Skimming: The Achilles’ Heel of the Audit?

By Joseph T. Wells

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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.

Revenue Skimming: Janet’s Coin Collection

Janet, by 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 $1 million.

Janet and 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.

Revenue skimming 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 reason.

The author 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?

Receivables 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.

Lapping is 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.

Should a 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 option.

Refund Skimming

The final 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.

Off-Book Frauds

Both accounts 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.

The following areas of the financial statements might provide clues that skimming has occurred:

  • Flat 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.
  • Increasing cost of sales. If reduced sales are not accompanied by reduced costs, then the ratio of cost of sales to total revenues will rise.
  • Decreasing ratio of cash sales to credit card sales. Should an employee be pocketing cash, the ratio of cash sales to credit card sales will decrease.
  • Decreasing ratio of cash sales to total sales. Similarly, a decrease in the ratio of cash sales to total sales might indicate revenue skimming.
  • Discrepancies between customer receipts and the company records. This could indicate that an employee is skimming part of the funds from sales or accounts receivable.
  • Ratio 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 sales.

The Verdict

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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Joseph 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 jwells@acfe.com.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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