Internal Controls Part 1: How Success Can Expose You to Fraud

 
 
 

Watching their company grow by leaps and bounds, the business owners of Awesome Bigwig Company (ABC) realized they needed to expand their team fast. They found Connor Artist, a bookkeeper seeking employment, on Craigslist and decided to hire him on the spot to take over collections.

Connor, who has large amounts of credit card debt, seizes an opportunity to steal money from the company when Customer DEF mails a check for $10,000 to ABC for services performed. The receptionist gives all customer payments to Connor who forges the endorsement of ABC then endorses the check to himself, and deposits it into his own bank account. Two days later, Customer GHI submits an electronic payment of $25,000 to ABC. In the accounts receivable ledger Connor applies $10,000 of this money to Customer DEF’s balance and the remainder to GHI’s account receivable balance.

Connor’s lapping scheme effectively hides the fact that the $10,000 check was rerouted to Connor’s account—DEF’s $10,000 balance was closed by month end and GHI’s account looks like it is being paid down from the original $25,000 owed, signaling no warning signs to management. However, if Connor is not able to apply additional funds to GHI’s account, the $15,000 balance will eventually become past due. To avoid anyone uncovering Connor’s scheme, he continues to lap payments as they come in, creatively hiding his original theft. As more time passes without getting caught, Connor Artist continues to embezzle receipts and lap payments. Over the course of 6 months he steals $320,000 in customer receipts.

Red Flags and the Importance of Internal Controls

Benefits of Conducting Employee Background Checks

Connor Artist was hired from Craigslist without any prescreening or interviewing procedures. Background and reference checks are cheap and effective methods to weed out applicants. Credit checks and calls to former employers might have uncovered a history of committing fraud or an incentive to commit fraud.

Safeguard Your Business by Segregating Duties

The lapping was concealed because of inadequate segregation of duties. The individual collecting the payments should not be the same person who records the collections in the books. For smaller owned businesses it is not always easy or affordable to hire both a collections manager and an accountant. However, in ABC’s case, the receptionist is an existing employee that could have been helpful in segregating duties. Upon receiving the mail, she should have opened it, restrictively endorsed the check, and notated the customer and payment amount before giving the check to Connor. With this form of documentation, the owners would be able to sporadically compare the receipts log per the receptionist to actual customer accounts and the restrictive endorsements would have made it more difficult for Connor to deposit the check.

Mandatory Leave Can Help Reveal Fraud

Connor Artist will need to be vigilant over incoming payments and maintain a separate set of books to keep track of payments received and by whom versus what is kept on the books. Missed days from work would prove very costly to Connor. By enforcing a mandatory 2-week vacation, the system Connor has set-up cannot be maintained and the person taking over his duties may be able to uncover the deception.

Let ATKG document and assess the internal controls over your accounts receivable or other business transactions cycles and make appropriate recommendations. Contact Partner – A.J. Sturm or Manager – Ruth Olivares at 210.733.6611 or via email at ajsturm@atkgcpa.com or rolivares@atkgcpa.com.

Be sure to stay tuned for Part 2 of ATKG’s Internal Controls series.

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