Common Fraud Scenarios

This page provides illustrations of different types of frauds and how such frauds
could be perpetrated. The focus of your assessment should be on those
programmes 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 theft

Expenditures and liabilities incurred for improper or illegal purposes

e.g., bribery and corruption payments that can result in reputation loss

Fraudulently obtained revenue and assets and/or avoidance of costs and

expenses e.g., scams and tax fraud that can result in reputation loss

Using the four categories of fraud listed above, the common fraud scenarios can
be summarised as follows:
1) Fraudulent financial reporting:

Earnings management
Improper revenue recognition

Overstatement of assets

Understatement of liabilities

Fraudulent journal entries

Round-trip or wash trades

2) Misappropriation of assets:

Billing schemes
Collusion

Concealment

Forgery

Ghost employees

Cross-firing

Teeming and Lading (Lapping)

Misapplication

Payroll fraud

Theft

3) Expenditures and liabilities incurred for improper or illegal purposes:

Bribes
Conflicts of interest

Kickbacks

Concealment

Money laundering

4) Fraudulently obtained revenue and assets and/or cost and expenses illegally
avoided:

Concealment
Scams

Tax fraud

These common schemes and scenarios can occur in any industry. However, the
way such frauds are perpetrated might be industry specific. An example of how
scenarios may be used is as follows:

Identify relevant scenarios that could potentially occur within the

organisation, resulting in a material impact on the financial statements.
For each identified scenario, describe how it would be perpetrated within
the organisation, the individuals who could make it happen and the
financial statement accounts that would be affected.

Based on the documented scenarios, identify the controls that would

prevent, deter or detect each scenario.

Compare the controls in place with the controls documented above and
identify any gaps.

Develop action plans to remedy significant gaps.

Asset Misappropriations: Fraudulent Payments

In fraudulent payment schemes, an employee makes a distribution of company
funds for a dishonest purpose. Examples of fraudulent payments include

forging company cheques, the submission of false invoices and doctoring

timesheets.
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 payments
are made in the purchasing cycle, larger thefts can be hidden through falsebilling schemes than through other kinds of fraudulent payments. There are
three principal types of billing schemes:

False invoicing via shell companies

False invoicing via non-accomplice vendors

Personal purchases made with company funds.

Bribery
Bribery schemes generally fall into two broad categories: kickbacks and bidrigging 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 over-billing 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.
Collusion
One way to obtain approval of a fraudulent timesheet is to collude with a
supervisor who authorises timekeeping information. In these schemes, a
supervisor knowingly signs false timesheets 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 upon as a control to assure
proper timekeeping.
Concealment - Fictitious Sales and Accounts Receivable (Debtors)
When the perpetrator makes an adjusting entry to the stock and cost of sales
accounts, there is no sales transaction on the books that corresponds to these
entries. In order 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 Stock and Other Assets

Writing off stock 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 stock records, either changing
the perpetual inventory or miscounting during the physical stock-take.
Alternatively, some employees try to make it appear that there are more assets
present in the warehouse or stockroom than there actually are. Empty boxes, for
example, may be stacked on shelves to create the illusion of extra inventory.
Conflicts of Interest
An employee or agent is put into a position of self-dealing. One example would
be if an accountant of an organisation set up an off-balance sheet entity, which
he managed and transacted business with, thereby becoming personally
enriched. This scenario compromises the internal control structure because
independent parties are not bargaining at arms length with each other.
Earnings Management
The pressure to meet or beat targets may lead management to engage in dubious
practices such as restructuring charges, creative acquisition accounting,
misapplications of accounting principles, and the premature recognition of
revenue.
Insistence on aggressive application of accounting principles, of always being
on the edge and on applying soft methods allowing for a lot of leeway 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.
Forgery
When using this method, an employee typically withholds his or her timesheet
from those being sent to the supervisor for approval, forges the supervisors
signature or initials, and then adds the timesheet to the others being sent to the
payroll department. The fraudulent timesheet arrives at the payroll department
with what appears to be a supervisors approval and a payment 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 supporting documentation

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 and/or 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 inter-company
accounts to hide expenses, and/or the capitalisation of costs that should be
expensed.
Ghost Employees
The term ghost employee refers to someone on the payroll who does not actually
work for the victim company. Through the falsification of personnel or payroll
records a fraudster causes payments to be generated to a ghost. The fraudster
or an accomplice then converts these payments. The ghost employee may be a
fictitious person or a 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
Organisations sometimes try to enhance revenue by manipulating the
recognition of revenue. Improper revenue recognition entails recognising
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, holding the books open until after shipment so that the sale can be
recorded in the desired period.
Lapping (or teeming and lading)
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 fraudsters version of robbing Peter to
pay Paul.
Theft
Stealing, taking and carrying, leading, riding, or driving away anothers personal
property, with intent to convert it or to deprive the owner thereof. For the
purposes of classifying asset misappropriations, the term is meant to refer to the
most basic type of asset theft, the schemes in which an employee simply takes
an asset from the company premises without attempting to conceal the theft in
the books and records. In other fraud schemes, employees may create false
documentation to justify the shipment of merchandise or tamper with records to
conceal missing assets.

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.
Overstatement of Assets
Areas where assets can easily be overstated include stock valuation, accounts
receivable and fixed assets:

Stock valuation the failure to write down obsolete stock and the
manipulation of physical counts
Accounts receivable fictitious receivables and the failure to write-off
bad debts
Fixed assets capitalising 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 payment. In payroll schemes, the perpetrator typically falsifies a
timesheet or alters information in the payroll records. The major difference
between payroll schemes and billing schemes is that payroll frauds involve
payments 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, pre-arranged buy-sell trades with the same counter-party, at the
same price and volume, and over the same term, resulting in neither profit nor
loss to the either transacting party.
Skimming
Skimming is the removal of cash from a victim entity prior to its entry in 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 organisations 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.
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.
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.