Our 2016 post on Accounts Receivable Fraud might seem “outdated” in the tech-heavy 2024 AI-assisted receivables world, but the principles are the same deep down: fraud happens. The bigger problem today is that all this technology makes the money disappear quicker and sometimes, harder to track and hidden more thoroughly. In response, you and your tools must keep pace.

What’s the solution? Updated software helps, but it is best to ensure you have strong internal controls, robust cross-check systems, and a critical assessment to see if there are any hidden problems. The improvements implemented based on the critical assessment may  be followed with periodic outsourced accounting services to maintain consistency and ensure no new weaknesses have occurred

Weaknesses in the Accounting Fabric

If there’s one constant for any internal theft, it’s the weaknesses of your accounting systems. Sometimes it’s that the accounts receivable internal controls are a little loose and can be fixed quite easily. Small and medium-sized businesses find they can only afford accounting departments with a single person in charge of accounts receivable and customer remittances. With a lack of direct supervision and inadequate approval and review processes, employees with access to accounts receivable records and customer remittances sometimes commit fraud at your expense. How do they do it?

  1. Lapping is one of the most prevalent accounts receivable fraud schemes, especially for small businesses with one bookkeeper and cash receipts in play. Lapping is recording a 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, making them “current.” This process continues with remittances from other customers. Along the way, the employee falsifies documents or may even fail to send statements to the companies with “zero” balances. This juggling act must be exhausting! it’s also one in which the employee in question cannot take a vacation. The house of cards will fold in on itself. (Hint: Employees who never take vacations are huge suspects for this and other frauds.)
  2. 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 received since there is no longer a receivable for this money on the company’s books. This diversion scheme is pretty gutsy. Your well-meaning customers maysend in some money they owe, but your A/R A/P clerk (one and the same) simply deposits the check to their account or gets it cashed by a “friend” who takes a cut. The banks are making this harder all the time, but it might be wise to audit “closed” accounts at least once a year. Imagine this: “Hey, Dan. Good to see you. Did you receive my check? I finally paid you for that old balance.” If you never saw the money, someone in your company may have it in their pocket.
  3. Fictitious customer accounts and sales. This fraud involves higher-level staff or officers. The motive of this scheme is to make the company appear to have higher revenues than in reality. Company officers may receive bonuses based on 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 salesperson and accounts receivable clerk recording the fraudulent sales.

There are more forms or A/R fraud. These are perhaps the easiest and oldest. Fighting fraud requires your attention, but sound accounting systems can help!

How to Combat Internal Fraud

Companies can minimize the likelihood of fraud by establishing a system of internal controls that costs nothing—except a change from old habits—even if your company is teeny. Internal controls can include the following safeguards:

  • Separate accounting functions. For example, minimize access for accounting personnel, i.e., one person records receivables paid by check, and another handles cash payments. People who write checks do not sign the checks.
  • Assign authority to write off bad debt or close accounts to supervisory personnel who do not post to accounts receivable records.
  • Send statements to customers every month so customers can reconcile the balance owed to their own accounts payable records.
  • Install bookkeeping software. QuickBooks online, for example, can be an inexpensive way to ensure that the company owners can keep an easy tab on receivables. Alternatively, an outsourced accountant can do external spot checks along with quarterly audits for a minimal fee.
    • Notice changes in your employees’ spending habits. As in “Wait! How does our bookkeeper afford a brand new bright red Tesla Model X?”
    • Insist that every employee take their vacation. Keeping all these accounts straight and moving money all around requires constant vigilance. Do not allow people to skip their vacation, however difficult their absence will be for your small or medium-sized company.
    • Check the bank statement against canceled checks. Reconcile the bank account monthly.
    • Assign different people to make the bank deposits than the cashier or A/R clerk.
    • Learn from your outsourced accountants and auditors. You can incorporate some of their processes into your systems either manually or electronically. You can purchase an accounting software program that your outsourced accountant will help you install and train your employees to use.

Here’s the thing: Artificial Intelligence can only go so far. You can and should instill some automation into your workflows with AI and software. But ultimately, management must have a sturdy handle on the accounting function.

As an accounting firm specializing in outsourced accounting, we evaluate and make recommendations to improve internal control procedures and systems for large and small companies across 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 act and institute robust internal control procedures. The idea behind outsourced accounting services—that includes anything from bookkeeping to Controller and CFO level employees—is to let you sleep better at night. The level of outsourced accounting you choose can be as little or as much as you want, for as long or as short a period as you need. Need help with tax preparation? Need to plan that expansion? Need to add a new product line? Let us help!

Contact our outsourced accounting professionals at 714.672.0022 to initiate a review of your internal controls systems.

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