Common frauds include payroll frauds, conspiracy with other parties and stealing assets. More subtle measures include teeming and lading and manipulation of bank reconciliations and cashbooks to conceal theft.
Theft of cash
Employees with access to cash may be tempted to steal it. A prime example is theft from petty cash.Small amounts taken at intervals may easily go unnoticed.
Theft of inventory
Similarly, employees may pilfer items of inventory. The most trivial example of this is employees taking office stationery, although larger items may be taken also.
These examples are of unsophisticated types of fraud, which generally go undetected because of their immateriality. On the whole, such fraud will tend to be too insignificant to have any serious impact on results or long-term performance.
Employees within or outside the payroll department can perpetrate payroll fraud.
(a) Employees external to the department can falsify their time sheets, for example by claiming overtime for hours which they did not really work.
(b) Members of the payroll department may have the opportunity deliberately to miscalculate selected payslips, either by applying an inflated rate of pay or by altering the hours to which the rate is applied.
(c) Alternatively, a fictitious member of staff can be added to the payroll list. The fraudster sets up a bank account in the bogus name and collects the extra cash himself. This is most feasible in a large organization with high numbers of personnel, where management is not personally acquainted with every employee.
Teeming and lading
This is one of the best known methods of fraud in the sales ledger area. Basically, teeming and lading is the theft of cash or cheque receipts. Setting subsequent receipts, not necessarily from the same customer, against the outstanding debt conceals the theft.
This is a more elaborate method of stealing inventory. Bogus orders are set up, and goods are dispatched on credit. The ‘customer’ then fails to pay for the goods and the cost is eventually written off as a bad debt. For this type of fraud to work, the employee must have responsibility for taking goods orders as well as the authority to approve a new customer for credit.
Collusion with customers
Employees may collude with customers to defraud the business by manipulating prices or the quality or quantity of goods dispatched.
(a) For example, a sales manager or director could reduce the price charged to a customer in return for a cut of the saving. Alternatively, the employee could write off a debt or issue a credit note in return for a financial reward.
(b) Another act of collusion might be for the employee to suppress invoices or under-record quantities of dispatched goods on delivery notes. Again, the customer would probably provide the employee with a financial incentive for doing this.
Bogus supply of goods or services
This typically involves senior staff who falsely invoice the firm for goods or services that were never supplied. One example would be the supply of consultancy services. To enhance authenticity, in many cases the individual involved will set up a personal company that invoices the business for its services. This type of fraud can be quite difficult to prove.
Paying for goods not received
Staff may collude with suppliers, who issue invoices for larger quantities of goods than were actually delivered. The additional payments made by the company are split between the two parties.
Meeting budgets/target performance measures
Management teams will readily agree that setting budgets and goals is an essential part of planning and an important ingredient for success. However, such targets can disguise frauds. In some cases, knowing that results are unlikely to be questioned once targets have been met, employees and/or management siphon off and pocket any profits in excess of the target.
Manipulation of bank reconciliations and cash books
Often the simplest techniques can hide the biggest frauds. We saw earlier how simple a technique teeming and lading is for concealing a theft. Similarly, other simple measures such as incorrect descriptions of items and use of compensating debits and credits to make a reconciliation work frequently ensure that fraudulent activities go undetected.
Misuse of pension funds or other assets
This type of fraud has received a high profile in the past. Ailing companies may raid the pension fund and steal assets to use as collateral in obtaining loan finance. Alternatively, company assets may be transferred to the fund at significant over-valuations.
Disposal of assets to employees
It may be possible for an employee to arrange to buy a company asset (eg a car) for personal use. In this situation, there may be scope to manipulate the book value of the asset so that the employee pays below market value for it. This could be achieved by over-depreciating the relevant asset.
Intentional misrepresentation of the financial position of the business
Here we consider examples in which the intention is to overstate profits. Note, however, that by reversing the logic we can also use them as examples of methods by which staff may deliberately understate profits.
Over-valuation of inventory
Inventory is a particularly attractive area for management wishing to inflate net assets artificially. There is a whole range of ways in which inventory may be incorrectly valued for accounts purposes.
(a) Inventory records may be manipulated, particularly by deliberate miscounting at inventory counts.
(b) Deliveries to customers may be omitted from the books.
(c) Returns to suppliers may not be recorded.
(d) Obsolete inventory may not be written off but rather held at cost on the statement of financial position.
Irrecoverable debt policy may not be enforced
Aged receivables who are obviously not going to pay should be written off. However, by not enforcing this policy management can avoid the negative effects it would have on profits and net assets.
These can be channeled through the accounts in a number of ways.
Manipulation of year end events
Cut off dates provide management with opportunities for window dressing the financial statements. Sales made just before year end can be deliberately over-invoiced and credit notes issued with an apology at the start of the new year. This will enhance turnover and profit during the year just ended.
Delaying the recording of pre-year-end purchases of goods not yet delivered can achieve the same objective.
Clearly, failure to record all expenses accurately will inflate the reported profit figure.
Manipulation of depreciation figures
As an expense that does not have any cash flow effect, depreciation figures may be easily tampered with. Applying incorrect rates or inconsistent policies in order to understate depreciation will result in a higher profit and a higher net book value, giving a more favorable impression of financial health.