Identifying Fraudulent Transactions
By Rehana Moosa
When businesses prepare a fidelity / crime insurance claim, much analysis is required to ensure that the claim only includes losses caused by employee theft, as opposed to errors. Depending on the scheme and the way it was carried out, distinguishing between fraud and errors can be challenging.
There are various ways to identify potentially fraudulent transactions:
Comparison to Normal Transactions
Many fraud schemes follow a specific pattern, in terms of how the funds were misappropriated and / or how the scheme was concealed. Once the pattern is identified, any suspicious transactions can be compared to the pattern to differentiate between potentially fraudulent transactions and errors.
Patterns can be identified by performing a walkthrough accounting processes and procedures that are typically followed for “normal” or non-fraudulent transactions. The purpose of the walkthrough is to understand the types of documents that are created during the transaction, the internal controls that are in place, and the evidence of those controls.
For example, a business suspects that an employee in the accounting department is issuing unauthorized cheques payable to cash and depositing them into their personal bank account. A walkthrough of the cash disbursement function reveals the following procedures are normally followed:
- All cheques are kept in a secure cabinet in the accounting department. All accounting personnel have a key to the cabinet, and no record or log is maintained tracking who has accessed the cabinet.
- Accounting personnel must complete a Cheque Disbursement Form when preparing a cheque. The form must list the payee, the reason for the payment, the amount, and how the payment is being recorded in the accounting records.
- The Cheque Disbursement Form and a copy of the cheque are provided to the controller for review.
- All cheques require two signatures, one from the controller and one from the Chief Financial Officer.
- Once the cheque has been signed, accounting personnel are responsible for mailing the cheque and filing the Cheque Disbursement Form.
- It is against company policy to issue cheques payable to cash.
The business has identified several suspicious cheques, which were made payable to cash. In reviewing the business’ procedures, no other cheques were made payable to cash in the past. Also, the suspicious cheques only have the controller’s signature. Since cheques issued to cash and having only one signature is not standard practice, the pattern of the potentially fraudulent cheques has been identified. All suspicious cheques can be compared to this pattern and investigated further.
If, during the walkthrough, multiple cheques were found that were payable to cash, this would mean that the suspicious cheques may not necessarily represent misappropriated funds. This is because there is evidence that company policy is not normally followed and non-fraudulent cheques have been made payable to cash in the past.
Fraudulent transactions will often be concealed by falsifying or destroying documents, or altering the accounting records. Potentially fraudulent transactions can be identified by identifying whether they have been disguised in some way, or where documentation to support the transaction is missing or incomplete.
For example, a company suspects a warehouse employee of stealing inventory. The company notices that when specific products are received into the system, a journal entry is immediately recorded to write-off the inventory and remove it from the system. The purpose of the journal entry may have been to remove the items so that the inventory physically on hand reconciles to the inventory in the accounting records. In other words, the journal entry hides the missing inventory.
In this case, the accounting records can be reviewed in detail to identify other inventory write-offs that appear suspicious, and whether the write-offs are supported by other documentation or were authorized by someone other than the warehouse employee.
Conducting interviews with employees, vendors, and customers may provide additional information that can assist with differentiating between potentially fraudulent transactions and errors.
For example, they may be aware of:
- How the fraud scheme was carried out
- How the fraud was concealed
- Individuals the suspected employee may have colluded with to carry out the misappropriation
- Any suspicious behaviour
These individuals may also be able to provide information about the employee’s skill level in carrying out their roles and responsibilities, which can assist in determining whether errors were commonplace. Reviewing the employee’s personnel file can also assist in understanding their level of competence and work performance.
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Communications are intended for informational purposes only and do not constitute legal advice or an opinion on any issue. For permission to republish this content, please contact Rehana Moosa Forensic Accounting Professional Corporation.
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