Rescuing the Company

Top executives can drive their companies close to bankruptcy because it’s often easy for them to circumvent controls. “Bob” was the deputy president director of a branch of an international technical consulting firm with its head office in Europe. He was able to make false disbursements of cash totaling approximately US$250,000 over two years because this branch firm didn’t have an internal auditing department. The head office’s internal auditors came about twice a year to review the branch firm’s compliance with technical rules and procedures, but they never conducted actual financial audits. (A deputy president director is similar to an American chief operating officer.)

The branch firm’s president director (similar to an American company president or CEO), who had very limited knowledge of accounting and finance, unwittingly verified and approved the fraudulent disbursements. He trusted Bob because they were longtime friends, and he let Bob approve disbursements without requiring his own authorization.

DEPUTY DIRECTOR PRESIDENT’S FALSE EXPENDITURES 

An established client had given the company a new assignment. The president director appointed Bob to manage the entire project. The board of management of the branch firm (which adopts the American board of director system) gave Bob the authority to oversee the project’s financial operations.

Bob created false disbursements of cash because he thought it was too risky to embezzle cash directly from the branch firm’s bank accounts. [For a different take on a cash/asset misappropriation scheme, see “To Catch a Thief.” – ed.]

He submitted false invoices to the accounting department for payments of certain expenditures – usually for fictitious payments to third parties. Bob would create false daily working paper and payment rates for existing freelance consultants and submit them – with bogus invoices – to the accounting department. He would then collect the checks ostensibly to give to these third parties.

He was certain he wouldn’t get caught because he had full control. In fact, he had more authority than even the president director on this project. [See the sidebar “Billing Schemes Detection Methods Work Best When Combined Together” below for ways to discover purchasing irregularities for goods and services. – ed.]

Bob also stole cash from the project’s expenditure accounts. He was able to easily manipulate the payments of consulting fees, project expenses, and travel and entertainment expenses. He simply created false invoices with fake names and rate calculations. He even brazenly printed out the phony supporting documents with his office’s computer and printer. Bob had no problems creating supporting documents for travel and entertainment expenses that he never actually incurred. He simply found the names and addresses of hotels and restaurants in the Yellow Pages and made the false invoices. Because he was in charge and there was nobody watching him, he was able to get away with everything he put his mind to.

RED FLAGS FLYING 

Here are some of the red flags the branch office’s accountants should have noticed:

1. Lack of strong internal control can provide opportunities for smart employees to commit fraud. 
2. A “one-man-show” culture without any balance of power from other parties will result in a far greater risk of internal fraud. 
3. Fraud can easily be committed when management adopts a “personally based relationship” philosophy.  
4. Unreasonable or a total lack of segregation of duties will always be the main reason fraud has been committed.  
5. Bob used mainly accounts that didn’t involve complex supporting documents such as consulting fees, project expenses, and travel and entertainment expenses.

In the first six months of his fraud, Bob embezzled hundreds of thousands of dollars. As a result, the branch office company didn’t have enough cash to finance its operations, and management finally had to borrow funds from its head office in Europe to keep the branch office running. This contributed to solvency problems because the company was now required to pay high interest in Euros. Also, the company had to cancel its investment and training plans for the year. Although the company narrowly escaped bankruptcy, Bob’s actions had a tremendous negative influence on the company’s future growth.

BOB’S INADEQUATE SUPPORTING DOCUMENTATION 

We can identify several more red flags from Bob’s fraudulent disbursements of cash. Sometimes he would submit expenses with no supporting documentation or just small notes. The president director occasionally brought this up with Bob because he was worried about the annual visit from external auditors. Bob was always able to give logical explanations about the expenses and assure the president director they wouldn’t pique the curiosity of the auditors. Bob was also careful to instruct the accounting department to tell the external auditors to speak to him directly if they had questions about his projects’ expenses.

There were some inconsistencies in supporting documents. For instance, Bob would submit false invoices for a consultant’s rate payment for seven days while the supporting documents showed the consultant only worked for three days. Or he would submit the lodging and meal payments for a consultant when no work was going on in the area during the indicated dates. Bob believed the branch office’s accounting department wouldn’t be able to track these inconsistencies.

Bob also asked the accounting department for true payment vouchers with their supporting documents. He said these vouchers and documents needed to be “adjusted” due to changes in the project. He altered the reported time frames for certain jobs and the number of consultants who were involved. Then he gave the vouchers back to the accounting department without explaining anything. When accounting asked some questions, Bob just said he made the adjustments because of “technical matters.”

Bob also visited the accounting filing room after working hours or on the weekends and destroyed his fraud trail by removing all suspicious supporting documentation.

BOB’S UNUSUAL BEHAVIOR 

Bob often acted odd when he was asked about expenditures. He would cancel meetings with the accounting department at the last minute. His secretary would frequently say he was unavailable for meetings. When he finally attended meetings, he always had convincing reasons for spending beyond the budgeted amount, such as extra consultant expenses, increased ticket prices, etc. The president director didn’t question him.

Bob was always upset at the staff meetings when the accounting department raised questions about certain expenditures. He said he was fully responsible for the project’s financial operations, and he would meet the targeted results for his project. He blamed missing documents on the accounting department for not safeguarding company records, which diminished the department’s performance in the eyes of management.

Even though the company hadn’t awarded any salary increases or bonuses, Bob bought a new luxury car a few months after the project started. Employees asked how he could afford such a car, but Bob told them to mind their own business.

So we can conclude that Bob’s frauds influenced his behavior. Beware when executives (and others):

• Avoid those who are asking them about projects’ financial situations 
• Show unreasonable anger in normal circumstances  
• Say everything is under control without being able to give further clarifications
• Find scapegoats (Bob found the accounting department) so they can cover their embezzlements and live beyond their means 

LESSONS LEARNED 

Organizations have to pay a high price and even risk bankruptcy when they don’t provide adequate checks and balances to prevent asset misappropriation frauds. CFEs and internal auditors can prevent and detect these frauds by exploring embezzlers’ motivations and opportunities for frauds before they grow out of control.

The motivational factors for an embezzler can include economic pressure, desire for a luxurious lifestyle, job dissatisfaction, addictive gambling habits, need for personal gain, hope of beating the system, and family or job pressure.

Frauds are often committed because of opportunities offered by the organizations such as significant internal controls, domination of management by a single person or group without proper oversight, ineffective board or audit committee oversight, existence of liquid assets, and ineffective accounting and communication systems.

There are several methods CFEs can use to detect the asset misappropriation frauds committed by employees:

1. Review the organizational structure. It’s important to understand the entire internal control system, including segregation of duties, and how the board or audit committee oversees the organization’s business.

2. Identify the organization’s key personnel. This analysis will show who has authority for financial and asset custody, who can approve transactions and disbursements, and those directly involved in financial operations and transactions. Key personnel might include the owners of the business, board of management, accountant, bookkeeper, and other financial staff.

3. Recognize suspicious behaviors of the organization’s key personnel. Focus on the suspicious actions of a person acting out of character so you can glean insight about the areas that might be at risk. You might also discover details and clues about the possible fraud.

4. Examine the organization’s disbursements. Identifying expenditures associated with suspect transactions will help reveal how frauds are committed. Several questions can be explored:

• Which disbursements are made to third parties?
• Did the organization have any extraordinary expenditures during the suspect time period?
• Are the expenses and disbursements paid by cash or bank check? 
• Did the organization have disbursements for payments for services? 
• How are the travel and entertainment expenses reimbursed?

5. Evaluate irregularities on supporting documents. Reviewing the absence, inconsistencies, and dubious alterations of supporting documentation will help solve the puzzle of frauds.

6. Assess the organization’s record-keeping system. Evaluate this system to find irregularities in supporting documentation. Also examine the policies on safeguarding files and records and the list of the parties that have direct access to these files.

7. Complete the analytical review. This will help find the relationships of disbursement accounts. Certain expenditures can be correlated with other expenditures. Therefore, fraud examiners can find and further analyze abnormal relationships among certain expenses, which may lead to the detection of embezzlement. For example, less field work by a consultant should be followed by fewer disbursements for travel, lodging, and meal expenses.

NEW HEAD OFFICE REQUIREMENTS 

The head office finally conducted a financial review after the branch firm experienced large losses on several ongoing projects. The head office found irregular accounting practices and lack of strong financial control. It fired Bob and the president director.

The head office now requires that the new president director acknowledge and approve all project expenses. The accounting department has to have access to the projects’ financial operations. The branch firm has to update the head office regularly on the financial status of the ongoing projects. The regional office periodically visits the branch office to review the accounting and financial practices.

Indra Djaja Utama, CFE, CMA, CTP, CIA, currently lives and works in Singapore.

Billing Schemes Detection Methods Work Best When Combined Together

Variations of purchasing fraud schemes are legion, so many detection methods also abound. A detection method is most effective when used in combination with others. They will point out anomalies and weaknesses in internal controls.

Analytical Review 

A review of the various general ledger accounts might reveal unusual or unexpected events. For example, a comparison of inventory purchases in relationship to net sales might indicate that purchases are too high or too low for that level of sales. This might be a red flag, which indicates purchasing schemes or fictitious sales schemes, respectively.

Another analytical method uses a comparison of the inventory purchases of prior years with those of the current year, which might indicate overbilling or duplicate-payment schemes.

Analytical reviews are most effective in detecting fraud schemes that are large so that anomalies will be apparent. Other detection methods are more effective for fraud schemes that are smaller in relationship to the financial statements taken as a whole. Regardless of fraud size, examination of source documentation will be necessary.

Computer-assisted Analytical Review

Anti-fraud software can assist in determining the presence of unusual patterns in the acquisition or purchasing function and provide a matrix of the purchasing activity to determine the presence of unusual patterns. Following is an analysis of three fraud schemes and corresponding computer-assisted detection methods:

Statistical Sampling

As with inventory, the source documentation for purchases can be statistically sampled and examined for irregularities. Statistical samples can be drawn to test specific attributes. This detection method is particularly effective if a single attribute is suspected such as fictitious vendors. A listing of all post office boxes addresses might reveal fictitious vendors.

Vendor or Outsider Complaints

Fraudulent schemes will often unravel because a vendor or other outsider complains to the employer or company. Complaints from customers, vendors, and others are good detection tools that can lead to further inquiry.

Site Visits

A site visit will often reveal much about internal controls, or lack of them, for any location.

Sample Audit Program

This partial audit program might be beneficial in detecting red flags to billing schemes for tangible items:

• Does the company have a purchasing department? If yes, is it independent of the accounting department, the receiving department, or the shipping department? 
• Are purchases made only after the respective department heads sign purchase requisitions? 
• Are purchases made by means of purchase orders sent to vendors for all purchases or only for purchases over a predetermined dollar limit? 
• Do purchase orders specify a description of items, quantity, price, terms, delivery requirements, and dates? 
• Is a list of unfilled purchase orders maintained and reviewed periodically? 
• Are purchase order forms pre-numbered, and is the list sequence accounted for periodically? 
• Does the client maintain an approved vendors list? 
• Are items purchased only after competitive bids are obtained? If so, are competitive bids obtained for all purchases or only for purchases over a predetermined dollar limit? 
• Is a log maintained of all receipts? 
• Does the receiving department prepare receiving reports for all items received? If yes, are receiving reports: 1) prepared for all items 2) prepared only for items that have purchase orders or 3) renumbered? 
• Are purchasing and receiving functions separate from invoice processing, accounts payable, and general ledger functions? 
• Are vendors’ invoices, receiving reports, and purchase orders matched before the related liabilities are recorded? 
• Are purchases recorded in a purchase register or voucher register before being processed through cash disbursements? 
• Does a responsible employee assign the appropriate general ledger account distribution to which the invoices are posted? 
• Are budgets used? If yes, are budgets approved by responsible officials, and are actual expenditures compared with budgeted amounts and variances analyzed and explained?

Adapted from “The Fraud Examiners’ Manual,” ©2010 The Association of Certified Fraud Examiners, Austin, Texas 

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