Billing Schemes, Part 4: Personal Purchases

Maintain your standards on routine business tasks or suffer the consequences.


This is the final installment in a four-part series on identifying false invoices and their issuers. The July and August columns focused on billing schemes involving shell companies criminals set up to facilitate fraud. Articles in this issue and September explain how to detect and prevent two scams that employ other, completely different phony-bill strategies.

This month’s case study shows CPAs the far-reaching consequences of not setting up controls in a business to detect and prevent seemingly immaterial frauds.

ost business owners enjoy their leadership role. But wearing the boss’s hat means shouldering diverse responsibilities, and many entrepreneurs don’t have time to manage human resources and other important administrative functions. So they often hire someone to do these jobs for them. If at first all goes well, the boss may no longer check to see if his or her managers follow proper supervisory procedures. That’s when trouble brews.

The following case study isn’t just for auditors, but rather for the thousands of CPAs heading their own businesses, occupying other management positions or advising business-owner clients. It demonstrates how “immaterial” fraud—especially in small organizations—can have companywide consequences.

A Midwestern CPA firm with about 50 full-time employees needed someone to run office errands. Deidre, a member of its bookkeeping staff, thought she knew the ideal candidate: a young man named Mark, who lived in her apartment complex. So she recommended him for an employment interview during which he appeared bright, energetic and sincere—everything the firm wanted. Gladys, the partner in charge, hired him on the spot.

How Crooks Help Themselves to Company Funds
Some employees can’t resist temptation and use their employers’ money to buy things for themselves. They do it in one or more of four ways.

Fraudulently authorizing invoices by an appropriate party. In many occupational fraud cases, the culprit’s duties include authorizing purchases, and his or her conscience is the only control in place.

Falsifying documents to obtain authorization. If the fraudster is not the authorizer of invoices, he or she often will forge a supervisor’s approval signature on purchase requisitions and other documents.

Altering legitimate purchase orders. In some cases, a crooked employee alters a legitimate purchase order, increasing the quantity of merchandise requested. When the goods arrive, the employee takes the excess items or returns them for a refund.

Misusing company credit cards. If a company has weak controls over the use of credit cards, some employees take advantage and buy everything from fuel for their automobiles to furniture for their homes.

The following Monday Mark began work enthusiastically: He hand-delivered urgent documents, used the company car to pick up visitors arriving from out of town and shopped for miscellaneous office supplies and groceries. The weeks passed swiftly as Mark got better at his job. Management even trusted him with making bank deposits, and after six months of exemplary performance, he received a positive evaluation and a modest raise.

One day, as Mark’s first anniversary neared, his good start came to a bad end. On the way back from picking up supplies at the supermarket, he stowed some of them in his car before bringing the rest to the office. But unfortunately for Mark, the firm’s receptionist saw what he had done and promptly informed the office manager, Harriett.

Given the firm’s lax purchase approval procedures, Mark had had no trouble using company funds to buy things for himself. Each time he made a list of necessary supplies and prepared to go shopping, Harriet issued Mark a blank, signed check. When he returned, Mark submitted the receipt for his purchases.

Because the office supplies and groceries weren’t particularly expensive, Harriett rarely examined the cash-register tapes—a fact that hadn’t escaped Mark’s attention. After the receptionist’s visit, though, Harriett scanned several of Mark’s receipts. She was shocked to discover that in addition to items for the office, Mark had been buying beer, cigarettes and other personal items without reimbursing the firm for them.

Taking a deep breath, Harriet reported the embarrassing facts to Gladys, who didn’t take the news well. Individually, Mark’s thefts weren’t material, but they would force Gladys to make a difficult decision. Although she couldn’t just reprimand Mark, she hesitated to fire him. And yet it was important to set an example that would deter other employees from committing fraud.

Source: Occupational Fraud and Abuse, by Joseph T. Wells, Obsidian Publishing Co. Inc., 1997.

The choice turned out to be clearer than Gladys expected, but it still was painful. After glancing at Mark’s personnel file, she summoned him to her office and closed the door. When he was seated she said she needed his help on a problem. Gladys paused and looked Mark right in the eye. “What would you do if you were the boss and you learned a valuable employee was stealing from the firm?” she asked.

Mark’s gaze wandered around the room. He frowned and said in a low voice, “I guess I’d call him in and ask him about it.” After five minutes of patient questioning, Gladys got Mark to confess. When she asked for a motive, he said the stolen items “weren’t expensive” and the company could “easily afford them.”

Hearing this casual admission, Gladys resisted an urge to shout at Mark in frustration. “We all liked and trusted this young man,” Gladys thought. “He’s been a good employee in every other way—he has a near-perfect attendance record, gets along well with everyone and makes a good impression on clients.”

But Gladys knew retaining Mark would set a dangerous legal precedent. If she let one thieving employee stay and in the future fired another for similar misdeeds, the firm would be vulnerable to a wrongful discharge suit. It was clear Mark had to go.

Gladys’s eyes moved again to Mark’s personnel file, open on her desk, with his employment application on top. She noticed Mark previously had worked for a nearby computer manufacturer. On a hunch, she asked, “What would your former employer say if I called and asked why you left?” She was struck by Mark’s curious reply: “I didn’t do it.”

As she said “I’m terminating you immediately for stealing from the company, Mark,” she realized it mattered more to her than it did to him.

Before leaving the boss’s office, Mark admitted the computer maker also had fired him for stealing. Gladys silently cursed herself for not instructing the staff to put Mark through a normal preemployment background check. Instead, she had trusted Deidre’s judgment and recommendation. At the time it seemed reasonable; Deidre had been with the company for more than four years and was an outstanding employee.

How to Prevent and Detect Personal Purchases
Ensure company policy clearly prohibits all personal purchases with company funds.

Do not permit the same employee to originate purchases and approve them.

Separate the invoice approval function from the payment and receiving function.

Establish maximum purchasing limits for each employee.

Install controls to detect multiple purchases just below employees’ approval limits.

Establish procedures to routinely check for deliveries of company-ordered goods to external addresses. And look for matches between invoice delivery addresses and employees’ home addresses.

Examine shipment receiving reports for merchandise ordered and paid for but not delivered.

Check invoices for vendors that are not usually associated with the company’s business. For example, it would be suspicious for a manufacturer to order goods from a department store.

Routinely examine individual employees’ buying habits, looking for increases in the amount or frequency of purchases.

Carefully control access to, and purchases that are made from, company credit cards. Be especially alert to purchases in round amounts, which might indicate false or inappropriate charges.

Gladys knew that in today’s litigious environment, Mark’s previous employer probably would not have revealed the true reason for his departure, even if her firm had asked. But the computer manufacturer’s HR manager probably would have admitted he would not rehire Mark, and that would have been a red flag.

Minutes after finishing with Mark, the boss called in Deidre, who, having heard the rumor quickly spreading through the office, was in tears and revealed—to Gladys’s growing anxiety—she and Mark had been dating for months. When questioned, Deidre admitted she knew Mark was pilfering groceries and said she had encouraged him to stop. But Mark continued stealing, and Deidre said she couldn’t bring herself to turn him in. Dazed, Gladys wondered if she’d checked her own brains at the door the day the firm hired Mark without knowing more about him. But she gritted her teeth and fired Deidre, too, for her ethical lapse.

But what of Gladys’s managerial error? The price for the firm’s slack cost controls and failure to follow appropriate hiring procedures was significant: Although Mark’s thefts were petty, two workers lost their jobs. Deidre had been next in line to head the bookkeeping department.

Furthermore, although Deidre’s coworkers knew why she was leaving, her popularity did not diminish and a blue mood pervaded her team for weeks. Gladys learned the hard way how a good employee’s departure under bad circumstances can foster low morale that, along with the cost of training replacements, burdens a firm with avoidable difficulties.

The moral? When it comes to fraud, do sweat the small stuff.

Checking References
Approximately 7% of employees who commit fraud did so at previous jobs, according to the Association of Certified Fraud Examiners’ 2002 Report to the Nation on Occupational Fraud and Abuse. To avoid hiring these high-risk workers, consider the following recommendations.

On the company’s employment application form, request information on all jobs held in the last seven years or longer.

Look for chronological gaps on an employee’s application, which may indicate he or she wants to avoid disclosing information about a particular position held or a criminal conviction.

Confirm all employment-history information. If possible, interview the applicant’s immediate supervisor. Fearful of employee litigation, most organizations will provide only basic information. But often they will reveal whether they would rehire the employee—a valuable indication of the circumstances under which he or she left the company.

JOSEPH T. WELLS, CPA, CFE, is founder and chairman of the Association of Certified Fraud Examiners in Austin, Texas, and professor of fraud examination at the University of Texas. Mr. Wells’ article, “ So That’s Why It's Called a Pyramid Scheme ” ( JofA , Oct.00, page 91), won the Lawler Award for the best article in the JofA in 2000. His e-mail address is .

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