Pam Hardy, an internal auditor with five years’ experience at a large national company, was auditing a remote distribution center when her routine sales and accounts receivable tests revealed minor discrepancies. Because the distribution center was small, it hadn’t been visited by internal audit for more than four years. Hardy initially thought that the two-hour drive to the distribution center wasn’t worth the time. But when other red flags appeared in addition to the minor discrepancies, Hardy knew she had to look into things further.
Comparing time clock work hours to the temporary payroll agency monthly billings, Hardy found a small difference in actual hours worked and hours billed for one employee. In reviewing personnel files, she also noted that two employees hired for seasonal work didn’t have Social Security numbers on file. Hardy learned from the temp agency that it had been trying to obtain the Social Security numbers for these employees, but was told to pay the employees until it could obtain and verify them. Further, Hardy noticed that the emergency contact information for one of the two employees was the same for the remote distribution center manager, Bob Lamp. She later discovered from Sally Wynn, the plant office manager, that the employee was Lamp’s son.
Growing uneasy about the circumstances, Hardy decided to review the center’s financials. Everything looked fine except that accounts receivable had significantly increased from the prior year. She contacted the corporate office that performed the bank reconciliations to inquire whether there were any issues and was assured that there were none. Hardy was relieved; nevertheless, she was still concerned about Lamp.
Hardy decided to drive to the distribution center the next day to meet with Lamp, but their conversation was constantly being interrupted. Consequently, she suggested that they go to lunch together, but Lamp was unable to attend because of urgent business. He asked Wynn to take Hardy to lunch instead. During lunch, Wynn stated out of the blue that her bank deposits had been consistently late because she was too busy and had to take the deposits to the night drop on her way home. Hardy hadn’t asked about the deposits and wondered why Wynn would volunteer that information.
Wynn then explained how difficult it was being a single mother to three children. They would only wear designer clothes, costing more than US$5,000, and they’d recently taken a weekend family trip to Disney World. Hardy also noticed that Wynn drove a luxury automobile. Her spending was far above an office manager’s salary. Wynn also complained she was so overworked that she never took vacations, only an occasional day off.
As Wynn described her duties, Hardy realized she had total control over cash collections, contrary to company policies. Hardy learned that Wynn was receiving and recording the daily route cash proceeds, preparing daily deposits, taking them to the bank, and entering sales invoices into the accounting system. She was also posting accounts receivable for mailed checks.
Hardy decided to review the cash book. She printed the daily sales reports and copied the cash book for the three months prior. While Hardy was doing this, Wynn suddenly became ill and left for the day, raising yet another red flag. Hardy requested and reviewed the bank reconciliations for the two previous months. She quickly realized they were a recap of the bank statement monthly summary: beginning balance plus deposits, minus disbursements equaling the ending balance. Notably, there was a difference in bank and book cash that hadn’t been investigated. There also were no deposits in transit, whereas most locations had at least one. Furthermore, there was no comparison between cash sales and monthly changes in accounts receivable.
Puzzled, Hardy called the accounting clerk who had been doing the reconciliations, who revealed there had been so many problems reconciling the location’s cash that she had given up and wasn’t reconciling the account. Hardy looked at the difference between the bank balance and general ledger cash and immediately knew there was a problem. There was a difference of almost US$210,000. Analyzing the cash book compared to daily route sales and accounts receivable postings, Hardy suspected Wynn was stealing most of the cash and only depositing checks.
The first instance of missing cash occurred about a year before. Hardy surmised Wynn had been lapping accounts receivable payments to cover the theft, misapplying customers’ payments to avoid detection. When checks came in the mail, she used them to conceal the cash embezzled from daily route sales, balancing the deposit to daily cash sales. If a customer complained, Wynn always answered the phone, allowing her to shield complaints from Lamp. She also tried to apply payments before subsequent billing dates, hoping customers wouldn’t notice the late payment postings.
Hardy confronted Wynn, who quickly confessed, stating she’d experienced financial problems and thought she would borrow the cash, intending to eventually make restitution. However, the longer the scheme went on, the more she believed it would never be detected.
In the aftermath, Wynn pleaded guilty and went to prison for two-and-a-half years. Because Hardy had so thoroughly documented the embezzlement, the insurance company fully paid the dishonesty claim. Corporate corrected the bank reconciliation protocols, and developed electronic exception reports that would immediately identify locations with large cash discrepancies and changes in accounts receivable as a percentage of sales. Further, all personnel were required to take a full week of vacation, at a minimum.
- Small or remote locations can be especially vulnerable to embezzlement. Controls consciousness on the part of management can wane in such cases, especially when controls are not audited regularly.
- Don’t be afraid to change your fraud hypothesis. Hardy originally thought Lamp might be a fraudster, which led her down the path to Wynn. Lamp’s only offense was lack of appropriate controls at his distribution center.
- Wait to confront someone until after the facts have been reviewed. Start by analyzing the underlying documentation. Make a plan regarding which documents need reviewing, who you’ll interview, and who needs to be informed about the proceedings. If there is predication of fraud, determine who the most likely suspect is.
- Be flexible and use common sense. Some auditors check the boxes, but fail to look at the big picture. The embezzlement could have been caught sooner if someone had analyzed the change in accounts receivable as a percentage of sales and the large discrepancies between book and bank cash.
- Controls that aren’t operating effectively are useless. The accounting clerk hadn’t reconciled the location’s bank account. Further, the supervisor had signed off without reviewing the reconciliations. Failing to appropriately apply controls can contribute to concealing