Auditors typically view property and equipment as a low – risk area. However, the opportunity for a significant fraud in a one-time transaction is actually high. The purchase of a building at an inflated price from a related party can cause significant losses. Long-term leases with an undisclosed senior manager can cause adverse publicity to the corporation. The misuse of corporate assets by a senior executive may be indicative of a disguised compensation scheme or a case of bribery where the funds may be used to bribe government officials. The nature of these schemes requires greater scrutiny by auditors.
This post discuss examination of asset fraud: theft of asset, red flag on theft of asset, asset theft audit cycle, and asset fraud schemes. Enjoy!
Theft Of Assets
One popular fraud scheme is the theft of assets associated with employees. Vendors and outside parties also may be involved in these schemes, but that is beyond the scope of this text. Audits of asset theft cases involve two parts:
- Part-1. Establish the internal employee responsible for the theft of the asset.
- Part-2. Determine the extent of the loss attributable to the theft.
The strategies for auditing theft are to catch the person in the act of the theft, obtain a confession from the party, obtain statements from witnesses, or obtain a statement from the person who purchased the asset from the perpetrator. The nature of the scheme does not lend itself to normal auditing techniques. Typically, investigative techniques are required.
Once an audit begins, the perpetrator is put on notice that the scheme has been detected. At that point, the perpetrator typically stops stealing. Unlike an embezzlement case were the fraudulent act is documented in the business records, once the person stops stealing, catching him or her in the act becomes difficult.
The red flags of theft vary by the nature of the scheme, but some typical signs include:
- Inventory variances resulting from physical counts
- Stock outages when the inventory records indicate sufficient quantities
- Drops in margins
The concealment of the theft will vary by the nature of the asset taken in a theft scheme. Concealment can include write-off of the asset as scrap, obsolescence, missing, donated, or destroyed. These normal day-to-day business activities can be used to conceal the theft of assets:
- Write – off of the asset through shrinkage
- Assets that are used in the normal course of business
- Labeling the movement of the asset as customer adjustment, no charge, promotional, transfer, or internal consumption
- Movement of assets between two control points with no documentation supporting the transfer
- Acceptance of goods without documentation or creating false documentation to support the receipt of the goods
- Creating false work orders
- Creating false receiving reports as to quantity, quality, or specifications (Assets that are consumed in the course of normal business are susceptible to this concealment strategy.)
- Creating fictitious credits to hide the shortage
- Nonbilling of the asset sale
- False inventory counts or alteration of records after the physical count
Theft Audit Cycle
Understanding the theft cycle is the key to investigating the occurrence of the fraud scheme. A discussion of the stages of the theft cycle follows.
Theft – “Theft” is defined as the physical movement of the asset from the company to the employee ’ s control. Employees may remove the asset:
- In the normal course of their duties
- During normal work hours
- In an off – hour scheme
Theft point – Assets may be diverted before or after the company takes possession. If the asset is diverted before possession, it usually is indicative of weaknesses in the receiving function. Diversion after possession is indicative of weaknesses in physical security controls.
Parties to theft – The theft may occur through employees, an accomplice, or a fictitious vendor or customer.
Concealment – This stage refers to how employees conceal the theft or misuse of the asset. The schemes range from nothing to creating internal documents to reflect a sale, transfer, or obsolescence of an asset.
Time – The amount of time between the theft and identification of the loss is a subset of the concealment phase.
Normal course of business – Supplies and inventory by their nature are consumed in the normal course of business. The consumption of the product becomes part of the concealment because the asset cannot be examined.
Conversion – In this phase, employees convert the asset to economic gain. In misuse cases, the conversion is the use of the asset. In theft, the conversion is the personal use or resale of the asset.
Likelihood – Auditors are not searching for the employee who uses a company pencil for personal use. Auditors need to assess whether an employee or group of employees could divert significant assets.
Opportunity – The type, nature, and extent of the asset conversion will impact this phase. In the simplest form, the employee walks out of the company with the asset.
Misuse – “Misuse” refers to business assets that are used for personal use or to bribe customers or government officials. In government contracts, the asset is purchased for a specific purpose but is used for nongovernmental contract purposes. These areas are typical for misuse fraud cases:
- Real estate, such as apartments and storage facilities
- Transportation assets, such as vehicles, air transportation, or boat transportation
- Office equipment
- Equipment and tools
- Assets used in other businesses
Other Asset Fraud Schemes
Some typical fraud schemes associated with assets are highlighted below.
No Business Use of the Asset Scheme – In this scheme, the asset acquired has no legitimate business purpose. The asset may be a disguised compensation scheme for a senior executive or an asset used to bribe customers or politicians. Auditors should search for assets or leases that would have a personal inurement value. The audit procedure is to inquire as to use, inspect the assets, or the verify logs documenting the use.
Excessive Expenditure Scheme – In this fraud scheme, the asset is acquired for a valid business purposes, but its cost exceeds the utility requirement of the organization. The New York City apartment in the Tyco case illustrates this fraud scheme. In terms of executive management, the Tyco scheme is a form of disguised compensation. The audit procedure is to determine by whom and how the asset is being used, understand the comparable costs, and ensure there is a reporting mechanism for the use of the asset.
Asset Purchase Scheme – In the asset purchase scheme, the asset is acquired from a related party without disclosure at an inflated price. Real estate flips are often associated with this scheme. The property changes hands several times to artificially increase the perception of the market value. This scheme is associated with kickback schemes. The audit procedure is to focus on the sales history of the asset and to what parties.
Asset Retirement Scheme – In an asset retirement scheme, the asset is intentionally sold below fair market value. The purchaser then either retains it for personal use or resells it at fair market value. Company automobiles are often associated with this fraud scheme. In one instance, a company – leased vehicle had zero miles usage for the two – year lease. The manager responsible for the lease purchased the car from the vendor at the end of the lease period. In essence he purchased a new car at a price of a two – year – old car.