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What Business Owners Need to Know About Fraud in Accounts Payable
Fraud happens in all organizations, whether small or large, for-profit or not-for-profit, privately-owned or publicly-traded.
When it comes to internal fraud, accounts payable or cash disbursements is the most common target for employees to steal company funds. With employee theft costing US businesses $50 billion annually, vendor fraud is by far the most prevalent method that is currently in use. As a business owner, your goal is to:
- Prevent the schemes
- Detect the schemes on a timely basis
- Ensure you have the right records to perform an investigation if one and two fail
However, doing this effectively requires a thorough understanding of the recent history of payments fraud and what factors have been driving it.
So, Why Do Employees Steal?
The Fraud Triangle is the most commonly accepted criminology theory on why people commit asset misappropriation schemes.
First, pressures facing people cause them to make bad decisions. Even good employees or the most trusted employee may have a life experience which causes them to steal money from the company.
Second, the rationalization aspect is how they justify their actions. Typically, people committing fraud will come up with an excuse for themselves that justify the dishonest actions that they are performing.
Lastly, the key item is opportunity. Unfortunately, the way most businesses pay their vendors creates plenty of opportunities throughout the process for employees to follow through on plans to commit fraud.
Here is a real-life story of the fraud triangle coming to fruition:
The treasurer of a volunteer fire department frequently discussed exciting bets and gambling opportunities with the other firemen on staff. However, what he wasn’t discussing was that he had an addiction to gambling, and was bankrolling money from the firehouse’s bank account into his own account to fund it. The staff only caught on to the habit when the telephone company turned off the fire chief’s phone line after failing to pay the bill. There was no money left in the department’s bank account. Ironically, the perpetrator was an auditor in his full-time job.
This story teaches a valuable lesson about the unexpected places that payment fraud can rear its ugly head. If a group of people that know each other well, risk their lives together, and have known each other for twenty years did not see the signs of something like this taking place, would you be able to?
Combatting the Fraud Triangle
As business owners, we need to be aware of the Pressures and Rationalization aspect of the fraud triangle. This does not mean becoming paranoid, but rather remaining open to the possibility that your employees can fall on hard times financially, and your company’s finances represent an appealing source of immediate funding to people in challenging situations. I call this open-mindedness educated skepticism.
Opportunity, on the other hand, is directly related to the job functions and the internal controls you have in your organization. Internal controls are both your administrative procedures and the controls that exist in your accounts payable system. Separation of duties and approval controls are the foundation of every internal control system and should be practiced during the process of paying every invoice.
To illustrate what this control looks like in action: The person entering vendor invoices is not the same person setting or changing vendor information. If you don’t have the headcount for that, you are receiving a report of all new vendors or changes to the vendor master file and ensuring that all changes are valid.
Understanding the Sophistication of Concealment
Fraud schemes facing accounts payable are predictable. They are not complex. What you need to understand is the difference between the scheme and the sophistication of concealment used by the perpetrator to create the illusion that the disbursements are for a valid purpose.
A false billing scheme is simple, you pay for services that you never received. The concealment aspect is creating a vendor invoice that looks real, actually creating a real company at the secretary of state, setting up a bank account to negotiate the checks, and recording the disbursement in the general ledger that receives less scrutiny.
Another common scheme involves intentionally paying invoices twice. For example, let’s say once a month, the accounts payable clerk intentionally pays a non-complicit vendor invoice twice. She recorded the first invoice as 1019 and the second invoice as 1019A. She would then call the vendor and state she had paid the invoice twice in error. She always waited a few days to make sure the company had deposited the check. Then, she would ask the company to send a refund to her attention. She would forge the endorsement on the back of the check and cash the check at a check cashing company.
Best Practices for Fraud Mitigation
There are some very simple procedures that you can perform to mitigate the likelihood of an employees stealing your money in schemes like these:
- Receive the bank statements at your home. Open the statements and review the disbursement activity. Are there any electronic withdrawals that are suspicious?
- Do not be predictable in your review of the general ledger, when you perform the review, what you look for and the type of questions you ask.
- Once a year, have someone other than the assigned person, reconcile the bank accounts. Maybe, hire your CPA firm to perform the job. Make sure everyone knows about this procedure. Your goal is to prevent versus catch someone.
- Perform background checks on new employees. Economic crime has one of the highest rates of repeat offenders.
- Ensure that your company is leveraging the built-in payment controls that come with AP Automation solutions like MineralTree.
And a friendly reminder: Many years ago, the famous bank robber Willie Sutton was asked why he robbed banks. He said, “That is where the money is.” Accounts payable is where the money is.
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