Table of Contents

COMMON FRAUD SCENARIOS GUIDE: SAMPLE 1.............................................................................................. 2

COMMON FRAUD SCENARIOS GUIDE: SAMPLE 2.............................................................................................. 4
COMMON FRAUD SCENARIOS GUIDE: SAMPLE 3.............................................................................................. 9

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 COMMON FRAUD SCENARIOS GUIDE: SAMPLE 1

COMMON INSIDER FRAUD AGAINST THE COMPANY

• Cash diversions, conversions, and thefts (front-end frauds).

• Check raising and signature or endorsement forgeries.
• Receivables manipulations such as lapping and false credit memos.
• Payables manipulations such as raising or fabricating vendor invoices, benefit claims, and expense vouchers,
and allowing vendors, suppliers, and contractors to overcharge.
• Payroll manipulations such as adding nonexistent employees or altering timecards.
• Inventory manipulations and diversions such as erroneous reclassifications of inventories to obsolete,
damaged, or sample status to create a cache from which thefts can be made more easily.
• Favors and payments to employees by vendors, suppliers, and contractors.

COMMON OUTSIDER FRAUD AGAINST THE COMPANY

• Vendor, suppliers, and contractor frauds, such as short shipping goods.

• Substituting goods of inferior quality.
• Overbilling
• Double billing
• Billing, but not delivering or delivering elsewhere.
• Vendor, supplier, and contractor corruption of employees.
• Customer corruption of employees.

COMMON FRAUDS FOR THE COMPANY

• Smoothing profits (cooking the books) through practices such as inflating sales, profits and assets
• Understating expenses, losses and liabilities
• Not recording or delaying the recording of sales returns
• Early booking of sales and inflating ending inventory
• Check kiting
• Price fixing
• Cheating customers by using devices such as short weights, counts and measures; substituting cheaper
materials; and false advertising
• Violating governmental regulations, including EEOC, OSHA, environmental, securities or tax violation
standards
• Corrupting customer personnel
• Engaging in political corruption
• Padding costs on government contracts

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 PROCEDURES USED BY TOP MANAGEMENT TO ACCOMPLISH FRAUD

From “Fraud, Window Dressing and Negligence in Financial Statements” by Loren B. Kellogg and Denise
Kellogg:

Procedures used (by top management) to accomplish fraud:

Cash: Inflate the bank balance by ordering false entries, keeping cash received records open beyond the balance
sheet date or closing the disbursement records before the balance sheet date.

Ratios: Ratios includes quick ratio, accounts receivable turnover and accounts payable turnover.

Accounts Receivable: Inflate accounts receivable by creating false charges to customers, shipping merchandise
not ordered, designating consignments as sales and shipping merchandise to customers with right of return.

Ratios: Ratios include accounts receivable turnover and revenue trends.

Inventories: Overvalue inventories, ignore obsolescence, alter inventory sheets, count empty boxes and alter
computer documents.

Ratios: Ratios include inventory turnover.

Prepaid Expenses: Instruct bookkeepers to reduce or eliminate amortization of expenses paid in advance:
insurance, taxes, advertising and supplies.

Ratios: Ratios include quick ratio.

Property, Plant and Equipment: Instruct bookkeepers to enter amounts to these asset accounts even though
the amounts properly belong in expenses like labor, supplies, repairs or tools:
• Instruct bookkeepers to reduce the depreciation rates on plant and equipment so that the write-off to expense
is understated.

Ratios: Ratios include depreciation and amortization as percentages of sales, fixed asset depreciated percent,
capital outlay as a percent of sales, capital outlay funded by operations and asset turnover.

Goodwill: Add amounts unreasonably to this account, and amortize it over an unreasonably long life; the result is
an understated expense and overstated net income.

Ratios: Ratios include depreciation and amortization as percentages of sales.

Other Intangibles: Add amounts unreasonably to this account, and amortize it over an unreasonably long life; the
result is an understated expense and overstated net income.

Ratios: Ratios include depreciation and amortization as percentages of sales.

Other Assets: Use the procedures listed above to create fictitious assets or to keep on the accounting records
assets that should be written off.

Ratios: Ratios include asset turnover, depreciation and amortization as percentages of sales, quick ratio and
inventory turnover.

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 COMMON FRAUD SCENARIOS GUIDE: SAMPLE 2

The purpose of this document is to provide a common understanding of the potential fraud schemes and
scenarios that ABC Company has included in its entity-level fraud risk assessment. Each of these
schemes/scenarios should be examined by the internal audit group and senior management from each of the
functional areas within the company.

FRAUD SCHEMES/SCENARIOS AND DEFINITIONS

Benefits Fraud: This scheme encompasses the receipt of benefits by employees that are not eligible,
dependents of employees that are not eligible or the receipt of benefits beyond their departure date from the
company.

Bid Rigging: This scheme occurs when an employee fraudulently assists a vendor in winning a contract through
the competitive bidding process. This may include related party transactions and vendor kickbacks, among other
frauds.

Check Fraud: This scheme includes the use of technology to design/reproduce bank checks and simple check
forgery.

Check Theft: This scheme involves the interception of a valid disbursement prior to delivery to the rightful
recipient.

Collateral or Records Management: This scheme involves employees using titles to secure other/personal debt.

Concealment of Investing Activity: This scheme involves the failure of personnel to report investing activity for
inclusion in the financial statement preparation process.

Disguised Purchases: This scheme involves the utilization of company funds to make non-company-related
purchases. The purchase may benefit the employee or another party and is intended to have the appearance of a
purchase made in the normal course of business.

Early Recognition of Revenue: Companies try to enhance revenue by manipulating the recognition of revenue.
Improper revenue recognition entails recognizing revenue before a sale is complete before the product is
delivered to a customer, or at a time when the customer still has options to terminate, void or delay the sale.
Examples of improper revenue recognition include recording sales to nonexistent customers, recording fictitious
sales to legitimate customers, recording purchase orders as sales, altering contract dates and shipping
documents, entering into “bill-and-hold” transactions, holding the books open until after shipment so that the sale
can be recorded in the desired period, entering into side agreements, and **channel stuffing.

Earnings Management/Smoothing: The pressure to meet or beat analyst expectations may lead management
to engage in dubious practices such as “big bath" restructuring charges, creative acquisition accounting, "cookie
jar reserves," "immaterial" misapplications of accounting principles, and the premature recognition of revenue.
Insistence on aggressive application of accounting principles, on always being “on the edge” and on applying
“soft” methods allowing for a lot of “running room” when making significant estimates in the financial reporting
process all contribute to an environment that impair or reduce the quality of earnings and breed earnings
management.

Electronic Transaction Fraud: This scheme is similar to embezzlement, but specifically relates to diversion,
theft, or misappropriation of funds that are received or disbursed electronically. This scheme may be perpetuated
at the initiation point of the transaction, during transmission or at the destination of the transaction.

Embezzlement: The property of another party is wrongfully taken or converted for the wrongdoer’s benefit. This
may include theft of cash or property or the use of company assets for personal gain.

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Employee Fraud: While every industry is at risk for employee fraud, the nature of the financial services industry
makes it an attractive target for employees who can figure out how to work around existing or lax controls and, for
example, create dummy loans, siphon money from customer accounts or arrange to get kickbacks for providing
services. This may also include fraud resulting from a “rogue employee,” (e.g., the trader who manages to trade
off-book and/or hide his trading losses in accounts that only he controls or from insider dealing (i.e., the use of
nonpublic information for personal gain)).

Fictitious Borrowing/Borrowing Fraud: Personnel may enter into borrowing arrangements for personal gain
utilizing company credentials/collateral.

Fictitious Vendors: This scheme involves the intent to divert funds to an employee or another party with no
corresponding receipt of goods or services.

Fictitious/False Employees: This refers to someone on payroll who does not work for the company. Through the
falsification of personnel or payroll records, a fraudster causes paychecks to be generated to a “ghost.” The
fraudster or an accomplice then converts these paychecks. The ghost employee may be a fictitious person or a
real individual who simply does not work for the victim's employer. When the ghost is a real person, it is often a
friend or relative of the perpetrator.

Financial Statement Fraud: Misstatement(s) of an entity’s financial statements accomplished by:

• Overstatement of revenue and revenue-related assets.
• Understatement of costs or expenses and their related liabilities.
• Omission or manipulation of required disclosures that involves violation(s) of generally accepted accounting
principles (GAAP) and that defrauds investors or creditors of the entity by manipulation, deception, or
contrivance using false and misleading financial information.

Fraudulent Account Activity: This scheme involves the manipulation of customer accounts to conceal
delinquency or boost portfolio performance metrics. The scheme may involve changing receivables status to
current or manipulating bankruptcy account status to boost the quality of receivables and lessen the need for a
bad debt reserve.

Fraudulent Capitalization of Costs: This scheme involves the capitalization of costs that do not provide a
benefit to future periods. Management may undertake this effort to delay the recognition of period expenses and
lessen the current P&L impact.

Fraudulent Journal Entries: Some characteristics may include the following entries:
• Made to unrelated, unusual, or seldom-used accounts.
• Made by individuals who typically do not make journal entries.
• Made with little or no support.
• Made post-closing or at the end of a period such as quarter- or year-end and might be reversed in a
subsequent period.
• Include round numbers.
• Affect earnings

Financial statement fraud is frequently accomplished through the use of fraudulent journal entries and is a form of
management override of the internal control structure. Of particular interest would be journal entries that mask
fund diversion, the improper reversal of reserve accounts, the use of intercompany accounts to hide expenses
and/or the capitalization of costs that should be expensed.

Fraudulent Disbursements: In fraudulent disbursement schemes, an employee makes a distribution of company

funds for a dishonest purpose. Examples of fraudulent disbursements include forging company checks, the
submission of false invoices, doctoring timecards and so forth.

Fraudulent Loan Setup/Funding Disbursement: This scheme involves booking loans that do not exist or
disbursing funds to fictitious customers. This scheme can inflate revenues, assets (loan receivables) and may
also include embezzlement of funds.

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Identity Theft: This scheme involves a crime in which an imposter obtains key pieces of personal information,
such as social security or driver's license numbers, in order to impersonate someone else.

Inflated Time Reporting: Employees may intentionally report hours that were not spent working. This may
involve reporting hours for days the employee did not work, incrementing hours beyond those spent at work, and
failing to report vacation or sick time.

Insider Trading: Insider trading is an illegal act that involves the use of nonpublic information to purchase/sell
company stock. Insider trading most often involves executive management or financial reporting personnel who
have access to company performance results in advance of public filings.

Intentional Misapplication of Payments: This scheme involves taking a customer payment and applying it to
another customer or another type of payable due from the customer.

Kiting: Check kiting is the act of writing checks against a bank account with insufficient funds to cover the check
in hopes that funds will be available prior to the payee depositing the check.

Lapping: Lapping customer payments is one of the most common methods of concealing skimming. It is a
technique that is particularly useful to employees who skim receivables. Lapping is the crediting of one account
through the abstraction of money from another account. It is the fraudster’s version of “robbing Peter to pay Paul.”

Loss Allowance Manipulation: The scheme involves changing allowance calculation assumptions, changing
input data, or simply changing the result of the allowance calculation to delay the impact of impending losses. This
scheme most often must be continued over time to conceal inevitable write-offs and may lead to other fraudulent
journal entries (defined above).

Manipulation of Bonus/Commission Criteria/Results: This scheme is similar to embezzlement but has distinct
characteristics. Personnel responsible for submitting bonus/commission attainment (HR and department
management) may modify compensation criteria or performance results to increase bonus/commission payouts to
themselves or the employees that work for them. In many cases, this scheme is justified by management to
reward employees that are perceived to be strong performers that are not rewarded by established performance
metrics.

Manipulation of Derivative Position: This scheme involves the intentional misreporting of a derivative position
to conceal a poor business decision or simply increase earnings. This scheme can be accomplished in various
manners, including the destruction or concealment of supporting documentation, falsifying documentation related
to hedging activities, or modifying the actual position to one more favorable to the company.

Manipulation of Inventory: This scheme involves the modification of inventory records to overstate assets or
failure to recognize the decline/impairment to its value. This scheme may involve the falsification or destruction of
records in an attempt to substantiate activity in the period that did not occur.

Manipulation or Concealment of Trigger Reporting: This scheme involves the intentional cover-up or
falsification of performance reports that would otherwise result in the violation of debt covenants.

Misappropriation of Customer Payments/Funds: Often accompanies embezzlement, but is a separate and

distinct offense. Misapplication is the wrongful taking or conversion of another’s property, in this case, customer
payments, for the benefit of someone else – that of the employee or for another customer.

Misappropriation of Funds: Often accompanies embezzlement, but is a separate and distinct offense.
Misapplication is the wrongful taking or conversion of another’s property, in this case, company funds, for the
benefit of someone else.

Misappropriation of Trustee Payments/Funds: Often accompanies embezzlement, but is a separate and

distinct offense. Misapplication is the wrongful taking or conversion of another’s property, in this case, trustee
payments, for the benefit of someone else.

Misleading Analyst Forecasts: This scheme is perpetrated by management to conceal a pending downturn or
flat revenues or to predict a significant increase in revenue despite the lack of supporting analysis.

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Overstatement of Assets: Areas where assets can easily be overstated include inventory valuation, accounts
receivable, business combinations and fixed assets:
• Inventory Valuation: Inventory valuation is the failure to write down obsolete inventory, manipulation of
physical inventory counts, recording “bill-and-hold” items as sales and including these items in inventory.
• Accounts Receivable: This scheme includes fictitious receivables and the failure to write off bad debts.
• Business Combinations: This scheme involves setting up excessive merger reserves and taking the
reserves into income.
• Fixed Assets: This scheme includes capitalizing costs that should be expensed or booking an asset although
the related equipment might be leased.

Proprietary Information Dissemination: This scheme involves the intentional dissemination of private company
information to potential customers, vendors or suppliers that give them an unfair advantage in dealing with the
company, whether applying for a loan or providing goods/services. This scheme may be coupled with other acts
such as embezzlement or bid rigging (defined above).

Speculative Investing: This scheme involves company personnel, either on their own or at the direction of
management, to enter into derivative/hedging transactions with no specific risk that is attempting to be mitigated.
This may be an attempt to circumvent investing policies to boost earnings or to profit individually from the
transaction.

Tax Evasion: The company intentionally evades payment of taxes that are otherwise owed to a taxing authority.
This conduct can include concealing assets or income, keeping two sets of books, manipulating quarterly
payment estimates, and destroying books and records.

Title Fraud: This scheme involves the use of company assets, in this case, vehicle titles, to secure personal/other
debt. This scheme is most likely to occur with collateral or records management employees due to their access to
such documents.

Unrecorded, Deferred or Understated Liabilities: The most common methods used to understate liabilities
include failing to record liabilities and/or expenses, failing to record warranty costs and liabilities, and failing to
disclose contingent liabilities. In one high-profile case, liabilities were hidden in off-balance-sheet affiliates.

OTHER FRAUD SCHEMES/SCENARIOS TO CONSIDER

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 Collusion With Dealers. Manipulation of Bank Account Status.

Concealment or Manipulation of Financial Results Manipulation of Estimates to Alter Quarterly Tax

and Disclosures. Payments.

Dealer Buyback: Theft of Funds Manipulation of Payroll Records.

Diversion of Funds/Misappropriation of Assets Manipulation of Performance Forecasting

Diversion/Misappropriation of Funds Manipulation of Performance Results

Diversion/Theft of Disbursements Manipulation of Significant Accounting Estimates

Electronic Payments Fraud Manipulation or Theft of Fees

Failure to Record/Remit Payroll Taxes Management Circumvention/Override of Loan

Setup Controls

Failure to Remit Ancillary Product Refund to Principal Credit Adjustments to Increase

Customer. Recoveries

False Repo Agent Invoices Principal Credit Adjustments to Reduce/Pay Off

Loans

Falsification of Expense Reports Related Party Purchases

Fraudulent Auction Invoices Related Party Transactions

Fraudulent Repo Agent Invoices/Auction Terminated Employee Payments

Expenses.

Fraudulent Settlement Negotiation Theft

Improper Re-Aging Accounts to Current Unauthorized Electronic Payments

Initiation of Fraudulent Check Unsupported Top-Side Entries

Kickbacks Use of Resources for Personal Gain

Manipulation of Assumptions Utilized by Financial Vendor Kickbacks

Reporting

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 COMMON FRAUD SCENARIOS GUIDE: SAMPLE 3

The purpose of this document is to assist Section 404 compliance teams and others who have a responsibility to
conduct a fraud risk assessment under Statement of Auditing Standard No. 99 (SAS 99) and in accordance with
the requirements of Section 404 of Sarbanes-Oxley Act of 2002 to assess the design and operating effectiveness
of internal controls over financial reporting. In our companion document, COSO-Based Anti-Fraud Program and
Controls, we suggested that one approach to evidencing the use of control activities to mitigate fraud was the
consideration of fraud scenarios common across industries. This document provides illustrations of different types
of frauds and how such frauds could be perpetrated. It is intended to facilitate an approach of using fraud
scenarios to make fraud explicit in a Section 404 assessment.

Anti-fraud programs and controls are controls related to the prevention, deterrence and detection of fraud. The
focus of management’s assessment should be on those programs and controls that are intended to mitigate the
risk of fraudulent actions that could have a material impact on financial reporting.

For example, fraud might include:

• Fraudulent Financial Reporting: Inappropriate earnings management or “cooking the books” (e.g., improper
revenue recognition, intentional overstatement of assets or understatement of liabilities, etc.)
• Misappropriation of Assets: Embezzlement and theft
• Expenditures and Liabilities Incurred for Improper or Illegal Purposes: Bribery and influence payments
that can result in reputation loss
• Fraudulently Obtained Revenue and Assets and/or Avoidance of Costs and Expenses: Scams and tax
fraud that can result in reputation loss

Using these four categories of fraud listed above, we have summarized examples of common fraud scenarios
below:
• Fraudulent Financial Reporting:
− Earnings management
− Improper revenue recognition
− Overstatement of assets
− Understatement of liabilities
− Fraudulent journal entries
− Round-trip or “wash” trades
• Misappropriation of Assets:
− Billing schemes
− Collusion
− Concealment
− Embezzlement
− Forgery
− Ghost employees
− Kiting
− Lapping
− Larceny
− Misapplication
− Payroll fraud
− Theft

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• Expenditures and Liabilities Incurred for Improper or Illegal Purposes:
− Bribes
− Conflicts of interest
− Kickbacks
− Concealment
− Money laundering
• Fraudulently Obtained Revenue and Assets and/or Cost and Expenses Illegally Avoided:
− Concealment
− Scams
− Tax fraud

These common schemes/scenarios can occur in any industry. However, the way such frauds are perpetrated
might be industry-specific. Regardless, the definitions and/or examples of some of the fraud scenarios listed
above are detailed beginning on the next page. An example as to how scenarios may be used is as follows:
(a) First, identify relevant scenarios that could potentially occur within the organization, resulting in a material
impact on the financial statements.
(b) Second, for each identified scenario, describe how it would be perpetrated within the company, the individuals
who could make it happen and the financial statement accounts that would be affected.
(c) Based on the documented scenarios, identify the controls that would prevent, deter or detect each scenario.
(d) Compare the controls in place with the controls documented in (c) and identify any gaps.
(e) Develop action plans to remediate significant gaps.

The fraud scenarios listed above are detailed starting on the following page.

ASSET MISAPPROPRIATIONS: FRAUDULENT DISBURSEMENTS

In fraudulent disbursement schemes, an employee makes a distribution of company funds for a dishonest
purpose. Examples of fraudulent disbursements include forging company checks, the submission of false
invoices, doctoring timecards and so forth.

BILLING SCHEMES

Billing schemes are a popular form of employee fraud mainly because they offer the prospect of large rewards.
Since the majority of most businesses’ disbursements are made in the purchasing cycle, larger thefts can be
hidden through false-billing schemes than through other kinds of fraudulent disbursements. There are three
principal types of billing schemes: false invoicing via shell companies, false invoicing via nonaccomplice vendors
and personal purchases made with company funds.

BRIBERY

Bribery schemes generally fall into two broad categories: kickbacks and bid-rigging schemes.
• Kickbacks are undisclosed payments made by vendors to employees of purchasing companies. The purpose
of a kickback is usually to enlist the corrupt employee in an overbilling scheme. Sometimes vendors pay
kickbacks simply to get extra business from the purchasing company.
• Bid-rigging schemes occur when an employee fraudulently assists a vendor in winning a contract through the
competitive bidding process.

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 COLLUSION

The way to obtain approval of a fraudulent timecard is to collude with a supervisor who authorizes timekeeping
information. In these schemes, a supervisor knowingly signs false timecards and the employee kicks back a
portion of the overpaid wages to the supervisor. In some cases, the supervisor may take the entire amount of the
overpayment. It may be particularly difficult to detect payroll fraud when a supervisor colludes with an employee
because managers are often relied on as a control to assure proper timekeeping.

CONCEALMENT: FICTITIOUS SALES AND ACCOUNTS RECEIVABLE

When the perpetrator makes an adjusting entry to the perpetual inventory and cost of sales accounts, there is no
sales transaction on the books that correspond to these entries. To fix this problem, a perpetrator might enter a
debit to accounts receivable and a corresponding credit to the sales account so that it appears the missing goods
have been sold.

CONCEALMENT: WRITE OFF OF INVENTORY AND OTHER ASSETS

Writing off inventory and other assets is a relatively common way for employees to remove assets from the books
before or after they are stolen. This eliminates the problem of shrinkage that inherently exists in every case of
non-cash-asset misappropriation.

CONCEALMENT: PHYSICAL PADDING

Most methods of concealment deal with altering inventory records, either changing the perpetual inventory or
miscounting during the physical inventory. In the alternative, some employees try to make it appear that there are
more assets present in the warehouse or stockroom than there are. Empty boxes may be stacked on shelves to
create the illusion of extra inventory.

CONFLICTS OF INTEREST

An employee, fiduciary or agent, is put into a position of self-dealing. One example would be if a CFO of an
organization set up an off-balance-sheet entity, which he managed and transacted business, thereby becoming
personally enriched. This scenario compromises the internal control structure because independent parties are
not bargaining at arm’s length with each other. A waiver of the conflicts of interest provision of the code of ethics
requires board approval and must be disclosed.

EMBEZZLEMENT

The property of another party is wrongfully taken or converted for the wrongdoer’s benefit.

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 EARNINGS MANAGEMENT

The pressure to meet or beat analyst expectations may lead management to engage in dubious practices such as
“big bath" restructuring charges, creative acquisition accounting, "cookie jar reserves," "immaterial"
misapplications of accounting principles and the premature recognition of revenue. Insistence on aggressive
application of accounting principles, on always being “on the edge” and on applying “soft” methods allowing for a
lot of “running room” when making significant estimates in the financial reporting process all contribute to an
environment that impair or reduce the quality of earnings and breed earnings management.

FINANCIAL STATEMENT FRAUD

Misstatement(s) of an entity’s financial statements accomplished by:

• Overstatement of revenue and revenue-related assets
• Understatement of costs or expenses and their related liabilities, which involves violation(s) of Generally
Accepted Accounting Principles (GAAP) and which defrauds investors or creditors of the entity by
manipulation, deception or contrivance using false and misleading financial information.

FORGERY

When using this method, an employee typically withholds his or her timecard from those being sent to the
supervisor for approval, forges the supervisor’s signature or initials, and then adds the timecard to the stack of
authorized cards sent to the payroll department. The fraudulent timecard arrives at the payroll department with
what appears to be a supervisor’s approval and a paycheck is subsequently issued.

FRAUDULENT JOURNAL ENTRIES

Some characteristics may include entries:

• Made to unrelated, unusual or seldom-used accounts
• Made by individuals who typically do not make journal entries
• Made with little or no support
• Made post-closing or at the end of a period such as quarter- or year-end and might be reversed in a
subsequent period
• Include round numbers
• Affect earnings

Financial statement fraud is frequently accomplished through the use of fraudulent journal entries and is a form of
management override of the internal control structure. Of particular interest would be journal entries that mask
fund diversion, the improper reversal of reserve accounts, the use of intercompany accounts to hide expenses
and/or the capitalization of costs that should be expensed.

GHOST EMPLOYEES

The term ghost employee refers to someone on the payroll who does not work for the victim company. Through
the falsification of personnel or payroll records, a fraudster causes paychecks to be generated to a ghost. The
fraudster or an accomplice then converts these paychecks. The ghost employee may be a fictitious person or a

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real individual who simply does not work for the victim employer. When the ghost is a real person, it is often a
friend or relative of the perpetrator.

IMPROPER REVENUE RECOGNITION

Companies try to enhance revenue by manipulating the recognition of revenue. Improper revenue recognition
entails recognizing revenue before a sale is complete; before the product is delivered to a customer; or at a time
when the customer still has options to terminate, void or delay the sale. Examples of improper revenue
recognition include recording sales to nonexistent customers, recording fictitious sales to legitimate customers,
recording purchase orders as sales, altering contract dates and shipping documents, entering into *“bill and hold”
transactions, holding the books open until after shipment so that the sale can be recorded in the desired period,
entering into side agreements and **channel stuffing.

KITING

Kiting is when the wrongdoer opens two accounts in two separate banks and floats checks between the two,
receiving cash back on each deposit. The deposits keep escalating in amount, though and are always
uncollected. Eventually, the financial institution should see the pattern and put a stop to it.

LAPPING

Lapping customer payments is one of the most common methods of concealing skimming. It is a technique, which
is particularly useful to employees who skim receivables. Lapping is the crediting of one account through the
abstraction of money from another account. It is the fraudster’s version of “robbing Peter to pay Paul.”

LARCENY

“Larceny” is defined as felonious stealing, taking and carrying, leading, riding, or driving away another’s personal
property with the intent to convert it or to deprive the owner thereof. To classify asset misappropriations, the term
larceny is meant to refer to the most basic type of inventory theft, the schemes in which an employee simply takes
inventory from the company premises without attempting to conceal the theft in the books and records. (See
“Non-Cash Larceny” flow chart) In other fraud schemes, employees may create false documentation to justify the
shipment of merchandise or tamper with inventory records to conceal missing assets.

MISAPPLICATION

Misapplication often accompanies embezzlement but is a separate and distinct offense. Misapplication is the
wrongful taking or conversion of another’s property for the benefit of someone else.

MONEY LAUNDERING

Money laundering often includes the use of offshore accounts. It can be defined as the illegal practice of filtering
“dirty” money or ill-gotten gains through a series of transactions to make it appear that the proceeds are from legal
activities.

*“Bill-and-hold” transactions are sales where the customer agrees to purchase the goods but the seller retains
physical possession until the customer requests shipment.

**“Channel stuffing” is boosting sales by enticing distributors to buy substantially more inventory than they can
sell, usually giving the distributors the right to return unsold goods through the use of side agreements.

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 OVERSTATEMENT OF ASSETS

Areas where assets can easily be overstated include inventory valuation, accounts receivable, business
combinations and fixed assets:
• Inventory Valuation: The failure to write down obsolete inventory, manipulation of physical inventory counts,
recording *“bill-and-hold” items as sales and including these items in inventory.
• Accounts Receivable: Fictitious receivables and the failure to write off bad debts.
• Business Combinations: Setting up excessive merger reserves and taking the reserves into income.
• Fixed Assets: Capitalizing costs that should be expensed or booking an asset although the related equipment
might be leased.

PAYROLL SCHEMES

Payroll schemes are similar to billing schemes. The perpetrators of these frauds produce false documents, which
cause the victim company to unknowingly make a fraudulent disbursement. In payroll schemes, the perpetrator
typically falsifies a timecard or alters information in the payroll records. The major difference between payroll
schemes and billing schemes is that payroll frauds involve disbursements to employees rather than to external
parties. The most common payroll frauds are ghost employee schemes, falsified hours and salary schemes, and
commission schemes.

ROUND TRIP OR “WASH” TRADES

Simultaneous, prearranged buy-sell trades with the same counterparty, at the same price and volume, and over
the same term, resulting in neither profit nor loss to either transacting party.

SKIMMING

Skimming is the removal of cash from a victim entity before it enters into an accounting system. Employees who
skim from their companies steal sales or receivables before they are recorded in the company books. Skimming
schemes are known as “off-book” frauds, meaning money is stolen before it is recorded in the victim
organization’s accounts. Short-term skimming is that the perpetrator only keeps the stolen money for a short while
before eventually passing it on to his employer. The employee merely delays the posting of the payment.

TAX FRAUD

The company intentionally evades payment of taxes that are otherwise owed to a taxing authority. This conduct
can include the concealment of assets or income, keeping two sets of books, and the destruction of books and
records.

TURNAROUND SALE OR FLIP

A special kind of purchasing scheme sometimes used by fraudsters is called the turnaround sale or the flip. In
this type of scheme, an employee knows his employer is seeking to purchase a certain asset and takes
advantage of the situation by purchasing the asset himself (usually in the name of an accomplice or shell
company). The fraudster then turns around and resells the item to his employer at an inflated price.

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14 Source: www.knowledgeleader.com
 UNDERSTATEMENT OF LIABILITIES

The most common methods used to understate liabilities include failing to record liabilities and/or expenses,
failing to record warranty costs and liabilities, and failing to disclose contingent liabilities. In one high-profile case,
liabilities were hidden in off-balance-sheet affiliates.

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15 Source: www.knowledgeleader.com