DETECTING AND DETERRING ASSET MISAPPROPRIATION

What is Misappropriation of Assets?

Asset misappropriation fraud involves third parties or employees in an organization who abuse their position to steal from it through fraudulent activity. It can also be known as insider fraud.

Misappropriation can occur at any stage of routine business operations; before assets are recorded, while assets are being retained and as assets are being purchased. Asset misappropriation schemes fall under the misappropriation of Cash or Inventory and All Other Assets.

ASSET MISAPPROPRIATION- CASH

Theft of Cash on Hand

Theft of cash on hand is any scheme in which the perpetrator misappropriates cash kept on hand at the victim organization’s premises (e.g., employee steals cash from a company vault).

Theft of Cash Receipts

Theft of cash receipts is any scheme in which the perpetrator misappropriates cash receipts. This can be separated into two types: Skimming and Cash Larceny.

SKIMMING

This involves any scheme in which cash is stolen from an organization before it is recorded on the organization’s books and records. This is an “off-book scheme” because the receipt of the cash is never reported to the entity.

The most common skimming schemes include:

1. Sales schemes

• • Unrecorded sales
  • Understated sales

2. Accounts receivable schemes

• • Write-off schemes
  • Lapping schemes
  • Unconcealed receivables

3. Refund and other schemes

CASH LARCENY:

This involves any scheme in which cash is stolen from an organization after it has been recorded on the organization’s books and records. In other words, cash larceny schemes are on-book frauds.

FRAUDULENT DISBURSEMENTS

Fraudulent disbursements are the most common form of asset misappropriation, and they occur when an employee uses his position of employment to cause a payment for some inappropriate purpose.

Fraudulent disbursements are on-book fraud schemes, meaning that cash (checks) leaves the entity fraudulently, but it is recorded on the books and thus an audit trail exists.

Fraudulent disbursement schemes are broken down into the following types:

• • Billing schemes
  • Payroll schemes
  • Expense reimbursement schemes
  • Check tampering schemes
  • Register disbursements schemes

1. 1. Billing Schemes

      The most common and costly example of a fraudulent disbursement is the billing scheme. A billing scheme is a fraud in which an employee causes the victim organization to issue fraudulent payments by submitting invoices for fictitious goods or services, inflated invoices, or invoices for personal purchases. Billing schemes are usually classified into three categories, shell company schemes, non-accomplice vendor schemes, and personal purchase schemes.

1. 2. Payroll Schemes
      

      Payroll schemes are one of the most common types of workplace frauds. This can be broken down into the following types:

• • • Ghost Employee
    • Falsified wages
    • Commissions schemes
    • Timesheet Falsification
    • Buddy Punching
    • Advance Fee schemes
    • Paycheck Diversion

1. 3. Expense reimbursement Schemes
      

      Travel and expense budgets are a common target for occupational fraud. This type of scheme is most commonly perpetrated by sales personnel who overstate or create fictitious expenses in areas such as client entertainment and business travel.Expense reimbursement schemes fall into four general categories:

• • • Mischaracterized expenses
    • Overstated Expenses
    • Fictitious Expenses
    • Multiple Reimbursements

1. 4. Check Tampering
      

      This occurs when an employee alters the checks so that they can be deposited into a bank account under their control. This could involve forgery, altering payee information, or issuing inappropriate manual checks.This can be broken down into four major categories:

• • • Forged Maker
    • Forged Endorsement
    • Altered Payee
    • Authorized Maker

1. 1. 1. Forged Maker
         

         In a forged maker scheme, an employee misappropriates a check and fraudulently applies the signature of an authorized maker (person who signs the check). In order to forge a check, an employee must have access to a blank check and be able to produce a convincing forgery of an authorized signature. Blank checks and signature stamps should only be accessible to authorized personnel.

      2. Forged Endorsement
         

         This occurs when an employee intercepts a company check intended for a third party and converts the check by signing the third party’s name on the endorsement line of the check. For example, someone may write a cheque with a forged signature. Forging endorsements can be used to prevent the person or legal entity that the payment is made out to from being able to receive its value (such as cashing a cheque).

      3. Altered Payee
         

         This occurs when an employee changes the payee on the check so that he/she can deposit the check into his own account.

      4. Authorized Maker
         

         This occurs when an employee with signature authority on a company account writes fraudulent checks for his own benefit.

1. 5. Register Disbursements
      

      When cash is stolen as part of a register disbursement scheme, the removal of the cash is recorded on the register tape. A false transaction is entered so it appears that the disbursement of money was legitimate.Register disbursements schemes fall under these two categories:

• • • False Voids
    • False Refunds

1. 1. 1. False Voids
         

         A refund is processed at the register when a customer returns an item of merchandise that was purchased from the store. The transaction that is entered on the register indicates the merchandise is being replaced in the store’s inventory and the purchase price is being returned to the customer. In other words, a refund shows cash being disbursed from the register to the customer.

      2. False Refunds
         

         In a false refund scheme, an employee processes a transaction as if a customer were returning merchandise, even though there is no actual return.

ASSET MISAPPROPRIATION- INVENTORY AND ALL OTHER ASSETS

Asset Misappropriation also involves the misuse of non-cash assets, such as inventory and all other assets. This might include taking office supplies home for personal use or stealing expensive company equipment.

This can be broken down into the following categories:

• Misuse
• Larceny

Misuse

This occurs when an employee uses company inventory for personal use.

For example, this may involve an employee taking office supplies home for personal use. Even if the assets are not stolen, they are exposed to additional wear and tear that decreases their value.

Larceny

This occurs when an employee takes inventory from the company premises without attempting to conceal the theft in the accounting records.

This can be broken down into the following sub-categories:

• • Asset Requisitions and Transfers
  • False Sales and Shipping
  • Purchasing and Receiving
  • Unconcealed Larceny

1. 1. Asset Requisitions and Transfers
      

      This occurs when an employee steals the inventory during the process by which an employee requisitions inventory to be moved internally from one location to another.

   2. False Sales and Shipping
      

      False sales schemes occur when an accomplice of an employee “buys” merchandise, but the employee does not ring up the sale and the accomplice takes the merchandise without making any payment.False shipment schemes, which occur when an employee creates false sales documents and false shipping documents to make it appear that missing inventory was not actually stolen, but rather sold.

   3. Purchasing and Receiving
      

      Purchasing schemes occur when an employee with purchasing authority uses that authority to purchase and misappropriate merchandise.Receiving schemes occur when an employee misappropriates assets purchased by the company as they are received at the company.

   4. Unconcealed Larceny
      

      This occurs when an employee takes inventory from the company premises without attempting to conceal the theft in the accounting records.

How to Prevent and Detect Asset Misappropriation

The risk of asset appropriation fraud can be mitigated in a number of ways. Two effective methods are a fraud risk assessment and/or the implementation of adequate internal controls. A fraud risk assessment can clearly identify areas of the organization that are most susceptible to fraud. As a result of this, an organization can implement or strengthen their internal controls more confidently.

Organizations who lack segregation of duties, physical safeguarding, asset reconcilement, management review and personnel competency are the most susceptible to fraud. At the very least, if your organization has segregation of duties in place, there will be collusion required between employees to execute fraud. Companies should review their internal controls to determine whether their controls are adequate to mitigate the risk of asset misappropriation before becoming a victim of asset appropriation fraud.

Alia Noor (FCMA, CIMA, MBA, GCC VAT Comp Dip, Oxford fintech programme, COSO Framework)

Associate Partner
Ahmad Alagbari Chartered Accountants