Detection of Billing Schemes

Because there are many variations of billing schemes, there are also several detection methods. Detection methods are most effective when used in combinations. Each detection method is likely to point out anomalies that can then be investigated further to determine if a fraud scheme has occurred or is currently underway. Additionally, the detection methods will point out the weaknesses in internal controls and alert the auditor to potential opportunities for future fraud schemes.

Analytical Review

A review of the various general ledger accounts might reveal unusual or unexpected events. These events could be undetected purchasing fraud. For example, a comparison of inventory purchases in relationship to net sales might indicate that purchases are too high or too low for that level of sales. This might be a red flag that indicates excess purchasing schemes or fictitious sales schemes.

Another analytical method uses a comparison of the inventory purchases of prior years with those of the current year. This comparison might indicate that an overbilling scheme or a duplicate-payment scheme is in progress.

Analyses such as those described previously can be performed for any acquisition of a company’s goods or services. Analytical reviews are most effective in detecting fraud schemes that are large because the anomalies will be apparent. Other detection methods are more effective for fraud schemes that are smaller in relationship to the financial statements taken as a whole. Regardless of fraud size, examination of source documentation will be necessary. When an anomaly is detected, further investigation is required, which will demand an examination of source documentation.

Computer-Assisted Analytical Review

The computer can assist the auditor in determining the presence of unusual patterns in the acquisition or purchasing function. The computer can provide the auditor with a matrix of the purchasing activity to determine the presence of unusual patterns. An analysis of the following data might uncover billing schemes:

FRAUD SCHEME DETECTION METHOD
Fictitious vendors Vendors and employees with matching addresses More than one vendor with the same address Vendors with only PO Box addresses
Overbilling Unusual or “one-time” extra charges
Conflict of interest Vendors with employees who are employee family members

An unusually high occurrence of complaints

Complaints about specific vendors

Higher prices or substandard quality

Statistical Sampling

As with inventory, the source documentation for purchases can be statistically sampled and examined for irregularities. Statistical samples can be drawn to test specific attributes. This detection method is particularly effective if a single attribute is suspected, such as fictitious vendors. A listing of all PO Box addresses might reveal fictitious vendors.

Vendor or Outsider Complaints

Fraudulent schemes will often unravel because a vendor or other outsider complains to the employer or company. Complaints from customers, vendors, and others are good detection tools that can lead the fraud examiner to further inquiry.

Site Visits—Observation

A site visit will often reveal much about the internal control, or lack thereof, for any location. The observation of how the accounting transactions are actually transcribed will sometimes alert the fraud examiner to potential problem areas.

Sample Audit Programme

The following audit programme might be beneficial in detecting red flags of billing schemes:

  • Does the company have a purchasing department? If yes, is it independent of (1) the accounting department, (2) the receiving department, or (3) the shipping department?
  • Are purchases made only after the respective department heads sign purchase requisitions?
  • Are purchases made by means of purchase orders sent to vendors for all purchases or only for purchases over a predetermined dollar limit?
  • Do purchase orders specify a description of items, quantity, price, terms, delivery requirements, and dates?
  • Is a list of unfilled purchase orders maintained and reviewed periodically?
  • Are purchase order forms prenumbered and is the sequence accounted for periodically?
  • Does the client maintain an approved vendors list?
  • Are items purchased only after competitive bids are obtained? If so, are competitive bids obtained for all purchases or only for purchases over a predetermined dollar limit?
  • Is a log maintained of all receipts?
  • Does the receiving department prepare receiving reports for all items received? If yes, are receiving reports (1) prepared for all items, (2) prepared only for items that have purchase orders, or (3) renumbered?
  • At the time the items are received, does someone independent of the purchasing department check the merchandise before acceptance as to description, quantity, and condition?
  • Are copies of receiving reports (1) furnished to the accounting department, (2) furnished to the purchasing department, or (3) filed in the receiving department?
  • Are receipts under blanket purchase orders monitored, and are quantities exceeding the authorised total returned to the vendor?
  • Are procedures adequate for the proper accounting of partial deliveries of purchase orders?
  • Are purchasing and receiving functions separate from invoice processing, accounts payable, and general ledger functions?
  • Are vendors’ invoices, receiving reports, and purchase orders matched before the related liability is recorded?
  • Are invoices checked as to prices, extensions, footings, freight charges, allowances, and credit terms?
  • Are controls adequate to ensure that all available discounts are taken?
  • Are purchases recorded in a purchase register or voucher register before being processed through cash disbursements?
  • Does a responsible employee assign the appropriate general ledger account distribution to which the invoices are to be posted?
  • Are procedures adequate to ensure that invoices have been processed before payment and to prevent duplicate payment (e.g., a block stamp)?
  • Does a responsible official approve invoices for payment?
  • Are procedures adequate to ensure that merchandise purchased for direct delivery to customers is promptly billed to the customers and recorded as both a receivable and a payable?
  • Are records of goods returned to vendors matched to vendor credit memos?
  • Are unmatched receiving reports, purchase orders, and vendors’ invoices periodicallynreviewed and investigated for proper recording?
  • Is the accounts payable ledger or voucher register reconciled monthly to the general ledger control accounts?
  • Are statements from vendors regularly reviewed and reconciled against recorded liabilities?
  • Do adjustments to accounts payable (e.g., writing off of debit balances) require the approval of a designated official?
  • Are budgets used? If yes, are budgets approved by responsible officials, and are actual expenditures compared with budgeted amounts and variances analysed and explained?
  • If excess inventory purchasing is suspected, verify that all inventory purchased was received (receiving report) at the proper location. An examination of receiving reports or invoices might reveal alternate shipping sites.

Prevention of Billing Schemes

The prevention of billing schemes can be especially difficult. Purchasing personnel are often held to a different standard than other employees of a company. For example, sales people often are given inducements or perquisites to persuade potential customers. These same inducements are offered to the purchasing personnel of the company from the company’s vendors. And yet, the company expects the purchasing personnel to perform their function without bias and to make decisions that are in the company’s best interest, without regard to the inducements offered by suppliers. Additionally, the personnel involved in the purchasing and payment functions are generally not compensated on a basis commensurate with their performance, as are salespeople. Therefore, there is a reverse incentive to perform in the company’s best interest.

Probably the most effective prevention measure for billing schemes is education and training of the purchasing and accounts payable personnel. The second most effective prevention measure is an objective compensation arrangement with people responsible for purchasing decisions.

Education (Training)

Purchasing personnel should be trained thoroughly in ethical situations. As an additional deterrent to fraud, companies might consider enrolment and certification in a certification programme for purchasing managers and employees.

Compensation

People responsible for the purchasing decisions (buyers) should be paid well enough to reduce the motive and rationalisation for fraud. Auditors can examine the compensation of purchasers and determine if any buyers were recently passed over for raises. This might be an indication of discontent that could lead to the formation of a fraudulent scheme against the employer.

Proper Documentation

Proper documentation for purchasing should include prenumbered and controlled purchase requisitions, purchase orders, receiving reports, and cheques.

Proper Approvals

Before adding a vendor to the list, there should be an investigation of the “proposed” vendor, performed by someone other than the personnel in purchasing and accounts payable. If a vendor number is required before payment is made and the personnel responsible for the investigation assigns the vendor that identification number, then the buyer cannot place fictitious vendors on the list. Large or unusual purchases should be approved by someone independent of the purchasing department.

Separation of Duties

For the best results and accountability, each company sufficient in size should have a separate purchasing department. Regardless of the company size, the purchasing function should be separate from the payment function.

Hotlines

When possible, companies should implement a hotline function to provide a forum for complaints and fraud tips by employees and outsiders.

Competitive Bidding

Ensure that bid policies and procedures are thoroughly reviewed. Whenever possible, enforce competitive bidding. Competitive bidding is a transparent procurement method in which bids from competing contractors, suppliers, or vendors are invited by openly publicising the scope, specifications, and terms and conditions of the proposed contract as well as the criteria by which the bids will be evaluated. Competitive bidding aims to obtain goods and services at the lowest prices by stimulating competition, and by preventing bias and fraud.

After the bidding process has been completed, a questionnaire can be sent to successful and unsuccessful bidders. This questionnaire can reveal areas that will make the bidding process more effective and can provide a forum for bidders to express concerns over questionable or fraudulent activities.

Prevention Checklist

The following is a list of billing scheme prevention methods that might be helpful in the deterrence of billing fraud:

  • Authorisation procedures of purchase orders, invoicing, and payments should be documented and adhered to.
  • The accounts payable list of vendors should be periodically reviewed for strange vendors and addresses.
  • Payment codings should be reviewed for abnormal descriptions.
  • Vendor purchases should be analysed for abnormal levels on both a monthly and yearly basis.
  • Purchases and inventory levels should be compared and analysed.
  • Control methods to check for duplicate invoices and purchase order numbers should be in place.
  • A separation of duties between authorisation, purchasing, receiving, shipping, and accounting should be in place.
  • Payment of vouchers should be periodically reviewed to ensure integrity of proper documentation.
  • Receiving and shipping reports should be reviewed for completeness and accuracy.
  • Asset information should include purchasing trails and other information.
  • Journal entries to inventory accounts should be strictly scrutinised.
  • Appropriate bank reconciliation and review procedures should be performed periodically, checking for out-of-place vendors and endorsements.
  • Credit card and purchasing card statements should be reviewed often for irregularities.
  • The validity of invoices with a PO Box address should be verified.
  • Proper controls for the receipt and handling of “return to sender” cheques should be installed.

Detection of Billing Schemes
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