Accounts receivable are a popular fraud target because so many transactions are recorded to it. This article describes common receivables scams, as well as various preventive measures and methods of detection.
Put simply, receivables fraud happens when dishonest employees divert customer payments for their personal use. They can accomplish this in various ways, including:
Lapping. This is the most common type of receivables fraud. It involves the application of receipts from one account to cover misappropriations from another. For example, rather than credit Customer A’s account for its payment, a dishonest employee pockets the funds and later posts a payment from Customer B to A’s account, Customer C’s payment to B’s account and so on.
Write-offs and discounts. Instead of crediting a payment to the customer’s account, fraudsters might pocket the funds and then record a bad debt write-off or discount to reduce the customer’s account. This allows the customer’s account to reflect the expected current balance despite the diversion of incoming payments.
Additionally, employees may report sales to phony accounts to artificially inflate the company’s financial results — or when their compensation is based on sales (rather than collections). Sales to phony customers generate bogus receivables that will never be collected.
Clients can implement numerous preventive measures to head off receivables fraud. For example, segregation of duties can eliminate the opportunity for employees to steal. In terms of preventing receivables fraud, the employee who handles incoming payments from customers should be separate from the person who handles invoicing. Large companies may even task a different employee with managing customer complaints. Why? Customer complaints can provide a red flag that receivables fraud has occurred — and fraudsters who receive complaints are likely to stifle them.
In addition, businesses should require mandatory vacation time for all employees. Receivables schemes typically require their perpetrators to remain ever vigilant to avoid detection. For this reason, it’s also advisable to rotate job duties among employees.
Methods of Detection
Receivables fraud schemes are difficult — but not impossible — to detect. And the transparent use of the detection tools can also deter those contemplating fraud.
If a client discovers anomalies in the receivables ledger or notices a receivables clerk is acting suspiciously, it may be time to call in a forensic accounting expert. He or she may start by tracing a sample of cash receipts to the sales ledger and deposit slips. The purpose of this exercise is to find discrepancies in dates, payee names and amounts. The expert also may compare deposit slips against the books and send requests for confirmations to a sample of customers to verify current balances and payment histories.
Another hot spot is bad debt write-offs. A forensic accountant is likely to review this account, including the reasons provided for specific write-offs. He or she also will be on the lookout for accounts with unexplained credits, increased customer credit limits and random adjustments to the accounts receivable ledger.
Most important, the expert will interview company personnel in a confidential manner, searching for potential weaknesses in the company’s internal controls, signs of collusion and other information. After all, tips are the most common method of detection for any type of fraud.
Best Defense is a Strong Offense
Despite their best fraud prevention efforts, employers may still fall victim to receivables fraud and other scams. If one of your clients suspects foul play, a forensic accountant can help uncover the requisite proof.