CPAs Can Help Prevent, Find Occupational Fraud (Jerry E. Spratt Commentary)

“Occupational fraud” is the intentional misappropriation or improper use of an organization’s assets by an employee. Is prevention difficult? No.

Organizations employ certified public accountants to deter occupational fraud. CPAs understand the mind-set of occupational fraud perpetrators.

According to a 2004 report by the Association of Certified Fraud Examiners, the most frequently reported perpetrator is a male employee, age 41-50, making less than $50,000 a year, with three to five years of tenure, a high school education or less, and acting alone.

The ACFE also found one or more of the following elements in each occupational fraud case:

n Incentive to steal. The incentive may be some type of financial pressure — college tuition, medical bills, divorce, keeping up with the neighbors, gambling, drug use, alcoholism, etc. Frauds the Arkansas Division of Legislative Audit detects generally begin and increase with elevations in the perpetrator’s financial pressures.

n Rationalization. The perpetrator tells himself that his employer “owes him something.” He may believe he is overworked and underpaid, he should have received the promotion instead of a co-worker, he has not been properly trained, etc.

n Opportunity. First he must determine how to steal company assets without being caught by identifying control deficiencies in the accounting system. Internal controls are the “checks and balances” — if not in place, or if there is intentional override of controls, the perpetrator may gain undetected, unauthorized access to the organization’s assets.

Education and training provide CPAs with a frame of reference to understand how perpetrators conceal occupational fraud and ways to detect and deter such fraud.

Occupational fraud includes cash larceny, skimming, check tampering, payroll, employee reimbursement, false billing, collusion and financial statement fraud.

Cash larceny is the theft of receipted or recorded revenue. The concealment schemes are kiting; lapping; check/cash substitution; improper record alteration, duplication, voidance, destruction and false creation; posting false journal entries; and lack of recording required financial statement disclosures.

Kiting is the transferring of funds between organization bank accounts, where the transferring check is omitted from the transferring bank’s list of outstanding checks, making it appear that the funds are represented in both account balances.

Once the kiting starts, the amount of the kite must increase along with the amount of the stolen funds. An increasing monthly deposit-in-transit figure on a bank reconciliation is a red flag to a kiting scheme.

Lapping occurs when the perpetrator steals yesterday’s receipts and then uses today’s receipts to satisfy the deposit of yesterday’s receipts. Like kiting, once the lap begins the perpetrator must increase the amount of the lap to equal the amount of the stolen funds. The only ways out is to repay and deposit the stolen funds or to inappropriately write off accounts receivable in the amount of the lapped funds.

Check/cash substitution involves the theft of receipted cash and the deposit of unreceipted checks for receipted cash.

Two basic methods for deterring cash larceny and detecting its concealment methods are segregating accounting duties and requiring independent verification of accounting and reporting processes.

The accounting functions of receipting, posting accounts receivable, preparing deposits, posting deposits, opening and reviewing the bank statements, and preparing the bank reconciliations should all be segregated among different individuals.

Organization policy should require independent verification that:

– Receipts are properly recorded and deposited intact.

– Accounts receivable write-offs, credits and voided receipts are properly authorized.

– Bank reconciliations are accurate.

– All revenue is logged in at the point of entry in the organization.

– All checks are stamped “For deposit only, Organization X” at the point of entry into the organization.

– Changes to recorded accounting data evidenced in information edit reports are properly authorized.

– All unusual accounting entries or miscellaneous journal entries are properly authorized.

(Jerry E. Spratt is the assistant legislative auditor for the Arkansas Division of Legislative Audit.)