Fraudsters can steal with inflated invoices. In the story below, you’ll see that a school maintenance director was able to take millions by doing so. Today, we look at how this scheme works and how you can prevent it.
The school maintenance director, Derek Brown, purchases materials from two local hardware stores; also, the school contracts with a nearby electrical services company. Each of these businesses is owned by relatives of Derek. While the school board knows about the familial relationships, they are accustomed to the use of these vendors. After all, it’s been that way for years.
What the board doesn’t know is that Derek often receives inflated invoices from these related parties. For example, if the school orders $30,000 of supplies, it receives an invoice for $45,000. Derek approves the purchase orders, the physical receipt of the goods, and the payment of the invoice. (At times, one of Derek’s assistants counts the physical goods received, but he is party to the fraud as well.) It’s easy for Derek to approve the overstated bills.
Additionally, some of Derek’s business friends (persons doing business with the school) send invoices to the school for services never provided. He approves these payments as well.
About once a month, the related-party vendors pay Derek 50% of the excess billings.
The above fraud example is based (partially) on an ongoing case involving the Floyd County Schools where millions were stolen.
The weakness lies in the lack of segregation of duties. Derek approves:
A contributing element is the school board going to sleep–these types of relationships should be vetted. If no other vendors are available–often the reason for using such local businesses–then additional scrutiny should be brought to bear upon the related payments.
Segregate the duties, especially the purchase order approval. A conflict-of-interest policy should be adopted requiring all school officials and key administrative personnel to disclose questionable relationships. If key conflicts are not eliminated, the related activity should be subject to audit by an outside CPA or Certified Fraud Examiner.
If you work with local governments, you will find my fraud book useful in identifying and preventing fraud. See the book on Amazon by clicking the icon below.
Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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