Employee Theft Schemes

What you don’t know about employee theft and fraud can hurt you. Small businesses (those with 100 employees or less) have the highest percentage of incidences of fraud and the highest average loss. To help small business owners understand how fraud schemes occur and how to prevent them, we will publish a series of case studies related to different fraud schemes.

First, we begin by defining the most prevalent schemes:

Check Fraud: There are several types of check frauds. Basically, a check fraud is any fraud involving the use of checks to steal money from others. These frauds include writing checks on insufficient funds or on accounts that are known to be closed, check kiting, and check tampering. Check kiting occurs when an individual uses the time it takes the bank to clear a check in order to falsely inflate the bank account balance, a scheme that is becoming  almost impossible with today’s processing technology. Check tampering includes forgery or making unauthorized revisions to a check, including the payee, amount and/or endorsement. Tampering is becoming ever more prevalent due to technological advances which make it easy for fraudsters to create fake checks, “wash” checks (the use of chemicals to remove the check’s information so it can be replaced with one’s own), and record checks to false payees in small business accounting systems.

Skimming: Skimming can occur at any point at which cash is received by the business. When skimming, an individual pocket payments and finds a way to avoid recording a sale, a customer’s payment on an account, or a refund for a prior overpayment. When an employee skims revenue, meaning (s)he stole payments for a sale and never recorded the sales transaction, the fraud is considered to be “off-the-books” because no direct evidence may be available in the financial records. Skimming of accounts receivable and refund payments is “on-the-books” because someone has to “fix” the related accounts receivable and expense accounts.

Vendor Billing: These schemes involve the accounts payable function within a business in which the fraudster causes the business to pay for goods that are non-existent, overpriced or obsolescent in order to generate cash or obtain personal items. The major categories in this area include shell companies, kick-backs, and personal purchases using company funds.

Expense Reimbursement: Travel and entertainment expenses are padded for the benefit of the traveler. Many companies don’t have the will or the resources to identify this fraud because the size of the incident is low and the crime is easy to commit and can be costly to detect. Left unchecked this abuse can become company culture and the expense account becomes an employee benefit. The expenses can be mischaracterized, overstated, fictitious, or duplicated.

Corruption: We often equate corruption with bribery, but it is more comprehensive. It is any act that is in violation of that person’s official duty or the rights of others, regardless if an advantage was offered to induce the act.

Cash Larceny: Cash larceny occurs when an individual steals cash already received by the business. It’s not as costly as skimming to detect or prevent, but it is certainly a concern, especially in some types of businesses. The most common form of cash larceny occurs when employees take money out of deposits.  

Payroll: This is a very common category of fraudulent disbursement. Simply, the fraudster abuses the company’s payroll system to over-compensate himself or another person. The most common forms are falsified hours and salary, ghost employees, and commission schemes.

Non-Cash: This category occurs when the fraudster takes non-cash company assets such as inventory, supplies or equipment. The items are stolen for personal use or for resale. The common types are unconcealed larceny, falsified receiving reports, fraudulent shipments and fraudulent write-offs.

Financial Statement Fraud: Financial statement fraud is the deliberate misstatements or omissions of amounts or disclosures of financial statements to deceive financial statement users. While not as common as other types of frauds, financial statement fraud losses can be huge and they usually affect more people. Common examples include Health South, MCI, WorldCom, and Enron. Financial statement fraud doesn’t just happen in big, public companies. A private company may have incentive if trying to obtain a loan from a bank or support from an investor. Similarly, a small business owner may be at risk if (s)he depends on someone else to manage operations and prepare financial reports and those same financials are used to calculate year-end bonuses.

Register Disbursement: There are two forms, refunds and voids. Employees process these fictitious transactions to conceal theft of funds from the cash register. This appears on the books as a legitimate disbursement. Many of the schemes require more than one persons working in tandem.