Grant Gabriel was hired by a small regional gift store chain to start an internal audit function for the growing company. His first task was to perform a risk assessment. As part of the assessment, Gabriel looked at store-by-store comparative financials. In doing so, he noticed that monthly sales and margins for each store seemed consistent, except in one case. The Springfield store had lower margins and sales growth during the holiday season for the previous three years. Gabriel decided to visit the Springfield store and meet with the manager, Mark Adams.
Adams had been the Springfield store manager for seven years. He was a valued employee who led by example with his work ethic and dependability. Often operating without an assistant manager, Adams was known for handling the store on his own.
Upon arrival, Gabriel asked Adams about the lower seasonal margins and revenues. Adams indicated that it was tough to find good help during the holiday season and new, seasonal people make mistakes. He also noted that margins might be a little lower during the holidays because Springfield has many frugal shoppers and the redemption rate of seasonal coupons is high. Adams boasted, "Our redemption rate has been the highest in the company for the last four years."
Adams then explained, "We have a group of five retired women who work the holiday season for us each year. They are great because they are trained, dependable, can handle the customers, and do not need supervision every second." The women had become friends over the years and referred to this job as their "holiday bonus." So, each year before the holidays, Adams would call and ask them if they wanted their holiday bonus. He also said he paid them 75 cents more an hour than other seasonal employees because they were so good.
Adams went on to explain that since the women started working for him, their shrinkage in gum and candy always dropped during the holidays. Oddly enough, they even had a small overage this year. He attributed it to the seasonal employees deterring kids from stealing gum and candy. "The ladies are shrewd and probably do a good job of keeping watch."
Gabriel asked Adams if he noticed any unusual transactions in the point-of-sale (POS) system. Adams indicated that he was too busy to dig deep into the reports, but didn't notice any major trends in his monthly scan. He mostly checked for a high number of "no rings" — when the cash register is opened but a transaction is not entered — to see if cash was being pocketed instead of deposited in the cash register. He did notice more no rings during the holiday season, but that was likely due to higher volume and the inexperienced seasonal employees.
After his interview with Adams, Gabriel performed his own detailed analysis. He looked at three years of data and found two irregularities worthy of follow-up:
- No rings occurred, but were consistently two to three times per day with the seasonal help and less than one per day with full-time employees.
- Store coupon redemption was 5 percent higher, but 20 percent higher on cash transactions and normal for credit card transactions, when compared to other stores.
- Using detailed analysis within the risk assessment process can help quickly direct internal audit toward fraud risk areas.
- Data analytics cannot solve all problems by itself. Analytics and fieldwork are a powerful combination. Consistent irregularities can always be explained. Whether the answer is fraud or something else, internal audit should never be satisfied without an explanation.
- Never underestimate the value of objectivity. Many frauds go undetected because management would never believe a certain person would steal. Being open to the possibility and following the data to its conclusion is the job of internal audit.
- Detecting fraud early prevents significant future losses as they often continue over time and grow in scale. In addition, it is often difficult to identify the extent of the fraud. Assuming what has been identified is the minimum amount of the fraud keeps the value of fraud detection in perspective.
- It is always useful to an organization to detect frauds of any size as it allows management to adapt the internal control environment based on the discovered weaknesses.
Gabriel returned to the store to observe and ask questions of the employees. Unfortunately, the holiday season was over and the seasonal employees left, so Gabriel didn't expect to uncover much during his observations and discussions with full-time employees. Luckily, one of the seasonal employees, Michele Webster, accepted a part-time position and was working during Gabriel's observation.
"Is this about the cash register scanning problem?" she asked. Gabriel requested an explanation of what she meant. Webster said she saw Caren, one of the holiday employees, scanning gum one day while she was ringing up Tina, another woman from the group of five, and asked her about it. Caren told her the scanner acts up sometimes and could be reset by scanning something, like gum or candy. She also told Webster she could prevent the scanning problem by pressing the no ring button a few times during her shift.
Remembering the inventory variances in gum and candy, Gabriel began to realize why the holiday bonus comment was funny. After interviewing Adams, the loss prevention director, and numerous employees, a significant and coordinated fraud effort was uncovered. The group of "holiday bonus" employees was running a series of small and difficult-to-detect fraud schemes.
The women would help each other with holiday shopping by ringing up gum or candy for other higher dollar items. The false sales of gum and candy did not create a flag until there was an inventory overage. Holiday shrinkage, or theft, explained the other items.
To avoid detection, they would hit the no ring button on cash transactions and then pocket the cash, but no more than twice a day. If the customer asked for the receipt, they would apologize and claim it was a system error. The transactions were masked by telling other seasonal employees — who they called "kids" — to hit the no ring button twice a day to prevent scanner problems.
Items were then returned at higher values than paid. Apparently, the women would identify an unsuspecting new employee who did not know how to process a return. One would step in to help the new employee by handling the return for him or her on the register. The item was purchased at a significant discount, sometimes fraudulently, and then returned at full price.
Given how carefully the scams were concealed, it was difficult to quantify the total amount. Based on some estimates, though, it appeared that $18,000 was stolen each year during the holiday season.