Audit of Cash Employee Fraud

Employee Fraud and the
Audit of Cash
"Rather fail with honor than succeed by fraud."

--Sophocles (496-406 BCE)
McGraw-Hill/Irwin
6-2
Fraud Opportunities Revisited

6-3
Definitions Related to
Employee Fraud
• White collar crime is fraud perpetrated by people who work in offices
and steal with a pencil or a computer terminal. The contrast is violent
street crime.
• Employee fraud is the use of fraudulent means to take money or other
property from an employer. It consists of three phases: (1) the
fraudulent act, (2) the conversion of the money or property to the
fraudster's use and (3) the cover-up.
• Embezzlement is a type of fraud involving employees' or
nonemployees' wrongfully taking money or property entrusted to their
care, custody, and control, often accompanied by false accounting
entries and other forms of lying and cover-up.
• Larceny is simple theft of an employers property that is not entrusted
to an employee's care, custody or control.
• Defalcation is another name for employee fraud and embezzlement.
6-4
Exhibit 6-1
Fraud Elements
Motivation Opportunity
Rationalization
High
Risk
Source: W.Hillison, D. Sinason, and C. Pacini, “The Role of the Internal Auditor in Implementing SAS 82,” Corporate
Controller, July/August 1998, page 20.
6-5
Motive
• A motive is some kind of pressure a person
experiences and believes unshareable with friends
and confidants
– Actual or perceived need for money (Economic motive)
– “Habitual criminal” who steals for the sake of stealing
(Psychotic motive)
– Committing fraud for personal prestige (Egocentric
motive)
– Cause is morally superior, justified in making others
victims (Ideological motive)
6-6
Opportunity
• An opportunity is an open door for solving
the unshareable problem by violating a
trust.
– Weak internal controls
– Circumvention of internal controls
– The greater the position, the greater the trust
and exposure to unprotected assets.
6-7
Rationalization
• When people do things that are contrary to their personal
beliefs – outside their normal behavior – they provide an
argument to make the action seem like it is in line with
their moral and ethical beliefs.
– Some of the most frequent rationalizations are:
• I need it more than the other person.
• I’m borrowing the money and will pay it back.
• Everybody does it.
• The company is big and will never miss it.
• Nobody will get hurt.
• I am underpaid, so this is due compensation
• I need to maintain a lifestyle and image.
6-8
Red Flags: Employee Fraud

o Missing documents. o Cash shortages and overages.
o Alterations on documents. o Excessive voids and credit
o Photocopied documents. memos.
o Second endorsements on checks. o Customer complaints.
o Unusual endorsements. o Common names or addresses for
o Old outstanding checks. refunds.
o Unexplained adjustments to o Increased past due receivables.
accounts receivable and o Inventory shortages.
inventory balances. o Increased scrap.
o Unusual patterns in deposits in o Duplicate payments.
transit. o Employees that cannot be found.
o General ledgers that do not o Dormant accounts that have
balance. become active.
6-9
Fraud Prevention
• Managing people pressures in the
workplace
– Counseling services
– Hotlines
• Control procedures and employee
monitoring
• Integrity by example and enforcement
6-10
Cash Collections and Disbursements
• Cash is highly liquid, easily transportable,

and not easily identifiable, and therefore is a
primary target for employee thieves.
• Some strong internal controls:
– Dual custody of cash at all times
– Lockbox arrangement
– Fidelity bonds
Lockbox System
6-12
Exhibit 6.2
Processing Cash Receipts
6-13
Cash Collections: Typical Activities
• Receive cash and REMITTANCE ADVICE in mail.

• Prepare REMITTANCE LISTING.
• Enter total from REMITTANCE LISTING (or
REMITTANCE ADVICE) in CASH RECEIPTS
JOURNAL.
• Prepare DEPOSIT SLIP and deposit cash receipts in bank
(INTACT and DAILY).
• Record update to SUBSIDIARY ACCOUNTS
RECEIVABLE using REMITTANCE ADVICE.
• Reconcile REMITTANCE LISTING, SUBSIDIARY
ACCOUNTS RECEIVABLE , and DEPOSIT SLIP daily
6-14
Cash Collections and Disbursements:
Key Control Activities
• INFORMATION PROCESSING
– Voucher packet (Purchase requisition, purchase order, receiving report, invoice)
matched prior to cash disbursement authorization
– Deposits reconciled to amounts credited to accounts receivable ledger
– Bank reconciliation
• PHYSICAL CONTROLS OVER THE SECURITY OF ASSETS
– Deposit cash and checks daily and intact
– Lock box account
– EDI transactions
– Dual custody over cash
– Unused checks secured
– Check imprinting machine
• SEGREGATION OF DUTIES
– Separate custody, authorization, recording, execution
• PERFORMANCE REVIEWS
• RECONCILIATIONS
6-15
Cash Disbursements:
Control Risk Assessment
• Control considerations
– Proper separation of duties
– Detail control (error-checking) activities
– Internal control questionnaires (ICQs)
– Transaction process “walkthrough”
• Detail test of controls audit procedures
(Exhibit 6.4)
6-16
Exhibit 6.4
Tests of Controls Over Cash Disbursements
6-17
Audit Evidence in Management
Reports and Data Files
• Cash receipts journal
• Cash disbursements journal
• Bank reconciliations
• Cancelled checks
• Bank statements
– The audit team will often request that a CUTOFF BANK
STATEMENT be sent directly to the auditor prior to subsequent
month-end in order to verify deposits-in-transit and cleared checks
on a timely basis.
6-18
Exhibit 6.6
Small Business
Bank Statement
6-19
Audit of Cash
• Cash on hand
– Count SIMULTANEOUSLY with other liquid
assets
– Count in presence of client employee
– Undeposited receipts
• Trace to cash receipts journal (CRJ)
• Vouch to subsequent deposit in bank statement
• Cash on Deposit
– Audited mainly through the client’s BANK
RECONCILIATION.
6-20
Bank Reconciliation
• Balance per bank
– CONFIRM (STANDARD BANK CONFIRMATION) directly
with bank
– Agree to CUTOFF BANK STATEMENT
• Add Deposits-in-transit
– TRACE to cash receipts journal
– VOUCH to CUTOFF BANK STATEMENT
• Subtract Outstanding Checks
– VOUCH to cash disbursements journal
– TRACE checks cleared from cutoff bank statement
• Add/Subtract Debit/Credit Memos
– Inspect bank credit/debit memo
• Balance per books
– FOOT Reconciliation
– TRACE to trial balance
6-21
Exhibit 6.7
Bank Reconciliation
6-22
Standard Bank Confirmation
• In addition to corroborating cash and

loan balances, a STANDARD BANK
CONFIRMATION INQUIRY also
requests information about contingent
liabilities and secured transactions.
6-23
Exhibit
6.8
Bank
Confirma
tion
6-24
Check Kiting
• KITING is a fraud that occurs by reporting cash
simultaneously in two different bank accounts.
• A Schedule of Interbank Transfers (Exhibit 6-10)
is generally useful in detecting KITING.
6-25
Exhibit 6.9
Illustrative Check Kiting Transactions
6-26
Exhibit 6.10
Illustration of Interbank Transfer Schedule
6-27
Proof of Cash
• A PROOF OF CASH is used when controls over

cash are weak.
• It essentially combines two bank reconciliations,
reconciling all transactions that occurred during the
period to the client’s Cash Receipts Journal and Cash
Disbursements Journal.
6-28
Exhibit 6.11
Illustration of Proof of Cash—First National Bank
6-29
Fraud Detection Procedures for Cash
• Count the petty cash twice in one day

• Examine endorsements on canceled checks
• Audit general journal entries
• Retrieve customer checks
• Use marked coins and currency
• Measure deposit lag time
• Examine documents (bank statements) for
alteration (See Exhibit 6.6)
• Inquiry, ask questions
• Covert surveillance

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Employee Fraud and the

"Rather fail with honor than succeed by fraud."

Fraud Opportunities Revisited

Red Flags: Employee Fraud

Cash Collections and Disbursements

• Cash is highly liquid, easily transportable,

Cash Collections: Typical Activities

• Receive cash and REMITTANCE ADVICE in mail.

Standard Bank Confirmation

• In addition to corroborating cash and

• A PROOF OF CASH is used when controls over

• Count the petty cash twice in one day

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