Accounts Receivable Fraud
In this month's article, part of a series written on employee frauds, I examine typical accounts receivable fraud schemes. Accounts receivable is the money due a company from its customers. A Company's accounts receivable can be manipulated through a variety of schemes. Employees at any level in an organization can perform the commission of accounts receivable frauds.
The most prevalent type of internal fraud scheme is lapping. Lapping of accounts receivable is the recording of payment on a customer's account sometime after the payment has been received. The basic lapping scheme operates as follows: the employee has misappropriated company funds through customer A's account, by diverting a cash payment or issuing a refund payable to the employee. In order to conceal the misappropriation, the employee now records payments made by customer B to customer A's account, payments made by customer C to customer B's account, and so on. Lapping schemes do not require the employee to divert funds for personal use. The funds can be used for other business purposes. Employees will usually falsify documents to conceal the fact that a lapping scheme is being employed.
Another internal fraud scheme is the diversion of payments on old or slow paying accounts. Once an account has been written-off, the employee has the opportunity to keep the funds for himself since companies typically do not keep track of old, written-off accounts receivable. Also, the use of outside collection agencies can allow for fraud to be committed. A Company has to insure that accounts assigned for collection with an outside agency are truly delinquent accounts and not ones which can be collected through the routine course of business. Also, the company has to insure that the collection agency can not collect payments on the accounts referred to it but not remit the monies due. A company's CFO hired an outside collection agency to assist in collecting old receivables. Payments were first sent to the CFO who then forwarded them to the accounting department for recording. No one reviewed the percentage billing from the agency. The CFO was receiving kickbacks from the agency for assigning current receivables to the agency. Because the agency was collecting recent receivables, their collections were higher and therefore their billing was higher. The underlying fraud was estimated at approximately $250,000.
Another potential problem with accounts receivable is the creation of fictitious accounts and sales. The primary motive behind creating accounts receivable is to have the company appear to be in better financial condition or to receive additional compensation. A Company can utilize accounts receivable to inflate its sales amounts for a period so that it appears in better financial shape for creditors and investors. In 1992, the SEC filed a lawsuit against a company alleging that the company's officers were creating fictitious sales and using proceeds from stock sales to reduce accounts receivable so that the company appeared to have more sales than it actually had. The other motive for creating accounts receivable is for additional compensation. This is the case when sales staffs are paid based upon sales volume without regard to collection of those sales. This can cause a salesperson to look at only quantity of sales rather than quality of those sales.
Another though less common fraud is when an employee will use a company's accounts receivable as collateral for a personal loan.
Businesses can minimize the likelihood of frauds through strengthening its internal controls. There are numerous methods to detect accounts receivable frauds so if a business finds itself a victim of a fraud, it should consult its legal counsel, accountant, and a competent fraud examiner.
© 2019 McGovern & Greene LLP All rights reserved.