4 Chapter Review Questions 4-1 (Learning objective 4-1) What are the five categories of fraudulent disbursements, and where did billing schemes rank in terms of frequency and cost in the 2009 Global Fraud Survey? Answer: The five categories of fraudulent disbursements are: billing schemes, check tampering schemes, payroll schemes, expense reimbursement schemes, and register disbursement schemes. Among these categories, billing schemes were most commonly reported. Fifty-two percent of fraudulent disbursements in the survey involved billing fraud. Billing schemes were the second most costly form of fraudulent disbursement, with a reported median loss of $128,000. (Learning objectives 4-2 and 4-3) How is the term "billing schemes" defined, and what are the three categories of billing schemes covered in this chapter? Answer: Billing schemes are frauds in which a perpetrator causes the victim organization to issue a fraudulent payment by submitting invoices for fictitious goods or services, inflated invoices, or invoices for personal purchases. The three categories of billing schemes are: shell company schemes, non-accomplice vendor schemes, and personal purchases schemes.
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(Learning objective 4-4) What is the purpose of a shell company and how is it normally formed? Answer: A shell company is a fictitious entity established for the purpose of committing fraud. It may be nothing more than a fictitious name and a post office box that the employee uses to collect disbursements from false billings. Since checks received will be payable to the shell company, the fraudster will normally set up a bank account in the name of the fictitious company, listing himself as the authorized signer on the account.
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(Learning objective 4-5) There are four ways in which fraudulent invoices are approved for payment. What are they? Answer: Fraudulent invoices are approved for payment by self-approval, by a rubber stamp supervisor, or through the normal internal control system by reliance on the authenticity of the false voucher the fraudster creates. In addition, collusion among several employees can overcome even well-designed internal controls and can enable fraudsters to obtain approval on bogus invoices.
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(Learning objective 4-5) Why does collusion among employees in the purchasing process make it very difficult to detect billing schemes? Answer: One of the main purposes of a well-defined internal control system is to separate the duties of individuals who are involved in the purchasing process in order to prevent any one person from having too much control over a particular business function. It provides a built-in monitoring mechanism in which each person's actions are verified by another person. But, if everyone in this process works together to create fraudulent voucher documents, then billing schemes will be very difficult to detect.
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(Learning objective 4-6) Why do most shell company schemes involve the purchase of services rather than goods? Answer: Services are intangible, which makes it more difficult for the victimized company to verify whether they were ever actually delivered by a vendor. If a billing scheme involves fictitious goods, the defrauded company may be able to detect the fraud by comparing its purchases to inventory levels, but this comparison will not identify the purchase of nonexistent services.
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(Learning objective 4-7) What is a pass-through scheme and how does it differ from a typical shell company billing scheme? Answer: In a typical shell company scheme, the perpetrator bills the victim organization for fictitious goods and services. In a pass-through scheme, on the other hand, the perpetrator actually provides real goods and services. Pass-through schemes are usually undertaken by employees in charge of purchasing on behalf of the victim company. Instead of buying merchandise directly from a vendor, the employee sets up a shell company and purchases the merchandise through that fictitious entity. He then resells the merchandise to his employer from the shell company at an inflated price, thereby making an unauthorized profit on the transaction.
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(Learning objective 4-9) What is a pay-and-return scheme? List three examples of how this type of fraud can be committed. Answer: In a pay-and-return scheme, an employee intentionally mishandles payments to a vendor and then steals the excess payment when it is returned by the vendor. Generally, the perpetrator either double-pays an invoice, intentionally makes a vendor payment for an excess amount, or sends a payment to the wrong vendor. In all cases, the perpetrator then contacts the non-accomplice vendor, explains that a "mistake" was made, and asks the vendor to return the excess payment to her attention. When the overpayment is returned, the fraudster steals it.
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(Learning objective 4-10) How does an employee use a non-accomplice vendor's invoice to generate a fraudulent payment? Answer: Typically, the fraudster either prepares a fake vendor invoice and submits it to his company for payment or reruns an invoice that already has been paid. After his company prepares a check for payment, the perpetrator intercepts the check before it is sent out or has an accomplice do the same after the check arrives at the vendor's place of business. Alternatively, he could alter the vendor's address or electronic payment information in the payables and online banking system so that the check is delivered to the fraudster or an accomplice. In addition to the preceding examples, an employee can generate fraudulent payments using a non-accomplice vendor invoice by committing a pay-and-return scheme, as was discussed in the preceding question.
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(Learning objective 4-12) How does an employee make personal purchases on company credit cards, purchasing cards, or running charge accounts? Answer: Instead of running false invoices through accounts payable, some employees make personal purchases on company credit cards, purchasing cards, or running charge accounts with vendors. An employee with a company credit card or purchasing card can buy an item merely by signing his name (or forging someone else's) at the time of purchase. Some companies keep open charge accounts with vendors with whom they do regular business. Office supply companies are a good example of this kind of vendor. Purchases on charge accounts may require a signature or other form of authorization from designated a company representative. Obviously, that representative is in a position to buy personal items on the company account. Other employees might do the same by forging the signature of an authorized person at the time of a fraudulent purchase. In some informal settings, purchases can be verified by as little as a phone call.
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Discussion Issues 4-1 (Learning objectives 4-3 and 4-4) In the case study of Cheryl Brown, the administrative assistant at a Southeastern medical school, what type of billing scheme did she commit? Answer: Cheryl committed a shell company scheme. She and an outside accomplice created a shell company and bilked her employer out of thousands of dollars through the use of fake invoices.
(Learning objectives 4-8, 4-11, and 4-13) Explain how separation of duties contributes to the prevention and detection of billing schemes. Answer: By enforcing a rigid separation of duties in the purchasing process, an organization can significantly limit its exposure to billing schemes. Segregating the purchasing process into four basic functions--purchasing, approval of purchase, receipt of goods, and cash disbursement-- can prevent most forms of billing fraud. This is because most billing schemes succeed only when an individual has control over two or more of these functions. If these duties are strictly segregated, it will be very difficult for an employee to commit most forms of billing fraud.
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(Learning objectives 4-8 and 4-14) List and explain at least four proactive audit tests that could be performed to help detect a shell company scheme. Answer: Examples of tests that can be used to detect a shell company scheme include the following. Vendors lacking certain identifying information such as a telephone number or tax ID can be extracted from the vendor master file for investigation. Similarly, the vendor master file can be matched to the employee master file for duplicate telephone numbers, addresses, and so on. The invoice payment file can be searched for vendors who had multiple invoices just below established review limits--a possible sign of an attempt to circumvent management review of bogus invoices. The vendor master file can also be matched to the invoice payment file to identify payments to any unapproved vendors. There are several other tests identified in this chapter that could also be used.
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(Learning objectives 4-4, 4-5, and 4-8) What are some of the ways shell company invoices can be identified? Answer: Auditors, accounting personnel, and other employees should be trained to identify red flags relating to fraudulent invoices. One common red flag is a lack of details such as a telephone, fax, tax identification, or invoice number. Another common red flag is an invoice that lacks detailed descriptions of items ordered. Lastly, using a mail drop or residential address may also indicate a billing fraud scheme. All of these red flags should be investigated.
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(Learning objectives 4-4 and 4-7) Sharon Forsyth worked in the purchasing department of a retail store. She was in charge of ordering merchandise inventory and various supplies for the organization. She purchased merchandise through a fictitious shell company and then resold it to her employer at an inflated price. What is the name of this type of fraud? Answer: This type of fraud is called a pass-through billing scheme and is a subcategory of shell company schemes in which actual goods or services are sold to the victim company.
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(Learning objective 4-9) Karen Martinis was responsible for opening mail, processing vendor claims, and authorizing payments. She was involved in a scheme in which she either double-paid vendor invoices, paid the wrong vendors, or overpaid the right vendors. What type of billing scheme is being described in this case? Answer: This is a pay-and-return billing scheme involving non-accomplices. In a pay-and-return billing scheme the perpetrator does not prepare fake invoices and submit them to the victim company. Instead, she intentionally mishandles vendor payments that are owed to a legitimate vendor. The perpetrator then requests that the vendor send a check for the amount owed back to the victim company.
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(Learning objective 4-9) What type of internal controls can be used to help prevent pay-andreturn billing schemes? Answer: As with most billing frauds, pay-and-return schemes can be mostly prevented if the duties of the purchasing, authorizing, and payment functions are separated and if invoices are matched to purchase orders before payments are made. Also, incoming mail should never be delivered directly to an employee, but rather opened at a centralized point with all incoming checks being properly recorded. Organizations should also instruct their banks not to cash checks made payable to the company. In some cases, employees attempt to conceal the theft of returned checks by running targeted invoices through the payables system a second time so that the intended recipient of a stolen check still gets paid. An effective duplicate checking system can help prevent this type of scheme and make it easier to detect a pay-and-return fraud.
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(Learning objective 4-12) In terms of classifying frauds under the Fraud Tree system, how does a scheme in which an employee fraudulently orders merchandise for his personal use differ from a scheme in which an employee steals merchandise from his company's warehouse? Answer: Even though both schemes involve an employee taking merchandise, the first scheme is classified as a billing scheme, whereas the second is classified as a theft of inventory (as will be discussed in Chapter 9). This is because when a person steals inventory from a warehouse, he is stealing an asset that the victim organization needs, that it has on hand for a particular reason. The harm to the victim company is not only the cost of the stolen asset, which will have to be replaced, but also the loss of the asset itself. In contrast, when an employee fraudulently buys merchandise with company funds, the asset he acquires is superfluous. The perpetrator causes the victim company to order and pay for an item which it does not really need, so the only damage to the victim organization is the money lost in purchasing the particular item. The victim organization suffers no harm in the loss of the
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asset that was purchased, because the victim had never designated a need for that asset in the first place.