Although opportunities and pressures exist for fraudulent
behavior, if an individual is following a strong moral / ethical compass fraud will not be
committed.
As an office manager at YESCO, you are the eyes/ears for Division management and
YESCO officers. If you see / hear anything that leads you to question the moral / ethical
behavior of a fellow employee, either in production or the office, it is expected that you will
notify Division or Corporate leadership.
Typical rationalizations might include:
• Am only borrowing this and will return it soon.
• Nobody will get hurt.
• I’m underpaid / overworked and am underappreciated.
• It’s only temporary, until conditions improve.
Opportunities
Arise when an employee/manager perceives that he/she has arrived
at a certain “level of trust” or when internal controls are weak or
nonexistent.
Examples of conditions that provide opportunities for fraud include:
•
•
•
•
• Inadequate segregation of duties.
• Under-training on company policies/procedures.
• Rapid employee turnover.
• Absence of mandatory vacations.
No accountability.
Related party transactions.
Use of many bank accounts.
Frequent change of auditors or legal counsel
Recent Criminal Investigations in the News:
This out of Colorado City:
A guy walked into a little corner store with a shot gun and demanded all the cash from the cash drawer.
After the cashier put the cash in a bag, the robber saw a bottle of scotch that he wanted behind the
counter on the shelf. He told the cashier to put it in the bag as well, but he refused and said Because I
don't believe you are over 21." The robber said he was, but the clerk still refused to give it to him because
he didn't believe him. At this point the robber took his drivers license out of his wallet and gave it to the
clerk. The clerk looked it over, and agreed that the man was in fact over 21 and he put the scotch in the
bag. The robber then ran from the store with his loot. The cashier promptly called the police and gave the
name and address of the robber that he got off the license. They arrested the robber two hours later.
From San Francisco:
A man, wanting to rob a downtown Bank of America, walked into the branch and wrote "this iz a stikkup.
Put all your muny into this bag." While standing in line, waiting to give his note to the teller, he began to
worry that someone had seen him write the note and might call the police before he reached the teller
window. So he left the Bank of America and crossed the street to Wells Fargo. After waiting a few minutes
in line, he handed his note to the Wells Fargo teller. She read it and, surmising from his spelling errors that
he was not the sharpest tool in the shed,told him that she could not accept his stickup note because it was
written on a Bank of America deposit slip and that he would either have to fill out a Wells Fargo deposit slip
or go back to Bank of America. Looking somewhat defeated, the man said "OK" and left. The Wells Fargo
teller then called the police who arrested the man a few minutes later, as he was waiting in line back at
Bank of America.
Employee Fraud examples
•
Theft of cash by means such as diverting cash receipts, manipulating accounts receivable, cash
postings (lapping), altering bank deposits, stealing or forging checks, stealing petty cash, etc.
•
Manipulation of invoices, including fictitious or overstated vendor invoices.
•
Theft of inventory or equipment, such as by diversion of goods received or sold, or by
unauthorized scrap sales.
•
Kickbacks.
•
Credit card fraud.
•
Abuse of travel and entertainment reimbursement to include personal items.
•
Payroll schemes such as ghost employees or overstated hours.
Fraud components
The act itself
Concealment
Conversion
Cash fraud schemes
Fraud scheme
Symptoms
Detection Methods
Skimming all or part of a cash sale
• Cash sales or receipts differing
from normal or expected patterns.
• Cash deposit totals differing from
normal or expected patterns.
• Inventory discrepancies.
• Unusual amount or pattern of cash
over/short.
• Customer complaints.
• Declining gross profit.
• Destroyed cash register control
tapes or “lost” sales registers.
•
•
•
•
Theft of a daily deposit
• Cash sales or receipts differing
from normal or expected patterns.
• Cash deposit totals are different
from normal or expected patterns.
• Inventory discrepancies.
• Lack of segregation of duties.
• Differences between daily list of
receipts and deposits on bank
statement.
• Comparison of bank deposits to cash receipts
records.
• Proof of cash.
• Review of journal entries.
• Review of bank reconciliations.
“Less cash” schemes (diverting cash from a
deposit)
• “Less cash” on deposit tickets.
• “Cash sales or receipts differing
from normal or expected patterns.
• Deposits per the bank statement
that do not match the company’s copy
of deposit tickets.
• Comparison of bank deposits to cash receipt
records.
• Review bank reconciliations.
• Review journal entries.
Theft of cash on hand
• Discrepancies between the cash
count and the account balance.
• Unusual or unexpected fluctuations
in cash on hand.
• Increased use of petty cash fund.
• Surprise cash counts.
Spotters and surveillance.
Alternate party to perform procedures.
Inventory comparisons.
Analyze gross profit.
A/R fraud schemes
Fraud scheme
Symptoms
Detection Methods
Lapping (stealing a customer’s payment and
concealing the theft by applying susbequent
payments)
• Customer complaints.
• Increased, unexplained aging of
receivables balances.
• Different dates between deposits
and credits to customer accounts.
• Persons with access to cash
receipts and related records don’t
take vacations.
• Confirmations.
• Proof of cash.
• Review journal entries.
• Tracing of deposits, paying particular attention to
composition of each deposit.
False credits, discounts, and other write-offs
• Unusual or unexplained credits.
• Unusual or unauthorized discounts.
• Unusual, unexpected or
unauthorized write-offs.
•
• Confirmation.
• Proof of cash.
• Review of allowance for bad debts account (acct
2521 and 2536)
• Interviews.
Inventory fraud schemes
Fraud scheme
Symptoms
Detection Methods
Theft of inventory or scrap
• Unexpected out of stock condition.
• Excessive or unusually large
adjustments after cycle counts.
• Significant, unexplained increases
in marginal costs.
• Significant decreases in margins
•
•
•
•
•
Physical inventory counts.
Surveillance.
Review inventory detail.
Confirmation and inspection.
Analytical procedures.
Scrapping and selling good inventory
• Unexpected out of stock condition.
• Lack of separation of duties
between inventory purchasing, scrap
processing, and sale of inventory
•
•
•
•
•
Review of inventory detail.
Physical inventory counts.
Analyze scrap sales.
Analyze materials usage
Cutoff procedures
PP&E fraud schemes
Fraud scheme
Symptoms
Detection Methods
Theft of fixed assets
• Unexpected asset purchases.
• Unexpected fluctuations in balances
or depreciation accounts.
• Missing assets.
• Physical count of fixed assets.
• Surveillance.
• Review of fully depreciated assets.
• Review of reconciliation between detail and
general ledger.
• Analyze capital expenditures.
Personal use of assets
• Unexpected asset purchases.
• Missing assets.
• Unexpected changes in ancillary
accounts.
•
•
•
•
Personal capital improvements paid by the
Company
• Unusual or unexpected changes in
balance or depreciation accounts.
• Changes in lifestyle of an individual
• Physical count of fixed assets.
• Review support for CAPX
• Inspect capital improvements.
Manipulation of records to conceal other
fraud
• Unusual or unexpected changes in
balance or depreciation accounts
• Unexpected changes in ancillary
accounts.
•
•
•
•
Surveillance.
Review of fully depreciated assets.
Physical count of fixed assets.
Review of journal entries.
Review of journal entries.
Review of reconciliation between detail and GL.
Complete physical count.
Analyze capital expenditures.
A/P and Disbursement fraud schemes
Fraud scheme
Symptoms
Detection Methods
Kickbacks
• Higher than usual costs.
• Lower quality of goods / services.
• Excess goods / services.
• Vendor complaints.
• Customer complaints.
• Employee tips.
• Increase in purchases from favored
suppliers.
• Vouching and tracing.
• Review of contracts and bids.
• Review of personnel files.
• Background checks of suspected employees and
vendors.
• Interviews.
• Analyze disbursements.
False or inflated vendor invoices
• Higher than usual costs.
• Excess goods or services.
• Copies of supporting documents
instead of originals.
• Addition of unauthorized vendors
added to master vendor file.
• Any unexpected changes in A/P
balance, expenses, or disbursements
• Review vendor lists.
• Vouching and tracing.
• Confirmations.
• Review contracts and bids.
• Review personnel files.
• Background checks of suspected employees and
vendors.
• Interviews.
Excess purchasing schemes
• Higher than usual costs.
• Employee tips.
• Unexpected increase in days sales
in inventory ratio.
• Vouching and tracing.
• Background checks of suspected employees and
vendors.
• Interviews.
Duplicate payment schemes
• Copies of supporting documents
instead of originals.
• Duplicate payments
• Vouching and tracing.
• Review of personnel files.
• Background checks of suspected employees /
suppliers.
Cost Management

Controls on purchases, manage inventory, reduce overhead.

Freeze on compensation increases or reduction of salaries / bonuses.

Re-negotiate on all rent and leases – realistic expectation of 20% overall reduction from landlords.

Management approval on all expenditures over $X amount.

3 quotes on all purchase contract negotiations.

Walk through inventory with a “just in time” mentality, question/challenge all inventory levels.

Challenge property taxes.

Conserve on utilities, power off lights during the daytime, power off computers & equipment at night.

Reduce or eliminate office cleaning.

Negotiate purchase discounts with suppliers (i.e. 3% / 15 days, net 45).

Review cell phone and land line usage and hold cell phone users accountable for responsible usage.
Cost Management

Reduce insurance coverage / shop for new insurance providers.

More hours from management personnel.

Reduce hours vs. layoffs, reduction of work-week to 32 hours.

More effort in sales and marketing as sales pool is smaller.
Top 25 accounts over plan YTD