The Achilles’ Heel of the Audit?
By Joseph T. Wells
JUNE 2007 - When
it comes to skimming used in fraud schemes, it’s important
to remember the “Three R’s”: revenues, receivables,
and refunds. According to data assembled by the Association of Certified
Fraud Examiners (ACFE) in its 2006 Report to the Nation on Occupational
Fraud and Abuse, revenues is by far the most popular target
for skimming. (The report may be downloaded free of charge from
www.acfe.com.) The total losses and the number of incidents exceed
the other two combined. It is not hard to understand why, because
skimming receivables and refunds invariably requires a fraudster
to manipulate the books and records. But that is not necessarily
the case with revenues. Skimming revenue before it enters the accounting
system can be the Achilles’ heel of the audit. After all,
what is examined is normally only in the books and records. This
article describes the various methods employees and owners use to
skim money and what the forensic accountant can do to better detect
and prevent such schemes.
Skimming: Janet’s Coin Collection
all accounts, was a packrat. When Janet passed away, two nieces
(Janet never married or had children) visited her residence and
were in shock at what they discovered. Janet’s small home
office was overflowing with boxes of junk and paperwork, including
tax returns going back to 1947. But what was most interesting
was under Janet’s bed: 22 bags of coins. A coin dealer later
determined that they were all rare. The estimated value was nearly
Raymond, her boyfriend of 30 years, co-owned a coin-operated laundromat
together. Any cash-intensive business like a laundromat is ripe
for skimming funds. When Raymond heard about the coins hidden
under Jane’s bed, he hired an attorney. The lawyer filed
suit against Janet’s estate, claiming that she had skimmed
the coins from the laundromat and that Raymond was entitled to
half of the value. The only thing lacking was proof. This is where
forensic accountants enter the story.
occurs at the point of sale. It can be as simple as a cashier
ringing “no sale” on the register and pocketing the
cash. Rental agents frequently collect rents and fail to remit
them to the property owner. Insurance salesmen sometimes write
policies for their companies, obtain the premiums directly from
the customer, and then don’t send the policy documents to
their employers. Business owners typically skim cash revenues
to avoid payment of income taxes. It might be speculation, but
any forensic accountant would suspect that Janet started skimming
coins from her and Raymond’s laundromat for exactly that
was hired by Raymond’s lawyer to help show that the bags
of coins came from the laundromat. Although it was obvious they
did, that’s not good enough for the courtroom, where the
standard is proof, not speculation. But because Janet did not
keep a schedule of the coins she skimmed, how could this be proved
to a judge and jury?
skimming. A less common method of skimming involves
accounts receivable. The typical culprit is an employee in the
mailroom, a cashier receiving payments over the counter, or a
bookkeeper. Regardless of the employee’s position, the obvious
problem with stealing a payment of receivables is that the customer’s
account balance will be overstated by the amount of the theft.
There are usually two different ways this can be covered, depending
on where the employee works in the company. If the worker does
not have access to the books and records, “lapping”
is the normal method.
a concealment technique where the subtraction of money from one
customer is covered by applying the payment of a different customer.
For example, a cashier may steal a payment from customer A and
cover it by applying a payment from customer B to customer A’s
account. Then, when customer C pays, that money is applied to
customer B and so on. Smart crooks would never lap accounts receivable,
but amateurs do not realize that this technique requires constant
monitoring to avoid detection. Most lapping schemes don’t
last long because of the continuous manual intervention required.
company be foolish enough to allow an employee access to the books
and records as well as to cash (a common scenario in small businesses),
concealment of theft involving accounts receivable is easy. All
that is required is a credit to the customer account and a debit
to an expense account. Smart thieves will spread the phony debits
to various accounts so that no one item seems completely amiss.
Of course, coin-operated laundries rarely have accounts receivable,
so examining such a technique in Janet’s case was not an
kind of skimming scheme, and the least common, involves refunds
due to the company for overpayment. They typically relate to accounts
payable or inventory. Surprisingly, many organizations don’t
book overpayments or refunds due. When this oversight occurs,
it is not necessary for the thief to manipulate the records. But
if the transactions have been recorded, then the concealment methods
are largely the same as described above: a phony debit to an expense
account and a credit to the refund due.
receivable and refund skimming are on-book frauds because
direct evidence can usually be found in the books and records.
Revenue skimming, as in Janet’s case, is typically an off-book
fraud and evidence must be proved circumstantially. In criminal
cases, the standard is proof “beyond a reasonable doubt.”
But in civil cases, proof is established by the “preponderance
of evidence.” That is, the evidence needs only to tip slightly
one way. With Janet, it was reasonable to assume that if she skimmed
the rare coins, she probably skimmed more.
areas of the financial statements might provide clues that skimming
or declining revenues. If other businesses in the same
industry are experiencing growth, however slight, then flat
or declining revenues can be an indication of skimming.
cost of sales. If reduced sales are not accompanied by
reduced costs, then the ratio of cost of sales to total revenues
ratio of cash sales to credit card sales. Should an employee
be pocketing cash, the ratio of cash sales to credit card sales
ratio of cash sales to total sales. Similarly, a decrease
in the ratio of cash sales to total sales might indicate revenue
between customer receipts and the company records. This
could indicate that an employee is skimming part of the funds
from sales or accounts receivable.
of gross sales to net sales is increasing. If a dishonest
worker is stealing refunds owed to the company, this can be
indicated by an increase in the ratio of gross sales to net
Some of the
above clues were present in Janet’s case. But this forensic
accountant took a slightly different tack. The author carefully
examined the receipts and disbursements from Janet’s personal
checking account for a period of seven years preceding her death.
He wasn’t struck with what was there, but rather with what
was missing. In all that time, there was never a disbursement
to cash: to a grocery store, to a cleaners, to a service station—none
of the ordinary circumstances where most people would write checks.
It didn’t take the court much time to conclude that if Janet
skimmed revenue to pay her personal expenses, she also skimmed
the rare coins. Raymond was awarded nearly $500,000, plus legal
expenses, from Janet’s estate.
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T. Wells, CPA, CFE, is the founder and chairman of the
Association of Certified Fraud Examiners, headquartered in Austin,
Texas. He is a member of The CPA Journal Editorial Board
and can be reached at firstname.lastname@example.org.