Common Fraud Scenarios Guide

ACCOUNTS PAYABLE
COMMON FRAUD POLICY GUIDE

SCENARIOS
1 Source: www.knowledgeleader.com
Table of Contents
COMMON FRAUD SCENARIOS GUIDE: SAMPLE 1.............................................................................................. 3
COMMON FRAUD SCENARIOS GUIDE: SAMPLE 2.............................................................................................. 5
COMMON FRAUD SCENARIOS GUIDE: SAMPLE 3............................................................................................10
COMMON FRAUD SCENARIOS GUIDE: SAMPLE 1
COMMON INSIDER FRAUD AGAINST THE COMPANY
• Cash diversions, conversions and thefts (front-end frauds)

• Check raising and signature or endorsement forgeries
• Receivables manipulations such as lapping and false credit memos
• Payables manipulations, such as raising or fabricating vendor invoices, benefit claims and expense vouchers
and allowing vendors, suppliers and contractors to overcharge
• Payroll manipulations, such as adding non-existent employees or altering timecards
• Inventory manipulations and diversions, such as erroneous reclassifications of inventories to obsolete,
damaged or sample status or the creation of a cache from which thefts can be made more easily
• Favors and payments to employees by vendors, suppliers and contractors
COMMON OUTSIDER FRAUD AGAINST THE COMPANY
• Vendor, supplier and contractor frauds, such as short shipping goods

• Substituting goods of inferior quality
• Overbilling
• Double billing
• Billing but not delivering or delivering elsewhere
• Vendor, supplier and contractor corruption of employees
• Customer corruption of employees
COMMON FRAUDS FOR THE COMPANY
• Smoothing profits (cooking the books) through practices such as inflating sales, profits and assets
• Understating expenses, losses and liabilities
• Not recording or delaying the recording of sales returns
• Early booking of sales and inflating ending inventory
• Check kiting
• Price fixing
• Cheating customers by using devices such as short weights, counts and measures; substituting cheaper
materials; and false advertising
• Violating governmental regulations, including EEOC, OSHA, environmental, securities or tax violation
standards
• Corrupting customer personnel
• Engaging in political corruption
• Padding costs on government contracts
PROCEDURES USED BY TOP MANAGEMENT TO ACCOMPLISH FRAUD
From “Fraud, Window Dressing and Negligence in Financial Statements” by Loren B. Kellogg and Denise Kellogg:
Procedures used (by top management) to accomplish fraud:
Cash: Inflate the bank balance by ordering false entries, keeping cash received records open beyond the balance
sheet date or closing the disbursement records before the balance sheet date.
Ratios: Ratios include quick ratio, accounts receivable turnover and accounts payable turnover.
Accounts Receivable: Inflate accounts receivable by creating false charges to customers, shipping merchandise
not ordered, and designating consignments as sales and shipping merchandise to customers with the right of
return.
Ratios: Ratios include accounts receivable turnover and revenue trends.
Inventories: Overvalue inventories, ignore obsolescence, alter inventory sheets, count empty boxes and alter
computer documents.
Ratios: Ratios include inventory turnover.
Prepaid Expenses: Instruct bookkeepers to reduce or eliminate amortization of expenses paid in advance:
insurance, taxes, advertising and supplies.
Ratios: Ratios include quick ratio.
Property, Plant and Equipment: Instruct bookkeepers to enter amounts to these asset accounts even though
the amounts properly belong in expenses like labor, supplies, repairs or tools:
• Instruct bookkeepers to reduce the depreciation rates on plant and equipment so that the write-off to expense
is understated.
Ratios: Ratios include depreciation and amortization as percentages of sales, fixed asset depreciated percent,
capital outlay as a percent of sales, capital outlay funded by operations and asset turnover.
Goodwill: Add amounts unreasonably to this account and amortize it over an unreasonably long life; the result is
an understated expense and overstated net income.
Ratios: Ratios include depreciation and amortization as percentages of sales.
Other Intangibles: Add amounts unreasonably to this account and amortize it over an unreasonably long life; the
result is an understated expense and overstated net income.
Ratios: Ratios include depreciation and amortization as percentages of sales.
Other Assets: Use the procedures listed above to create fictitious assets or to keep on the accounting records
assets that should be written off.
Ratios: Ratios include asset turnover, depreciation and amortization as percentages of sales, quick ratio and
inventory turnover.
The purpose of this document is to provide a common understanding of the potential fraud schemes and
scenarios that ABC Company has included in its entity-level fraud risk assessment. The internal audit group and
senior management from each functional area within the company should examine these schemes/scenarios.
FRAUD SCHEMES/SCENARIOS AND DEFINITIONS
Benefits Fraud: This scheme encompasses the receipt of benefits by employees that are not eligible,
dependents of employees that are not eligible or the receipt of benefits beyond their departure date from the
company.
Bid Rigging: This scheme occurs when an employee fraudulently assists a vendor in winning a contract through
the competitive bidding process. This may include related party transactions and vendor kickbacks, among other
frauds.
Check Fraud: This scheme includes the use of technology to design/reproduce bank checks and simple check
forgery.
Check Theft: This scheme involves the interception of a valid disbursement prior to delivery to the rightful
recipient.
Collateral or Records Management: This scheme involves employees using titles to secure other/personal debt.
Concealment of Investing Activity: This scheme involves the failure of personnel to report investing activity for
inclusion in the financial statement preparation process.
Disguised Purchases: This scheme involves the utilization of company funds to make non-company-related
purchases. The purchase may benefit the employee or another party and is intended to have the appearance of a
purchase made in the normal course of business.
Early Recognition of Revenue: Companies try to enhance revenue by manipulating the recognition of revenue.
Improper revenue recognition entails recognizing revenue before a sale is complete; before the product is
delivered to a customer; or when the customer still has options to terminate, void or delay the sale. Examples of
improper revenue recognition include recording sales to non-existent customers, recording fictitious sales to
legitimate customers, recording purchase orders as sales, altering contract dates and shipping documents,
entering into “bill-and-hold” transactions, holding the books open until after shipment so that the sale can be
recorded in the desired period, entering into side agreements, and **channel stuffing.
Earnings Management/Smoothing: The pressure to meet or beat analyst expectations may lead management
to engage in dubious practices such as “big bath" restructuring charges, creative acquisition accounting, "cookie
jar reserves," "immaterial" misapplications of accounting principles, and the premature recognition of revenue.
Insistence on aggressive application of accounting principles, on always being “on the edge,” and on applying
“soft” methods, allowing for a lot of “running room” when making significant estimates in the financial reporting
process all contribute to an environment that impairs or reduces the quality of earnings and breed earnings
management.
Electronic Transaction Fraud: This scheme is similar to embezzlement but relates explicitly to diversion, theft,
or the misappropriation of funds received or disbursed electronically. This scheme may be perpetuated at the
initiation point of the transaction, during transmission or at the transaction's destination.
Embezzlement: The property of another party is wrongfully taken or converted for the wrongdoer’s benefit. This
may include theft of cash or property or the use of company assets for personal gain.
Employee Fraud: While every industry is at risk for employee fraud, the nature of the financial services industry
makes it an attractive target for employees who can figure out how to work around existing or lax controls and, for
example, create dummy loans, siphon money from customer accounts or arrange to get kickbacks for providing
services. This may also include fraud resulting from a “rogue employee,” (e.g., the trader who manages to trade
off-book and/or hide his trading losses in accounts that only he controls or from insider dealing [i.e., the use of
non-public information for personal gain]).
Fictitious Borrowing/Borrowing Fraud: Personnel may enter into borrowing arrangements for personal gain
utilizing company credentials/collateral.
Fictitious Vendors: This scheme intends to divert funds to an employee or another party without corresponding
receipt of goods or services.
Fictitious/False Employees: This refers to someone on the payroll who does not work for the company. Through
the falsification of personnel or payroll records, a fraudster causes paychecks to be generated to a “ghost.” The
fraudster or an accomplice then converts these paychecks. The ghost employee may be a fictitious person or a
real individual who simply does not work for the victim's employer. When the ghost is a real person, it is often a
friend or relative of the perpetrator.
Financial Statement Fraud: Misstatement(s) of an entity’s financial statements accomplished by:

• Overstatement of revenue and revenue-related assets
• Understatement of costs or expenses and their related liabilities
• Omission or manipulation of required disclosures that involves violation(s) of accepted accounting principles
(GAAP) and that defrauds investors or creditors of the entity by manipulation, deception or contrivance using
false and misleading financial information
Fraudulent Account Activity: This scheme involves the manipulation of customer accounts to conceal
delinquency or boost portfolio performance metrics. The scheme may involve changing the receivables status to
the current one or manipulating the bankruptcy account status to boost the quality of receivables and lessen the
need for a bad debt reserve.
Fraudulent Capitalization of Costs: This scheme involves the capitalization of costs that do not provide a
benefit to future periods. Management may undertake this effort to delay the recognition of period expenses and
lessen the current P&L impact.
Fraudulent Journal Entries: Some characteristics may include the following entries:
• Made to unrelated, unusual or seldom-used accounts
• Made by individuals who typically do not make journal entries
• Made with little or no support
• Made post-closing or at the end of a period such as quarter- or year-end and might be reversed in a
subsequent period
• Include round numbers
• Affect earnings
Financial statement fraud is frequently accomplished using fraudulent journal entries and is a form of
management override of the internal control structure. Of particular interest would be journal entries that mask
fund diversion, the improper reversal of reserve accounts, the use of intercompany accounts to hide expenses
and/or the capitalization of costs that should be expensed.
Fraudulent Disbursements: In fraudulent disbursement schemes, an employee distributes company funds for
dishonest purposes. Examples of fraudulent disbursements include forging company checks, the submission of
false invoices, doctoring timecards, and so forth.
Fraudulent Loan Setup/Funding Disbursement: This scheme involves booking loans that do not exist or
disbursing funds to fictitious customers. This scheme can inflate revenues and assets (loan receivables) and may
also include embezzlement of funds.
Identity Theft: This scheme involves a crime in which an imposter obtains key personal information, such as
social security or driver's license numbers, to impersonate someone else.
Inflated Time Reporting: Employees may intentionally report hours not spent working. This may involve
reporting hours for days the employee did not work, incrementing hours beyond those spent at work, and failing to
report vacation or sick time.
Insider Trading: Insider trading is an illegal act involving using non-public information to purchase/sell company
stock. Insider trading most often involves executive management or financial reporting personnel with access to
company performance results before public filings.
Intentional Misapplication of Payments: This scheme involves taking a customer's payment and applying it to
another customer or another payable due from the customer.
Kiting: Check kiting is the act of writing checks against a bank account with insufficient funds to cover the check
in hopes that funds will be available before the payee deposits the check.
Lapping: Lapping customer payments is one of the most common methods of concealing skimming. It is a
technique that is particularly useful to employees who skim receivables. Lapping is crediting one account through
the abstraction of money from another account. It is the fraudster’s version of “robbing Peter to pay Paul.”
Loss Allowance Manipulation: The scheme involves changing allowance calculation assumptions, changing
input data or simply changing the result of the allowance calculation to delay the impact of impending losses. This
scheme must often be continued over time to conceal inevitable write-offs and may lead to other fraudulent
journal entries (defined above).
Manipulation of Bonus/Commission Criteria/Results: This scheme is similar to embezzlement but has distinct
characteristics. Personnel responsible for submitting bonus/commission attainment (HR and department
management) may modify compensation criteria or performance results to increase bonus/commission payouts to
themselves or the employees who work for them. In many cases, this scheme is justified by management to
reward employees perceived as strong performers who are not rewarded by established performance metrics.
Manipulation of Derivative Position: This scheme involves intentionally misreporting a derivative position to
conceal a poor business decision or increase earnings. This scheme can be accomplished in various manners,
including the destruction or concealment of supporting documentation, falsifying documentation related to hedging
activities or modifying the actual position to one more favorable to the company.
Manipulation of Inventory: This scheme involves the modification of inventory records to overstate assets or fail
to recognize the decline/impairment to their value. This scheme may include falsifying or destroying records to
substantiate activity in the period that did not occur.
Manipulation or Concealment of Trigger Reporting: This scheme involves the intentional coverup or
falsification of performance reports that would otherwise violate debt covenants.
Misappropriation of Customer Payments/Funds: Often accompanies embezzlement but is a separate and

distinct offense. Misapplication is the wrongful taking or conversion of another’s property, in this case, customer
payments, for the benefit of someone else – that of the employee or for another customer.
Misappropriation of Funds: Often accompanies embezzlement but is a separate and distinct offense.
Misapplication is the wrongful taking or conversion of another’s property, in this case, company funds, for the
benefit of someone else.
Misappropriation of Trustee Payments/Funds: Often accompanies embezzlement but is a separate and

distinct offense. Misapplication is the wrongful taking or conversion of another’s property, in this case, trustee
payments, for the benefit of someone else.
Misleading Analyst Forecasts: This scheme is perpetrated by management to conceal a pending downturn or
flat revenues or predict a significant revenue increase despite the lack of supporting analysis.
Overstatement of Assets: Areas where assets can easily be overstated include inventory valuation, accounts
receivable, business combinations and fixed assets:
• Inventory Valuation: Inventory valuation is the failure to write down obsolete inventory, manipulation of
physical inventory counts, recording “bill-and-hold” items as sales and including these items in inventory.
• Accounts Receivable: This scheme includes fictitious receivables and failing to write off bad debts.
• Business Combinations: This scheme involves setting up excessive merger reserves and taking the
reserves into income.
• Fixed Assets: This scheme includes capitalizing costs that should be expensed or booking an asset, although
the related equipment might be leased.
Proprietary Information Dissemination: This scheme involves intentionally disseminating private company
information to potential customers, vendors or suppliers that give them an unfair advantage in dealing with the
company, whether applying for a loan or providing goods/services. This scheme may be coupled with other acts
such as embezzlement or bid rigging (defined above).
Speculative Investing: This scheme involves company personnel, either on their own or at the direction of
management, entering into derivative/hedging transactions with no specific risk that is attempting to be mitigated.
This may be an attempt to circumvent investing policies to boost earnings or to profit individually from the
transaction.
Tax Evasion: The company intentionally evades payment of taxes that are otherwise owed to a taxing authority.
This conduct can include concealing assets or income, keeping two sets of books, manipulating quarterly
payment estimates, and destroying books and records.
Title Fraud: This scheme involves the use of company assets, in this case, vehicle titles, to secure personal/other
debt. This scheme is most likely to occur with collateral or records management employees due to their access to
such documents.
Unrecorded, Deferred or Understated Liabilities: The most common methods used to understate liabilities
include failing to record liabilities and/or expenses, record warranty costs and liabilities, and disclose contingent
liabilities. In one high-profile case, liabilities were hidden in off-balance-sheet affiliates.
OTHER FRAUD SCHEMES/SCENARIOS TO CONSIDER
Collusion With Dealers Manipulation of Bank Account Status
Concealment or Manipulation of Financial Results and Manipulation of Estimates to Alter Quarterly Tax
Disclosures Payments
Dealer Buyback: Theft of Funds Manipulation of Payroll Records
Diversion of Funds/Misappropriation of Assets Manipulation of Performance Forecasting
Diversion/Misappropriation of Funds Manipulation of Performance Results
Diversion/Theft of Disbursements Manipulation of Significant Accounting Estimates
Electronic Payments Fraud Manipulation or Theft of Fees
Failure to Record/Remit Payroll Taxes Management Circumvention/Override of Loan Setup

Controls
Failure to Remit Ancillary Product Refund to Customer Principal Credit Adjustments to Increase Recoveries
False Repo Agent Invoices Principal Credit Adjustments to Reduce/Pay Off Loans
Falsification of Expense Reports Related-Party Purchases
Fraudulent Auction Invoices Related-Party Transactions
Fraudulent Repo Agent Invoices/Auction Expenses Terminated Employee Payments
Fraudulent Settlement Negotiation Theft
Improper Re-Aging Accounts to Current Unauthorized Electronic Payments
Initiation of Fraudulent Check Unsupported Top-Side Entries
Kickbacks Use of Resources for Personal Gain
Manipulation of Assumptions Utilized by Financial Vendor Kickbacks

Reporting
The purpose of this document is to assist Section 404 compliance teams and others who have a responsibility to
conduct a fraud risk assessment under Statement of Auditing Standard No. 99 (SAS 99) and in accordance with
the requirements of Section 404 of Sarbanes-Oxley Act of 2002 to assess the design and operating effectiveness
of internal controls over financial reporting. In our companion document, COSO-based anti-fraud program and
controls, we suggested that one approach to evidencing the use of control activities to mitigate fraud was the
consideration of fraud scenarios common across industries. This document provides illustrations of different types
of frauds and how such frauds could be perpetrated. It is intended to facilitate using fraud scenarios to make fraud
explicit in a Section 404 assessment.
Anti-fraud programs and controls are controls related to preventing, deterring and detecting fraud. Management’s
assessment should focus on programs and controls intended to mitigate the risk of fraudulent actions that could
have a material impact on financial reporting.
For example, fraud might include:

• Fraudulent Financial Reporting: Inappropriate earnings management or “cooking the books” (e.g., improper
revenue recognition, intentional overstatement of assets or understatement of liabilities, etc.)
• Misappropriation of Assets: Embezzlement and theft
• Expenditures and Liabilities Incurred for Improper or Illegal Purposes: Bribery and influence payments
that can result in reputation loss
• Fraudulently Obtained Revenue and Assets and/or Avoidance of Costs and Expenses: Scams and tax
fraud that can result in reputation loss
Using these four categories of fraud listed above, we have summarized examples of common fraud scenarios
below:
• Fraudulent Financial Reporting:
− Earnings management
− Improper revenue recognition
− Overstatement of assets
− Understatement of liabilities
− Fraudulent journal entries
− Round-trip or “wash” trades
• Misappropriation of Assets:
− Billing schemes
− Collusion
− Concealment
− Embezzlement
− Forgery
− Ghost employees
− Kiting
− Lapping
− Larceny
− Misapplication
− Payroll fraud
− Theft
• Expenditures and Liabilities Incurred for Improper or Illegal Purposes:
− Bribes
− Conflicts of interest
− Kickbacks
− Concealment
− Money laundering
• Fraudulently Obtained Revenue and Assets and/or Cost and Expenses Illegally Avoided:
− Concealment
− Scams
− Tax fraud
These common schemes/scenarios can occur in any industry. However, the way such frauds are perpetrated
might be industry-specific. Regardless, the definitions and/or examples of some of the fraud scenarios listed
above are detailed at the beginning of the next page. An example of how scenarios may be used is as follows:
(a) First, identify relevant scenarios that could occur within the organization, resulting in a material impact on the
financial statements.
(b) Second, for each identified scenario, describe how it would be perpetrated within the company, the individuals
who could make it happen and the financial statement accounts that would be affected.
(c) Based on the documented scenarios, identify the controls that would prevent, deter or detect each scenario.
(d) Compare the controls in place with those documented in (c) and identify gaps.
(e) Develop action plans to remediate significant gaps.
The fraud scenarios listed above are detailed starting on the following page.
ASSET MISAPPROPRIATIONS: FRAUDULENT DISBURSEMENTS
In fraudulent disbursement schemes, an employee makes a distribution of company funds for a dishonest
purpose. Examples of fraudulent disbursements include forging company checks, submitting false invoices,
doctoring timecards and so forth.
BILLING SCHEMES
Billing schemes are a popular form of employee fraud mainly because they offer the prospect of large rewards.
Since most businesses’ disbursements are made in the purchasing cycle, larger thefts can be hidden through
false-billing schemes than other fraudulent disbursements. There are three principal billing schemes: false
invoicing via shell companies, false invoicing via non-accomplice vendors and personal purchases made with
company funds.
BRIBERY
Bribery schemes fall into two broad categories: kickbacks and bid-rigging schemes.
• Kickbacks are undisclosed payments made by vendors to employees of purchasing companies. The purpose
of a kickback is usually to enlist the corrupt employee in an overbilling scheme. Sometimes, vendors pay
kickbacks to get extra business from the purchasing company.
• Bid-rigging schemes occur when an employee fraudulently assists a vendor in winning a contract through the
competitive bidding process.
COLLUSION
To obtain approval for a fraudulent timecard, collude with a supervisor who authorizes timekeeping information. In
these schemes, a supervisor knowingly signs false timecards and the employee kicks back a portion of the
overpaid wages to the supervisor. In some cases, the supervisor may take the entire overpayment amount. It may
be particularly difficult to detect payroll fraud when a supervisor colludes with an employee because managers are
often relied on as a control to ensure proper timekeeping.
CONCEALMENT: FICTITIOUS SALES AND ACCOUNTS RECEIVABLE
When the perpetrator makes an adjusting entry to the perpetual inventory and cost of sales accounts, there is no
sales transaction on the books that correspond to these entries. To fix this problem, a perpetrator might enter a
debit to accounts receivable and a corresponding credit to the sales account so that the missing goods have been
sold.
CONCEALMENT: WRITE OFF OF INVENTORY AND OTHER ASSETS
Writing off inventory and other assets is a common way for employees to remove assets from the books before or
after they are stolen. This eliminates the problem of shrinkage that inherently exists in every case of non-cash-
asset misappropriation.
CONCEALMENT: PHYSICAL PADDING
Most methods of concealment deal with altering inventory records, either changing the perpetual inventory or
miscounting during the physical inventory. In the alternative, some employees try to make it appear that more
assets are present in the warehouse or stockroom than there are. Empty boxes may be stacked on shelves to
create the illusion of extra inventory.
CONFLICTS OF INTEREST
An employee, fiduciary or agent is put into a position of self-dealing. One example would be if a CFO of an
organization set up an off-balance-sheet entity, which he managed and transacted business, thereby becoming
personally enriched. This scenario compromises the internal control structure because independent parties are
not bargaining at arm’s length with each other. A waiver of the conflicts of interest provision of the code of ethics
requires board approval and must be disclosed.
EMBEZZLEMENT
The property of another party is wrongfully taken or converted for the wrongdoer’s benefit.
EARNINGS MANAGEMENT
The pressure to meet or beat analyst expectations may lead management to engage in dubious practices such as
“big bath” restructuring charges, creative acquisition accounting, “cookie jar reserves,” “immaterial”
misapplications of accounting principles and the premature recognition of revenue. Insistence on aggressive
application of accounting principles, on always being “on the edge,” and on applying “soft” methods, allowing for a
lot of “running room” when making significant estimates in the financial reporting process all contribute to an
environment that impairs or reduces the quality of earnings and breed earnings management.
FINANCIAL STATEMENT FRAUD
Misstatement(s) of an entity’s financial statements accomplished by:

• Overstatement of revenue and revenue-related assets
• Understatement of costs or expenses and their related liabilities, which involves violation(s) of generally
accepted accounting principles (GAAPs), and which defrauds investors or creditors of the entity by
manipulation, deception or contrivance using false and misleading financial information
FORGERY
When using this method, an employee typically withholds their timecard from those sent to the supervisor for
approval, forges the supervisor’s signature or initials, and then adds the timecard to the stack of authorized cards
sent to the payroll department. The fraudulent timecard arrives at the payroll department with what appears to be
a supervisor’s approval and a paycheck is subsequently issued.
FRAUDULENT JOURNAL ENTRIES
Some characteristics may include entries:

• Made to unrelated, unusual or seldom-used accounts
• Made by individuals who typically do not make journal entries
• Made with little or no support
• Made post-closing or at the end of a period such as quarter- or year-end and might be reversed in a
subsequent period
• Include round numbers
• Affect earnings
Financial statement fraud is frequently accomplished using fraudulent journal entries and is a form of
management override of the internal control structure. Of particular interest would be journal entries that mask
fund diversion, the improper reversal of reserve accounts, the use of intercompany accounts to hide expenses
and/or the capitalization of costs that should be expensed.
GHOST EMPLOYEES
A ghost employee refers to someone on the payroll who does not work for the victim company. Through the
falsification of personnel or payroll records, a fraudster causes paychecks to be generated by a ghost. The
fraudster or an accomplice then converts these paychecks. The ghost employee may be a fictitious person or a
real individual who simply does not work for the victim's employer. When the ghost is a real person, it is often a
friend or relative of the perpetrator.
IMPROPER REVENUE RECOGNITION
Companies try to enhance revenue by manipulating the recognition of revenue. Improper revenue recognition
entails recognizing revenue before a sale is complete; before the product is delivered to a customer; or when the
customer still has options to terminate, void or delay the sale. Examples of improper revenue recognition include
recording sales to non-existent customers, recording fictitious sales to legitimate customers, recording purchase
orders as sales, altering contract dates and shipping documents, entering into *“bill and hold” transactions,
holding the books open until after shipment so that the sale can be recorded in the desired period, entering into
side agreements and **channel stuffing.
KITING
Kiting is when the wrongdoer opens two accounts in two separate banks and floats checks between the two,
receiving cash back on each deposit. The deposits keep escalating in amount, though and are always
uncollected. Eventually, the financial institution should see the pattern and stop it.
LAPPING
Lapping customer payments is one of the most common methods of concealing skimming. It is a technique, which
is particularly useful to employees who skim receivables. Lapping is crediting one account through the abstraction
of money from another account. It is the fraudster’s version of “robbing Peter to pay Paul.”
LARCENY
“Larceny” is defined as felonious stealing, taking and carrying, leading, riding, or driving away another’s personal
property to convert it or deprive the owner thereof. To classify asset misappropriations, the term larceny is meant
to refer to the most basic type of inventory theft, the scheme in which an employee takes inventory from the
company premises without attempting to conceal the theft in the books and records. (See “Non-Cash Larceny”
flow chart) In other fraud schemes, employees may create false documentation to justify the shipment of
merchandise or tamper with inventory records to conceal missing assets.
MISAPPLICATION
Misapplication often accompanies embezzlement but is a separate and distinct offense. Misapplication is the
wrongful taking or conversion of another’s property for the benefit of someone else.
MONEY LAUNDERING
Money laundering often includes the use of offshore accounts. It can be defined as the illegal practice of filtering
“dirty” money or ill-gotten gains through a series of transactions to make it appear that the proceeds are from legal
activities.
*“Bill-and-hold” transactions are sales where the customer agrees to purchase the goods, but the seller retains
physical possession until the customer requests shipment.
**“Channel stuffing” boosts sales by enticing distributors to buy more inventory than they can sell, usually giving
them the right to return unsold goods using side agreements.
OVERSTATEMENT OF ASSETS
Areas where assets can easily be overstated include inventory valuation, accounts receivable, business
combinations and fixed assets:
• Inventory Valuation: The failure to write down obsolete inventory, manipulation of physical inventory counts,
recording *“bill-and-hold” items as sales and including these items in inventory
• Accounts Receivable: Fictitious receivables and the failure to write off bad debts
• Business Combinations: Setting up excessive merger reserves and taking the reserves into income
• Fixed Assets: Capitalizing costs that should be expensed or booking an asset, although the related
equipment might be leased
PAYROLL SCHEMES
Payroll schemes are similar to billing schemes. The perpetrators of these frauds produce false documents, which
unknowingly cause the victim company to make a fraudulent disbursement. In payroll schemes, the perpetrator
typically falsifies a timecard or alters information in the payroll records. The major difference between payroll
schemes and billing schemes is that payroll frauds involve disbursements to employees rather than to external
parties. The most common payroll frauds are ghost employee schemes, falsified hours and salary schemes, and
commission schemes.
ROUND TRIP OR “WASH” TRADES
These trades are simultaneous, prearranged buy-sell trades with the same counterparty, at the same price and
volume, and over the same term, resulting in neither profit nor loss to either transacting party.
SKIMMING
Skimming is removing cash from a victim entity before entering into an accounting system. Employees who skim
from their companies steal sales or receivables before they are recorded in the company books. Skimming
schemes are known as “off-book” frauds, meaning money is stolen before it is recorded in the victim
organization’s accounts. Short-term skimming is when the perpetrator only keeps the stolen money for a short
while before eventually passing it on to his employer. The employee merely delays the posting of the payment.
TAX FRAUD
The company intentionally evades payment of taxes that are otherwise owed to a taxing authority. This conduct
can include the concealment of assets or income, keeping two sets of books, and the destruction of books and
records.
TURNAROUND SALE OR FLIP
A special purchasing scheme sometimes used by fraudsters is called the turnaround sale or the flip. In this
scheme, an employee knows his employer is seeking to purchase a certain asset and takes advantage of the
situation by purchasing the asset himself (usually in the name of an accomplice or shell company). The fraudster
then turns around and resells the item to his employer at an inflated price.
UNDERSTATEMENT OF LIABILITIES
The most common methods used to understate liabilities include failing to record liabilities and/or expenses,
record warranty costs and liabilities, and disclose contingent liabilities. In one high-profile case, liabilities were
hidden in off-balance-sheet affiliates.

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ACCOUNTS PAYABLE

COMMON FRAUD POLICY GUIDE

COMMON INSIDER FRAUD AGAINST THE COMPANY

• Cash diversions, conversions and thefts (front-end frauds)

COMMON OUTSIDER FRAUD AGAINST THE COMPANY

• Vendor, supplier and contractor frauds, such as short shipping goods

COMMON FRAUDS FOR THE COMPANY

Procedures used (by top management) to accomplish fraud:

Ratios: Ratios include accounts receivable turnover and revenue trends.

Ratios: Ratios include inventory turnover.

Ratios: Ratios include quick ratio.

Ratios: Ratios include depreciation and amortization as percentages of sales.

Ratios: Ratios include depreciation and amortization as percentages of sales.

FRAUD SCHEMES/SCENARIOS AND DEFINITIONS

Financial Statement Fraud: Misstatement(s) of an entity’s financial statements accomplished by:

Misappropriation of Customer Payments/Funds: Often accompanies embezzlement but is a separate and

Misappropriation of Trustee Payments/Funds: Often accompanies embezzlement but is a separate and

OTHER FRAUD SCHEMES/SCENARIOS TO CONSIDER

Dealer Buyback: Theft of Funds Manipulation of Payroll Records

Diversion of Funds/Misappropriation of Assets Manipulation of Performance Forecasting

Diversion/Misappropriation of Funds Manipulation of Performance Results

Diversion/Theft of Disbursements Manipulation of Significant Accounting Estimates

Electronic Payments Fraud Manipulation or Theft of Fees

Failure to Record/Remit Payroll Taxes Management Circumvention/Override of Loan Setup

Falsification of Expense Reports Related-Party Purchases

Fraudulent Auction Invoices Related-Party Transactions

Fraudulent Repo Agent Invoices/Auction Expenses Terminated Employee Payments

Fraudulent Settlement Negotiation Theft

Improper Re-Aging Accounts to Current Unauthorized Electronic Payments

Initiation of Fraudulent Check Unsupported Top-Side Entries

Kickbacks Use of Resources for Personal Gain

Manipulation of Assumptions Utilized by Financial Vendor Kickbacks

For example, fraud might include:

ASSET MISAPPROPRIATIONS: FRAUDULENT DISBURSEMENTS

CONCEALMENT: FICTITIOUS SALES AND ACCOUNTS RECEIVABLE

CONCEALMENT: WRITE OFF OF INVENTORY AND OTHER ASSETS

CONCEALMENT: PHYSICAL PADDING

FINANCIAL STATEMENT FRAUD

Misstatement(s) of an entity’s financial statements accomplished by:

FRAUDULENT JOURNAL ENTRIES

Some characteristics may include entries:

IMPROPER REVENUE RECOGNITION

ROUND TRIP OR “WASH” TRADES

TURNAROUND SALE OR FLIP

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