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:

• Management fraud:

Asset misappropriation (i.e. theft)

• Employee fraud:

Fraudulent financial reporting

The Fraud Triangle

Perceived Pressure

OpportunityRationalization (Personal integrity)

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

Concealment

Conversion

The act itself

Cash fraud schemesFraud 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.

• Spotters and surveillance.• Alternate party to perform procedures.• Inventory comparisons.• Analyze gross profit.

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.

A/R fraud schemesFraud 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 schemesFraud 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 schemesFraud 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.

• Surveillance.• Review of fully depreciated assets.• Physical count of fixed assets.• Review of journal entries.

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.

• Review of journal entries.• Review of reconciliation between detail and GL.• Complete physical count.• Analyze capital expenditures.

A/P and Disbursement fraud schemesFraud 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.

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.

Challenge property taxes.

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