Employee fraud can be perpetrated in many ways. Taking advantage of weaknesses in internal controls relating to accounts receivable is not uncommon in closely held businesses. Entrepreneurial businesses many times have small accounting departments that do not have adequate internal controls in general and specifically in the area of accounts receivable recording and the handling of customer remittances. With a lack of direct supervision and inadequate approval and review processes, employees that have access to accounts receivable records and customer remittances are positioned to perpetuate fraud.
- Lapping is the most prevalent internal fraud scheme relating to accounts receivables. Lapping is the recording of payment on a customer’s account sometime after the actual payment is received. Initially the employee will misappropriate a payment made by Company A. Then at a later date the employee will divert a payment from Company B and record it against Company A’s outstanding accounts receivable balance. This process continues with remittances from other customers. Along the way the employee falsifies documents to conceal the fact that fraud is occurring and a lapping scheme is being utilized.
- A second internal fraud scheme involves the diversion of payments from old or slow paying customers. Once an account is written off as uncollectible the employee has the opportunity to keep any funds that are received since there is no longer a receivable for this money on the company’s books.
- Another fraud scheme that typically involves higher level staff or officers is to create fictitious customer accounts and sales. The motive of this scheme is to make the company appear to be more profitable than it really is. Company officers may receive bonuses based upon sales growth. In addition, sales staff may be compensated on sales volume rather than collections which is an incentive to commit fraud and can lead to collusion between the sales person and accounts receivable clerk recording the fraudulent sales.
Companies can minimize the likelihood of fraud by establishing a system of internal controls. Internal controls can include the following safeguards:
- Separate accounting functions as much as possible. For example, minimize access of accounting personnel to both the recording of receivables and the handling of customer payments.
- Approval to write-off old outstanding accounts receivable balances should be handled by supervisory personnel who do not post to accounts receivable records.
- The Company should send statements to customers on a monthly basis so customers can reconcile the balance owed to their own accounts payable records.
As an outside CPA firm, we evaluate and make recommendations to improve internal control procedures for large and small companies in all industries. We can conduct a review of your company’s internal control procedures and make recommendations for improvement.
Do not wait until you have been victimized by a fraud scheme to take action and institute good internal control procedures. Contact your LSL auditor at 714.569.1000 to initiate a review of your system of internal controls.
