Veronica Vanatamm was the internal auditor for East Mining Co. (EMC), an underground mining company that relied on heavy machinery powered by diesel fuel it purchased from Best Fuel Plc. Vanatamm was assigned to audit whether the diesel fuel consumed by EMC’s machinery was accounted for correctly and whether fraud risks were mitigated.
When Vanatamm began the audit, she learned that the main refueling facility was located at EMC’s mine site, but the equipment and diesel fuel in the tanks were owned by Best Fuel. EMC drivers purchased diesel fuel in the same way as at an ordinary gasoline station. After refueling, EMC drivers received receipts that they would submit to EMC accounting. Best Fuel transferred information about refueling electronically to EMC at the end of each month.
EMC vehicles had the capacity to carry 5,000 liters of diesel. After refueling, they transported diesel fuel to the underground mine and dispatched it to 12 underground tanks for trucks, loaders, and stationary mining machinery. Carrying vehicles had fuel pistols with meters and underground tanks had fuel counters.
EMC became the owner of the diesel fuel when the vehicle used to transport diesel underground tanked at Best Fuel’s main on-land facility. So, Vanatamm had to trace diesel from the time it was purchased until its usage was recorded and reported. She decided to test whether the balancing equation worked. Namely, whether the monthly end balance equaled the balance at the beginning of the month plus the purchased amount, minus the amount consumed by the machines.
EMC performed a physical inventory of the underground fuel tanks every Sunday and the first day of the month, and compared actual measurements to expected calculated results. The calculated results were based on sales receipts from Best Fuel and meter readings from the underground tanks. Vanatamm extracted data for three months and discovered the physically measured balance of diesel fuel was always precisely the same as the calculated end balance. There never was a single liter difference. She became suspicious and extracted a new data set looking at two years’ worth of data. Still, there was always an exact match.
Vanatamm discussed her concern with Peter Kirs, the mine’s main engineer. He told her that EMC reconciled the physical inventory balance with the calculated inventory balance. However, the reconciliation required an additional adjustment. During this step, any differences between the measured physical end balance and calculated end balance were solved. Kirs explained that diesel fuel contracts and expands depending on the temperature of the environment. The mine maintains a temperature of 8 degrees Celsius, so, during winter months when it is colder outside, the diesel expands in the underground tanks. However, during summer months, when it is warmer outside, the diesel contracts in the underground tanks. As a result, Kirs explained to Vanatamm, it was not possible to conduct precise verifications without automated corrections that took into account those peculiarities.
- When conducting an operational audit, technical nuances and peculiarities of business processes must be investigated so that auditors fully understand what the purpose of each procedure is. It could indicate that a claimed control is an actual control or a smart workaround to conceal process deficiencies.
- Understand the data. Data that is perfect or close to perfect may have another story to tell. Internal auditors should pay attention and try to comprehend the story behind it.
- Sometimes it is more convenient for managers not to see fraud, even if it takes place on their watch. Management might be content with explanations of anomalies as long as the reasoning is plausible. The role of any diligent auditor is to work closely with management, and advise and train them on fraud risks and anomalies.
Vanatamm decided to verify Kirs’ statements. She inquired with the IT department on exactly how the automatic algorithm worked and obtained data before corrections. From data and algorithm analysis, she found that Kirs’ statement regarding contraction and expansion of diesel due to changes in temperature was not the main reason automatic corrections were introduced into the process.
Vanatamm discovered that almost every month, the physical inventory of diesel fuel measured considerably less than it was supposed to, according to expected, receipts-based calculations. In addition, the variances existed in both winter and summer months. The algorithm always neatly enlarged the amount of diesel issued from underground tanks so that figures would equal the calculated ones.
Vanatamm observed that there were substantial differences between purchased amounts and the diesel month-end balance that could not be fully explained either by temperature changes or by imprecise counters. Her recommendation was to inspect all tanks and vehicles and calibrate all meters that belonged to EMC.
Three months later, Anton Pavlovski was appointed as the new main mining engineer. He implemented Vanatamm’s audit recommendations and spoke to her about their shared feelings that diesel fuel was possibly being stolen. Vanatamm pointed out that because there was video surveillance near the underground tanks, she did not think fuel was being stolen there. She believed that the weakest point in the process was in the transportation of fuel from the ground facility to the underground tanks. Pavlovski placed the refueling facility under video surveillance, which captured one of the drivers making a strange gesture near the diesel pistol. He conducted a site visit of the refueling facility with representatives of Best Fuel, where they discovered a backflow pipe with a tap.
The team found that EMC drivers would open the backflow tap during the fueling process, allowing diesel fuel to flow back into Best Fuel’s tank. The backflow was not recorded. For example, while fueling a 5,000 liter tank, the driver opened the backflow tap, allowing 300 liters of diesel fuel to flow back into Best Fuel’s tank. The driver would close the tap, collect the receipt for 5,000 liters, and transport 4,700 liters underground.
The investigation found that the backflow scam had been in place for more than 10 years and every EMC vehicle driver was involved. Each driver would report how many liters were pumped back to a “cashier” at Best Fuel and would be paid for each liter. Shortages were concealed with the help of the work-around algorithm, shrinkage and expansion explanations, and imprecise underground meters.
The investigation results were submitted to the authorities, and a criminal investigation was initiated. Management at Best Fuel claimed to have no knowledge of any diesel surplus and said that there was never any intention to defraud EMC. EMC drivers involved in the scam were fired and investigated by police. Financial loss was estimated to be in the hundreds of thousand of dollars; however, not all of it was possible to prove.