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How can I Identify Accounting Fraud?

By Carol Francois
Updated May 16, 2024
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Accounting fraud occurs when an employee of a business steals or hides money. The potential perpetrators of this type of fraud can be anyone from the accounting clerk to the Chief Financial Officer. The purpose of the fraud can be for personal gain, to hide business errors or incompetence. There are three common methods of accounting fraud: accounts payable, accounts receivable and dummy companies. All three methods allow the perpetrator to remove money from the business.

Accounts payable fraud occurs when people steal money by issuing payments for fictitious work. These checks can be paid to existing, legitimate suppliers, or to shell corporations created simply to cash these checks. The process for this type of fraud is fairly simple.

The fake invoice is paid through the accounting system and a check is processed. Either the employee or a co-conspirator cashes the check and takes the money. Look for this type of fraud by inspecting the check register and comparing the payments to original invoices. Investigate any unfamiliar company names and question the payment frequency.

Accounts receivable fraud involves accepting cash payments from customers and not depositing the money in the company's bank account. Instead, a credit memo is issued to the customer’s account, so that there are no collection calls to the customer. This method of fraud can be identified by reviewing the credit memos issued to clients and confirming the reason they were issued. This type of fraud can be quite complex to trace, as there may be multiple credit memos to several clients to hide the amount of cash stolen.

Financial statement fraud is typically on a much larger scale than the first two types of fraud. This type of fraud is only possible by members of upper management. Fictitious companies are created within the corporation and money is moved around through a complex series of transactions.

Money is paid to these other, related firms for imaginary work or consulting services. Frequently, upper management or their family members own these shell corporations. This method is used to remove very large sums of money over an extended period of time. To locate this type of fraud, check into the details behind any related companies that receive inter-company transfers.

There are several audit software packages available to assist in the detection of accounting fraud. The most effective way to identify fraud is to move staff. Shift responsibilities within the accounting department without notice and pay attention to changes in behavior.

To identify large-scale fraud, look at personal spending habits and lifestyle. People who commit accounting fraud often spend lavishly, but avoid extended absences from work. They are defensive when questioned about current business practices. They are also very resistant to any changes in responsibility that restrict their access to cash or check production.

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Discussion Comments
By Logicfest — On Mar 17, 2014

Here's something else to consider -- accepting cash compounds problems when it comes to companies that accept cash for services rendered AND uses both invoices and sales slips.

Let's say a nonprofit is holding a fundraiser for a charity. Everyone who attends the event pays at the door. The money raised is recorded through custom sales slips. It's hard to get away with not recording checks and credit card transactions, but it's easy for the person handling the money to pocket a bunch of cash and simply never generate a sales slip for it.

Stealing from a charity is a horrible thing, but it happens when unscrupulous people can get way with it.

By Terrificli — On Mar 17, 2014

This is why cash is such a problem for businesses. A lot of companies that don't deal in the retail industry prefer people to pay invoices with checks or credit cards so there is a paper trail that is independent of the company's own accounting package or procedures.

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