Cash Larceny, Part Five: Alteration of accounting documents

Unscrupulous cashiers often prepare false accounting records or alter these documents in cash receipting operations to conceal a misappropriation of funds from their employers. Once these cases have been detected, fraud examiners must first understand the attributes and mechanics of the fraud, learn from the experience, and then be prepared to detect similar frauds in the future. The next three columns present fraud cases that illustrate some of the common alterations of accounting records I've encountered in my practice. Each case has one or more learning objectives. 

School district student fund-raising activities
In my state, the proceeds from student fund-raising events are public funds. A student body council manages the money, but an accounting clerk employed by the district performs all accounting services. In almost all cases, the accounting clerk works alone with little or no assistance from student volunteers. In addition, managers usually provide limited or no oversight of the receipting and disbursing transactions associated with student clubs that operate a plethora of fund-raising activities each year. Monitoring is absent.

In certain types of fund-raising activities, students collect funds and give the money to the accounting clerk without taking the time to count it or to obtain a cash receipt. As a result, the accounting clerk is often able to establish his own accountability for funds. When this happens, this individual becomes one of the most dangerous people in the organization. Why? Because fraud is almost guaranteed to occur under these circumstances.

But other kinds of fraud also occur in this environment. Many of these cases involve a simple falsification of the accounting records. The primary question is: "Can you actually see the fraud?" (See case study No. 1)

Case study No. 1 - Accounting clerk raises funds for herself
Accounting clerks often misappropriate funds by failing to record all receipt transactions in the journal, a simple omission of revenue. Fraud examiners must account for all manual cash receipts forms issued to detect this type of fraud.

In this case, the district's accounting clerk totally controlled all receipting and disbursing activities for student fund-raising events with no management oversight. When students would turn in money from fund-raising events, the accounting clerk would issue a manual cash receipt form to the student or club. She would then establish accountability for the funds by listing the revenue transaction in a cash receipts journal.

She kept immaculate records and was careful to properly record all revenue transactions in the journal. At the end of each day, she summarized all revenue transactions and then entered the total amount of the bank deposit in the journal. If a manager or fraud examiner casually examined the journal and related bank deposit slips, the amount of funds deposited in the bank would always equal the amount of accountability the accounting clerk recorded for the summarized total of all transactions each day. But often apparently perfect accounting records spell danger. In this case, the amount of funds deposited in the bank didn't agree with the total amount of funds collected each day. The accounting clerk concealed these shortages by falsely totaling the accountability for the day and entering a lesser amount for the total of the bank deposit in the journal. When all cash receipt transactions were accurately totaled, these short deposits were readily apparent. Therefore, fraud examiners must actually do the math to detect this fraud.

This chart illustrates the crime:

In case study No. 1, the amount of revenue collected on 01/10/XX was actually $3,500. If the person who was reviewing these records simply had matched the bank deposit slip from 01/11/XX with the amount of funds recorded for the deposit total shown in the journal on that date, the deposit shortage of $500 could easily be overlooked. A fraud examiner could have totaled the accountability for all revenue transactions on 01/10/XX ($3,500), compared that amount to the total shown for the bank deposit in the journal for that date ($3,000), and then finally compared the amount with the total amount of funds actually deposited in the bank ($3,000). That procedure always detects the fraud.

Note that the mode of payment information (such as currency, check, or credit card) for each cash receipt transaction has been omitted from this example. But if this financial information is present, fraud examiners should also compare the mode of payment information from the supporting cash receipt forms to the check and cash composition of the daily bank deposit for agreement. This test detects check-for-cash substitution schemes in which revenue checks that haven't been recorded for accountability purposes are substituted in the bank deposit for currency that has been collected.

External auditors detected this fraud during its first year of operation when the amount of the loss was less than $10,000. The court sentenced the district accounting clerk to a nominal period in jail.

Preparing the daily activity report at the end of each business day
All cash receipting activities within the organization prepare some type of daily activity report at the end of each business day. This report identifies the date, shift, cashier, accountability documents, and the check and cash composition of the revenue collected. Other documents supporting the daily activity report vary depending upon the cash receipting system used. These could include: copies of manual cash receipt forms; the "Z" tape for total accountability of funds for manual and computer cash registers; and copies, of or explanations for, any void or paid-out transactions. The purpose of these records is to account for the change fund and the cash receipts and supporting documents from all revenue transactions processed each day. A supervisory cashier or manager usually reviews these documents and then prepares and makes the daily bank deposit. Why is this information important? During routine cash receipt testing, an auditor recently determined that revenue totaling $1,225 from a decentralized audit location wasn't deposited in the bank. The organization's procedures didn't detect this cash shortage from 18 months before because they weren't monitoring the sequential use of all "Z" tape numbers produced by the computer cash register system. (I'll discuss the importance of this internal control in a future column.)

Sometimes, an external auditor will perform an unannounced cash count during the business day. She will use the daily activity report and supporting documents to make sure that all transactions included in the unannounced count have been properly accounted for at the end of the business day and that all funds collected have been deposited in the bank. Case study No. 2 illustrates the reasons fraud examiners must physically review the original daily activity report while performing these verifications.

Case study No. 2 - Town municipal court

External auditors performed an unannounced cash count at the town's municipal court and then performed audits in other departments. The court clerk subsequently prepared the daily activity report for the date of the cash count and made the bank deposit. However, the court clerk misappropriated the funds of several customers that they paid to her after the auditors made the unannounced count but nonetheless properly recorded all cash receipt transactions on the computer cash register system. The clerk concealed the resulting shortage of funds in the bank deposits by destroying the daily activity reports and other related accounting documents for all transactions that occured each day. Because the amounts of funds deposited in the bank was less than the amount of funds listed on the computer cash register system daily activity report, she altered the report to indicate that the total amount of funds received agreed with the total amount of funds deposited in the bank. She first printed the daily activity report from the computer system and then methodically identified all the data entries that had to be altered so that the amount of revenue shown on that daily activity report would agree with the amount of funds deposited in the bank. She used scissors to cut out information on the report that had to be altered, used a typewriter to change the amounts throughout the report, copied the altered report for the file, and then faxed the altered document to the external auditors.

Unraveling fraud
The auditors in case study No. 2 found many serious internal control weaknesses when they returned to the municipal court to complete the audit. They uncovered evidence of the misappropriation of funds and the fraud then began to unravel. The mayor placed the court clerk on administrative leave, and the police chief immediately arrested her. During an interview with the police chief, the court clerk admitted misappropriating funds from the court. Accounting records at the court were in complete disarray, and all cash receipting records had been destroyed. In addition, the state managers of the computer system could only retrieve a portion of the daily activity reports for the auditors. The mode of payment information was no longer available for prior year reports that had been archived. Using the available records, the auditors were able to determine that the court clerk misappropriated cash receipts totaling more than $18,000 during a 15-month period. However, the auditors also found that the court clerk falsified computer accounting records to conceal irregular accounting practices and transactions that represented revenue losses totaling an additional $46,000. As of press time, the case hasn't yet been prosecuted, but based upon the amount of the loss, I suspect that the court clerk will be sentenced to a nominal period in jail.

Lessons learned 

• Review internal controls to ensure that all revenue transactions are recorded in the accounting records.
• Employees from decentralized locations should always obtain a receipt for funds transmitted to or turned in at the central treasurer function.
• Fraud examiners should always find time to make unannounced cash counts at all cash receipting locations within the organization even if they do it on a cyclical basis. They should perform this count during the business day so that at least some cash receipt transactions can be included in the review. It does little good to merely count the change fund at the beginning of the day.
• During cash receipt testing, fraud examiners should account for all manual cash receipt forms issued, calculate the mathematical accuracy of all cash receipt transactions included in bank deposits, and then verify that the mode of payment for all cash receipt forms issued agrees with the check and cash composition of the daily bank deposit.
• Fraud examiners should physically review the original copy of the daily activity report to ensure that it's an accurate representation of all cash receipt transactions for the day.

Imprest fund accounts
We're not finished with this topic yet. Stay tuned for exciting information on the alteration of accounting documents in imprest fund accounts such as the advance travel fund and the petty cash fund.

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