Accounts Receivable Fraud: What To Look For

Small businesses are more susceptible to accounting fraud than enterprises due to the lack of resources and best practices needed to prevent fraud. The 2018 Association for Financial Professionals (AFP) Payments Fraud and Control Survey Report found that, in 2017, 78 percent of organizations were impacted by financial fraud. That’s up from 60 percent in 2013. Additionally, checks are the primary target for fraud.

There are many deceptive ways that thieves can make off with your hard-earned money. In this article, you’ll learn about various types of accounts-receivable fraud, helping you better to identify and eliminate such fraud.

Lapping

Lapping involves, stealing the payment of Customer 1, and using the payment of Customer 2 to fill the hole left by Customer 1’s stolen payment. This scheme continues this way with future payments, creating a hard-to-detect absence of funds. Here’s an example of how it works:

  • Jan 10 - Customer 1 pays $500 on its invoice.

  • Jan 15 - Customer 2 pays $1000. An employee steals Customer 1’s $500 payment and applies $500 of Customer 2’s payment to Customer 1.

  • Jan 20 - Customer 3 pays $500, which is applied to Customer 2’s payment.

At some point, the employee may steal more if future payments are large enough to cover stolen payments. Write-offs, discussed in the next section, can also be used with lapping.

Another method similar to lapping is check kiting. Because many banks now clear checks before they are cashed, eliminating the float period, check kiting is no longer possible with most banks.

This is how it use to work: At least two banks must be used. A check is written from bank 2 and cashed at bank 1. The thief takes advantage of the float period in which bank 1 doesn’t know if funds exist at bank 2. Basically, the thief gets an interest free loan. Funds must be paid back to bank 2 before the float period ends.

Write-Offs

A write-off can come in the form of a customer discount in which a credit is applied rather than issuing a refund. Write-offs can also be used with bad or old accounts that are closed out. In both cases, the thief takes advantage of loose tracking of funds.

For example, a customer pays for a product in full and the thief may apply a discount after the fact, pocketing the difference between the full and discounted amounts. For bad or old accounts, when money is received from the customer to clear out these accounts, it can be scraped off the books, making it difficult to detect. The account is then cleared out by writing off the owed amount as if it was never received.

Fake Accounts and Sales

This fraud can take place by someone managing accounts receivable or by the business owner. In the first case, a fake account is established, and fake sales are recorded against it. These sales help hide money the thief is taking from the company.

At a higher level, the business owner might try to inflate sales to appear more attractive to potential customers or prospective buyers of the business. Scrutiny into the company’s books by a prospective buyer will likely uncover the fraud, but a potentially large customer may not have such access or inquire into the details of the company’s finances.

Statement Alterations

Statement alterations are just as they sound. An employee makes small changes to statements, basically hiding the money they take. When someone else looks at the statements, they won’t realize that money has been taken from the company. Without further digging, the fraud will never be found.

The key to pulling off statement fraud, as with other forms of accounts receivable fraud, is theft of small amounts. Larger amounts are easier to detect. In the final section, we’ll share some tips for detecting fraud of any amount.

How To Prevent Accounts Receivable Fraud

There are a number of steps companies can take to prevent accounting fraud. It’s worth noting that most A/R fraud occurs in small companies. This is because A/R is often left to one person. This individual has free reign of the place without any oversight.

To solve the single-person A/R management problem, implement a policy called segregation of duties and responsibilities. This policy prevents any one person from controlling an entire process. It does mean hiring another person so at least two people are working A/R. One person might send out invoices and take in payments. The other is responsible for bookkeeping and payment verification. These roles should rotate as well.

Additionally, each person should be required to take a vacation, letting a third person rotate in. All the rotation ensures more people have access into what’s happening within A/R.

Periodic outside audits are a great way to verify A/R whether you have one employee managing A/R or multiple. It’s the same concept as mentioned above – more eyes mean more visibility and less chance of fraud or errors.

Introducing automation removes the human element from A/R, which leaves little if any chance for fraud or errors.

Accounts receivable fraud hits small businesses more than enterprises. Small businesses focused on eliminating A/R fraud can certainly do it without incurring big costs. Using the tips mentioned above will help you get a head start against A/R fraud.

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