Where is fraud likely to occur in an entity? The answer is that fraud can occur anywhere in an organization. All it takes is someone to determine how the internal controls in the organizations can be circumvented and how to undertake the fraudulent conduct (usually the theft of assets).
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For internal control to function properly there needs to be separation of the responsibility for custodianship of the assets and the record keeping for those assets. Many small organizations lack the personnel to completely separate those functions. When that occurs management must take responsibility for certain functions to ensure separation of duties. For example, when the organization only has one bookkeeper who writes the checks and does the bookkeeping, the monthly bank statement should go directly from the bank to someone in management who should review the cleared checks before the bookkeeper does the bank reconciliation. The manager should also review the completed bank reconciliation when it is done.In future blogs we will discuss specific areas where fraud might be likely within the organization and the steps management can take to prevent fraud from occurring. As long as entities have had accounts receivable lapping has taken place. Lapping occurs when someone in the organization steals accounts receivable payments by diverting them. The person committing the fraud then uses a subsequent payment from a different customer to credit the original amount stolen. As more and more funds are diverted, the number of accounts receivable credited with late payments becomes larger and larger.
The easiest way to prevent lapping is to have adequate separation of duties. Amounts received from customers should be listed and deposited by one individual and the details should be given to another individual to post the credits to accounts receivable. Periodically, a third individual should check the posting of receivable payments to ensure that the correct accounts were credited for payment. Beware of the trusted bookkeeper who handles all elements of the accounts receivable transactions and never takes vacations. The person committing lapping cannot take a long vacation where someone else performs his or her duties because the scheme will surely be revealed.Make sure your auditor confirms receivables at year end. It won’t prevent lapping, but it should catch it. Kiting is a very old scheme and is not as likely to happen as it once was, but any entity with multiple bank accounts should be aware of the possibility. For kiting to work, an individual must have complete authority over two or more bank accounts. The perpetrator must be able to sign and draw checks and must be the person reconciling the bank accounts.
The fraud starts when the perpetrator drafts a check on Bank A for a large amount (let’s say $50,000) and deposits it in Bank B. Before the funds clear, he draws a check for $50,000 on Bank B and deposits it in Bank A. The drawing of checks continues until a large float occurs. The perpetrator then siphons off a substantial balance of cash and deposits it in his own account to earn interest. The scheme can continue indefinitely as long as enough checks are drawn and deposited. The checks are never recorded on the books of the entity and the perpetrator destroys the bogus checks when they are returned with the bank statement. The best way to prevent kiting is never to give an individual the authority to sign checks and to reconcile cash. If kiting has occurred, it will be caught if the perpetrator has to take vacation for an extended period. A proof of cash will also catch kiting.
