Revenue coming into a business is an obvious temptation for a dishonest person. Picture the stacks of bills in the till of a cash register. “It’s right there,” the nefarious individual thinks. “All I have to do is take it.”
For this reason, accounts receivable fraud is among the most common crimes committed internally against business owners — and contractors are hardly immune. While you’re in a preconstruction meeting or out at a jobsite, a disgruntled or desperate staff member could be plotting to take what you’ve earned.
Put simply, accounts receivable fraud happens when dishonest employees divert customer payments for their personal use. They can accomplish this in various ways, including:
- Lapping. This is a frequent form of receivables fraud. It involves the application of receipts from one account to cover misappropriations from another. For example, rather than credit Customer A’s account for its payment, a dishonest employee pockets the funds and later posts a payment from Customer B to A’s account, Customer C’s payment to B’s account and so on.
- Write-offs and discounts. Instead of crediting a payment to the customer’s account, fraudsters might pocket the funds and then record a bad debt write-off or discount to reduce the customer’s account. This allows the customer’s account to reflect the expected current balance despite the diversion of incoming payments.
Additionally, employees may report sales to phony accounts to artificially inflate the company’s financial results — or when their compensation is based on sales (rather than collections). Sales to phony customers generate bogus receivables that will never be collected.
Construction companies can implement different preventive measures to head off accounts receivable fraud, depending on their areas of vulnerability. For example, segregation of duties can eliminate the opportunity for one employee to steal. Assuming your staff is large enough, the employee who handles incoming payments from customers should be separate from the person who handles invoicing.
Larger construction businesses even set up customer service departments to handle complaints. Why? Customer grievances regarding billing can represent a red flag that receivables fraud has occurred — and fraudsters who receive the complaints will likely stifle them.
In addition, your construction company should require mandatory vacation time for employees who handle receivables. These schemes typically require perpetrators to remain vigilant to avoid detection, so time away from the office may offer the necessary distraction to prevent them from committing fraud or to enable you to detect it.
Methods of detection
Receivables fraud schemes are difficult — but not impossible — to detect. The transparent and regular use of detection tools can also deter those contemplating fraud.
If you discover anomalies in your receivables ledger or notice a receivables clerk is acting suspiciously, your CPA may be able to help, or he or she might refer you to a forensic accountant. In either case, the investigation will likely begin by tracing a sample of cash receipts to the sales ledger and deposit slips. The purpose of this exercise is to find discrepancies in dates, payee names and amounts. An investigation may also compare deposit slips against the books and send requests for confirmations to a sample of customers to verify current balances and payment histories.
Another hot spot is any account with bad debt write-offs. Your CPA or a forensic accountant will likely review the account, including the reasons provided for specific write-offs. He or she also will be on the lookout for accounts with unexplained credits, increased customer credit limits and journal entries adjusting the accounts receivable ledger.
Most important, any viable investigation should involve confidential interviews with company personnel. These discussions will seek out potential weaknesses in your internal controls, signs of collusion and other information. After all, tips are a common method of fraud detection.
With the tragic outbreak of the coronavirus (COVID-19), incidences of fraud may increase. Although you likely employ honest people, fear and uncertainty can affect anyone’s judgment. Now is the time to be extra vigilant of accounts receivable fraud and many other forms of financial malfeasance.
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