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Chapter 6

Employee Fraud and the

Audit of Cash
"Rather fail with honor than succeed by fraud."
--Sophocles (496-406 BCE)

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Presentation Outline

I. An Overview of Fraud
II. Cash Collections and Disbursements
III. Audit of Cash

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 6-3

I. An Overview of Fraud
A. Fraud Opportunities
B. Definitions Related to Fraud
C. The Elements of Fraud
D. Red Flags: Employee Fraud
E. Fraud Prevention

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A. Fraud Opportunities

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B. Definitions Related to Employee

Fraud
 White collar crime is fraud perpetrated by people who work in offices
and steal with a pencil or a computer terminal. The contrast is violent
street crime.
 Employee fraud is the use of fraudulent means to take money or other
property from an employer. It consists of three phases: (1) the
fraudulent act, (2) the conversion of the money or property to the
fraudster's use and (3) the cover-up.
 Embezzlement is a type of fraud involving employees' or
nonemployees' wrongfully taking money or property entrusted to their
care, custody, and control, often accompanied by false accounting
entries and other forms of lying and cover-up.
 Larceny is simple theft of an employers property that is not entrusted
to an employee's care, custody or control.
 Defalcation is another name for employee fraud and embezzlement.

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C. The Elements of Fraud

1. Motive 2. Opportunity

3. Rationalization
High
Risk

Source: W.Hillison, D. Sinason, and C. Pacini, “The Role of the Internal Auditor in Implementing SAS 82,”
Corporate Controller, July/August 1998, page 20.

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1. Motive
A motive is some kind of pressure a person
experiences and believes unshareable with friends
and confidants
– Psychotic: “Habitual criminal” who steals for the sake
of stealing
– Egocentric: Committing fraud for personal prestige
– Ideological: Cause is morally superior, justified in
making others victims
– Economic: Desperate or perceived need for money

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2. Opportunity
An opportunity is an open door for solving
the unshareable problem by violating a
trust.
– Weak internal controls
– Circumvention of internal controls
– The greater the position, the greater the trust
and exposure to unprotected assets.

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3. Rationalization
When people do things that are contrary to their personal
beliefs – outside their normal behavior – they provide an
argument to make the action seem like it is in line with
their moral and ethical beliefs.
– Some of the most frequent rationalizations are:
• I need it more than the other person.
• I’m borrowing the money and will pay it back.
• Everybody does it.
• The company is big and will never miss it.
• Nobody will get hurt.
• I am underpaid, so this is due compensation
• I need to maintain a lifestyle and image.

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 6-10
D. Red Flags: Employee Fraud
 Missing documents.  General ledgers that do not
 Unusual endorsements. balance.
 Unexplained adjustments to Increased past due
accounts receivable and receivables.
inventory balances.  Inventory shortages.
 Old outstanding checks.  Alterations on documents.
 Unusual patterns in  Duplicate payments.
deposits in transit.  Employees that cannot be
 Cash shortages and found.
overages.  Dormant accounts that
 Excessive voids and credit have become active.
memos.  Common names or
 Customer complaints. addresses for refunds.

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E. Fraud Prevention
• Managing people pressures in the
workplace
– Counseling services
– Hotlines
• Control procedures and employee
monitoring
• Integrity by example and enforcement

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II. Cash Collections and

Disbursements

A. Cash as the Most Susceptible Asset

B. The Processing of Cash Receipts
C. Key Control Activities Over Cash
Collections and Disbursements

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A. Cash as the Most Susceptible

Asset
Cash is highly liquid, easily transportable,
and not easily identifiable, and therefore is a
primary target for employee thieves.
Some strong internal controls:
– Dual custody of cash at all times
– Lockbox arrangement
– Fidelity bonds

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B. The Processing of Cash Receipts

(Refer to Exhibit 6.2 on p 212)
 Receive cash and REMITTANCE ADVICE in mail.
 Prepare REMITTANCE LISTING.
 Enter total from REMITTANCE LISTING (or
REMITTANCE ADVICE) in CASH RECEIPTS
JOURNAL.
 Prepare DEPOSIT SLIP and deposit cash receipts in bank
(INTACT and DAILY).
 Record update to SUBSIDIARY ACCOUNTS
RECEIVABLE using REMITTANCE ADVICE.
 Reconcile REMITTANCE LISTING, SUBSIDIARY
ACCOUNTS RECEIVABLE , and DEPOSIT SLIP daily

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C. Key Control Activities Over Cash
Collections and Disbursements:
(Also refer to Exhibits 6.3 and 6.4)
INFORMATION PROCESSING
 Voucher packet (Purchase requisition, purchase order,
receiving report, invoice) matched prior to cash disbursement
authorization
 Deposits reconciled to amounts credited to accounts receivable
ledger
 Bank reconciliation
PHYSICAL CONTROLS OVER THE SECURITY
OF ASSETS
 Deposit cash and checks daily and intact
 Lock box account
 Dual custody over cash
 Unused checks secured
SEGREGATION OF DUTIES
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III. Audit of Cash

A. Cash on Hand and on Deposit
B. Bank Reconciliation
C. Standard Bank Confirmation
D. Check Kiting
E. Proof of Cash

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A. Cash on Hand and on

Deposit
Cash on hand
 Count SIMULTANEOUSLY with other liquid
assets
 Count in presence of client employee
 Undeposited receipts
• Trace to cash receipts journal (CRJ)
• Vouch to subsequent deposit in bank statement
Cash on Deposit
Audited mainly through the client’s bank
reconciliation.

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B. Bank Reconciliation
 Balance per bank
 CONFIRM directly with bank using a standard bank confirmation
 Agree to CUTOFF BANK STATEMENT
 Add Deposits-in-transit
 TRACE to cash receipts journal
 VOUCH to CUTOFF BANK STATEMENT
 Subtract Outstanding Checks
 VOUCH to cash disbursements journal
 TRACE checks cleared from cutoff bank statement
 Add/Subtract Debit/Credit Memos
 Inspect bank credit/debit memo
 Balance per books
 FOOT Reconciliation
 TRACE to trial balance

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B. Bank 6-19
Reconciliation
(Continued)

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C. Standard Bank Confirmation

(Refer to Exhibit 6.8 on p. 221)
In addition to corroborating cash and loan
balances, a STANDARD BANK
CONFIRMATION INQUIRY also
requests information about contingent
liabilities and secured transactions.

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D. Check Kiting
KITING is a fraud that occurs by reporting cash
simultaneously in two different bank accounts.
A Schedule of Interbank Transfers is generally
useful in detecting KITING.
See Exhibits 6.9 and 6.10 on pages 223 and 224.

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E. Proof of Cash

A PROOF OF CASH is used when controls over

cash are weak.
It essentially combines two bank reconciliations,
reconciling all transactions that occurred during the
period to the client’s Cash Receipts Journal and Cash
Disbursements Journal.
See Exhibit 6.11 on p. 225.

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Summary
Fraud includes elements for motive,
opportunity, and rationalization
Overview of cash receipts processing
Controls over cash in the form of bank
reconciliations and bank confirmations
Check kiting and proof of cash

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