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Chapter 7 Expense Reimbursement Schemes Review Questions 7-1 Explain what constitutes -expense reimbursement fraud and list the four categories of ¬expense reimbursement schemes. Answer: Expense reimbursement schemes, as the name ¬implies, occur when employees make false claims for reimbursement of fictitious or inflated business expenses. This is a very common form of occupational fraud and one that, by its nature, can be extremely difficult to detect. Employees who ¬engage in this type of fraud generally seek to have the company pay for their personal expenses, or they pad the amount of business expenses they have incurred in order to generate excess ¬reimbursements. The four categories of expense reimbursement fraud are: (1) mischaracterized expense reimbursements; (2) overstated expense reimbursements; (3) fictitious expense reimbursements; and (4) multiple reimbursements. 7-2 Alpha is a salesperson for ABC Company. In July, Alpha flies to Miami for two weeks of vacation. Instead of buying a coach class ticket, he flies business class, which is more expensive. A few weeks later, Alpha prepares an expense report and includes the Miami flight on it. He lists the reason for the flight as “customer development.” What category of expense reimbursement fraud has Alpha committed? Answer: Alpha has committed a mischaracterized expense ¬reimbursement scheme, which occurs when an employee seeks to be reimbursed for personal—rather than business-related—expenses. 7-3 Why is it important to require original receipts as support for expenses listed on a travel and entertainment expense report? Answer: One of the ways in which employees commit ¬expense reimbursement fraud is by overstating business ¬expenses. This is often accomplished when an employee alters supporting ¬documentation to reflect a higher cost than what he actually paid. These alterations are less noticeable on a ¬photocopy than on the original document. Therefore, by ¬requiring original ¬support an organization will be more likely to detect this kind of fraud, and employees will be less likely to attempt it. 7-4 What is meant by the term “over purchasing”? Answer: Over purchasing is a method of overstating business expenses in which a fraudster buys two or more business ¬expense items at different prices (such as airline tickets). The perpetrator returns the more expensive item for a refund yet still claims reimbursement for this item. As a result, he is reimbursed for more than his actual expenses. 7-5 Provide two examples of how an employee can commit a fictitious expense reimbursement scheme. Answer: An employee can document wholly fictitious items for reimbursement by producing her own fictitious receipts and/or bogus support documentation, which are used to -support nonexistent items on an expense report. Additionally, an employee may steal or otherwise obtain blank receipts from common vendors, such as hotels or restaurants, and fill these in to justify fictitious expenses. Another method is for an ¬employee to claim expenses that were paid by someone else, such as a case in which a client pays for a business lunch but the employee submits an expense report for the lunch. 7-6 How is a multiple reimbursement scheme committed? Answer: This type of fraud involves the submission of a single expense several times to receive multiple reimbursements. The most frequent example of a duplicate reimbursement scheme is the submission of several different types of support for the same expense, such as submitting an airline ticket stub and the travel agency invoice on separate expense reports. ¬Alternatively, the same expense report may be submitted more than once. Typically, the perpetrator will have the duplicate ¬reports approved by separate supervisors and will also allow a time lag between the two reports to help avoid detection. 7-7 Beta is an auditor for ABC ¬Company. He runs a report that extracts payments to employees for business expenses incurred on dates that do not coincide with scheduled business trips or that were incurred while the employee was on leave time. What category or ¬categories of expense reimbursement scheme would this report most likely identify? Answer: Beta’s report would most likely detect a mischaracterized expense scheme. Since the report targets expenses that were incurred on leave time or apart from scheduled business trips, it most likely would highlight personal expenses that are being claimed as business expenses. Beta’s report could also catch a fictitious expense scheme because a fraudster who ¬creates hypothetical expenses might inadvertently use dates that do not correspond to actual business trips. Beta’s test would be unlikely to detect overstated ¬expenses or multiple reimbursements, because these two schemes both seek to create extra reimbursement for actual business ¬expenses. These expenses would typically be incurred on scheduled business trips or meetings, not on personal or leave time. Thus, they would not be highlighted by Beta’s ¬report. Discussion Issues 7-1 What internal controls can be put into place to prevent an employee from committing a ¬mischaracterized expense scheme? Answer: If a company wishes to prevent employees from charging their personal expenses to the company, there are ¬several things it can do. The company should require detailed expense reports for all reimbursable expenses. Expense reports should include the following information: original support ¬documents, dates and times of business expenses, methods of payment, and descriptions of the business purpose for expenses. All travel and entertainment expenses should be independently reviewed by a direct supervisor who is familiar with the ¬employee’s schedule and duties. High-level managers should not be exempt from this monitoring. Organizations should also develop a policy on expenses that clearly explains what types of expenses are reimbursable and sets reasonable limits for expense reimbursements. This policy should be disseminated to all employees, who should be required to sign a statement acknowledging that they have received and understood its provisions. Additionally, vacation and business schedules should be compared to the dates for which reimbursement is requested. This can help to prevent someone from claiming his or her ¬vacation expenses as business related. 7-2 In the case study “Frequent Flier’s Fraud Crashes,” what internal controls could have detected the fraud earlier? Answer: Clarification and better enforcement of the policy that travel for the entire company must be booked through the company travel agent using a designated company credit card could have helped to detect Marcus Lane’s fraud sooner, and likely would have prevented it altogether. 7-3 Discuss how establishing travel and entertainment budgets can help an organization detect expense reimbursement fraud. Answer: Expense reimbursement fraud is very common and can be very difficult to detect. One detection method that is often employed is to compare expense reimbursement levels to budgeted amounts and prior years’ expenses. This enables an -organization to see if reimbursed expenses have significantly increased over expected and/or historical amounts, which may be a sign of fraud. In addition, establishing budgets is a good way to control costs, regardless of fraud. Finally, if ¬employees know this kind of comparison is made, they may be less likely to attempt expense reimbursement schemes, at least on a large scale. 7-4 ABC Company has three in-house salespeople (Red, White, and Blue) who all make frequent trips to Santa Fe, New Mexico, where one of the ¬company’s largest customers is based. A manager at ABC has noticed that the average airfare expense claimed by Red for these trips is $755 round trip. The average airfare expense claimed by White is $778. The average airfare expense claimed by Blue is $1,159. What type of expense reimbursement fraud might this indicate, and what controls would you recommend to the company to prevent this kind of scheme? Answer: These facts point to an overstated expense scheme. While all three salespeople have legitimate, business-related purposes for their trips, it appears that Blue might be inflating the costs of his airfare on his expense reports, given the fact that his flight costs are significantly higher than those claimed by the other two employees, even though they all have the same destination. (Note that additional investigation would be required to make sure there was not a legitimate reason for the discrepancy. For example, maybe Blue’s flights coincided with busy travel dates or had to be booked at the last minute, which might have caused the extra expense). Assuming this is an overstated expense scheme, the company should make sure to establish proper controls for the review of expenses, including detailed expense reports and independent review by direct ¬supervisors. Furthermore, the company should specify that it will accept only original support for expenses, and should specify the type of support that is allowable (e.g., airline ticket receipts, not travel agency itineraries). It would be advisable for the company to have all travel booked through a centralized in-house department, or through a specified travel agency using a company credit card. This would help ensure consistency in travel costs and should prevent an employee from exaggerating his expenses. 7-5 Baker is an auditor for ABC Company. He is reviewing the expense reports that Green, a salesperson, has submitted over the last 12 months. Baker ¬notices that Green’s expenses for “customer development ¬dinners” consistently range between $160 and $170, and the amounts are almost always a round number. ABC Company has a policy that limits reimbursement for ¬business dinners to $175 unless otherwise authorized. In ¬addition, most of the ¬expense reports show that Green paid for the meals in cash, even though he has been issued a company credit card that he usually uses for other travel and entertainment expenses. What kind of expense reimbursement scheme is most likely, based on these circumstances? Answer: These facts are all consistent with a fictitious ¬expense scheme, particularly because the expenses are just below the reimbursement limit and were ostensibly paid in cash, which is not how Green normally pays for business -expenses. Fraudsters who commit fictitious expense schemes often claim to have paid in cash because this explains the lack of an audit trail for the expense. It is also possible that this is a mischaracterized expense scheme (involving personal ¬expenses) or an overstated expense scheme in which Green is inflating the costs of real business dinners. 7-6 What internal controls would help to prevent an employee from claiming an expense more than once? Answer: Employees should be allowed to submit only ¬original receipts for expenses. They should be required to ¬submit all documentation of expenses, including receipts showing charge totals, and that includes details of what exactly was ¬purchased. Photocopies of receipts should not be allowed. ¬Additionally, expense reports should identify the budget from which the ¬reimbursement should be paid, to help prevent ¬multiple ¬reimbursements being made from two different ¬budgets. All ¬expense reports should be closely reviewed by both the ¬supervisor and accounting personnel for potential fraud. Chapter 8 Register Disbursement Schemes Review Questions 8-1 What is a register disbursement scheme? Answer: A register disbursement scheme is a type of occu-pational fraud in which an employee processes a fraudulent ¬reversing transaction on a cash register to justify the removal of cash from that cash register. 8-2 How do register disbursement schemes differ from skimming and cash larceny, both of which frequently involve thefts of cash from cash registers? Answer: Register disbursements schemes differ from other types of cash register frauds in that in these schemes the removal of money is recorded on the cash register as though it were a legitimate disbursement of funds. This is why these schemes are ¬referred to as register disbursements. In skimming and cash ¬larceny, by contrast, there is no record of the disbursement. 8-3 What are the two main categories of register disbursement schemes? Answer: The two basic fraudulent disbursement schemes that take place at the cash register are false refunds and false voids. 8-4 What is the difference between a fictitious refund scheme and an overstated refund scheme? Answer: In a fictitious refund scheme the fraudster processes a refund as if a customer were returning merchandise, even though there is no actual return. The perpetrator then steals cash from the register in the amount of the false return. The disbursement appears legitimate because the register tape shows that a merchandise return has been made. Because the money that was taken from the register was supposed to have been -removed and given to a customer as a refund, the register tape balances with the amount of money in the register. This scheme differs from an overstated refund scheme in which the fraudster overstates the amount of a legitimate refund and skims off the excess money. 8-5 How are fraudulent void schemes used to generate a disbursement from a cash register? Answer: Normally, when a sale is voided, an honest employee attaches a copy of the customer’s sales slip to a ¬completed void slip and asks a manager to initial the transaction for approval. To process a falsified void slip, a fraudster must first get access to a customer’s sales slip and then get the approval of the transaction from a manager. A customer’s sales slip can be obtained by simply “forgetting” to give it to a customer. The fraudulent transaction is completed when the -dishonest ¬employee takes the cash from the register. The copy of the ¬customer’s receipt is used to verify the authenticity of the transaction. 8-6 How do register disbursement schemes cause shrinkage? Answer: When a false refund or void is recorded on a cash ¬register, two things happen. The first is that the employee ¬committing the fraud removes cash from the register, and the second is that the item allegedly being returned is debited back into ¬inventory. The result is shrinkage: The amount of inventory that is actually on hand will be less than the amount that should be on hand. 8-7 How can the processing of low-dollar refunds help a fraudster conceal a register disbursement scheme? Answer: Companies often set limits below which management review of a refund is not required. When this is the case, fraudsters are sometimes able to avoid detection by processing ¬numerous refunds that fall below the review limit, as opposed to processing a smaller number of high-dollar transactions. 8-8 Why is it important for all cashiers to maintain distinct login codes for work at the cash register? Answer: If all cashiers are required to log into a cash register before using it, this enables an organization to trace fraudulent reversing transactions back to the employee who processed them. It also enables organizations to run tests for various red flags such as employees who process an inordinate number of reversing transactions, process transactions for unusually large amounts, process recurring transactions for the same amount, and so on. Discussion Issues 8-1 In the case study involving Bob Walker at the beginning of this chapter, what type of register disbursement schemes did he commit? Discuss the role his ¬recent demotion played in the scheme. Answer: Bob Walker committed fictitious refund and overstated refund schemes. In both cases, he took money from the cash register and wrote fake cash refunds by recording either fictitious or real names and telephone numbers in the ¬refund log. With the use of real names, he simply altered legitimate refunds that he had issued earlier in the day. Shortly before the scheme began, Walker was demoted and received a pay cut. This likely provided the rationalization Walker needed to commit the scheme. Recall that under the Fraud Triangle model, there are three factors that are typically present when an employee commits fraud. A non-shareable ¬financial need, a perceived opportunity, and a rationalization. Wanting to get even with one’s company for perceived unfair treatment is a common rationalization that is used to justify fraud. Indeed, when confronted about his crime, Walker ¬referred to his managers who had “unjustly” demoted him. The pay cut may also have created a non-shareable ¬financial need for Walker. In his interview with the investigators he stated that he had financial problems that were exacerbated by the pay cut, and that proceeds from the fraud initially went to his mortgage payments. 8-2 In the 2009 Global Fraud ¬Survey, register disbursements were reported far less ¬frequently than any other fraudulent disbursement scheme. Discuss some reasons why this result might not reflect the True frequency of register disbursements. Answer: Although register disbursement schemes accounted for a small percentage of the reported fraudulent disbursement schemes, it must be remembered that the respondents to the survey were only asked to report one case they had investigated; the study was not designed to measure the overall frequency of various types of schemes within a particular organization. So the low ¬response rate for register disbursements does not necessarily reflect how often these schemes occur. Furthermore, the type of fraud that occurs within an organization is to some extent determined by the nature of business the organization conducts. For example, register disbursement schemes would tend to be much more common in a large retail store that employs several cash register clerks than in a law firm where a cash register would not even be present. 8-3 What are some tests that can help detect fictitious refund schemes that involve the overstatement of inventories? Answer: When a customer returns merchandise, a journal entry is normally made to increase the merchandise inventory account and decrease the cost of goods sold account for the cost of the returned merchandise. In a fictitious refund scheme, no merchandise is actually returned. Nevertheless, the same journal entry is made as if a real refund were taking place. ¬Because no merchandise was returned, the merchandise inventory ¬account is overstated and will not agree with the actual ¬inventory on hand. This scheme may be detected by periodically taking a count of the physical inventory and comparing it to the perpetual inventory records, which measure the amount of inventory that “should be on hand.” An unusual discrepancy may indicate that a fictitious refund scheme is occurring. However, in many register disbursement cases the level of shrinkage is not large enough to raise a red flag. Other tests that could be used to detect fictitious refund schemes include ¬running audit tests for the following conditions: •Locations with unusually high levels of refunds or voids •Employees who process unusually high levels of refunds or voids •Unsupported adjustments to inventory, particularly those ¬entered by employees who also record refunds or voids 8-4 In the “silent crime” case study mentioned in the chapter, how did Joe Anderson involve other individuals in his credit card refund scheme? Answer: Joe eventually used over 200 credit cards belonging to 110 individuals to steal from his employer. Each week he would credit over $2,000 in fake returns to the credit cards of his friends, neighbors, and relatives. In return, he was paid up to 50 percent of the amount charged to the credit card. 8-5 Explain how each of the following three conditions could be a red flag for a register disbursement scheme. 1. Able, a cash register teller, is authorized to approve sales -refunds and she is also authorized to make inventory ¬adjustments. 2. Baker is a cashier who, in the last week, processed 15 ¬refunds. No other cashier processed more than 5 over that same period. Each of the transactions was for between $13.50 and $14.99. 3. Over 70 percent of the refunds processed by Chase, a cash register clerk, were run on the same date as the original sale. Answer: The conditions under which Able works are ripe for fraud. Able is a cash register teller, which means she is in a ¬position to enter refunds, but she also has the authority to -approve refunds, meaning there is an inadequate separation of duties. In addition, Able is authorized to make inventory ¬adjustments, which could enable her to conceal any shrinkage that would ¬result from a register disbursement scheme. Even though this scenario does not contain any evidence that Able is actually ¬committing fraud, the conditions are such that if she did commit fraud, she would most likely be successful. The fact that Baker processed three times more refunds than any other cashier over the relevant period does not prove that he is involved in a register disbursement scheme, but it is consistent with that type of scheme and there is sufficient reason to conduct further inquiry. The fact that all of the refunds were for amounts in a very narrow range just under $15.00 is also suspicious. It would be worth checking to see whether Baker’s company has a review limit for refunds at or near $15, since the ¬pattern of his transactions suggests he may be structuring false refunds to avoid review. The scenario involving Chase contains less hard evidence than the other two, but the fact that most of the -refunds Chase processes occur on the same date as the underlying sales could point to fraud. It would make sense for an employee to run fraudulent refunds close to the time of the original sale, since he would be more likely to remember the details from the sales transaction, such as the amount, the customer’s name, the item purchased, etc. There is no information here that would tell us whether it is typical for a customer to return ¬merchandise on the same date he or she purchased it, but that is something that should be tested, given the ¬information here. Chapter 9 Noncash Assets Review Questions 9-1 What are the five categories of schemes used to misappropriate non-cash tangible assets identified in this chapter? Answer: The five categories identified in this chapter are misuse, unconcealed larceny, asset requisitions and transfers, purchasing and receiving schemes, and fraudulent shipments. 9-2 According to the 2009 Global Fraud Survey, how do non-cash misappropriations compare with cash misappropriations in terms of frequency and cost? What two types of non-cash assets were most commonly ¬misappropriated? Answer: According to the 2009 Global Fraud Survey, cash schemes were much more common than non-cash schemes. Eighty-six percent of asset misappropriations involved the theft of cash, whereas only 20% involved the theft or misuse of non-cash assets. In terms of median loss, cash schemes were also slightly costlier: cash schemes had a median loss of $120,000, while non-cash schemes had a median loss of $90,000. Physical assets, such as equipment and inventory, were the most frequently targeted type of non-cash asset in the study, with seventy-five percent of non-cash cases involving the misappropriation of a physical asset. 9-3 What are some examples of asset misuse? Give at least three. Answer: There are many ways in which non-cash assets are misused by employees without being stolen. Company vehicles can be used for personal trips. Computers, supplies, and ¬office equipment can be used by employees for personal work on company time. Employees might also take home tools or equipment for a personal project, then return them. 9-4 What is an “unconcealed ¬larceny” scheme? Answer: An unconcealed larceny scheme is one in which an employee takes property from the organization without ¬attempting to conceal the theft on the organization’s books and records. 9-5 Able is a job-site supervisor for ABC Construction. Able is responsible for overseeing the ¬construction of a number of residential homes, and for making sure each of his crews has sufficient materials to complete its work. All of ABC’s lumber and other building materials are stored in a central warehouse and are released upon signed authorization from job-site supervisors as needed. Able ¬requests twice the amount of lumber that is actually needed for a particular job. He uses the excess materials to build a new deck on his home. How would Able’s scheme be ¬categorized? Answer: Able has committed an asset requisition and transfer scheme. He falsified internal materials requisitions in order to gain access to lumber that he then stole. This is not a case of ¬unconcealed larceny because Able falsified documentation (the materials requisition) to conceal the theft (by justifying the ¬removal of the lumber from the warehouse). 9-6 What is “shrinkage”? Answer: Shrinkage is the unaccounted-for reduction in an ¬organization’s inventory that results from theft. When inventory is stolen, shrinkage is generally the key concealment issue for the fraudster. 9-7 Baker works in the sales department of ABC Company, which manufactures ¬computer chips. Baker creates false documentation indicating that XYZ, Inc. (a nonexistent company) has agreed to purchase a large quantity of computer chips. The computer chips are shipped to XYZ, Inc. “headquarters,” which is really Baker’s house. How would Baker’s scheme be categorized and what are some red flags that might occur as a result of the scheme? Answer: Baker’s scheme would be classified as a fraudulent shipment. The fake sale he generated resulted in the unauthorized shipment of inventory to a nonexistent customer. Several red flags could show up in this scheme: •The “customer” has the same address as Baker, an employee. •The “sale” was fabricated, meaning any support documents and/or authorization for the sale were bogus. •Since the customer does not exist, no credit check could have been done on XYZ prior to the issuance of this sale on credit. (The sale had to have been on credit since XYZ, a nonexistent company, could not have paid for the chips.) •Presumably, XYZ’s account will age and eventually need to be written off as uncollectible. 9-8 How do employees use falsified receiving reports as part of schemes to steal inventory? Answer: Falsified receiving reports are sometimes used as part of a purchasing and receiving scheme. The perpetrator—¬typically a warehouse employee—falsifies records of incoming shipments by marking them “short” (meaning that items were ¬missing) or by listing certain items as being damaged or sub¬standard. The perpetrator then steals the unaccounted-for items. For instance, if 1,000 units of an item are received, the fraudster indicates that only 900 are received, then steals the 100 ¬“missing” units. 9-9 What is meant by the term “physical padding”? Answer: Physical padding is a method for concealing inventory theft in which fraudsters attempt to create the physical ¬appearance of extra inventory in a warehouse or stockroom to compensate for the inventory they have stolen. For example, empty boxes may be stacked on top of existing inventory or merchandise may be moved from one storage location to ¬another so that it is counted twice. 9-10 What are the four methods identified in this chapter by which employees conceal ¬inventory shrinkage? Answer: The four methods are: (1) altering inventory records (or forced reconciliation); (2) creating fictitious sales and ¬debiting fictitious or existing accounts receivable (and in some cases writing off the fictitious accounts); (3) writing off non-cash assets as scrap, lost, damaged, obsolete, and so on; and (4) physically padding the warehouse or storeroom. 9-11 Provide an example of a misappropriation of intangibles scheme. Answer: An example of an intangibles scheme is an employee who, out of a sense of entitlement, steals a building plan he helped design from his former employer to attempt to get ahead in his new job with a competitor. Another example is a disgruntled employee who retaliates against his employer, for perceived unfair treatment, by selling a trade secret of his employer to a competitor. Discussion Issues 9-1 Jones is the manager of ABC Auto Repair. Unbeknownst to his employer, Jones also does freelance auto repair work to earn extra cash. He sometimes uses ABC’s ¬facilities and tools for these jobs. Discuss the costs and potential costs that ABC might suffer as a result of Jones’s actions. Answer: Jones is engaged in a misuse scheme that could cause losses to ABC in a number of ways. First, Jones is ¬making unauthorized use of tools that could damage them or shorten their lifespan. Second, ABC may suffer from a loss of productivity since Jones is performing freelance repairs at ABC’s facilities. He is occupying space, equipment, and labor that could be used for legitimate business. The company may even have to buy new equipment or hire additional labor to make up for the shortfall. Third, ABC may be losing customers as a result of Jones’s scheme. Presumably, at least some of the customers who have hired Jones to fix their cars would have come to ABC if he were not freelancing. Jones also has an ¬unfair competitive advan¬tage in this respect. His expenses are significantly lower than ABC’s, since he is getting free use of facilities and equipment that most likely required a ¬significant investment by ABC. Therefore, he is probably undercutting ABC’s prices in order to attract customers, which is common in this type of scheme. 9-2 Discuss how establishing a strong system of communication between employees and management can help deter and detect inventory larceny. Answer: As was discussed in this chapter, employees often know that others in the organization are stealing assets, yet they refrain from reporting the crimes. This can occur for a number of reasons, such as a sense of duty to friends, a “management versus labor” mentality, intimidation, poor channels of communication, or simply not knowing how to report a crime. When management makes an effort to foster open communication with employees, this removes many obstacles that may otherwise keep thefts from being reported. Employees should be ¬educated on how fraud hurts everyone in the organization, and they should be made aware that crimes can be ¬reported anonymously and without fear of retribution. In ¬addition, a clear means of reporting crimes (such as a hotline) should be specified so that employees know how and to whom they can make their reports. Remember that according to the 2009 Global Fraud Survey, employee tips are one of the most common methods for detecting occupational fraud. Organizations that do not make use of employees as a fraud detection tool are shortchanging themselves. 9-3 In the case study “Chipping Away at High-Tech Theft,” do you believe the ¬procedures and controls maintained by the manufacturer contributed to the theft? Why or why not? Answer: While the company’s controls and procedures (or lack thereof) did not cause the theft, they certainly contributed to its success. There were a number of deficiencies that aided Larry Gunter in his scheme. First, the company had no internal transfer documentation, which meant that product could be moved from one building to another without being accounted for. Employees were simply moving the inventory across an open, unmonitored parking lot without boxes being checked or documented. To compound the problem, the company’s ¬security cameras were set up improperly so that they did not deter theft, and security tapes were not saved long enough, which made the security cameras useless in trying to determine who had committed the thefts. In addition, -security guards were inattentive and did not do a good job of checking the product that left the building. Finally, the fact that the company verified its product inventory only once a month meant that it took longer for the company to detect the missing inventory. 9-4 Discuss the controls that an ¬organization should have in place to effectively prevent and detect larceny of inventory. Answer: As with most forms of asset misappropriation, the first key to preventing and detecting non-cash larceny is to make sure the organization has adequately separated duties. To prevent inventory larceny, it is crucial that the duties of ¬requisitioning, purchasing, and receiving inventory should be separated. In addition, physical controls should be in place. All merchandise should be physically guarded and locked, with access restricted to authorized personnel only. Access logs should be used to track those who enter restricted areas, including their entry times. Any removal or transfer of inventory to ¬another location should be properly documented. Security cameras also can be effective at deterring theft of inventory. To maximize the deterrent effect of security cameras, employees should be made aware of the presence of the cameras. Physical inventory counts should be conducted on a periodic basis by someone independent of the purchasing and warehousing functions. Shipping and receiving activities should be suspended during physical counts to ensure a proper cut-off, and the physical counts should be subject to recounts or spot-checks by independent personnel. It is also important for organizations to have in place a mechanism for receiving customer complaints, to help detect cases in which employees steal merchandise from ¬outgoing shipments. An employee who is independent of the purchasing and warehousing functions should be assigned to follow up on complaints. 9-5 Baker was in charge of computer systems for ABC Company. As part of a general upgrade, the company authorized the purchase of 20 new computers for the employees in its marketing department. Baker secretly changed the order so that 21 computers were purchased. When they were delivered, he stole the extra computer. Later, 10 more new computers were purchased for the 10 employees in the company’s research and development department. Baker also stole one of these computers. How should these two schemes be classified under the fraud tree? Answer: The first scheme should be classified as a billing scheme (personal purchases), and the second scheme should be classified as a non-cash misappropriation (purchasing and receiving). The difference in the two frauds is that in the first, Baker caused the company to buy a computer it did not need. The harm to the company was that it overpaid for what it ¬received. The fact that Baker took the computer is ¬inconsequential because the company did not need and did not order the computer; Baker could have purchased anything with the excess funds and the harm to the company would have been the same. In the second scheme, Baker stole an asset that was ¬intentionally purchased by the company. All 10 computers were needed for the 10 employees in the research and development department. Now, the company has not only lost the money it paid for the computer, but it has lost the computer itself and will presumably have to replace it. This scheme is classified as a non-cash mis¬appropriation because the harm to the company is that it has been deprived of a non-cash asset. 9-6 Baker is an auditor for ABC Company. As part of a proactive fraud audit, Baker runs the following tests: (1) a review of the Sales Register for dormant customer accounts that posted a sale within the last two months; and (2) a comparison of the Sales Register and the Shipment Register for shipping documents that have no ¬associated sales order. Taken together, what type of non-cash scheme is Baker most likely to find with these tests? Explain how each one might identify fraud. Answer: The tests Baker is performing were both identified in this chapter as proactive audit tests for false shipments. The first test may identify cases in which employees have posted fraudulent sales to justify the false shipment of ¬inventory. Frequently, these fraudulent sales are charged to dormant accounts and then allowed to age or are subsequently written off. The second test would tend to identify cases in which inventory was fraudulently shipped offsite without a corresponding sale, a clear indicator of fraud. 9-7 Explain why the following ¬circumstances might indicate that one or more employees are stealing merchandise: (1) an increase in uncollectible sales from previous periods and (2) an increase in damaged or ¬obsolete inventory from previous periods. Answer: The conditions listed above are consistent with two techniques that are sometimes used to conceal the theft of -merchandise. As was explained in this chapter, employees sometimes create fictitious sales to justify the shipment of ¬merchandise, then later write off those sales as ¬uncollectible. Similarly, employees sometimes designate merchandise as damaged or obsolete, either to justify the fact that it is missing, or to make it easier to steal (because some organizations do not maintain strict controls over scrap items). Keep in mind that neither of these conditions provides concrete proof that fraud has occurred; there may be legitimate reasons to explain them. But they may be sufficient to warrant further investigation, ¬particularly if combined with other ¬indicators of fraud, such as missing inventory. Solution Manual for Principles of Fraud Examination 9780470646298, 9781118922347 Joseph T. Wells
