protecting king cash from fraud

12
I n today’s troubling economic times, many executives find themselves actively working to maintain a healthy cash position. Not sur- prisingly, most focus on minimizing cash- related expenses. How- ever, given that cash activities exist throughout an organization, cash management approaches must include protect- ing the entire cycle of cash pro- cessing. Naturally, in this envi- ronment, managers often turn a critical eye toward eliminating fraud. As Exhibit 1 indicates, this approach is reasonable for sev- eral reasons. First, reducing costs and monitoring cash inflow and outflow activities improve the bottom line. There- fore, adopting cash manage- ment approaches that involve identifying and reducing cash- related fraud is a value-added step. Second, efforts to mini- mize fraud-induced cash out- flows can easily be introduced without affecting revenues, which is a major selling point to stakeholders. Finally, protecting cash from fraud just makes plain good business sense because it provides evidence that someone is “minding the store.” This last point is particu- larly important because com- pany morale can be undermined when top managers are either caught with their hands in the cookie jar or unwittingly allow fraud schemes to exist for the benefit of others. Moreover, because cash is king, and because cash transactions per- meate all aspects of business operations, developing and implementing a framework to ensure proper cash operations boosts both worker morale and the bottom line, and is a win- ning proposition. The outcome is a sense of “esprit de corps”: a tool management can use to signal its commitment to creating and maintaining an environment where hard-fought economic strides are not under- mined by the acts of a few unscrupu- lous employees. As Burnett et al. 1 indicate, such a tool—combining the efforts of manage- ment and employees to combat bad eco- nomic times—could be the difference between success and failure. When viewed in this man- ner, collaborative cash-flow management creates two bene- fits. First, it signals that cash defalcations will not be toler- ated. In essence, word is spread that both management and fel- low employees are watching cash. Second, if it is imple- mented effectively, employees get the sense that they are work- ing with management to improve firm performance and, thus, play a part in protecting their jobs. Management can then easily typify the decision to identify and reduce cash fraud as a necessary component of an overall cost-reduction strategy that is good for all. Accordingly, the objective of this article is to provide some scenarios that are involved in cash fraud and suggest how they might be addressed. 2 In today’s troubling economic environment, many executives are scrambling to maintain a healthy cash position. But cutting cash-related expenses is only part of the solution. The authors take a comprehensive look at the different kinds of cash fraud and show you how to stop it. © 2009 Wiley Periodicals, Inc. 11 © 2009 Wiley Periodicals, Inc. Published online in Wiley InterScience (www.interscience.wiley.com). DOI 10.1002/jcaf.20541 Protecting King Cash From Fraud Royce D. Burnett, Mark Friedman, and Olga Quintana f e a t u r e a r t i c l e

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Page 1: Protecting king cash from fraud

In today’s troublingeconomic times,many executives

find themselvesactively working tomaintain a healthycash position. Not sur-prisingly, most focuson minimizing cash-related expenses. How-ever, given that cashactivities exist throughout anorganization, cash managementapproaches must include protect-ing the entire cycle of cash pro-cessing. Naturally, in this envi-ronment, managers often turn acritical eye toward eliminatingfraud.

As Exhibit 1 indicates, thisapproach is reasonable for sev-eral reasons. First, reducingcosts and monitoring cashinflow and outflow activitiesimprove the bottom line. There-fore, adopting cash manage-ment approaches that involveidentifying and reducing cash-related fraud is a value-addedstep. Second, efforts to mini-mize fraud-induced cash out-flows can easily be introducedwithout affecting revenues,which is a major selling pointto stakeholders. Finally, protecting cash from fraud justmakes plain good business

sense because it provides evidence that someone is“minding the store.”

This last point is particu-larly important because com-pany morale can be underminedwhen top managers are eithercaught with their hands in thecookie jar or unwittingly allowfraud schemes to exist for the benefit of others. Moreover,because cash is king, andbecause cash transactions per-meate all aspects of businessoperations, developing andimplementing a framework toensure proper cash operationsboosts both worker morale andthe bottom line, and is a win-ning proposition. The outcomeis a sense of “esprit de corps”:a tool management can use to signal its commitment to creating and maintaining anenvironment where hard-foughteconomic strides are not under-

mined by the acts of a few unscrupu-lous employees. As Burnett et al.1

indicate, such atool—combining theefforts of manage-ment and employeesto combat bad eco-nomic times—couldbe the difference

between success and failure.When viewed in this man-

ner, collaborative cash-flowmanagement creates two bene-fits. First, it signals that cashdefalcations will not be toler-ated. In essence, word is spreadthat both management and fel-low employees are watchingcash. Second, if it is imple-mented effectively, employeesget the sense that they are work-ing with management toimprove firm performance and,thus, play a part in protectingtheir jobs. Management can theneasily typify the decision toidentify and reduce cash fraudas a necessary component of anoverall cost-reduction strategythat is good for all. Accordingly,the objective of this article is toprovide some scenarios that areinvolved in cash fraud and suggest how they might beaddressed.2

In today’s troubling economic environment, manyexecutives are scrambling to maintain a healthycash position. But cutting cash-related expensesis only part of the solution. The authors take acomprehensive look at the different kinds of cashfraud and show you how to stop it.

© 2009 Wiley Periodicals, Inc.

11

© 2009 Wiley Periodicals, Inc.Published online in Wiley InterScience (www.interscience.wiley.com).DOI 10.1002/jcaf.20541

Protecting King Cash From Fraud

Royce D. Burnett, Mark Friedman, and Olga Quintana

featur

e artic

le

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WHY MANAGING CASH IS TOUGH

How many times have youheard of a company that has anoutstanding income statementbut is cash poor? Whilerecorded revenues may allow afirm to boast about its perfor-mance, cash allows it to operate.However, as indicated inExhibit 2, working with cashrequires some interesting obser-vations for those enlisted tomanage the process, both froma general and operational per-spective. In essence, cash isessential to managing a busi-ness, and therefore planning,organizing, directing, and con-trolling cash—both inflow andoutflow—is vital. Unfortu-nately, the very nature of cash

transactions makes this a diffi-cult task. This is the case forseveral reasons. For example,cash transactions are numerousand can defy any models devel-oped to monitor them. Also,cash-related transactions usu-ally involve several parties. Forinstance, the Marketing Depart-ment initiates and frames thecredit limits and payment termsextended to customers. Then, aSalesman, in negotiating a sale,can offer a discount on thespot. Once in-house, theReceivables Department main-tains customer files, and theTreasury Department directswhere payments are to be sent.Finally, the Accounting Depart-ment is responsible for pullingall of this interaction togetherand records and reports results.

In this maze, it takes only onedisgruntled or unethicalemployee to make a singlechange and “poof!” a cashreceipt may never reach its des-tination. Moreover, even if apayment is received, it may befor the wrong amount.

This scenario demonstratesthat cash flows can be impactedat any point along the transac-tion path by a fraud schemethat can be implemented andmaintained by just about any-one. In order to mitigate this, aframework to prevent cashfraud should be established.The first step toward develop-ing such a framework is to rec-ognize that cash fraud occursalong two dimensions: cash-theft schemes and fraudulentdisbursement schemes. Exhibit3 provides a view of fraudalong a continuum based onhow simple schemes are tooperate and the extent to whichthey involve additional or exter-nal processing. In brief, the keyattributes that differentiatethese scheme types are as follows:

• the ease with which thescheme can be established,

• the intricate nature of thescheme and its implementa-tion,

• the extent to which thescheme involves processingexternal to the firm,

• the involvement of multipleparties and the control theparties have over cashtransactions as well as other accounting subsys-tems,

• the extent to which access to funds occurs before theyhave been recorded,

• the extent to which thescheme is part of normaland ongoing transaction processing, and

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Exhibit 1

The Benefits of Monitoring Cash-Induced Fraud

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• the ease with which con-trols can be added to thenormal and ongoing pro-cessing to address thescheme.

Looking at Exhibit 3, itwould appear that cash theft is simpler to implement andrequires less reliance on a system of defalcations to per-petrate. However, fraudulentdisbursement schemes, whilemore difficult, may be easierto maintain on an ongoingbasis because they rely on thecontrols that are in place toactually commit a crime. Now,let’s look at each of the schemetypes and how they can be sub-divided. Exhibit 4 provides amatrix of some of the morecommon cash-fraud proceduresthat are available to employeesand outsiders.

CASH-THEFT SCHEMES

Cash-theft schemes are thesimplest and easiest of the two toimplement. Exhibit 5 providessome general characteristics thatone should be on the lookout forwhen trying to identifying cash-theft schemes. These schemesinvolve tasks that can bedescribed as nothing more thanoutright stealing. They are alsounique in that they usuallyinvolve an interaction with cashas it comes into the door. More-over, they can be perpetrated bya single individual with ease.Finally, their success usuallydepends on the extent actionsassociated with a cash transac-tion can be manipulated.

As indicated in Exhibit 4,cash-theft schemes fall into two categories, skimming andlarceny. Skimming refers to

activities that involve intercept-ing cash before it hits thebooks. As such, these schemesrely on actions that fall outsidenormal or regular transactionprocessing and may be moredifficult to detect because con-trols may not be in place. Lar-ceny, on the other hand, resultswhen actions are taken to ille-gally obtain funds that havebeen posted or recorded in thefinancial records of a firm.Because these schemes involvepilfering recorded assets, theyare much more likely to bedetected because checks andbalances have been established.Thus, in part, the ability to pro-ceed with cash larceny dependson the extent to which controlsare in place.

Type 1: Skimming

Skimming is the theft ofcash before it has been recordedin a firm’s financial records.One of the biggest advantages ofthis technique—at least for thescam artist—is that it may notleave a well-defined audit trailor a series of actions or transac-tions that can be investigated.Skimming is also uniquebecause it can occur at any pointalong a cash transaction cycle.While the purpose of all skim-ming scams is the same—togain access to unrecordedcash—the methods adopteddepend on the nature of thefunds targeted and the accountsthat these funds relate to. Gain-ing knowledge about the charac-ter of the funds being targetedand the reaction of these fundsto change (i.e., the possiblepresence of fraud) is an impor-tant step for management toadopt in order to control thistype of fraud. As depicted inExhibit 4, skimming schemestarget either sales or receivables.

The Journal of Corporate Accounting & Finance / November/December 2009 13

© 2009 Wiley Periodicals, Inc. DOI 10.1002/jcaf

Tasks to Consider Before Attacking Cash Management

Management

Perspective Observation

General Issue • Cash is essential to managing a business.

General Issue • The nature of cash transactions makes managing cash difficult.

Operational Issue • Cash transactions are numerous.

Operational Issue • Cash transactions involve several parties:• Assess the role of Marketing.• Assess the role of Sales.• Assess the role of Treasury.• Assess the role of Accounting.

Operational Issue • Disgruntled employees can create a fertile ground for cash fraud.

Operational Issue • Understand how cash fraud can be implemented.

Operational Issue • Recognize the fraud frameworks:• cash theft and• fraudulent disbursements.

Exhibit 2

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Sales Skimming: Transaction-Oriented Theft

Sales skimming involves themanipulation of the link betweena sale and the ultimate receipt ofcash related to the sale. Thisactivity may be hard to track.The most common examples ofsales skimming include:

• onsite theft: mailroom,• onsite theft: sales transac-

tions,• remote employee manipula-

tion, and• after-hours activity.

Theft in the Mailroom.Mailroom theft occurs whenemployees pocket incomingchecks rather than processingthem. This is most prevalentwhen there is a lack of separa-tion of duties or when only oneperson is responsible for receiv-ing, opening, and distributingincoming mail. While a lack of

separation of duties may exist ina large firm because of sheervolume or in a small firmbecause of economics, severalactions can be adopted to controlfor this type of skimming activ-ity in either environment. Forinstance, in small firms wherefraud is almost invited because itis almost certain that one personis likely to be responsible forseveral tasks related to cash,mail processing could be mademore visible and interactive,with maybe the receptionist pro-cessing all of the mail. Also, forboth small and large firms, asimple camera system could beinstalled to monitor employeeactivities. Another good idea foreither type of firm is to establishstrict mailroom processing pro-cedures relative to the receipt ofchecks. For example, a firmcould require that the receipt ofa check be recorded—in ink—with an understanding that the

log will be used as part of theaudit process. Two results willemerge from this approach. First,documentation will exist thatwill provide a cross-reference tothe amount, timing, and accu-racy of the cash receiptsrecorded in the financial records.Second, employees will be puton notice that the flow of cash isbeing monitored and, thus, coulddiscourage them from the temp-tation to be involved in fraud.

Sales Transactions. Thistype is often initiated via theuse of a cash register and pro-vides another ample opportu-nity to disconnect a sale fromits cash receipt. Understandinghow these schemes work isimportant because they mayhelp both large and small firmsdesign better fraud-detectionsystems for all types of cashtransactions. Theft at the cashregister involves an employeediverting the cash receivedfrom a sale. For instance,employees might ring up a “nosale” to reflect the transaction.Another way is to record fraud-ulent refunds, voids, or the useof a “rogue” cash register thatdoes not feed transactions intothe accounting system.

Sales transaction fraud isbest dealt with by addressing afew areas. For instance, it mightbe a good idea to determine ifyou and others around youunderstand the need for andimpact of verification and segre-gation controls related to cash-register point of sales. Some ofthe issues that might lead to youranalysis of these issues are thelevel of sales involved and theextent to which employees areable to override authorizationsimposed by the processing sys-tem. Next, search for evidence oftampering with cash sales via thecash register. Items that maypoint to a problem include: actual

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DOI 10.1002/jcaf © 2009 Wiley Periodicals, Inc.

The Continuum of the Characteristics of Cash Fraud—Simple

to Intricate

Cash Fraudulent

Theft Transactions

Characteristic (Simple) (Intricate)

• Easily established �

• Involves intricate implementation �

• Involves possible external processing �

• Involves possible multiple parties �

• Gains access to funds before they are recorded �

• Involves normal or ongoing transaction processing �

• Controls can be easily adapted to address scheme � �

Exhibit 3

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inventory levels lower than thesales activity indicate; gaps inreceipt numbering schemes; andmissing and unaccounted forregister tapes. Finally, once youhave decided that controls arewarranted, then you shoulddecide on which controls youneed. Several procedures can beimplemented. They include:depositing cash receipts daily;promptly reconciling cash tosales receipts after each shift;the use of recording devices thatcapture employee activities; and,probably most important, devel-oping a sound segregation ofduties.

Remote Employee Manipu-lation and After-Hours Activity.Remote employee manipulation

and after-hours activity involvedefalcations occurring eitheraway from a primary place ofbusiness or outside of normalbusiness hours. In addition, theyare promoted because of a lackof direct supervision. Forinstance, employees operating atremote sites can offer cash dealsfor work that normally would becharged to the firm. In addition,they might be able to chargehigher prices for services andpocket the difference. After-hours activity is primarily theresult of employees conductingactivity (i.e., selling merchan-dise or rendering services) ontheir own time without theknowledge of their supervisors.In doing so, the employee

merely pockets the unrecordedincome.

While this type of cashfraud can be hard to detect,especially in the age of 24-hoursales processing, there are somemethods you might want to con-sider. For example, you mightwant to monitor employee use ofcompany equipment and recon-cile that use with work ordersand billings. Moreover, youmight want to expand yourreviews to the use of e-mailaccounts and laptops to ensurethat all communications con-ducted by an employee relate tolegitimate and recorded businesstransactions. In addition, youmight want to conduct periodicaudits of contracts and make

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© 2009 Wiley Periodicals, Inc. DOI 10.1002/jcaf

The Cash-Fraud Opportunity Matrix

Exhibit 4

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surprise visits with customers toensure what has been billed andpaid agrees with the contract.Finally, you might want to tagalong with a representative toremote locations to see howbusiness is handled.

Receivables Skimming: Theft Afterthe Fact

Skimming receivables ismore difficult than skimmingsales. This is because the moneythat is associated with a receiv-able is expected to be deposited.The trick related to skimmingreceivables is to develop a wayto hide the theft: the employeehas to take time to figure outhow to cover up the disconnectbetween the recorded (antici-pated) activity and the theft.This is an especially important

aspect of the scheme because toensure the success of the defal-cation, the scam artist has tooften incorporate the destruc-tion of records, good and bad.Therefore, the challenge formanagement is to develop waysthat will highlight when a thefthas occurred and to establishcontrols that will prevent thescam artist from hiding his/heractions.

The most common types ofreceivable skimming are:

• lapping, and• fraudulent write-offs

Lapping. Lapping is themost common receivable skim-ming tool and is most easily car-ried out when an employee whoreceives collections is also

responsible for recording thereceipts. Remember that skim-ming receivables requires thatthe displacement of money beaccounted for. Lapping falls trueto form with respect to salesskimming in that it involves tak-ing the cash from one receivableand using it to cover the theft ofcash related to another receiv-able. For instance, say that thescam artist stole $200 from thecash receipt of receivable A.He/she may have the cash, butthe receivable balance still needsto be reduced or the customerwill complain if a late notice isreceived. Therefore, when thecash receipt of $500 related toreceivable B arrives, $200 of thatpayment is used to reduce thebalance of receivable A. Subse-quent receipts will then be used

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The Signs of Possible Cash Theft

Question Condition

You might want to investigate ✓ Mailroom processing has no evidence of a segregation of duties.for cash theft when: ✓ Checks are not properly recorded when received.

✓ There is no real tracking of sales voids or discounts given at the point of sale.

✓ Cash registers can be substituted or allowed to enter the sales transaction process without authorization.

✓ Inventory and sales amounts do not agree.

✓ Sales are allowed after hours and at remote locations.

✓ Employees involved in sales and cash activities do not take vacations or sick time.

✓ Bad debts and allowances are high.

✓ Deposits in transit are numerous and remain on the books for long periods of time.

✓ Variations in deposit activity occur on a frequent basis.

✓ There is an increase in accounts payable aging.

✓ There is an increase in customer account address changes.

✓ There is an increase in the incidence of unusual cash journal entries.

Exhibit 5

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to cover the balance of receiv-able B, and the cycle continues.Due to the nature of this scheme,it can get pretty complicated. Assuch, management should be onthe lookout for signs that theyexist. These signs include anincrease in accounts receivableaging; an increase in the billingto collection time frame; and fre-quent address changes. Directtests can also be implemented todetect the presence of lapping.These include confirmingaccounts receivable balances andwrite-offs; authenticatingdeposit slips; a comparisonof monthly statements tocustomer accounts; andmandatory vacations.

Fraudulent Write-Offs. Fraudulent write-offsinvolve the inappropriateremoval of a valid receiv-able. This is usually doneto facilitate the illegitimateor misdirected collection ofcash related to the receiv-able. The main issue with thistype of technique is that thefraud might not be detected viaregular channels because thereceivable has been removedfrom the books, and therefore,there is no payment that isexpected. However, there aresome signals that can point tothe possibility that the schememay exist. Specifically, anincrease in the level of bad debtor discounts and allowances maysuggest something is not right.An investigation of theseaccounts would include discus-sions with sales, inventory, andmarketing personnel.

Type 2: Larceny

As depicted in Exhibit 4, theother common type of cash theftis larceny: the intentional takingof firm cash without consent.This cash scheme differs from

skimming along a simple dimen-sion: larceny involves stealingcash that is already recorded onthe firm’s books. Symptoms thatmight lead one to believe larcenyexists include cash sales ordeposits suddenly differing fromnormal or expected patterns;inventory variances; unusualcash-related journal entries; andan excess incidence of voidedsales.

Comparatively, larceny isless common and less costlythan skimming. In addition, it is

more likely to be detectedbecause the actions involvedleave an audit trail. A simpleexample makes this point appar-ent. Suppose, for example, that acash payment is received andincluded as part of a bankdeposit slip. Moreover, supposethat the amount reflected on thedeposit slip has also beenincluded in the general ledger aspart of the daily journal entryprocess. If, however, some or allof the cash is removed by anemployee before it reaches thebank, cash larceny occurs. How-ever, because the deposit hasbeen recorded on the books forthe full amount, a problem willarise for the scam artist: how toaccount for the difference in thefunds deposited and the amountrecorded on the deposit slip andthe general ledger. The real keyfor the scam is to prevent itsdetection.

As you can see, a lot morethought and planning goes intoimplementing cash larceny.Thus, it is important that man-agers be aware of the schemeand how it can be addressed.Here are a few tips that mayhelp. In brief, the scheme is usu-ally associated with activitiesrelated to thefts from incomingcash and deposits. They are oftenfacilitated through the use offalse refunds and the destructionand manipulation of source doc-uments (i.e., deposit slips and

receivables schedules).Moreover, the accountingsystem can often be usedto conceal larceny activity.For instance, missingmoney can simply bereflected as deposits intransit.

There are several mea-sures that can be adopted tocounter larceny. The mostimportant is to establish aneffective segregation of

duties related to cash receipts,counts, deposits, recording, andreconciliation. Other controlsinclude surprise cash counts, acomplete review of cash-relatedjournal entries, and expandedreviews of bank reconciliationswith a focus on the existence ofdeposits in transit and their timing.

FRAUDULENT DISBURSEMENTSCHEMES

Targeting cash is one of thesimplest approaches for a scamartist. As denoted above, cashschemes focus on the relativeease with which cash can beaccessed and transactions asso-ciated with it can be manipu-lated. The key agenda underthese schemes is to get in andget out with very little audittrail or business activity disrup-tion. Moreover, these schemesrarely involve more than one

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© 2009 Wiley Periodicals, Inc. DOI 10.1002/jcaf

Fraudulent write-offs involve theinappropriate removal of a validreceivable. This is usually done tofacilitate the illegitimate or misdi-rected collection of cash related tothe receivable.

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accounting subsystem so thatany defalcations employed areconducted under the directionor control of a single individ-ual. Thus, the discovery of cash schemes depends on theextent to which the actions ofan individual come underscrutiny.

Fraudulent disbursementschemes involve the disburse-ment of funds for unintended orfictitious purposes. For exam-ple, they often reflect a paymentmade that is not related to anyobligation of a firm. The key tothese schemes is to provide con-vincing evidence that money isowed. Thus, these schemes areunique and, in a way, morecompelling than cash-theftschemes because they mostoften rely on the generation anduse of false information to pil-fer cash. In addition, most oftenthey rely extensively on normalprocessing to ensure their suc-cess: they simply introduce baddata into a good system to

create a defalcation or improperrerouting of cash.

As Exhibit 6 illustrates, thereare several warning signs that oneshould look for when trying todecide if a company is at risk forfraudulent schemes. One canreadily see that fraudulent dis-bursement schemes differ fromcash schemes in several ways.First, fraudulent disbursementschemes actually rely on theaccurate processing of severalaccounting subsystems (i.e., pay-roll, billing, receivables, inven-tory, etc.) to be successful. Indoing so, the schemes can accessand remove funds in whatappears to be normal processing.Second, fraudulent schemes,unlike cash schemes, embraceand depend on the use of docu-mentation. However, the docu-ments used in a disbursementscheme are almost always bogusor counterfeit. Third, theseschemes are often associated withtransactions that are routine,occur frequently, and display

disbursement-level patterns that fluctuate. As such, they defyefforts to create patterns orbenchmarks useful for tracking.For example, it is not uncommonfor these types of schemes to beprevalent in payroll because ofthe constant and ever-changingactivity associated with the hiringand firing of employees or travelreimbursement processing whereemployee expenses can vary withlittle explanation. Finally, becauseof the need for these schemes torely on the interrelationships thatexist between the accounting sub-systems, they are invariably initi-ated and maintained by personnelin the Accounting Department.As such, these schemes pose anadditional threat for a firmbecause an accountant motivatedto conceal wrongdoing could cre-ate all types of false entries tocover his/her tracks. The result:the real possibility of incorrectfinancial statements.

Because of these issues,fraudulent disbursement schemes

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The Signs of Possible Fraudulent Disbursements

Question Condition

You might want to investigate for ✓ Several accounting subsystems are under the control of a single individualfraudulent disbursements when: (lack of segregation of duties).

✓ Bogus documentation (invoices, bills, etc.) can be easily re-created.

✓ Valid documentation is not required for reimbursement.

✓ Routine transactions do not follow a general pattern of disbursement.

✓ Routine transactions do not have established disbursement levels.

✓ Employee records related to hiring and firing are not updated on a regular basis.

✓ Vendor files are not updated on a regular basis.

✓ There is a high volume of manual checks.

✓ Changes in how payments are made are on the increase.

✓ An increase in the use of post office boxes for payment is experienced.

Exhibit 6

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require special attention anddirection from a manager. How-ever, a real key for the manageris to understand how theschemes emerge and the extentto which controls can be put inplace to identify and mitigate theimpact of these schemes on cashflow. Indeed, fraudulent schemescan exist in multitudes. However,in order to provide some basicinsight about these schemes andhow they might affect a firm, wehave chosen to discuss some ofthe most common. In doing so,we offer some direction on how fraudulent schemes, ingeneral, can be identified.

The schemes presentedin Exhibit 4 and discussedhere are:

• billing,• payroll, and• expense reimburse-

ment.

Billing schemes are aclear example of fraudulent dis-bursement schemes in that theyintroduce bogus or counterfeitdocumentation into the account-ing system to steal funds. Indoing so, the system accuratelyprocesses a bogus transaction asif it were legitimate. Billingschemes can use twoapproaches. The most commonbilling schemes involve a currentvendor where the scam artistsimply submits a regular invoice;in essence, they make use ofexisting vendors or companyfiles. Under this scenario, theamount being invoiced is mostlikely to be similar to theamounts billed in the past. Thereal astute current vendor-usescheme might be savvy enoughto include vendor approvals ornames of contacts that are rou-tinely used. The only differencein this instance would be achange in mailing address or

mode of payment. However,because of the routine nature ofthese transactions, discovery ofsuch simple changes might bedelayed until after payment hasbeen made. The result: the scamartist merely grabs a checkbefore it is mailed or retrieves itfrom the fraudulent location.

These billing schemes canbe mitigated in several ways. Forexample, access to vendor filesshould be protected and proce-dures developed to highlightchanges in such important mark-ers as address and name. In

addition, it is important to moni-tor the number of checks beingwritten to a vendor; an excessivenumber should be investigated.Also, to prevent unauthorizedaccess to cash, all checks shouldbe mailed immediately. However,before doing so, it might be agood idea to sort checks by ven-dor name to detect more thanone address for a vendor.

Billing schemes might alsoinvolve a shell company. In thisinstance, fraud is being commit-ted using firms created solely toperpetuate fraudulent activity.Some of the characteristics of ashell company scheme are asfollows. First, most exist only onpaper. Second, they usuallyinvoice for services renderedrather than goods purchased,making confirmation of a pur-chase transaction harder to ver-ify. Third, payment usually isdirected to a post office box.

Finally, approval of shell com-pany invoices is often tracedback to those who created themand rely on the presence of col-lusion.

Shell company schemes canbe detected. Probably the mosteffective steps to adopt are tolook closely at invoices to ensurethat they include detail. No mat-ter how good a scam artist maybe, he may not know or haveaccess to all of the informationnecessary for a “perfect”invoice. Next, if you are uncom-fortable with the vendor, look

for evidence that it exists.For example, look it up inthe phone book or Googlefor an address. Finally, justdelay payment and wait foran inquiry.

The next type ofbilling scheme that occurscommonly in businessrelates to payments toemployees for servicesrendered. Payroll schemes

rely on the ability to create andmaintain a false employee inthe system. As such, paymentsare being made for wages notearned. The signs of payrollfraud include unusual fluctua-tions in payroll expense, a highvolume of manual checks,changes in employee addressesand/or methods of payment(direct deposit to mailing) forcurrent employees, and anincrease in the use of postoffice boxes as payment loca-tions for the newly hired. Thekey to these schemes is a lackof control over the addition andtermination of employees. Thisis an important componentbecause a lack of control inpayroll would allow fictitiousnew employees to be added andterminated employees toremain.

Two common payrollschemes are included in Exhibit 4:

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© 2009 Wiley Periodicals, Inc. DOI 10.1002/jcaf

The most common billing schemesinvolve a current vendor where thescam artist simply submits a regularinvoice; in essence, they make use ofexisting vendors or company files.

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ghost employee and falsifiedsalary. Ghost employee schemesinvolve payments to individualswho are not employees. Thisscheme relies on the ability ofthe scam artist to set theemployee up and maintain timereporting. In the short run, evi-dence of a ghost employeeincludes the lack of proper docu-mentation in the files, missingSocial Security numbers, andincorrect and mismatched pay-roll tax deductions. Evidence ofthe long-term use of ghostemployees includes a lack ofvacation or sick leave.

The second payroll schemeis falsified salary schemes,which involve the intentionalmisreporting of time worked

with the intent to defraud afirm of wages income. This isprimarily related to hourlyemployees who are paid basedon time. To be effective, thisscheme requires interactionsbetween recording and report-ing time. One of the most effec-tive tools to mitigate thisscheme is to implement dualreporting (i.e., have theemployee and the managermaintain a record of signing inand signing out and developinga process that reconciles thetwo). Consistent variationshould be investigated.

The last fraudulent schemepresented in Exhibit 4 relates toreimbursements and involves theinflation of expenses that are

perceived as ordinary and cus-tomary relative to travel andother business development–related expenditures. Becausethe level of these expenses differs so wildly, developing abenchmark for trending purposesmay be difficult. Therefore, evenwhen caps on expenditure levelsin this area are imposed, there isstill the very real possibility thatpadding is present. Examples ofthe types of issues that couldarise in this area include: charg-ing for personal items; billingfor services that never occurred;inflating mileage; taking standard nonsupported mealallowances when the cost ofthese meals was paid for by others; and reflecting charges

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Exhibit 7

The Layers of Cash Protection

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made using a personal creditcard that were subsequentlycredited back to the cardholder.These issues can be controlledby issuing company credit cards,requiring documentation, andperforming spot audits on travelactivities, with a particularemphasis on questioning routineor customary charges. Theseactivities will put employees onnotice that travel expendituresare not part of a slush fund andwill be investigated.

PROTECTING KING CASH

As cash becomes more of anissue in this new resource-con-strained environment, the pru-dent manager would be wise toaddress all aspects of businessactivity to search for and iden-

tify improvements in cash flow.By adding a review of cash fraudto these activities, managers canaccomplish two things. First, inthe immediate sense, sources ofcash and/or the reduction ofunnecessary outflows willemerge. However, it is the long-run impact that may be morebeneficial. Specifically, by lay-ing a foundation that fraud willnot be tolerated, managementindicates that it is serious aboutimproving the integrity of theorganization.

Second, by soliciting andinviting employees to becomeinvolved, management is allowingthem to participate in not onlycost savings and cash-flow man-agement but also, in a very bigway, allowing employees toshape how the firm works. In

these uncertain employmenttimes, this could be interpreted byemployees that they have beengiven an active role in reducingcosts and, possibly, saving theirjobs. Exhibit 7 demonstrates justhow this interaction can be con-structed within a cash manage-ment profile, and Exhibit 8 pro-vides a list of the controls thatcould be implemented underthis interaction. As indicated,access to cash is protected bylayers of checks and balancesconstructed by management andemployees. Then, together,employees and managementdecide how to implement theiractions via a framework of con-trols that will protect cash fromtheft. Thus, both managementand employees have a new set offiscal responsibilities. How well

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© 2009 Wiley Periodicals, Inc. DOI 10.1002/jcaf

Controls Against Cash Fraud: The Emperor’s New Clothes

Question Condition

What types of controls are ✓ Ensure segregation of duties.available to address cash fraud? ✓ Record cash activity in multiple ways and reconcile approaches adopted

on a regular basis.

✓ Deposit cash receipts on a timely basis.

✓ Mail checks promptly.

✓ Monitor point-of-sale transactions.

✓ Evaluate after-hours and offsite sales.

✓ Confirm accounts receivable balances and processing.

✓ Evaluate deposits in transit.

✓ Verify and protect vendor files.

✓ Verify and protect sales customer files.

✓ Verify and protect employee files.

✓ Review travel logs.

✓ Evaluate bad debt and allowances.

✓ Review all cash journal entries.

Exhibit 8

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do they work? Take the chal-lenge and try them out. Youmight be surprised with somenewfound cash. Good luck!

NOTES

1. Burnett, R., Friedel, A., & Friedman, M. (2009). The bad economy: Why you

need more IT security now. Journal ofCorporate Accounting and Finance, 20, 41–48.

2. This article provides a general overviewof cash fraud and its components. For amore in-depth review of this issue, werecommend four sources. The first threeare books: Singleton, T. W., Singleton,A. J., Bologna, G. J., & Linquist, R. J. (2006). Fraud auditing and

forensic accounting (3rd ed.). Hoboken, NJ: Wiley; McMillian, E. J. (2006). Preventing fraud in nonprofit organizations. Hoboken, NJ: Wiley; and Wells, J. T. (2005). Principles of fraud examination. Hoboken, NJ: Wiley. The fourth reference is the Association of Fraud Examiners Web site, which can be found at http://www.acfe.com.

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Royce D. Burnett, PhD, CPA, CMA, is an assistant professor of accounting in the School of Business atSouthern Illinois University Carbondale (SIUC). At SIUC, Professor Burnett teaches cost and managementaccounting at both the undergraduate and graduate levels. Prior to a career in academia, Professor Burnettwas employed in the business sector, where he held positions with Ernst and Young, Pricewaterhouse-Coopers, Electronic Data Systems, General Motors, and BP Amoco. Positions held include staff and seniorauditor, financial analyst, system analyst, policy analyst, manager of general accounting, and manager ofstrategic planning and budgeting. In addition to working for corporate America, Professor Burnett estab-lished and ran a successful CPA practice that focused on nonprofit management. Mark Friedman, PhD,CPA, is an associate professor of accounting at the University of Miami, Florida. Dr. Friedman teachesaccounting information systems, managerial accounting, and financial accounting at both the undergrad-uate and graduate levels. He is past president of the Miami Chapter of the Institute of Management Accoun-tants and past chairman of the Dade County Chapter of the Florida Institute of Certified Public Accountants’committee on microcomputer applications. Dr. Friedman has created several Internet-based Excel, self-grading, randomly generated case studies that are currently used in financial and managerial courses. Dr.Friedman consults with several firms relative to the use of the microcomputer as a problem-solving tool.Olga Quintana, DBA, CPA, is an associate professor of accounting in the School of Business at the Univer-sity of Miami, Florida. Professor Quintana teaches financial accounting and cost and management account-ing. Professor Quintana has served as a consultant in various countries in Central America, South America,and the Middle East.

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