Spring 2006 issue of Horizons

ments unopened directly from the bank. This person should thoroughly review all cancelled checks prior to returning them to the accounting department for reconciliation.

Fictitious Vendors

A common type of fraud is payment of invoices to a fictitious vendor. Contractors are vulnerable to this scheme because numerous vendors often are involved in day-to-day opera- tions. To perpetrate this scheme, the embezzler establishes a fake vendor and enters it into the company's records as a legitimate one. The embezzler then produces invoices for the fake vendor and submits the invoices for processing in the accounts payable system. In many cases, the embezzler is involved in field operations and has the authority to approve invoices for payment. Senior management should periodically examine the company's approved vendor list. In addition, a careful review of invoices often can detect this type of fraud. Invoices for fictitious ven- dors often have a P.O. box as an address or have no phone number listed on the invoice. In other instances, the fictitious vendor has the same address or phone number as an employee. Often, the amount of each invoice from a fictitious vendor falls just below a threshold level that the company has established for a detailed review of invoices. Cash Disbursements This type of fraud involves schemes in which the embezzler uses company checks to either withdraw cash directly for his or her own benefit or to pay personal expenses. For example, an employee may write checks payable to himself/herself and post the checks to various expense accounts. In other instances, the employee may use company checks to pay personal bills such as credit card charges. In both cases, the employee discards the cancelled checks when they are enclosed with the monthly bank statements. These types of fraud occur primarily due to a lack of segre- gation of functions in the accounting process. This can be fairly widespread among smaller companies, since they often lack sufficient personnel to maintain a strong system of inter- nal controls. Ideally, different personnel should be responsi- ble for the authorizing, processing, recording and custody functions. If these functions cannot be segregated due to a lack of personnel, then it is imperative that someone inde- pendent of the accounting function receive all bank state-

Kickbacks

A less common type of fraud that can affect contractors involves kickbacks paid by a vendor to the company's pur- chasing agent. Under this scheme, the purchasing agent receives a kickback for allowing the vendor to submit fraudu- lent bills for materials. Examples include overbilling for mate- rials delivered, billing for materials never received, or substi- tuting lower quality materials than the ones billed. Kickbacks are “off-the-book” frauds in that they are not recorded on the books of the company. Kickbacks can be particularly difficult to detect and often are discovered when profit margins change substantially upon the hiring of a new purchasing agent or the switching of vendors. Implementing a strong system of internal controls is the best way to prevent or detect all of the aforementioned fraud schemes. Once established, the system should be periodical- ly reviewed to ensure the internal controls are operating as designed. Small contractors may find it difficult to have a strong system of internal controls since often it is not cost efficient. In these circumstances, it is important that the owner or other management personnel be actively involved in the oversight of the accounting function. Although no company is 100 percent fraud-proof, solid inter- nal controls and effective management oversight can keep your company from being victimized by the many fraudulent schemes we have discussed. Questions? Contact either Frank Hogg, Partner-in-Charge, Contractor Services Group 314-290-3413 frank.hogg@rubinbrown.com or Mark Jansen, Partner, Contractor Services Group 314-290-3208 mark.jansen@rubinbrown.com In Conclusion

28 • spring 2006 issue