Accounts receivable is a fraudsters dream. What kind of fraud falls under the accounts receivable umbrella? Do you have the tools to detect it? To prevent it?
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.
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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.
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.
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 (now Case IQ)”, 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 the 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 a 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.
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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.
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.
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.