Fraud and abuse in school cafeterias

Every school in my state, Washington, has a cafeteria, which provides healthy and nutritious breakfast and lunch meals for students. The policies and procedures for managing food service operations vary from state to state. Thus, fraud examiners in other U.S. states and in other countries should research the rules and regulations that apply to these activities for the guidance needed to investigate them. Food service managers often commit fraud when schools fail to establish proper policies and procedures governing the critical aspects of operating a cafeteria.

ASSET MISAPPROPRIATION IS THE FRAUD OF CHOICE

In the ACFE’s Fraud Tree, fraud schemes applicable in the food service department include asset misappropriation (i.e., theft of inventory) and cash schemes. These involve stealing an entity’s funds and fall into three categories: larceny, fraudulent disbursements and skimming.

Cash larceny schemes involve the theft of funds recorded in the entity’s accounting records. In fraudulent disbursement schemes, an individual makes a distribution of entity funds for a dishonest purpose. Fraudulent disbursement schemes in public-sector schools are rare because staff disburse funds outside the food service department. However, fraudulent disbursement schemes in private-sector restaurants occur frequently because one person, usually the bookkeeper, is responsible for all banking functions (e.g., deposits of cash receipts and disbursement of funds by check). Skimming is the theft of off-book funds, a common scheme in the cafeteria.

SUGGESTED PLAN FOR MANAGING A CAFETERIA

The following discussion presents a plan I’ve recommended schools use to manage their food service departments and reduce entities’ risk of fraud, waste and abuse.

Policies and procedures
All public entities should approve policies and procedures governing food service at all schools under their jurisdictions. Policies should clearly define management’s financial expectations, including establishing an annual budget, using gross-profits testing and monitoring revenue in relationship to the number of meals served, such as by using tray counts and the number of free and reduced-priced meals provided to eligible children under the U.S. Department of Agriculture’s child nutrition programs. Schools also should conduct training classes for staff working in the food service department.

Accountability and fixed responsibility
Each school board should establish a food service change fund, assign responsibility for the money to the manager and require him or her to store the funds in a secure facility, such as a safe or vault. Each school should change combinations to the safe or vault periodically and not write them down and also fix responsibility at all times for funds to a specific individual.

Managers should assign a separate cash drawer to each cashier. Cashiers and supervisors should sign all documents transferring funds from one person to another at the beginning and end of each shift. Multiple cashiers shouldn’t operate from one cash drawer or commingle cash receipts. Cashiers should record all transactions, by type of meal provided, on a cash register and document Z-tape numbers (e.g., total fund accountability) on daily activity reports.

Schools should require and monitor the use of prenumbered documents used throughout food service departments, such as cash receipt forms, transmittal forms for change funds and/or cash receipts from the manager to cashiers (and return), cash register Z-tape numbers, meal tickets or meal cards issued and daily activity reports.

Free and reduced-priced meals
Schools must adhere to strict federal requirements for eligible children that aren’t further described here. In general, schools must collect parent financial information to verify that children are eligible for programs and retain all forms on file for review and audit.

Once schools approve children, parents usually make any required payments to school administrative staff who then transmit these funds to the food service departments. Schools use a variety of control procedures, such as meal tickets or meal cards, to ensure that others aren’t discriminating against children participating in these programs when they eat meals at the cafeterias.

Fraud examiners should research the rules and regulations that apply to each of the various systems used in other U.S. states and in other countries for guidance in investigating the free and reduced-priced meal programs.

Monitoring
Schools should periodically monitor the implementation of food service policies and procedures to ensure their financial expectations will be met. This includes unannounced cash counts, review of cash register tapes and comparison to daily bank deposits, review of monthly bank statement reconciliations and bank-validated deposit slips, verification of sequential use of all prenumbered forms, periodic visual inspections to observe actual cafeteria and cash receipting practices, computation of gross-profits testing (which compares inventory used and revenue received for reasonableness) and installation of security cameras for both food inventory storage facilities and cashiering areas.

RED FLAGS IN THE SCHOOL CAFETERIAS

The following presentation summarizes many of the internal control weaknesses —red flags — that have occurred in the food service department at schools in my state.

Poor school policies and procedures allowed individuals to misappropriate funds or inventory for personal benefit. Critical deficiencies included a lack of accounting records (records were often missing or had been destroyed), a lack of accountability for revenue and inventory (inventory records weren’t maintained and too many people were involved or had access to funds) and poor oversight of cafeteria activities by school officials (because of a lack of formal training).

Catering
See a related discussion in the January/February 2013 column. The most common failings in catering are lack of accounting records and management oversight. Entities didn’t require the use of prenumbered cash receipt and work-order forms for catered events or special orders. Records weren’t available to determine the level of catering activity or the amount of revenue. Thus, fraud examiners weren’t able to document losses under these circumstances. Prosecutions were rare.

Inventory
Food products are stored in freezers, refrigerators and open dry goods areas. However, most schools don’t use perpetual inventory systems to control these products. At a minimum, the staff should conduct inventories at the beginning and end of each school year. Schools should restrict access to storage facilities to the greatest possible extent and install security cameras to monitor access to inventory locations.

When schools don’t use security cameras, staff members often steal inventory for personal benefit. Then schools are unable to assign responsibility to specific individuals when they discover losses or when unusual gross-profits testing results indicate that management’s expectations aren’t being met. This situation frequently unfolds on reality television shows and in the media when restaurant owners in the private-sector hire private investigators to discover why they’re going bankrupt.

Managers or investigators first install security cameras to observe their staffs when they discover losses. Investigations usually confirm that employees are stealing inventory from the restaurants and show that managers must be present on the premises during all hours of operation. Unscrupulous employees only have to wait for the right opportunities, such as an absent owner, to steal inventory for personal benefit.

The lesson learned is that security cameras are the primary solution to employee theft in the restaurant business and food service department. Resulting fraud cases document only small losses — often less than US$1,000 — because restaurants can only establish losses based on fraudulent activities found on the tapes. Unscrupulous employees generally make restitution and resign, and restaurants don’t prosecute.

Manipulation of free and reduced-price meal counts
Schools must maintain daily records of the number of meals served (e.g., food tray counts) and the types of meals recorded (e.g., full-price, free and reduced-priced) on the cash receipting system. I call these latter two categories “non-cash transactions” because they reduce accountability for revenue — similar to false accounts receivable write-off transactions in utilities and courts and false voids and refund transactions in all types of cash-receipting operations. For every legitimate use of these transaction types, there are also abuses resulting in fraud.

Here are some examples. Cashiers would collect the full prices for meals but wouldn’t record the transactions on the cash register system (a fraud commonly known as skimming). Cashiers would record student identification numbers on the cash registers at the time of payments and then delete the transactions. These transactions resulted in cash overages at the end of each shift, which the cashiers then stole for personal benefit.

Cashiers also would record full-price meal payments on the cash registers as free or reduced-price meals, which would inflate the number of meals served in these latter categories and cause false reporting on federal claims reports for reimbursement.

Cashiers also removed cash overages from the cash drawers for personal benefit. The most common red flag for this is when the total number of free and reduced-price meals served in a single day exceeds the number of students enrolled in these programs. Losses in such cases typically range from US$1,000 to US$50,000. Employees enter into plea-bargaining agreements with county prosecutors. Courts sentence these individuals to jail time of one year or less and restitution of the loss amount.

Misappropriation of cash receipts
Cashiers often skim revenue from food service operations, but supervisors also misappropriate revenue by depositing less funds in the bank than cashiers collected. Schools must periodically monitor food-service cash collections to ensure that food-service supervisors deposit all funds each business day.

These misappropriation cases can be huge — often more than US$50,000. Employees normally enter into plea-bargaining agreements with county prosecutors. Courts sentence them from one to five years in state penitentiaries and demand restitution of the loss amount. The following case study shows why monitoring is critical to protect assets from loss.

CASE STUDY: COMMUNITY SENIOR CITIZEN FOOD SERVICES

Jane, 51, worked as a bookkeeper in a food service program for senior citizens in the largest school district in my state. This program served meals to and provided activities and employment opportunities for senior citizens in the community. It also encouraged the participation of senior citizens and schoolchildren in a variety of social, educational and inter-generational activities. The program served meals at several community centers located near public schools in the city.

The program operated with minimal staffing. Jane had too many responsibilities, and they were inadequately segregated. Her boss, the executive director, rarely monitored her. One day, when she was away from the office her boss tried to find some bank records in her desk. He was devastated when he found them. Jane had issued checks to herself from the program’s bank account. She’d also forged his signature on the bank signature card for an off-book bank account that he knew nothing about. Jane wasn’t authorized to withdraw funds from any program bank account.

When Jane returned, the executive director confronted her. She refused to cooperate with him, abruptly left the office and never returned. The executive director then learned that Jane had removed numerous files from the office without authorization.

Jane failed to meet with the district to respond to the allegations of misconduct. The district immediately terminated her employment. She and her attorney did meet with the district about eight months later. She claimed she’d deposited her personal funds in the program’s bank account to cover funding shortages and explained that she had written checks to herself to repay these amounts. The investigation determined the bookkeeper actually did deposit US$4,235 of her money in the program bank account. Her transactions reduced the amount of loss.

The bookkeeper alleged the executive director mismanaged the food service program, and she couldn’t be held accountable for everything that was wrong. However, a private investigator found the executive director didn’t use any program funds for his personal purposes. The county prosecutor decided that there was no probable cause to file any charges against the executive director. However, the district issued a letter of reprimand to him for his poor performance while managing the program and transferred him to a different position.

The county prosecuting attorney’s office extensively reviewed the records of all known program bank accounts prior to charging the bookkeeper with 68 counts of theft totaling US$176,678 over five years — the net amount of loss after considering her personal deposits in the program bank account. She’d issued checks to herself and to “cash” from these bank accounts and either cashed them at various banks or deposited them into her personal bank account.

A jury convicted Jane after a relatively short trial. She failed to report for sentencing several times, entered the hospital several times and then went into hiding. She finally turned herself in to law enforcement officials after eight months on the lam. Because she showed no remorse for her actions and had made no attempt to repay the district, the court sentenced her to 50 months in the state penitentiary.

LESSONS LEARNED

Let’s review some of the finer points of fraud and abuse in the food service department:

• Public-sector schools and private-sector restaurants should protect assets from loss by establishing policies and procedures for cash receipting and banking, segregating the duties of key employees, using prenumbered forms and performing gross profits testing.
• Fraud examiners should determine if public-sector schools and private-sector restaurants have established plans to successfully control inventory and revenue in their food service departments when assessing the risk of fraud and abuse.