Cooking the Books isn’t What Julia Child was Doing

Cooking the books is fraud used to falsify the company’s financial statements.  It is often used to improve the earnings of a company by recording revenues that are either nonexistent or have not been earned by year end.  In recent years, several Fortune 500 companies have cooked their books to improve their financial figures.  Enron and WorldCom are among those accused of cooking their books.  To help prevent this type of fraud, the external auditors of a company should carefully examine significant transactions close to the end of the year to ensure that questionable transactions are not being booked close to the end of the year.  Anyone associated with the entity should also ask the question – Do I understand how and why the company is recording its revenue?  If that question cannot be answered satisfactorily, there may be someone cooking the books.

Window Dressing Has Nothing to do With the Drapes in Your House

Window dressing refers to any action taken by an individual or individuals to make the financial statements look better than they actually are at the end of an accounting period by manipulating the numbers.  Suppose that the accountant for a company hasn’t done a very good job of collecting receivables.  As a consequence, the company’s cash balance is very low at year end and its accounts receivable balance is very high.  The accountant holds open the cash receipts journal of the company and posts all receipts through January 10, as though they were collected in December.  As a consequence, cash and the accounts receivable balance both “look better” at year end.  The fix is only temporary, but the manipulating employee believes he will be able to work similar magic when the next set of financial statements are needed.

Net Pay Does Not Tell the Whole Story

A company president took pride in signing the company’s pay checks.  He knew that owner-manager controls were important, so he looked carefully at each paycheck as he signed it and he knew what each person’s bet pay should be.  He also knew the total amount of net pay for each pay period.  The internal accountant for the company knew that the resident only looked at net pay.  He inflated his gross salary substantially and increased his federal withholding by the exact same amount.  He knew that the company president never looked at gross salaries or at the payroll returns.  It was several years before the fraud was discovered.

The company president should have been looking at all payroll - gross to net.  Someone independent of the internal accountant should have approved the payroll tax returns.

Two Signatures on a Check May Be No Better than One

Many entities insist that every check have two signatures.  It is an excellent internal control if it works properly.  Don’t be fooled into thinking, however, that two signatures are always better than one.

Take the following scenario:  a bookkeeper realizes that one of the signators on the bank account is going out of town.  The individual agrees to sign blank checks because he knows that his co-signer always looks carefully at the supporting documentation before signing.  The scheming bookkeeper then catches the second signer in a hurry going out the door.  He asks if his co-signer looked at the supporting documentation and the bookkeeper says yes.  The checks are signed quickly without looking at anything.  Among the checks is one for several hundred thousand made payable to the bookkeeper.  Before anyone discovers the theft, the bookkeeper has been in his new foreign locale for several weeks.

If you are going to use two signers on a check, make sure that they swear to independently look carefully at the supporting documentation each time checks are signed.

The Petty Thief Always Gets Greedy

A person is caught stealing small amounts from a company.  The perpetrator confesses and asks for another chance at the same job.  The company president feels sorry for the individual and agrees.  Is this a smart move?

There is a chance that the company president’s decision will work out.  The contrite employee may never steal again – but it is not very likely!  The person caught stealing is likely to steal again and this time it may be for a far greater amount.  If the company president wants to keep the employee, then move him or her to a position in the company where internal controls will prevent that person from stealing.  Compassion is fine.  Compassion and intelligence is even better.

The Auditor Can’t Find What isn’t on the Books

Anytime a fraud occurs, someone is bound to ask “where were the auditors?”  Many times the auditor should have suspected or caught the fraud.  There are circumstances, however, where it is almost impossible to find the fraudulent conduct.  One of those times is when the transaction is never shown on the entity’s books.

Assume that a company has a bank account that is no longer useful and the company president tells Joe to close the account.  Joe does not close the account, but uses the account to deposit checks made payable to the company.  He deposits checks that he does not think the company will miss, such as refund checks or checks for sales of equipment.  Since Joe has signature authority on that account, he makes checks payable to himself and no one is the wiser.

Always confirm with the bank that accounts which are supposed to be closed are actually closed.

You Can Buy a Receipt Book at a Stationary Store

Just because a receipt is attached to a request for reimbursement, it does not necessarily make the receipt valid. An entity hired us to investigate a situation where an employee was being reimbursed for a substantial number of business means on a regular basis.  The company policy required the individual to submit credit card receipts for any mean over $25 and a stub from the restaurant for all meals under $25.

We observed that the employee received reimbursement for many meals just under the $25 cut off.  All of these meals had a stub for the amount.  Most of the numbered stubs did not contain the restaurant name.  We took the stubs and sorted them by type.  We concluded that the individual was buying packs of 100 receipts from the local stationary store.  He was then pulling stuns at random and attaching then to his requested reimbursement form.  Since he was pulling stubs at random, the sequence numbers were not normal (e.g. receipt number 80678 was used before receipt number 80632) and the fraud was revealed.

Petty Cash Can Be the Tip of the Iceberg

External auditors often ignore petty cash because the amount of the petty cash fund is immaterial to the financial statements.  Even so, the auditor should look at the volume of transactions in petty cash and should scan those transactions looking for the unusual.

An astute auditor noticed in one company that local travel expenses were being paid by the petty cash fund.  The auditor noticed that the volume of transactions appeared to be excessive compared to prior years.  The auditor selected ten travel payments made to a single individual and showed the reimbursement forms to that individual.  The person disclaimed any knowledge of most of the forms he was shown.  Further investigation revealed the person who was the custodian of petty cash had been stealing and covering the theft with the phony travel reimbursement forms.

Larceny Often Starts with the Credit Card Charges

Auditors suspecting fraud often start by analyzing the credit card charges of those who are in a position to perpetuate fraud.  Why?  The person stealing from the business entity often starts small and they often start where it is easiest to steal.  Falsifying credit card charges is the easiest place to start.

On one audit, I was analyzing credit card charges.  The company president took three people to dinner and wrote their names on the credit card slip.  I knew it was fraudulent because one of the people listed on the slip was me, and I knew I had not been there.  I then checked and found the date was a Saturday night.  When confronted, the company president admitted that he had taken personal friends to dinner and charged the evening to the company.

Once you find fraud in the credit card charges, you can look at other places where that person could have perpetuated fraud.

Kiting is a very old scheme and is not as likely to happen as it once was, but any entity with multiple bank accounts should be aware of the possibility.  For kiting to work, an individual must have complete authority over two or more bank accounts.  The perpetrator must be able to sign and draw checks and must be the person reconciling the bank accounts.

The fraud starts when the perpetrator drafts a check on Bank A for a large amount (let’s say $50,000) and deposits it in Bank B.  Before the funds clear, he draws a check for $50,000 on Bank B and deposits it in Bank A.  The drawing of checks continues until a large float occurs.  The perpetrator then siphons off a substantial balance of cash and deposits it in his own account to earn interest.  The scheme can continue indefinitely as long as enough checks are drawn and deposited.  The checks are never recorded on the books of the entity and the perpetrator destroys the bogus checks when they are returned with the bank statement.  The best way to prevent kiting is never to give an individual the authority to sign checks and to reconcile cash.  If kiting has occurred, it will be caught if the perpetrator has to take vacation for an extended period.  A proof of cash will also catch kiting.