Cash Fraud and Necessary Controls Research Paper

Introduction

The aim of this paper is to provide a comprehensive analysis of cash fraud. To achieve this, the paper will review the current statistics of cash fraud. Further, the paper will discuss how cash fraud affects the economy. Various controls that can detect, prevent, and correct the risks that are associated with cash fraud will also be discussed. The various audit procedures that can be used to detect cash fraud will be highlighted. Finally, the paper will give an evaluation of three case studies.

Overview of cash fraud

The Association of Certified Fraud Examiners (ACFE) outlines that cash fraud can occur through theft of cash on hand, theft of cash receipts, and fraudulent disbursements (Association of Certified Fraud Examiners, 2011). Based on the reports generated by the ACFE, asset misappropriation was the most frequent type of fraud. In 2010, the frequency of this type of fraud was 86.7%. Corruption had a frequency of 33.4% while financial statement fraud had a frequency of 7.6% (Association of Certified Fraud Examiners, 2012). When compared to the other types of fraud, the frequency of cash fraud was quite high over the years. This can be attributed to the fact that it is easy to commit and there are a number of easy avenues through which asset misappropriate can be executed. Further, the Association provided the data for the frequency of fraud under the various sub-categories of the asset misappropriation for the year 2012. From the statistics provided, it can be pointed cash fraud has the highest frequency with a total of 1410 cases out of 1649 cases (Association of Certified Fraud Examiners, 2012).

How cash fraud effect the economy and auditors’ reputation

The impact of cash fraud on the economy is quite significant. First, cash fraud results in massive losses to the company and the economy as a whole. The statistics provided by the ACFE show that financial statement fraud results in the highest amount of losses in the economy (Association of Certified Fraud Examiners, 2011). “The median loss that arose from financial statement fraud in 2012 was $1,000,000” (Association of Certified Fraud Examiners, 2011). “This was followed by corruption with a median loss of $250,000 and finally asset misappropriation with a median loss of $120,000” (Association of Certified Fraud Examiners, 2011). Thus, asset misappropriation is the least costly to the economy in terms of losses. However, under the category of asset misappropriation, cash fraud contributed the highest amount of loss to the economy. Secondly, cash fraud results in loss of investor confidence. This reduces the level of investment in the country. Thirdly, cash fraud destabilizes the operation in the capital markets and stock exchange market because companies are key players in the stock exchange market.

The occurrence of fraud has a serious negative impact on the reputation of an audit firm because it indicates that the firm did not carry out its work comprehensively to establish the possibility of the occurrence of the fraud. It may also indicate that the audit firm is part of the conspiracy. An example is the case of Arthur Anderson in the Enroll Scandal (Association of Certified Fraud Examiners, 2012).

Why didcash fraud occurr from the standpoint of the company’s control

The controls put in place by a company provide some level of assurance that there is no possibility of cash fraud. There are a number of control issues that propagate the cash fraud in an organization. First, weak controls create room for cash fraud because employees will find loopholes in the system. The employees will attempt to circumvent the controls to enable them to commit cash fraud. Secondly, failure to review the effectiveness of the controls in place creates room for cash fraud. Therefore, companies should frequently review controls that surround cash operations to enable them to establish if they are adequate and effective. Finally, failure to benchmark current controls with good practice in the industry also creates room to commit fraud.

Necessary controls that might have prevented, detected, or corrected the risks

Cash receipt fraud

First, a company should make use of new technology and automate the process of cash receipt. An example is the use of the new check-scanning technology. It ensures that all expected cash receipts are channeled to the company. Secondly, the company should consider segregating the cash receipts and cash deposit function. This can be achieved if the size of the company is large. However, it the company is small in size, then the management should consider using other features such as lockbox for payments. Thirdly, the management needs to segregate the role of the employee who prepares deposit and the employee who post credit to customer account. It will minimize the possibility of misappropriating payments. The fourth control is that the management needs to segregate the function of handing customers’ queries and complaints, and cash receipt. This argument is based on the fact that a customer can alert the company about the possibility of fraud through queries and complaints. Failure to separate these roles will propagate cash fraud. Further, a company should keep hard copies of supporting documentation for transactions relating to cash receipt. Finally, the company should put in place fraud hotline. It enhances the ability to detect and control fraud (Burnett, Margolis & Elder, 2012).

Cash transaction fraud

The first way to control cash transaction fraud is through the segregation of the duties of the employees involved in processing of cash transaction. Thus a single transaction should not be initiated and completed by a one employee. Secondly, the management of a company needs to come up with a mechanism of verifying the cash transactions at the end of the day. This can be achieved by comparing the print out from the system and supporting documentation of the cash transactions processed at the end of the day. Also, the management should ensure that the physical cash balance is compared with the system balance at the end of the day. Thirdly, there is a need to strengthen the approval mechanism for cash transactions. For instance, all refunds must go through double approval before being executed. The fourth control is that the management should ensure that cash collected in a day is deposited into to bank account without delay. This minimizes the possibility of theft.

Further, the sales employees and messengers should not be allowed to handle cash receipts. The next measure is that the management should segregate the role of cash receipts and maintenance of records of accounts receivables. This minimizes the possibility of manipulation of the records. Further, the management needs to put in place effective ways of monitoring miscellaneous cash transactions in the organization. The transactions are avenues for propagation of cash fraud. In addition, the management should ensure that reconciliation of various cash accounts such as bank are done on a timely basis. This control will ensure that misappropriations are detected early. Finally, the management of a company should put in place internal audit function. The audit department should periodically review the controls and identify areas that require improvement (Gambrell, 2007).

Appropriate auditor’s procedure for cash fraud detection

The first step in cash fraud detection is to send confirmation form to the various financial institutions. The confirmation process entails having a direct contact with third parties in response to request for information that relate to a company. Auditors often use this strategy to obtain bank, account receivables, account payables balances and any other item in the financial statement. Thus, confirmation helps auditors in obtaining audit evidence for the assertions made by the management in the financial statement. Audit evidence is reliable when an auditor receives it from independent parties. Once confirmation is obtained, the auditors will ascertain if the information provided by the third party matches the information reported by the company. Any inconsistency established will be an indication of fraud. Thus, this procedure verifies the existence and accuracy of balances reported. The second procedure entails carrying out reconciliations (Kremer, 2008). Reconciliation is the process harmonizing various balances reported in the financial statement. For instance, bank reconciliation will entail comparing the bank account maintained in the books of account of the company and the bank statement. If the two balances fail to agree after making necessary adjustments, then it may be an indication of fraud.

Reconciliations ensure that transactions are complete. The third procedure is conducting cash count. In this case, an auditor will count all the physical cash held by the institution at a specific time in the safe and compare it with the balance in the system or books of account. This will indicate if the cash balance reported is correct and accurate. Besides, it will give information on areas that have weak control. This procedure verifies that cash balances are complete and accurate. The next item than an auditor can look at are the bank transfers occurring at the end of the year. The auditor should review the source and destination of the transactions and the supporting documentation. Such transfers are often used by the management to conceal misappropriations. Further, the auditor needs to review the cutoff for cash transaction. This will ensure that all the cash transactions recorded related to the financial year under review (Kremer, 2008). This procedure is important because it aids in detecting the possibility of manipulation of accounts by carrying forward or bringing back cash transactions that do not relate to the financial period under review. The next procedure is to investigate transactions with the related parties. Transactions with related parties are a common way through which companies commit fraud. Therefore, the auditor should verify the nature of transactions with the related parties and ensure that the transactions comply with the various accounting standards. Finally, the auditor should obtain bank cutoff statements. This will give information on the accuracy of outstanding balances at the end of the year (Kremer, 2008).

Case studies

Case 1: Parmalat Broadens scandal

In this case study, the company used complex financial structure to cover fraud for several years. Also, some company money were siphoned out to enrich a few prominent individuals (Galloni, Mollenkamp & McDermott, 2003). The scandal resulted in a loss worth $8 billion. There are a number of audit procedures that can be used to detect this fraud. The first procedure is confirmation of various balances reported in the financial statements. Secondly, a physical stock take should be taken to verify the existence of the assets. Further, a reconciliation of various accounts should be carried out to verify the balances reported. Finally, the auditor needs to review the nature of transactions of the company with the related parties. The company can control the possible occurrence of this fraud by simplifying the accounting structure. Secondly, internal controls should be reinforced and an independent well-functioning internal audit department should be set up to review the effectiveness of internal controls.

Case 2: Bookkeeper sentenced to prison for fraud and aggravated identity theft

In this case, the company lost more than $900,000 through forgery and identity theft (The Federal Bureau of Investigation, 2013). The auditor can identify the fraud by carrying out bank reconciliation. The reconciliation will entail reviewing the supporting documentations for the bank transactions. Also, the auditor should review the use of checkbooks. The future occurrence of this fraud can be minimized through segregation of duties. Besides, daily reconciliation of cash related accounts should be reinforced. Finally, the company should implement adequate controls over the usage of the checkbooks.

Case 3: Satyam Computer Services scandal

The fraud relates to manipulation of accounts to a tune of about $1.47 billion. An auditor can detect the fraud by obtaining evidence for the various management assertions (Sheth, Range & Anand, 2009). Besides, the auditor should also review the nature of transactions between the company and related parties. The auditor can also ascertain the existence of the employees reported through callbacks and other procedures. The occurrence of the fraud can be minimized by putting in place an independent internal audit function. Besides, there should be a change in management. This will reduce the influence of the family in the business.

Conclusion

In summary, the discussion above shows that cash fraud had the highest frequency of occurrence in the year 2012. However, the cost of the fraud to the economy is quite dismal. Also, the discussion shows that cash fraud can be minimized by implementing tight control around the handling of cash. Management of an entity should adequately segregate the duties that require handling of cash as the major control mechanism.

References

Association of Certified Fraud Examiners. (2011). Introduction to fraud examination. Web.

Association of Certified Fraud Examiners. (2012). Report to the nations on occupational fraud and abuse – 2012 global fraud study. Web.

Burnett, R., Margolis, D., & Elder, J. (2012). Cash and fraud: A destructive alliance revisited. Journal of Corporate Accounting & Finance, 24(1), 45 – 56.

Galloni, A., Mollenkamp, C., & McDermott, D. (2003). Scandal at Parmalat broadens: Staff may have destroyed files. Web.

Gambrell, R. (2007). Six ways to prevent cash receipt fraud. ColoradoBiz, 34(4), 12.

Kremer, D. (2008). How employees commit fraud via cash schemes. Westchester Country Business Journal, 47(12), 11.

Sheth, N., Range, J., & Anand, G. (2009). Corporate scandal shakes India. Web.

The Federal Bureau of Investigation. (2013). Bookkeeper sentenced to prison for fraud and aggravated identity theft. Web.