David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting and marital dissolution services in Philadelphia and the Delaware Valley.

Among the less-frequent but more-expensive frauds are those targeting Accounts Receivable.  In this column, I’ll discuss some of the Accounts Receivable-related frauds I have encountered.

Fraudsters can manipulate Accounts Receivable to conceal their diversion of payments made by customers.  A common element of these diversions is that the fraudster has set up separate bank accounts under his/her control, and that the bank account names are similar to that of the business being defrauded.

For example, if the business being defrauded is ABC Services Company, the fraudster may set up a business entitled “ABC Company”.  The fraudster can then deposit checks made payable to ABC Services Company by its customers.  Additionally, the fraudster can provide new wire instructions to ABC Services Company customers with the ABC Company name.

Because the names are so similar, most customers won’t notice the small difference in company name.  Additionally, banks allow leeway in processing checks made out to a similar name and may not notice the difference either. (For example, some customers may just make their checks out to “ABC.”)

If the perpetration of the fraud is based on diverting customer checks, the fraudster either needs to provide customers with a new mailing address (such as a P. O. Box under the fraudster’s control) or have the ability to open mail and remove the customer’s checks before entry into the company’s accounting system.  If the perpetration of the fraud is based on diverting customer wires, the fraudster needs the ability to “hide” receipt of the wires into the alternate bank account.

So, how can the fraudster manipulate the fact that payments have not been received by the company?  Here are a few of the ways:

• If the fraudster has control of credit, collections, and bad-debt write-offs, the fraudster can just allow the unpaid customer invoices to sit on the system and get older and older. Eventually, the fraudster writes off the unpaid invoices to bad debts.
• Depending on the type of accounting system in place, the fraudster can cancel the customer invoice. Of course, if the accounting system is tracking inventory, the cancellation would cause the system to show a higher amount of inventory than exists.  However, if the accounting system does not track inventory or if the company is providing services instead of products, this won’t be a problem for the fraudster.
• If the fraudster has the ability to post credits against a customer’s account, the fraudster can post a credit (for such things as sales discounts, sales adjustments, sales returns and allowances, etc.) against the invoice paid by the diverted check or wire to eliminate the invoice balance.

Because the above schemes are more complex than other fraud schemes (such as theft of cash or inventory), it is usually a higher-level accounting person (such as a Chief Financial Officer, Controller or Accounting Manager) who perpetrates this type of fraud.

So, how can a company defend itself against Accounts Receivable fraud.  Here are a few recommendations:

• Management should require and review a regular monthly report of open invoices by age. Once an invoice reaches a certain age (for example 45 days past the billing date), a more senior employee outside the accounting department should be asking the customer why the invoice is unpaid and when it will be paid.
• Management signoff should be required (and documented) for any credits posted to customer accounts, whether for sales discounts, sales adjustments, sales returns and allowances, etc.
• Management should implement an invoice numbering system that allows for tracking of invoice numbers. It should require and review a regular monthly report of invoice numbers to include customer name and billing date.  An explanation should be required for any gaps in invoice numbers.
• Management (or a more senior employee outside of the accounting department) should periodically verify with each customer’s accounts payable department the check mailing addresses and wire instructions to make sure they have not been changed.

In cases where management lacks the time to perform the above tasks, or the company is too small to separate duties sufficiently, corporate leaders should consider engaging a reliable and impartial outside forensic accounting expert to perform these services.

If you would like to speak with such a forensic accounting expert in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner, and a Certified Valuation Analyst.