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Employee theft: Don't think you're vulnerable? Think again!
By Thomas Rafferty, CPA

The bookkeeper at a small electrical supplies company, a grandmother with long and dedicated service to the business, was arrested on charges of embezzling more than $400,000 from the organization over a five-year period.

Using the one-write checking system followed by many small businesses, she would write herself a $5,000 check every month at the same time she sent the next check to a large vendor for $15,000. On the ledger sheet, she would then void the check made out to herself and enter $20,000 as the amount payable to the vendor. When checks were returned in the bank statement, she would merely destroy the one with her name as payee.

Sobering stats
Although this is one case of fraud perpetrated by a long and trusted employee, the story in various shades seems to replay itself over and over again. Studies show that white collar crime is 100 times more frequent than street crime. About 90 percent of all businesses report that they are experiencing or have experienced employee-perpetrated theft of some kind.

According to the Association of Certified Fraud Examiners, fraud and abuse cost U.S. employers more than $400 billion annually. This includes incidents of asset misappropriation, corruption, false statements, false overtime, petty theft and pilferage, use of company property for personal benefit, and payroll and sick time abuses.

In many cases, the crime is never detected. If and when the perpetrator is discovered, it's typically a trusted employee who works in the financial/administrative area and enjoys considerable independence - in short, someone the employer least suspects.

Small businesses - those with fewer than 100 employees - are most vulnerable. These tend to be organizations where internal financial and cash controls don't exist or are inadequate. Many small businesses have no internal controls in place and offer little if any supervision of the employee who runs their financial operation.

Types of fraud
Fraud consists of "on-book" and "off-book" schemes. Off-book schemes, which occur primarily in cash businesses, are commonly perpetrated by employees who ring in only a portion of the actual sales. Common cash off-book schemes include:

  • Skimming, where some of the actual sale is pocketed before it is rung into the register.
  • Voids/under-rings, where sales are voided under the appearance that the customer returned the goods.
  • Swapping checks for cash, where checks or credit card sales are not entered in the register and a similar amount of cash is removed.

On-book schemes are usually perpetrated around accounts receivable, accounts payable, inventory, purchasing and payroll. The most difficult of these to detect are either small ones that occur over a long period of time or relatively large "one-shot deals" where the audit trail quickly cools.

In accounts receivable, a white collar criminal steals a check from a customer and forges documents that a cursory examination may never discover. In such a scheme, called lapping, an employee typically steals a check from a customer's account. Money received from a second customer is credited to the first customer's account, a third customer to the second customer and so forth, until the last customer's account is adjusted by falsifying documents (usually a credit memo and supporting documentation) by a fictitious charge to an expense account.

With inventory, generally the greater the volume of transactions, the easier it is to perpetrate the fraud. Such frauds may involve "borrowing goods" or ordering excess inventory and then converting it to personal use. Since inventory accounting may only be adjusted annually, unlike accounts receivable, charging fraudulent transactions as part of purchases is difficult to detect.

Fraud centered around the purchasing function may include the creation of fictitious invoices and phony vendors, overbilling schemes and duplicate payments. A trusted individual may be able to record a transaction by circumventing normal operating procedures and internal controls.

For example, an accounts payable supervisor may be able to override the company's computer controls - which prohibited duplicate vendor payments - by creating a second, slightly altered ledger entry for that vendor. Checks made out to this fictitious vendor could then be deposited in a bank account set up under his name.

A company's payroll can also be exploited by a dishonest employee. Most common is the use of "ghost" employees (in which a friend or relative receives a weekly check), overtime abuses and tax withholding scams, where payroll tax deposits are diverted into the employee's pocket.

Common red flags
In almost all cases of occupational fraud, multiple red flags are raised, but often missed. These may include:

  • Missing or altered documentation
  • Weak bookkeeping/accounting records
  • Out-of-balance accounts
  • Unreasonable - or too many - explanations upon inquiry
  • Copies of invoices rather than originals
  • Unexplained adjustments to accounts receivables
  • Large, unexplained inventory shortages
  • Cash shortages

So be aware of these and other similar signs that something may be amiss. There are a number of preventive measures you can take to help deter white collar crime - see the boxed article for some suggestions. It all starts by creating the impression to employees that someone is watching.

Preventive measures
Small business owners can put in place several different measures that will eliminate, or at least greatly limit, the likelihood of fraud. Here are five suggestions to consider:

  1. Have all bank statements mailed to your home, and review cancelled checks and deposit activity monthly. Question and review all large and unusual transactions, including bank reconciliations.
  2. Segregate responsibilities within the accounting department so that no one individual controls all facets of a financial function.
  3. Limit access to assets of physical value, such as inventory, particularly if it is a readily marketable item. This includes locking up your check stock.
  4. Consider using fraud-proof checks with chemical sensitivity that can't be photocopied.
  5. Insist that all employees take their allotted vacation time. Many white collar criminals can't afford to be out of the office for extended periods of time because their schemes could be exposed (this is when most plots are uncovered).
  6. Ask your bank about fraud protection products and services, such as online STOP Pay or Positive Pay features. 


Thomas Rafferty is a partner in the CPA firm of Mintz Rosenfeld & Co. in Fairfield, NJ. He regularly conducts internal audits where fraud is suspected and leads small business seminars on white collar crime.

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