Altered Checks: A Fraud Scheme
Some fraudsters steal money with altered check payees.
As a kid I once threw a match in a half-gallon of gasoline—just to see what would happen. I quickly found out. In a panic, I kicked the gas container—a plastic milk jug—several times, thinking this would somehow kill the fire. But just the opposite happened. And when my father found out, something else was on fire.
Some accounting weaknesses create unintended consequences. Show me an accounting clerk who (1) can sign checks (whether by hand, with a signature stamp, or with a computer-generated signature), (2) posts transactions to the accounting system, and (3) reconciles the bank account, and I will show you another combustible situation. Here’s how one city clerk created her own blaze.
Altered Check Example
Using the city’s signature stamp, the clerk signed handwritten checks made out to herself; however, when the payee name was entered into the general ledger (with a journal entry), another name was used—usually that of a legitimate vendor.
For example, Susie, the clerk, created manual checks made out to herself and signed them with the signature stamp. But the check payee was entered into the accounting system as Macon Hardware (for example). Also, she allocated the disbursements to accounts with sufficient remaining budgetary balances. The subterfuge worked as the expense accounts reflected appropriate vendor activity and expenses stayed within the budgetary appropriations. No red flags.
The accounting clerk, when confronted with evidence of her deception, responded, “I don’t know why I did it, I didn’t need the money.” We do a disservice to accounting employees when we make it so easy to steal. Given human nature, we should do what we can to limit the temptation.
How?
Controls to Lessen Check Fraud
First, if possible, segregate the disbursement duties so that only one person performs each of the following:
• Creating checks
• Signing checks
• Reconciling bank statements
• Entering checks into the general ledger
If you can’t segregate duties, have someone (the Mayor, a non-accounting employee, or an outside CPA) review cleared checks for appropriateness.
Secondly, have a second person approve all journal entries. False journal entries can used to hide theft. With sleight of hand, the city clerk made improper journal entries such as:
Dr. Cr.
Supply Expense $5,234
Cash $5,234
The check was made out to Susie, but the transaction was, in this example, coded as a supply expense paid to Macon Hardware. You can lessen the risk of fraud by preventing improper journal entries.
Thirdly, restrict access to check stock. It’s wise to keep blank check stock locked up until needed.
Finally, limit who can sign checks, and deep-six the signature stamp.
A Fraud Test for Auditors
Here’s a word to external auditors looking for a fraud test idea (or those just looking for check fraud): Consider testing a random sample of cleared checks by agreeing them to related invoices.
Work from the cleared check to the invoice. It is best for the auditor to pull the invoices from the invoice file; if you ask someone in accounting to pull the invoices, that person might create fictitious invoices to support your list (not hard to do these days). If the payee has been altered, you will, in many cases, not find a corresponding invoice. Pay particular attention to checks with company employees on the payee line.
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Alan, good thinking. Sad that many banks these days don’t provide cleared checks. Clients should be looking at the payees on cleared checks as well.
When testing cash disbursements during an audit, I always obtain the cleared checks or check images and vouch to source documents. Makes life easier and you never know what you may stumble upon without trying.
Very good point Jim. I think most small business owners never consider that falsified checks can clear their accounts.
When clients ask why they need to review the bank statement, because they sign all checks, I reply “you sign all the checks you sign, but do you sign all the checks that clear the bank?” It usually gets them to think.
Yes Margaret. Thank goodness for those “few honest people left.”
As a bookkeeper for different companies at different times I can attest that internal theft is a common concern. Segregation of duties is helpful, but usually to only large companies. Smaller companies need independent audits. Of course there are a few honest people left out there.
That concentration is a free ticket to theft. Too bad this happens all too often.
It is true; an accounting clerk with such functions concentration is most tempting. I always have paid attention to the functions segregation, and always have made test of the disbursements.