Asset Misappropriation by Fraudulent Disbursements: Occupational Fraud

  • By William Kelting, Ph. D

Fraudulent disbursements accounted for 71.1 percent of asset misappropriation fraud according to the Association of Fraud Ex-aminers (ACFE) 2002 study of occupational fraud. Cash skimming and cash larceny schemes were discussed in previous articles. This article will focus on the important area of fraudulent disbursements which are subdivided into five principal categories in the ACFE report:

Billing schemes:

The three most common billing schemes are (1) the use of shell companies, (2) duplicate or altered payments to nonaccomplice vendors, and (3) using company funds for personal items.

Many occupational fraud cases have involved situations where the perpetrator has set up a shell company which is used to submit false billings for payment. Checks are made out to the shell company, mailed to an address which is often a post office box established by the fraudster, and deposited in an account set up in the name of the shell company with the fraudster as the authorized signer on the account. Nonaccomplice vendors may be used in schemes involving duplicate payments or overpayments followed by requests to return the overpayments. The fraudster then pockets the returned check. The use of company funds for personal purchases involves purchases for the fraudster, family members, etc.

In order to minimize the opportunity for employees to carry out billing schemes, key internal control measures include the use of purchase requisitions, purchase orders and receiving reports as support for payments to vendors. Documents should be prepared carefully, reviewed and include proper authorization and should be cancelled upon payment to avoid duplicate payments. Vendor activity should be monitored for unusual patterns, addresses, names and timing and volume of orders. Lists of authorized vendors should be maintained.

Payroll schemes:

Two of the most common payroll schemes involve “ghost employees” and falsification of hours or pay rates. Ghost employee schemes involve fictitious employees and have generated the largest losses. Fictitious employees are sometimes added to the payroll or employees that have left the company remain on the payroll.

One of the more notorious cases involving ghost employees involved the Los Angeles Dodgers a few years ago. The perpetrator misappropriated substantial sums over a relatively long period of time before discovery. He also engaged in a second activity by overstating hours worked by some employees resulting in overpayment of wages. He then “split” the amount of overpayment with his accomplices. The principal reason that he was able to carry out the fraud was the fact that he had the opportunity. The fraudster had responsibility for almost every aspect of payroll, including distribution of the checks. In order to conceal the fraud, when a pay period occurred during his vacation he would return in order to process the payroll.

This is a good example of the serious problems that can result from failure to separate the duties of employees. This is a recur-rent theme throughout most of the fraudulent activities discussed in each of these articles. If possible, the duties of authorization, custody of assets, and record keeping must be assigned to different individuals.

Check tampering:

Check tampering differs from the other fraudulent disbursement schemes in that the fraudsters actually prepare or alter the checks. Check tampering usually involves forgery. In these cases, the perpetrator may forge the signature of the authorized check signer or forge an endorsement. Another common method is to alter the payee. In order to carry out check tampering the fraudster must have access to the checks. Checks should be kept in a secure location to prevent unauthorized access. Unfortunately, individuals that normally have access to checks — such as bookkeepers or accounts payable clerks — have carried out most of the check tampering frauds. One important control useful in preventing and detecting such activity is to make sure that bank reconciliations are prepared regularly and by a person(s) with no responsibility for cash record keeping for the handling of cash.

The bank reconciliations should also be reviewed by an independent person and in the case of a small business, by the owner. Indeed, the small business owner may prepare the bank reconciliation herself.

Expense reimbursements:

Expense disbursement schemes usually involve the submission of bogus or altered documents in support of a claim for reim-bursement. Four common ploys are (1) submit fictitious expenses, (2) submit overstated expenses, (3) submit personal expenses as business expenses, and (4) submit the same claims more than once. It is relatively easy to produce false receipts by using available computer programs or by simply purchasing blank receipts and completing them. Claims for reimbursement should be carefully scrutinized and approved by a responsible individual. Employee claims should be monitored for any unusual patterns or activity.

Register disbursements:

Register disbursement fraud is the least common method of perpetrating fraudulent disbursements. A reason for this may be that two of the more common methods — false refunds and false voids — are often easy to detect.

In the case of false returns, the fraudster processes a merchandise return by a customer when, in fact, no return has been made. The perpetrator then takes the amount of the refund from the register and the register tape shows that a merchandise refund has oc-curred.

A false void works much the same way. After making a sale the clerk voids the sale and takes the money from the register. The sales clerk retains the customer’s receipt and attaches it to the void slip as support for the transaction.

Both of these approaches cause a problem for the fraudster because the inventory records will now include the returned merchan-dise resulting in a difference between the actual inventory and the inventory record. An important control feature is to make sure that proper inventory records are maintained, that the records are updated on a timely basis and that periodic comparisons are made between the actual inventory on hand and the inventory record. Someone independent of responsibility for inventory custody and record keeping should do these comparisons.

A more difficult scheme to detect involves “overefunding”. In these instances, the sales clerk processes a customer refund in-volving a true return of merchandise but records the refund at a greater amount than the amount paid to the customer and pockets the difference.

The results of the ACFE study indicate that occupational fraud is a serious and growing problem. As fraud awareness increases, employers will continue to address this costly problem with expanded efforts to prevent and detect fraudulent activity.

Previous articles discussed the three key elements of occupational fraud: incentive, opportunity and rationalization. Although opportunity is probably the one element over which the employer can have the greatest impact, as discussed in the introductory article, there are important steps that can be taken to address both incentive and rationalization. These steps included careful screening of employees or prospective employees, established policies regarding expectations as to ethical behavior and the implications of unethical behavior, keeping open lines of communication with employees, establishing employee assistance plans (EAPs) and encouraging reporting of fraudulent activity through “hot lines” and other means. Opportunity is best addressed through an excellent system of internal control.

William Kelting, Ph.D. is an Associate Professor in the Department of Accounting at Plattsburgh State University of New York.

Percent of            Median

Total Cases Loss

Billing schemes                         45.5                        $160,000

Payroll schemes                        17.7                        $140,000

Check tampering                       30.2                        $140,000

Expense reimbursements        22.1                        $  60,000

Register disbursements            3.0                          $  18.000

(Note: percentages sum to more than 100 percent because some cases involved more than one type of scheme.)

You must be logged in to post a comment.