In our introduction to this series, we wrote that the war on government fraud starts with the five components of internal control known as the Committee of Sponsoring Organizations (COSO) framework. Internal controls are the foundation every government needs to ensure fraud can be detected and prevented, internally and externally. This article will continue the discussion by highlighting areas in which every government should apply this framework.
Accounts Payable: Money leaving while going unnoticed
One of the most vulnerable accounts in need of control activity is Accounts Payable. Accounts Payable is a department highly targeted in fraud manipulations. In fact, the largest municipal fraud scheme in United States history occurred through the accounts payable department. As discussed in our previous article, Rita A. Crundwell was the Comptroller and Treasurer for Dixon, Illinois from 1983-2012. During her 22 year-long stint, she managed to embezzle $53.7 million from the city. Through the submission of false state invoices and checks payable to herself, she was able to net $2.5 million annually to fund her lavish lifestyle and a champion horse breeding operation.
At the time, Dixon, Illinois’ government lacked the proper internal controls to discover Crundwell’s deposits to a fraudulent fund to which she was the only signatory. This scheme went unnoticed for over two decades, until an employee happened to stumble across the fraudulent account during Rita Crundwell’s extended vacation. The fake fund revealed over 150 transactions defrauding Dixon, IL. The employee notified the mayor, resulting in a six-month long FBI investigation that concluded with Rita Crundwell’s arrest and later sentencing to 19.5 years in prison. While justice may have been served, the transgressions committed could have been avoided with the proper oversight and account awareness.
The following are risks, red flags and best practices to observe in a governmental accounts payable operations.
RISKS |
RED FLAGS |
BEST PRACTICES |
|
General Guidance |
Fraud involving cash expenditures can involve substantial amounts and come in many forms. |
Understand the security features of your accounting system. Update the job descriptions of accounts payable employees to ensure segregation of duties. Analyze accounts payable transactions regularly with data mining tools. Have an annual review of the accounts payable function by an internal control expert. |
| Duplicate Payments |
Payments for the same amounts or to the same vendor for the same amount (Other than normal recurring payments). Expenditure in excess of budgeted or normal amounts. Credit balances in the accounts payable subsidiary ledger. |
If permitted by policies and laws, convert payments to ACH or other electronic methods. These take more time to establish so are less likely to be fraudulent. |
| Kickback Scheme | Consistent preferential (early payments to one vendor.
Vendor invoices that are not folded as if they came in the mail. Sequential invoice numbers from the same vendor or invoice numbers with an alpha suffix. Payments based on invoice copies, not originals. Vendor invoices are received by a department other than accounts payable. |
Segregate check writing and checking account reconciliation.
A tax ID on the vendor invoice can indicate the legitimacy of the invoice. Segregate duties between processing accounts payable invoices and updates to the vendor master files. |
| Misdirected Payments | No proper documentation or approval of additions, changes, or deletions to the vendor master file.
Vendor addresses do not agree with vendor approval application. |
A policy that all vendor master file changes to name, address and bank accounts are submitted by an authorized vendor signatory and approved by a government signatory.
Segregate duties between processing accounts payable invoices and updates to the vendor master files. |
| Overpayments | Excessive purchases of unneeded items.
Frequent shipments to P.O. Boxes. Weekend or holiday delivery dates on invoices. Same person signs both the purchase order and the receipt. |
Use data analytics tools to analyze and compare data on vendors, employees and transactions.
Reconcile checking accounts promptly. Maintain blank check stock and signature stamps securely with limited access. Centralize check writing to minimize the need to review. Immediately notify the bank when check signature authorizations change. |
Applying Best Practices
Accounts payable fraud occurs in many different ways. The most effective ways to mitigate these risks with internal controls is through monitoring and segregation of duties among employees to reduce any chance for collusion and mitigate losses. Best practices would include strict processes for approving payments and having multiple levels of approval to ensure the payment is legitimate. All of these best practices would ensure that the government has established a robust system of internal control in line with the Committee of Sponsoring Organizations (COSO) framework. In the next article in this series, we will present the risks, red flags, and best practices for accounts receivable.
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Recommended Resources:
Association of Government Accountants (AGA) https://www.agacgfm.org/Tools-Resources/intergov.aspx