Examining fraud and abuse in trade-skill education programs

Hundreds of taxpayer-supported public high schools and colleges offer trade-skill programs that enable many to pursue lifelong technical careers. However, fraud examiners often are faced with a common roadblock when they investigate these programs: a lack of documentation of financial transactions. Program directors and employees often don't create records when students pay their school bills or they immediately destroy them after student projects are completed. Therefore, entities and fraud examiners can't properly analyze these programs because it's impossible to determine the total number and value of all transactions that have occurred over a period of time.

We'll focus on this challenge and others as we discuss some of the special situations of examining trade-skill education programs in this column followed by a two-part complex fraud case study on the topic.

SKIMMING IS THE FRAUD OF CHOICE

Employee fraud in trade-skill education programs is usually simple asset misappropriation. In the ACFE's Fraud Tree, cash larceny by stealing an entity's funds falls into two major categories: fraudulent disbursement schemes and theft schemes. Theft schemes fall into two categories: skimming and cash larceny schemes. Skimming is the theft of off-book funds; cash larceny schemes involve the theft of funds recorded in the entity's accounting records. This discussion will focus on skimming.

INCOMPLETE ACCOUNTING RECORDS

You might have detected possible fraud or abuse, but you can't find many supporting financial documents. You can't gather evidence to prove beyond a reasonable doubt that an employee you've had your eye on has misappropriated program revenue.

This is a tragedy because it most often results in a finding that only encourages the school to improve internal controls rather than solid evidence that an employee committed fraud or abuse. Of course, there are exceptions when you're able to obtain a confession from an employee during an interview or when you find stolen revenue checks in an employee's bank account after a subpoenaed personal bank account search.

INTERNAL CONTROL PROCEDURES

Now if an auditor does find some supporting documents and management reports, the best thing he or she can do is analyze the profitability of student educational programs and review the internal control system by performing a walk-through of transactions and the program's policies and procedures. These primary steps will tell you how much additional audit work is needed and where to focus your efforts.

Unfortunately, auditors often are under time and budget constraints and don't document the internal control systems for each aspect of these small operations. Big mistake. A simple walk-through of revenue generation procedures often uncovers weaknesses of high-risk areas that then require a detailed audit to determine if fraud can or has already occurred — even if the amount of the loss isn't material to the entity's financial statements.

THE PERPETRATORS

In the private sector, you must concentrate on owners and key employees when determining those most likely to succeed in perpetrating fraud and abuse in trade-skill education programs. However, in the government sector, you can usually eliminate the owners — governing bodies, councils, mayors, etc. In my experience, key entity managers often are the perpetrators of these crimes for personal benefit. In fact, it's the very people responsible for educating students who are likely to be those that kill the goose that lays the golden egg. I often wonder what kind of education they think they're providing to the students in such poorly managed operations.

COMMON PROGRAM PROCEDURES

Here are some of the most common internal control procedures these trade-skill education programs should institute:

• Managers should establish policies and procedures concerning: 1) advance deposits for work 2) systems to track purchases to work orders 3) receipts from vendors that show descriptions of purchased items plus serial or parts numbers 4) records of program fees collected by the entity's independent bookkeeper or treasury function 5) rules governing an equitable system of access to the facilities by students, instructors and others 6) inventory records for projects performed on a periodic frequency and 7) monitoring of the continuous flow of work through the program.
• Accounting records should document units/levels of activity and accountability for revenue.
• Managers should be restricted from using the programs to benefit themselves and their friends rather than the students. Ethics must be emphasized.

The entity must also periodically monitor these programs to determine if their financial expectations are being met.

Let's take a look at several examples of inappropriately managed trade-school education programs to illustrate most of these key points.

Case No. 1: School district auto body shop

High school students in this auto body shop learned skills by repairing customer and student vehicles. However, external auditors found only one work order for estimated or actual vehicle repair work performed during the current school year. Reliable school employees and participating students estimated that the shop repaired approximately 40 to 50 vehicles during the year, but no one knew how many were owned by customers or students. This was important because customers paid for parts and labor, but students paid only for parts.

Incomplete accounting records prevented the district and external auditors from 1) assigning responsibility for funds to a particular individual 2) determining how much activity occurred in the shop during the current year and 3) determining amounts of losses, if any.

Program policies required all repairs to be estimated and recorded on prenumbered work order forms, and all revenue had to be deposited with the school bookkeeper. However, the auto body shop instructor discarded work order forms after students completed vehicle repair work because he thought the documents were no longer necessary. These forms weren't prenumbered and didn't have the district's name printed on them. Therefore, eternal auditors were unable to trace district purchases for repairs to work order forms.

Because the school bookkeeper wasn't always available, the auto body shop instructor also issued receipts to customers for payments. These receipts were prenumbered but didn't include the district's name on them.

The instructor and some students issued at least 36 cash receipt forms to customers for vehicle repairs during the current school year totaling $1,928. Thirty-one of these forms (87 percent) weren't dated, and revenue from 13 of the transactions (36 percent) couldn't be traced to deposits made with the school bookkeeper. Twenty-four receipts (67 percent) didn't indicate the mode of payment (such as check or cash) for the transactions. Finally, three receipt forms were missing.

The district disciplined the instructor for these program failures, but didn't recommend the case for prosecution.

Case No. 2: University auto body shop

During an internal control review of cash receipting at a university auto body shop, the university determined that the director failed to promptly deposit all program revenue with the treasurer. During an interview, he admitted that he'd misappropriated the currency from several deposits; he subsequently returned all missing checks and body shop cash receipts to the university. The director paid the money back to the university for the missing currency and resigned. The county prosecutor declined to prosecute the director because the university incurred no net loss.

Case No. 3: Community college vocational center

An instructor used student labor and college-furnished parts to rebuild personal items such as diesel engines, starters for private boats and a vehicle for a private non-profit organization. The instructor disregarded the entity's pricing and purchasing guidelines and didn't prepare prenumbered work orders for any of these repairs for himself and his friends.

The instructor agreed to pay back $750 for the parts and labor of students who worked on these unauthorized projects. The college disciplined the instructor for these ethics violations. The county prosecutor declined to prosecute the instructor because he paid the money back to the college.

Case No. 4: School district auto shop

The auto shop instructor purchased a vehicle for student instruction purposes for $125. Several months later he registered the vehicle in his own name, but he'd already charged $150 in parts to the district's purchasing account for this vehicle. He also bought a $17 oil filter for another personal car with district funds.

A student also reported that the instructor had sold him an automobile engine and transmission for $125, but the instructor hadn't deposited the money with the district's bookkeeper. The instructor eventually reimbursed the district for all that he had stolen, and then he resigned. The county prosecutor declined to prosecute this case because the district incurred no net loss.

Case No. 5: Food service programs

Many school districts, community colleges and universities operate restaurants, bakeries, catering activities and other food service operations to train students in the culinary arts. However, these programs often don't train the students to manage the business sides of operations. That's tragic.

The most common failings in food service programs are lack of both accounting records and management oversight. For example, these programs often don't issue prenumbered cash receipts and work order forms with the entity's name printed on them for catered events or special orders.

If some programs did use these forms, managers often discarded them after they used them because they didn't consider them to be important enough to account for revenue or determine the profitability of the program. Of course, external auditors cited poor internal controls and the lack of accountability for funds in these cases, both of which could lead to fraud.

LESSONS LEARNED

Let's review some of the finer points of fraud detection for trade-skill education programs:

• Entities should establish formal written policies, procedures and internal controls for all functions, including even the smallest areas of operation in trade-skill education programs — such as wood hobby shops, auto body shops, food service catering and bakery special orders, espresso stands, snack bars, student-managed store outlets, etc. 
• Entities should periodically monitor the profitability of trade-skill education programs to ensure they're meeting their financial expectations. 
• Fraud examiners should review the completeness of supporting documents and assess internal control systems by performing a walk-through of transactions and procedures the entity uses for revenue generation. 

COMPLEX TRADE-SKILL EDUCATION FRAUD CASE

The next column will cover an unusual case study involving another type of trade-skill education program: an equipment repair class at a technical college. One person managed all aspects of the program, and no one monitored the program to determine if it was meeting the college's financial expectations. This was one of the most complex trade-skill education fraud cases I ever encountered.

Regent Emeritus Joseph R. Dervaes, CFE, CIA, ACFE Fellow, is retired after more than 42 years of government service. He is president emeritus of the ACFE's Pacific Northwest Chapter. 

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