Cash Larceny, Part Seven: Alteration of accounting documents in imprest fund accounts (continued)

Almost all organizations use a petty cash fund to disburse funds to employees who make miscellaneous purchases on their behalf. The fund's custodian must always have a sufficient amount of money on hand to pay for routine expenses of the organization. Most petty cash funds involve only a small amount of money. But, fraud examiners shouldn't be misled by the amount of the fund itself when assessing the risk of fraud. The true fraud indicator in a petty cash fund isn't necessarily the size of the fund itself, but rather the amount of funds that are cumulatively disbursed through the account each year. Significant disbursements can be made through small petty cash funds. 

Here are some standard procedures for petty cash funds:

• The authorized imprest fund amount should always equal the amount of all temporary advances to employees and the amount of funds on hand and in the bank.
• Typically, the authorized fund level for a petty cash fund is maintained at about 2 1/2 times the amount of monthly expenditures made through the fund.
• The petty cash fund should be reimbursed at least monthly and at the end of each accounting year.
• Someone independent of the bank account custodian should receive the unopened monthly bank statement from the bank and reconcile it promptly with all the supporting documents present.
• Petty cash fund expenses should be for official organization purposes only.
• All petty cash expense documents should be marked "paid" to preclude their reuse on subsequent reimbursements.
• Organizations should use prenumbered cash advance forms when custodians send employees on purchasing trips. Employees must sign these forms to acknowledge accountability for the funds advanced to them. After the purchase transaction has been completed, employees return any unused funds and a receipt for the transaction to the petty cash custodian. The custodian completes the cash advance form to indicate the results of the transaction and retains it on file for reference and audit.

PETTY CASH FUND FRAUD
In my state, Washington, the county treasurer is the treasurer of all small governments such as fire protection districts, water and sewer districts, port districts, etc. These entities must deposit all revenue with the county treasurer's office in their geographic area. The county auditor's office is responsible for issuing warrants to pay all payroll and other expenses of these small organizations. After the organization's governing body approves all disbursements, it prepares a disbursement list and submits copies of the supporting documents to the county auditor for review and payment. These small governments must retain all original source documents for these transactions on file for subsequent review and audit.

Petty cash custodians at these small governments sometimes falsify the supporting documents for petty cash reimbursements and misappropriating the excess funds received from each false reimbursement transaction. When losses occur in petty cash funds, fraud examiners usually find that the custodian merely borrowed funds from the account. These rather small account shortages are immediately detected by unannounced cash counts and other monitoring activities conducted by managers. An organization promptly corrects 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 seeking prosecution of the crime.

While most petty cash fund frauds occur on the cash side of the account as described above, there are additional risks involving frauds on the disbursement side of the account, such as the situations described in the following two case studies.

Case study No. 1 - Fire protection district petty cash fund
The custodian of the petty cash fund falsified accounting documents to receive reimbursement for amounts greater than that of the actual expenditures and then misappropriated the excess funds. The custodian didn't process petty cash reimbursements quickly. As a result, the list that she would present to the organization's governing body for review and approval was normally quite long. Members of the governing body would sign the custodian's original reimbursement document for expenditures during an official public meeting. Once approved, the governing body would return the list to the custodian who would send it to the county auditor for payment. This is a necessary step and yet a fatal flaw in the process because almost all fraud in such situations occurs after approval.

To obtain an amount greater than authorized, the custodian would prepare an altered list of petty cash disbursements with additional fictitious expenditures listed at or near the end of page two of the document. The custodian would then prepare and submit the inflated list of petty cash transactions to the county auditor for payment. Because the county required only copies of the supporting expenditure documents, the custodian would simply copy the signatures of the members of the governing body on the second page of the altered reimbursement list and submit it for payment.

The external auditors detected the fraud when they reviewed the district's actual accounting records and found that the custodian had also included the copied signatures on the false petty cash reimbursement lists on file at the district. They found that the signatures on the altered reimbursement lists always exactly matched loop for loop the signatures of the members of the governing body on other legitimate reimbursement requests, which is a highly unlikely attribute over a period of time. They also found that the custodian hadn't supported any of the expenses with actual receipt documents. Additionally, they found the pattern of adding fictitious transactions on page two of the petty cash reimbursement lists and determined that the amount of the reimbursement requests for the petty cash fund often exceeded the total amount of the fund - a definite red flag indicating irregular activity. Managers should never permit this practice. The false transactions included payments to the custodian, members of her family, and her friends for miscellaneous expenses that weren't for official public purposes.

The external auditors found this $9,200 case while the fraud was in its second year so the loss was still small. The court sentenced the fire protection district petty cash custodian to a nominal period in jail. This type of fraud isn't uncommon and even though it's just petty cash it can grow to huge losses if not stopped in its early stages. For example, my agency has just begun a fraud examination of a similar case except that the amount of loss is initially estimated at about $400,000 over a seven-year period.

Case No. 2 - County mental health department petty cash fund
The custodian of the department's petty cash fund falsified accounting documents to receive reimbursements for amounts greater than those of the actual expenditures. She also used the fund for money laundering purposes. (I use the term money laundering to describe the actions of employees to convert stolen revenue checks to money for their own personal gain.) There are two parts of this story: excess revenue and the fictitious withdrawal of funds from the bank account. So, what happened?

Excess revenue
The custodian used two methods to build up excess funds in the petty cash fund. She misappropriated revenue checks from transactions that weren't recorded for accountability purposes in the department's cash receipting records. Because there was no accountability for this money, the custodian deposited the checks in the petty cash fund to accumulate excess funds. She subsequently disbursed these excess funds only for unauthorized personal purposes.

Secondly, she requested reimbursements from the county auditor's office for fictitious disbursements. There were some supporting receipts on file for these transactions, but they actually were false. Also, the custodian either never issued the checks to the vendors or destroyed them because none of them ever subsequently cleared the bank. There were several examples of falsified vendor invoices, cash register receipts, and other types of receipts that were retained on file to support these disbursements.

The external auditors found invoices that didn't match the type of document issued by the vendor associated with the transactions. The custodian, during an interview with the auditors, admitted that she used a book of generic invoice forms to obtain reimbursement for many false transactions. She also admitted that she used her optical scanner to create vendor invoices and obtain fraudulent reimbursements.

The auditors also found several different types of cash register tapes that didn't match the types of receipt documents issued by vendors. In many cases, the names of the vendors were handwritten on the cash register tapes - an obvious red flag. The key to detecting these types of irregularities is to recognize, from prior experience, the appearance of cash receipt tapes, forms, and other documents from legitimate vendors. The auditors confirmed the type of receipt document used by each of the vendors in this case. Here's an example of a vendor response from one of these fictitious transactions: "We have reviewed the sales receipt you sent to us and confirm to you that it is not from our store. We do not use this type of form and do not have an employee with the initials 'J.K.' In addition, we list all of our products by inventory part number, and do not even stock the item shown as purchased from our store. Finally, our sales from the date in question do not show any sale for the amount of this transaction." This response proved that this transaction was obviously fictitious.

Auditors also found the use of sequentially numbered restaurant receipt ticket stubs even though the transactions occurred at different restaurants, in different cities, and on different dates. Obviously, this pattern of activity was another red flag.

Fictitious withdrawal of funds from bank account
The custodian used three methods to withdraw excess funds from the petty cash fund. She took "cash back" from petty cash fund bank deposits, an unauthorized practice. The custodian also wrote checks to cash, herself, or a blank payee from the petty cash fund checking account. These are definitely high-risk disbursement transactions and additional red flags. She also issued checks to vendors that were never submitted to the county auditor's office for reimbursement. The bank redeemed these checks, but they represented the petty cash fund custodian's personal purchases. She didn't need to seek reimbursement for these unauthorized transactions, which used the excess accumulated funds as explained above to simply pay her own personal bills.

The external auditors detected this $4,700 case during a routine audit while the fraud was in its third year of operation so the loss amount was small. The court sentenced the department petty cash fund custodian to a nominal period in jail for this crime.

LESSONS LEARNED
So, let's review.

• Someone independent of the bank account custodian should receive the unopened monthly bank statement directly from the bank and reconcile it promptly.
• The amount of temporary outstanding petty cash fund advances and all funds on hand and in the bank should always agree with the authorized amount of the petty cash fund.
• Petty cash fund reimbursements should never exceed the total authorized amount of the fund.
• Ensure that all disbursement documents, including petty cash reimbursement requests, are properly supported and contain the original signatures of the members of the governing or approval body.
• Consider suspicious any cash receipt form without a printed store name shown on the document.
• Confirm unusual cash receipt documents with vendors to determine authenticity.
• Review similar types of invoices and restaurant receipt stubs on file on successive petty cash fund reimbursements to determine if the documents are being used sequentially.
• If the receipts for petty cash expenses don't contain current dates (such as dates prior to the last reimbursement request), review the supporting documents for previous petty cash reimbursement requests to determine if the expense was paid again in a prior period. Mark all petty cash expense documents "paid" to preclude their re-use on subsequent reimbursements.
• Organizations must ensure that cash receipting functions are established wherever revenue is received. Record all revenue transactions immediately for accountability purposes, and restrictively endorse all checks "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.

COMING UP: 'Z' TAPES!
The next several columns in this series will demonstrate some of the ways that employees alter accounting documents. The next column deals with procedures related to missing "Z" tapes (total accountability records) from manual and computer cash registers. Stay tuned.

Regent Emeritus Joseph R. Dervaes, CFE, CIA, ACFE Fellow, has retired after more than 42 years of government service. He remains the vice chair of the ACFE Foundation Board of Directors.