To Catch a Thief

"Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold." – Leo Tolstoy

Russell has an online gambling habit and not a lot of money to support it. But he’s got a plan; he’s going to embezzle from his company. He just has to figure out how he’ll do it.

Fortunately, he’s really close to the money. He’s been the bookkeeper for a mid-sized electronics distribution company for more than seven years. Russell and his assistant manage most of the accounting functions.

Russell quickly rules out stealing from the standard stream of customer income. Tammie, the owner of the business, is no auditor, but she would notice if he manipulated any of those large customer payments. Russell considers his alternatives and finally settles on an area he thinks no one will detect – and no one does for more than a year and a half. By the time the company discovers Russell’s crimes, it’s $150,000 poorer.

A hired CFE eventually uncovered Russell’s clever embezzlement scheme with the powerful “proof-of-cash” tool – an excellent addition to any CFE’s arsenal for finding evidence of hidden or missing activity affecting the cash accounts.

Though this case is fictional, it shows the use of a valuable tool for CFEs.

CASH IS KING 

The ACFE’s 2010 “Report to the Nations on Occupational Fraud and Abuse” (RTN) found that 90 percent of all cases in the study were asset misappropriation schemes. Cash is frequently a preferred target in these schemes.

In many cash theft cases – which can include skimming, larceny, and fraudulent disbursements – it’s very difficult to detect the fraud when the theft is a result of unrecorded transactions. However, a CFE must be alert, prepared, and continually looking beyond the obvious.

The proof-of-cash method will isolate and identify specific unrecorded transactions. It proves that all the receipts and payments at the bank agree with all the receipts and payments in the cash receipts and disbursements journals.

TAMMIE IS SUSPICIOUS 

Like many business owners, Tammie has a lot to manage. The economy has made her job more difficult. She’s seen a decrease in orders and other income. She’s particularly concerned about her cash flow.

Tammie recently received an anonymous tip that Russell has some personal financial difficulties. She’s also overheard some heated exchanges during some of his recent telephone conversations. Maybe he was arguing with creditors or lenders? She has no proof, but she has a gut feeling that he might somehow be stealing money from the operations checking account.

Russell, who is middle-aged, has a solid accounting background. He and his assistant are responsible for preparing checks for the company as they receive approved invoices and check requests. Tammie is also involved in the process. She carefully reviews the supporting documents and signs all checks.

After the end of every month, Russell regularly reconciles the company’s bank account to an electronic statement that he downloads from the bank’s website. He uses a popular, off-the-shelf, computerized general accounting system to give Tammie updated reports and the daily account balance. He also gives her a check register and a cash receipts journal whenever she asks for it. Tammie has rarely seen anything that would cause her to question Russell’s reports.

On the surface, everything appears OK. If the account detail reconciles to the electronic statements and there’s no evidence of unusual transactions appearing on the check register and cash receipts journal, can there really be any problems? Is Tammie’s gut feeling just a case of indigestion?

DECISIONS, DECISIONS 

Russell has to find the perfect place from which to embezzle. Tammie frequently reviews not just the check register and cash receipts journal but the cash reconciliation and the balance.

During the annual external audit, the auditors always asked for the year-end cash reconciliation and did some testing in cash. So this wasn’t going to be easy for Russell. He would have to find some quiet way to embezzle, or he’d have to give up his online gambling accounts.

The answer came to him as he was recording a miscellaneous refund. At the time, the company received rebates and refunds from vendors. Russell had always deposited and recorded the checks as soon as they were received and never thought much about them before now.
    
But then he realized he could deposit these relatively small rebates and refunds into the operating account and never record the entries on the computer. Each amount was so small that if Tammie checked the balance she wouldn’t be able to detect it. And he could always explain away small differences. He rationalized that there are always going to be differences because of outstanding checks and deposits in transit. Unlike customer accounts, which he recorded, balanced, and tracked, he’d simply record miscellaneous receipts as received.

This could work, he thought. All he had to do was deposit the next refund check into the cash account of the company’s operating account as usual. But because he doesn’t record the deposit, he knew he couldn’t record expenditures either. And to keep things simple on the cash reconciliation, he secretly spent an amount on an online gambling site equal to that of the refund checks he deposited during the same month. He was able to embezzle funds successfully for more than a year.

TAMMIE HIRES A CFE  

Tammie becomes more suspicious. She hires a CFE and asks him to check the following records:

1. Check register for March (Exhibit 1)
2. February cash reconciliation (Exhibit 2)
3. March cash reconciliation (Exhibit 3)
4. March bank statement (Exhibit 4)  

PROOF OF CASH EXPOSES FRAUD 

Tammie wasn’t able to see Russell’s illegal activity, but the CFE sees a big red flag in the proof of cash. There’s a glaring $100 difference between the calculated balances and the actual balances at the bottom of Exhibit 5. The company has to resolve this error or irregularity. This particular difference between the actual and calculated balances indicates bank transactions that weren’t recorded on the books.

A sum of $100 was deposited but never recorded as a March receipt; it was spent but never recorded as a March disbursement. Looking at the March bank statement, Exhibit 4, it’s now relatively easy to find the two unrecorded $100 entries. Look at the deposit on March 17; it was never recorded in the check register. It’s the same story for the payment clearing the bank statement on March 30; it was never recorded as a disbursement. Russell now has some explaining to do.

After the CFE found irregularities in one month, he expanded the scope of the examination to review data for the previous three years. He discovered that Russell had been embezzling miscellaneous receipts for more than a year and a half. The total losses for the company exceeded $150,000.

LESSONS LEARNED 

This case study is consistent with the results of the ACFE’s 2010 RTN. The survey indicates that smaller businesses are prone to fraud. Fraud schemes typically go undetected, on average, for 18 months for all businesses in the study. The RTN shows that the median losses for small businesses caused by occupational fraud cases was $155,000.

It’s difficult to catch a thief who fails to record accounting entries. Ask the following:

• Are all miscellaneous receipts properly recorded? Or are miscellaneous receipts lower than expected or totally absent? In this case, Tammie would question Russell if large customer payments didn’t show up in the cash receipts. However, Russell realized she wasn’t likely to miss small, infrequent rebates and refund reimbursement checks. Be aware of the potential for these smaller, missing miscellaneous items. 
• Does anyone have overlapping, incompatible duties? If someone has the ability to initiate, record, and reconcile cash transactions, there’s a serious failure to properly segregate duties. Never trust any one person to manage an entire process. 
• Are you aware of pressures or incentives that might be affecting people who have access to assets? The 2010 RTN indicates that the two most common red flags are people living beyond their means and people experiencing financial difficulties.  
• Does your business have an employee sophisticated enough to accomplish this embezzlement? A shipping clerk in the back of the warehouse isn’t likely to have the ability to conceal this type of fraud. The bookkeeper or controller who can forge checks and reconcile the account can cover up a significant volume of questionable transactions. More than 30 percent of all fraud schemes involved the accounting department, according to the RTN. 
• Are you listening to tips? If Tammie hadn’t listened to the tips, would Russell still be secretly gambling away the company’s money? Historically, tips are the single best initial detection method. Many eyes and ears collect information that’s never printed on a report. 

TRUTH HIDDEN IN DETAILS 

This case study allows you to see the thought process an embezzler goes through to make this scheme work. As you can see, it’s no easy task to uncover this form of unrecorded embezzlement. The proof-of-cash test is the best tool to use when you suspect this form of manipulation in a cash account, and it will help you discover the truth hidden in details.

Ken Stalcup, CPA, CFE, CFF, is a litigation, valuation and forensic team manager for Somerset CPAs, P.C., in Indianapolis, Ind.  

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