Cash larceny, part six: Alteration of accounting documents in imprest fund accounts

This column continues our discussion about cash larceny frauds. In the fraud cases that follow, employees falsely prepared or altered cash receipt accounting records and documents in imprest fund accounts to conceal the misappropriation of funds from the organization. Here we'll discuss fraud in advance travel funds.  

• Management must approve all travel advance requests and ensure they're supported by pertinent documents associated with the travel such as conference brochures.
• Employees may not receive more than one travel advance at a time. In addition, the amount of these travel advances is normally set for an even-dollar amount (for example, $900, $1,000, etc.) that's less than the total expected amount of expenses for the trip.
• Employees must submit travel expense reimbursement reports to the organization within 10 days of completing the travel and the custodian of the advance travel fund shouldn't normally travel on behalf of the organization.
• Someone independent of the custodian must receive the monthly bank statement directly from the bank and reconcile it promptly.

Total accountability for the advance travel fund includes all outstanding travel advances and the balance of funds on hand or in the checking account. When losses occur, fraud examiners usually find that the custodian has borrowed funds from the account. These rather small account shortages are immediately detected by unannounced cash counts and other monitoring activities managers conduct. Organizations promptly correct this situation by removing the custodian from the position, taking disciplinary action against him, obtaining restitution of the loss amount from the custodian and/or its insurance carrier, and then seeking prosecution for the crime. (See case study No. 1.)

ADVANCE TRAVEL FUND DISBURSEMENT FRAUDS

Case study No. 1 - County treasurer's office advance travel fund 

After a detailed analysis of all travel advances and settlements, an external audit determined that the advance travel imprest fund was short by approximately $1,800. During a five-month period, the auditors found that three checks from county employees who previously settled their travel claims with the custodian of the advance travel fund had not yet been deposited in the bank. The custodian of the account didn't follow county procedures for managing this account and couldn't provide any reasonable explanation for the cash shortage. In addition, no one was able to fix responsibility for this loss to a specific individual. Why? Because there were too many employees who processed these transactions in the account and had access to the funds during the business day or while the money was stored in a safe overnight. Also, an independent party didn't reconcile the bank account promptly, and advance travel claims weren't settled in a timely manner.

Even after a thorough search of the office, no one was able to find any of the missing employee reimbursement checks or travel settlement documents. Also, the employees reported that their checks had never cleared the bank. Six months after the external auditors issued a report citing no fixed responsibility for this loss, the custodian retired. The new custodian subsequently found all the missing uncashed employee travel settlement checks in the prior custodian's desk. The end result of all this turmoil was that no real loss of funds existed in the travel advance fund after all.

While most advance travel fund frauds occur on the cash side of the account, such as described in this case, there are additional risks involving frauds on the disbursement side of these accounts, such as the situation in case study No. 2.

Case study No. 2 - School district advance travel fund 

One school district employee was the custodian of both an advance travel fund (public funds) and an employee union fund (non-public funds). This employee was in total control of all revenue and disbursement transactions in these two checking accounts. As a result, she was able to misappropriate $188,300 from the district because the organization didn't properly monitor her work. The employee used a facsimile rubber stamp for the name of the manager so that he didn't have to sign checks in person. While the manager dated and initialed the monthly bank reconciliation, this perfunctory review didn't include a review of the supporting bank deposit slips and redeemed checks. So, what happened?

Case study No. 2 involved the falsification of accounting records to conceal irregular disbursements and money laundering activity. (Here I use the term money laundering to describe what employees do to convert stolen revenue checks to funds for their personal gain.)

The school district employee, who misappropriated $188,300 from the district was in total control of all revenue and disbursement transactions in the checking accounts of an advance travel fund (public funds) and employee union fund (non-public funds).

Advance travel fund
Disbursement checks from the advance travel fund were initially prepared on a typewriter with a correction capability. The employee issued checks made payable to herself and then deposited them into her personal bank account. She also made payments on her personal credit cards from the account. The external auditors found 80 fictitious disbursement checks over a five-year period totaling losses of almost $55,000. When the advance travel fund checks made payable to herself and to credit card vendors were redeemed and returned to the district with the monthly bank statement, the custodian altered the checks again by using the correction capability on the typewriter to change her name and the vendor names on the payee line to the name of another employee who typically traveled on official business trips for the district. The payee area of these altered checks was also stamped with the word "received" to conceal the alteration. But once this action was taken, the payee on the front of the checks didn't agree with the endorsement on the back of the checks. And that was the irregularity the external auditors detected while reviewing the bank account during a routine audit. Also, there were no supporting documents on file for any of these unauthorized disbursements.

The employee routinely misappropriated district revenue checks from miscellaneous revenue sources that hadn't been receipted for accountability purposes. She then deposited them in the advance travel fund bank account. She made these deposits in an amount exactly equal to the amount of the disbursement checks the custodian previously issued to herself and to her credit card companies. Thus, the deposits reimbursed the fund for the amount of money that she misappropriated. As a result, the amount of funds in the advance travel fund always reconciled to the authorized balance for the account. These actions also transferred the loss of funds in this case from the advance travel fund to the district's general fund, the original source of the misappropriated revenue checks. The disbursement checks in this case were issued in dollars and cents (for example, $954.38) and were a visible attribute of the fraud because the amount of these checks were supposed to be for even dollar amounts (for example, $950).

Employee union fund
The employee also routinely misappropriated district revenue checks from miscellaneous revenue sources that weren't recorded for accountability purposes and deposited them in the employee union fund bank account. She then issued checks made payable to herself that she subsequently deposited into her personal bank account. She also issued checks made payable to vendors and credit card companies to pay her personal bills directly from the account. The irregularities in this fund reaped losses of more than $133,300 in 3 1/2 years from the district's general fund.

The district approved a change in custodians for the employee union fund just prior to the detection of this fraud. To wipe the slate clean and try to hide her crimes, the fraudster employee closed the original bank account, destroyed all the accounting records, opened a new bank account with the appropriate fund balance, and then transferred the checkbook and accounting records to the new custodian. Of course, the fraudster's actions were red flags indicating irregular activity. Managers should never permit this practice.

When the auditors detected the fraud in the advance travel fund, they used their administrative subpoena power to obtain access to the employee's personal bank account. During a review of deposits in the account, the auditors discovered some of the employee union fund checks. This led to an analysis of that account and the detection of the second of the two bank accounts used to commit this crime.

In cases like these, I'm always interested in the source of the misappropriated revenue checks used in the fraud. Why? Because this information discloses where internal controls need to be improved within the organization. As an example, the following miscellaneous revenue sources were involved in this case: a soft drink company; a telephone company; student fees; facility rent for athletic fields and buildings; parent donations; reimbursements for food service catering and print shop activities; and other individuals, businesses, and governments. This rather lengthy list of revenue sources demonstrates the magnitude of internal control changes the district needed to address.

The primary issue we dealt with in this case was that the misappropriated revenue checks had been received from so many sources throughout the organization; however, these transactions weren't receipted at the original point of entry into the organization such as by using manual cash receipts and manual or computer cash register systems. Instead of receipting these funds, employees in the organization simply received the money and sent the funds to the fraud perpetrator, believing she would properly record the transactions in the district's accounting records and deposit the money in the bank. However, she misappropriated the money instead. The internal control weakness over fund transmittals within the organization allowed her to perpetrate this crime. Thus, the employee who misappropriated these funds wasn't the employee who received the money first. There's a very big difference between the words "receive" and "receipt." And this case clearly demonstrates what it is. To appropriately deal with this condition, organizations must ensure that all employees immediately record every revenue transaction for accountability purposes, and then sign transmittal documents and/or obtain receipts to acknowledge the amount of funds transferred from decentralized locations to the central treasury function.

The court sentenced the district advance travel fund custodian employee to a period in jail for less than six months.

In case study No. 2, I discussed the alteration of the payees on advance travel fund checks. However, that's not the alteration of accounting documents that I initially intended to highlight in this case. When the auditors detected the irregularity between check payees and the endorsements on the advance travel checks, they asked the bank to send them copies of the microfilm records for several bank deposits. Instead of mailing this information directly to the auditors, the bank sent the information to the custodian of the account. Once the custodian realized what the external auditors were doing, she falsified the bank deposit information in a further attempt to conceal the irregular activity.

During the course of normal business, she made copies of employee checks for her records and then used the documents in her files to prepare a completely new bank microfilm record for the auditors. She first copied the front of recent checks from her files and then copied the back of other redeemed checks from her banking records to obtain endorsements by these same employees. Finally, she altered the bank microfilm record and presented it to the auditors for review. They quickly discovered that the only valid item on the altered bank microfilm records was the bank microfilm reference numbers. Everything else was false. The auditors also found that none of the redeemed checks included the Automated Clearing House encoding information for the amount of the redeemed checks. This information always appears on the front of redeemed checks immediately under the signature line. The auditors then contacted the bank and made a second request for the same information, this time making sure that the bank mailed the information directly to them so that they could complete the audit.

LESSONS LEARNED 

• Someone independent of the bank account custodian should receive the unopened monthly bank statement directly from the bank and reconcile it promptly with all of the supporting documents present.
• When custodians of bank accounts are changed, it's never necessary to close the old bank account and open a new one. This action is an immediate red flag and an irregularity that shouldn't escape the attention of any manager or fraud examiner.
• The authorized imprest fund amount should always equal the amount of all outstanding travel advances and the amount of funds on hand and in the bank.
• Organizations must ensure that cash receipting functions are established wherever revenue is received. All revenue transactions should be immediately recorded for accountability purposes, and all checks should be restrictively endorsed "For Deposit Only" immediately upon receipt.
• Employees should always sign transmittal documents and/or obtain cash receipt forms acknowledging the amount of funds transferred from decentralized locations to the central treasury function.
• Even though the client may request bank account information for use during audits, fraud examiners should always ensure that this financial data is mailed directly to them to prevent employees from compromising the documents.

YET MORE TO COME
The next column will conclude this discussion of the alteration of accounting documents in petty cash fund fraud cases. So stay tuned for more information.

Regent Emeritus Joseph R. Dervaes, CFE, CIA, ACFE Fellow, is audit manager for special investigations for the Washington State Auditor's Office.