Internal fraud schemes

This is my second of three articles on fraud and focuses on common schemes employees use to steal from their employers.

The 2010 Report to the Nations on Occupational Fraud and Abuse found that almost 90 percent of all frauds fell in the generic category of “asset misappropriation.” Not surprisingly the most common asset that is “misappropriated” is cash. No surprise there but theft can also mean stealing inventory, cash like items, fixed or other assets. You should also know that the average loss from an asset misappropriation was $160,000. Once an employee discovers that it’s easy to do, the thefts will continue until it is discovered which is often too late. These are frauds against the company & its owners.

There are a lot of ways to steal cash. The most obvious is by pilfering money directly from a cash drawer or by pocketing cash payments received from customers without recording the transaction. This type of theft can be detected and minimized with a good accounting system, basic financial controls and someone other than your accountant such as a CFO who reviews your financial records regularly. This type of theft is relatively easy when no one is looking at the financials to detect irregularities.

A spin off of this scenario is the theft of cash-equivalent items that can be redeemed easily for cash or merchandise. An example of a “cash equivalent” item is a gift card that is normally purchased by a customer to give as a gift to someone else and that can be redeemed for cash or merchandise. This happened to a client several years ago who sold vouchers for travel services (including airfare, hotel stays, etc.). An employee discovered that she had ready access to the voucher inventory and could steal vouchers from the middle of the pack where the loss would not likely be discovered for some time. She had planned on leaving the company before that happened. The theft cost this client thousands of dollars. It could have been prevented with an inventory control system and routine physical audits of the stock.

A similar scam can happen with inventory. If accounting records of inventory purchases and sales are weak and if physical inventories are not conducted regularly (and also at random) to validate existing stock levels, then the scam can thrive. This can (& does) happen to all sorts of inventory, even low dollar value items. Regardless of what items are being stolen, it is a loss to the company and money out of the owner’s pocket.

Then there is the phony vendor scam. A purchasing agent will set up a dummy company over which the agent has full control. The agent then directs payments from his/her employer to that bogus company. If no one is reviewing vendor payments and validating work performed or items received before a check is issued, this scam can thrive. I have first-hand experience with an employee who hired family members (who had different last names) as contractors then authorized payments to them that were either excessive for the work performed or that was never performed in the first place.

Another way an employee can steal is by writing checks to himself / herself or to an alias he/she has created. The fraud can be easily hidden if the person who writes the checks is also the check signer and reconciles the company’s bank statements.

Here is another not-so-uncommon fraud: A company’s trusted accountant diverts money that has been set aside to pay payroll taxes to a personal bank account. The company’s accounting records will look right and the bank account can be reconciled. But, withholding and social security taxes that have been withheld from employee paychecks do not get paid to the government but, rather, are diverted to the accountant’s personal account. Eventually, the IRS will come calling but by that time the amount due will be sizeable and, to make matters worse, penalties and interest will have been added. In this particular fraud, these taxes, called ‘trust funds’, cannot be discharged in a bankruptcy and are the personal responsibility of owners and officers of the company!

I’ve even heard of employees who budget for fraud. A department head, for example, can budget for the purchase of inventory, services, supplies, capital equipment, etc. Then, at a later date order the items from a fake company he/she created. Invoices for the purchase(s) get approved because “it’s in the budget” but the items never get delivered. It can happen if no one is looking. And, no one may become suspicious if the department is operating within its budget.

In all these examples, the three conditions that make fraud possible (the fraud triangle) must exist. It also should be noted that the most common employee to commit workplace fraud is someone in accounting. Beware of the controller, accountant or bookkeeper who never takes a vacation. They may be hiding something.

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