What's your fraud IQ?

BY ANDI MCNEAL, CPA

Nearly all organizations rely on vendors to provide certain goods and services to facilitate their business operations. Whether for repairs or maintenance service, a purchase of office supplies, a consulting engagement, or a large capital contract, the need for vendors is universal—but it also carries an inherent risk of fraud. The same pressures, opportunities, and rationalizations that lead dishonest employees to steal from a company can be catalysts for vendors to engage in fraudulent behavior. Are you familiar with the ways that suppliers and contractors can defraud their customers? Do you know the warning signs of vendor fraud? Take this quiz and find out.

1. XYZ Corp.’s management suspects that a vendor, Green Inc., is intentionally billing the company for the same product order multiple times. Which of the following tests would be most helpful in uncovering such a scheme?

a. Comparing XYZ Corp.’s vendor master list to its employee master list for matching information.
b. Selecting a sample of invoices from Green Inc. and recalculating the totals for each line item.
c. Sorting invoices from Green Inc. by amounts, purchase dates, and delivery dates.
d. Reviewing all purchases from Green Inc. that fall just under internal authorization thresholds.


2. Which of the following would be the most likely indicator that contractors have colluded to rig the bidding process on a contract?

a. The winning bid for the contract price is unusually low.
b. The losing bidders become subcontractors on the project.
c. A high bid is followed by amendments that reduce the total payments to the contractor.
d. Many more bidders responded to the request for proposals than expected.


3. Alexandra is a procurement agent at a government agency with authority to independently approve transactions of $5,000 or less that are not subject to competitive bidding. A project with a projected price of $20,000 has just been approved. Alexandra wants to make sure a company owned by her friend is awarded the entire project, as she knows her friend will provide her a kickback for directing the business her way. She manipulates the project procurement documents to divide the contract into five separate contracts worth $4,000 each. She then awards all five of the smaller contracts to her friend’s company. Which of the following schemes did Alexandra commit?

a. Bid tailoring.
b. Need recognition.
c. Bid rotation.
d. Bid splitting.


4. Three construction contractors that typically take contract work for the city collude to divide the city’s business among them. Contractor A takes contracts for work in the southern part of the city, Contractor B takes the central contracts, and Contractor C takes those in the north. Which of the following best describes their scheme?

a. Bid suppression.
b. Bid splitting.
c. Market division.
d. Complementary bidding.


5. Oak Inc. hires Gray Contracting to construct a storage building on Oak’s property. The storage building collapses four months after completion, and an investigator is assigned to determine the cause. The investigator finds several problems in the construction project documents, including missing compliance certificates, failed inspection reports, and employee complaints about the quality of the contractor’s materials. Given these facts, which of the following fraud schemes seems most likely to have been perpetrated?

a. Nonconforming goods or services.
b. False invoicing via shell companies.
c. Unnecessary purchases.
d. Change-order abuse.


6. Elm Software Co. has three contracts with a large multinational company. Each contract involves developing a software program for a particular department based on a single proprietary software framework that Elm must create. Elm’s ordinary charge for developing this type of software framework is $100,000. Knowing that each of the three contracts is being managed separately by the respective departments, Elm charges the full $100,000 to each department for the framework, in addition to the department-specific charges for the resulting software programs, resulting in an extra $200,000 of income for the projects. Which of the following best describes this type of fraud scheme?

a. Need recognition.
b. Commingling of contracts.
c. Change-order abuse.
d. Multiple reimbursements.


7. While reviewing vendor contracts for his employing company, Gregory finds a contract with an original price that appears unusually low for the type and amount of work to be performed. He also notes that the project’s requirements documentation lacks the detail he would have expected for the type of project under contract. Looking through the rest of the project documentation, he finds numerous change orders that the contractor submitted to “clarify project requirements,” the result of which is a 200% increase in the project cost. Based on Gregory’s findings, which of the following schemes is most likely occurring?

a. Change-order abuse.
b. Duplicate invoices.
c. Fictitious bidding.
d. Price fixing.


8. Acme Co.’s hotline received a call claiming that Acme’s purchasing manager has been ordering excessive amounts of certain inventory items to receive kickbacks from a vendor. Which of the following tests would be LEAST helpful in verifying the legitimacy of the tip received?

a. Identifying inventory items for which the quantity purchased is disproportionately high compared with the quantity sold.
b. Calculating the ratio of the largest purchase to the next-largest purchase by vendor.
c. Comparing total write-off and purchase quantities of inventory items by stock number.
d. Analyzing text descriptions for payments made to vendors for keywords such as “consulting fee” or “special commission.”

ANSWERS

1. (c) A common, unsophisticated form of vendor fraud involves submitting invoices to a customer more than once for payment. Often, the vendor simply issues an invoice with a new invoice number but leaves many other identifiers—such as delivery date and specific line items—the same. The duplicate invoice might be submitted days, weeks, or months after the original to deflect suspicion. A simple sorting of invoices by the invoice amounts is an effective first step in identifying possible duplicates. However, to help conceal the scheme, some vendors will change more than the invoice number when they submit duplicates. They might remove or alter line items, tax or freight amounts, or discounts, which would affect the invoice total. Consequently, these invoices would not show up on a duplicates test by invoice amount, but sorting the invoices by delivery or purchase dates can help uncover such schemes.

2. (b) In bid-rigging schemes, competitors in the same market collude to defeat competition or to inflate the prices of goods and services artificially. Some of these schemes involve an agreement that the winning bidder will award subcontracts to losing bidders. This allows losing bidders to profit from the contract in return for their part in the scheme. Other red flags of schemes involving collusion among contractors include:

  • The same contractors bid on each project or product.
  • The winning bid for a contract is unusually high.
  • All contractors submit consistently high bids.
  • Qualified contractors do not submit bids.
  • Fewer competitors than normal submit bids on a project or product.
  • There is a pattern in which the last party to bid repeatedly wins the contract.
  • There is evidence that several bids were prepared by the same party (e.g., they contain the same mathematical or spelling errors, or are prepared using the same typeface or template).
  • Bidders or their employees maintain unusually close relationships (e.g., competitors regularly socialize, hold meetings, or visit each other’s offices).


3. (d) Fraud schemes in which an employee conspires with a vendor to defraud the company can be particularly damaging and especially difficult to prevent. Bid splitting occurs when an employee breaks a large contract into smaller portions that fall below the bidding threshold to avoid competitive practices. By splitting a contract into several separate contracts, the employee has more opportunities to influence the award. Once the contract is split, the employee can award some or all of the component parts to a contractor with whom he or she is conspiring. Identifying unjustified split purchases or a series of purchases that fall under the competitive bidding or upper-level review limits can help uncover a bid-splitting scheme.

4. (c) Market division schemes occur when competitors collude to divide a procuring organization’s contracts into certain areas, such as geographic regions or classes of customers, and refrain from competing—either by not bidding or by submitting overly inflated bids—in one another’s designated areas. In some market division schemes, the contractors also submit bids from shell companies to give the appearance of competition and conceal the collusion. These bids from fictitious suppliers serve to validate an overpriced quote from the winning contractor. The result of these schemes is that the customer loses the benefit of true competition and pays a higher price than would be obtained through fair bidding under normal economic forces.

5. (a) Schemes involving nonconforming goods or services occur when a vendor or contractor delivers goods or services that do not meet contract specifications. The vendor does not inform the purchasing company of the deficiency and bills the company as if the goods or services were in line with the contract. Unfortunately, these schemes are difficult to detect without close inspections or tests by independent subject matter experts because materials substituted or omitted from products are not readily identifiable. However, several red flags are present in this situation. When a recently completed project collapses, inspection failures are noted, certifications are missing, and tips about poor work quality have been received, investigators should suspect nonconforming goods or services.

6. (b) Commingling of contracts occurs when a contractor bills for the same personnel, fees, or expenses under multiple contracts, resulting in overcharging for goods or services. To protect against this type of scheme, the employee responsible for approving contracts should review contracts prior to their award to ensure that the work to be performed under each contract is not duplicated in other contracts. In addition, the procuring entity should identify any contractors holding more than one contract to determine whether they run concurrently and cover similar items. For any such contracts identified, the contracting employee should closely monitor all billings on these contracts for any potential duplicate payments.

7. (a) Change orders often receive less scrutiny than original bids, making them an effective means to fraudulently increase a contract price or to generate funds for kickbacks. In most change-order abuses, a corrupt contractor submits a low bid to win the contract, then uses subsequent change orders to increase the project price. As a result, the procuring entity loses the advantages of the competitive bidding process and pays more for the project than initially agreed upon. Such schemes frequently involve collusion between the contractor and personnel from the procuring entity. For example, a dishonest contractor might collude with contracting personnel to underbid competitors and manipulate the change-order process to improperly extend or expand contracts or to avoid rebidding; in exchange, the contractor typically pays the procuring employee a kickback from the inflated project profits.

8. (d) One type of kickback scheme occurs when a vendor makes an undisclosed payment to a purchasing company employee to obtain extra business from the company. If the sought-after business involves the purchase of excess inventory, red flags of the scheme will exist within the company’s inventory system and purchasing records. For example, inventory items purchased in greater quantities or at greater frequencies than the amount supported by sales can be a warning sign that something is amiss in the purchasing process. Likewise, a vendor that receives a disproportionate number of purchases or disproportionately large purchases compared with other vendors—particularly when there is no obvious advantage to this trend—is another anomaly that merits further investigation. Additionally, inventory items repeatedly purchased and written off might indicate that a purchasing agent is intentionally overpurchasing the item. Running tests to identify such red flags can help determine whether a purchasing kickback scheme might be occurring. However, while examining payment text descriptions for keywords such as “consulting fee” or “special commission” could be helpful in identifying kickback schemes in which a company employee is paying kickbacks, this test would be much less effective in identifying schemes in which a company employee is receiving kickbacks.

SCORING

If you answered seven or eight questions correctly, congratulations. Your understanding of the risks of vendor fraud will help you protect your clients or employer from potentially fraudulent conduct. Keep up the good work.

If you answered five or six questions correctly, you’re on the right track. Continue to build on your knowledge of the ways dishonest suppliers and contractors defraud other organizations.

If you answered fewer than five questions correctly, you might want to brush up on your antifraud knowledge. Enhancing your understanding of vendor fraud and its red flags will help ensure that you have what it takes to keep these schemes from going unnoticed. 

Andi McNeal ( amcneal@acfe.com ) is director of research for the Association of Certified Fraud Examiners.

To comment on this article or to suggest an idea for another article, contact Jeff Drew, senior editor, at jdrew@aicpa.org or 919-402-4056.

AICPA RESOURCES

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