THE NATURE OF EMPLOYEE FRAUD (STUDY OBJECTIVE 4)
Employee fraud is conducted by nonmanagement employees. This usually means that an employee steals cash or assets for personal gain. While there are many different kinds of employee fraud, some of the most common are as follows:
- Inventory theft. Inventory can be stolen or misdirected. This could be merchandise, raw materials, supplies, or finished goods inventory.
- Cash receipts theft. This occurs when an employee steals cash from the company. An example would be the theft of checks collected from customers.
- Accounts payable fraud. Here, the employee may submit a false invoice, create a fictitious vendor, or collect kickbacks from a vendor. A kickback is a cash payment that the vendor gives the employee in exchange for the sale; it is like a business bribe.
- Payroll fraud. This occurs when an employee submits a false or inflated time card.
- Expense account fraud. This occurs when an employee submits false travel or entertainment expenses, or charges an expense ledger account to cover the theft of cash.
Cash receipts theft is the most common type of employee fraud. It is often pulled off through a technique known as skimming, where the organization's cash is stolen before it is entered into the accounting records. This type of theft is the most difficult to discover, since there is no internal record of the cash. For example, consider the case of a ticket agent in a movie theater who accepts cash from customers and permits those customers to enter the theater without a ticket. The cash collected could be pocketed by the agent, and there would be no record of the transaction.
Fraudsters also steal the company's cash after it has been recorded in the accounting records. This practice is known as larceny. Consider an example of an employee responsible for making the bank deposit who steals the cash after it has been recorded in the accounts receivable records. This type of fraud is uncommon because the fraudster is likely to be caught, since the accounting reports provide evidence of the existence of the cash. Larceny is typically detected when the reconciliation of cash counts (to the accounts receivable or payable records) is performed or when the bank reconciliation is prepared.
In some cases, fraud may involve collusion. Collusion occurs when two or more people work together to commit a fraud. Collusion can occur between two or more employees, employees and customers, or employees and vendors. Collusion between employees within a company is the most difficult to prevent or detect because it compromises the effectiveness of internal controls. This is true because collusion can make it much easier to conduct and conceal a fraud or theft even when segregation of duties is in place. For example, if a warehouse employee were to steal inventory and an accounting clerk were to cover it up by altering the inventory records, the fraud would be difficult to detect.
A recent article described fraud investigation at Dow Chemical Company, much of which is related to detecting employee fraud. The author indicated that the most common frauds at Dow are expense report fraud, kickback schemes, and embezzlement. Dow identifies the following examples of warning signs during its fraud investigations.6
Expense Report Fraud
- Excessive amount of expenses without receipts or supporting documentation
- Handwritten rather than computer-generated receipts
- Purchases from retail establishments, including toy stores and sporting-goods stores, which may indicate personal expenses
- Excessive cash advances taken against a company credit card
- Numerous expenses under the minimal amount requiring a receipt, which is usually less than $25
Kickback Schemes
- Vendor contracts awarded without bids
- Repeated use of the same vendor
- Excessive complaints about product quality
- Invoiced prices that differ from prices listed in the contract
- Employee living beyond his/her means
- Employee not taking any vacation time
- Photocopied invoices
- Vendor address listed as a Post Office box
- Continual instances of missing inventory
Embezzlement
- Discrepancies between invoice amount and amount paid
- Invoices for unusual items, with no supporting documentation
- Unexplainable cost variances between budget and actual amounts
- Duplicate or invalid employee Social Security numbers or addresses (may indicate ghost employees)
- Inflated salaries or travel expenses