[IMGCAP(1)]Yigal M. Rechtman of Grassi & Co. recently concluded a fraud investigation involving a cash-skimming scheme. Here he shares his findings to help give tax professionals performing audits new perspective.

The Scheme Investigated:
A clerk collected cash from customers and provided a sequentially numbered receipt. At the end of the day, the receipts were supposed to be entered into the accounts receivable system and reconciled with the deposit slip. Instead, the clerk pocketed the cash, and used one of several methods to conceal her acts:

1. She would record an unauthorized credit memo to the customer account

2. She would take payments from other customers, and credit the account from which she stole. This is a kiting scheme where the clerk “robbed Peter to pay Paul.”

After roughly three years, the clerk was able to pocket an amount greater than $270,000 (that’s $90,000 a year!) and was caught when a customer complained about their account status, which was shorted due to the scheme.

How did the audit fail?

Although we don’t know what the auditors (not our firm) did in terms of their audit procedures, from what we can gather, here are a few points we think they missed:

• The auditors apparently failed to see that this is a high-risk area. Most of the receipts were in cash—this presents a high risk for fraud and theft of cash. It appears they did very little by way of sampling the paper receipts and tracing them to the accounts receivable system. Had they done it, they had a good chance of finding discrepancies and raising questions.

• The auditors appear to have not identified a lack of segregation of duties; the clerk was the one collecting the cash, entering the cash in the accounts receivable system, reconciling the cash collected, depositing the cash, and responding to customer complaints and questions regarding their accounts. At no time did the auditor inform management this is a lack of segregation of duties that should be addressed, nor did he/she recommend changes.

• The cash shortfall could have been identified if the auditors had simply looked at the top-level analysis of the credit-memo balances. They would have noticed the allowance for uncollectable accounts (or its equivalent) would have been "off" because of all the credit memos. The amount would be material, and that should have prompted more questions, an expanded scope in terms of the nature, timing and extent of the audit procedures for revenues.

• The auditors also did not confirm balances, review the reconciliations, or look at why it takes sometimes up to three weeks for daily reconciliations to be prepared. The delay in the daily reconciliations (between the system and the bank deposit) should have been noticed, and at least mentioned to management and the board. That didn’t happen.

What I see here is a lack of critical thinking by the auditors. Although we are not entirely sure what they did, it appears they did not think in a skeptical manner about the risks to revenues, especially when cash collection was a significant portion of the receipts. They also appear to have created a good analysis of the risks of fraud and may have done “check-list mentality” on their audit programs.

Bottom Line:
• Think about what you see and hear.

• If you think there is a chance that the audit plan is not responsive to what’s needed, say something.

• If you think something is fishy, follow that trail.

• And most importantly, be skeptical of what you're told and verify the facts.

I hope this scenario helps all us auditors and accountants do a better job!

Yigal M. Rechtman, CPA, CFE, CITP, CISM, is a principal in Grassi & Co.’s Forensic and Litigation Practice specializing in fraud investigation and forensic accounting, information technology, data mining, computer aided auditing, statistical analysis, and internal controls. He manages engagements of forensic accounting, electronic discovery and analysis, search for assets and income sources, operational analysis and financial audits.

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