Fraud CPA discusses False Vendor Schemes

Fraud CPAs know that employee theft is a sad fact of life. False vendor schemes show good ingenuity on the employee’s part. The nature of false vendor schemes skews data. Only the clumsy schemes get caught and even then some companies keep that info confidential. How pervasive are false vendor schemes? Hard to say, but when they’re revealed the losses are staggering and can even force the victim company to fold.

I think most fraud CPAs agree that false vendor schemes are opportunistic. An employee becomes disgruntled. S/he notices some flaw in the company’s internal controls. And then deliberately exploits it.

I think most fraud CPAs agree that everyone will steal under the right circumstances. In Grad school I was grilled on my ethics. No I wouldn’t take money if the bank leaves the vault open. Disliking my employer wouldn’t inspire me to steal for vengeance. But if my child was sick I’d do almost anything. And yes, I consider myself normal.

False Vendor Schemes

• An employee sets up a shell company. This might be as a Corporation through the State or a DBA through the County.
• Then the employee bills your company for goods and services.
• Your company pays the invoice.

Plenty of false vendor scheme variations exist.

Example 1, Inventory Fraud

• Your inventory supervisor sets up a shell company (the false vendor).
• The supervisor personally buys inventory that your company actually uses, for the false vendor (the shell company).
• The supervisor then sells that same inventory to your company at a profit.
• When you pay the invoice from the shell company, the supervisor then pays off the original purchase.
• Notice that even a physical inventory count won’t detect this.

Examples of fraud prevention and detection:

• Establish an authorization process for approving a new vendor with another manager not directly involved in the inventory process. This isn’t fool proof. The approving manager may just rubber stamp all new vendor requests. The possibility of collusion exists.
• Setup an invoice approval process?
• Train the accounts receivable department to detect fraudulent invoices. Are they unfolded? Is the address a PO Box? Does it look like a typical invoice? Are invoice numbers sequential? Is the address the same as an employee’s? Is it hand written?
• Require another employee to sign off on inventory POs (purchase orders). But the inventory supervisor could forge that second signature.
• The accounting department can run a vendor analysis and verification, perhaps to spot more purchases being made through a single vendor. But the longer this false vendor scheme operates, the harder it is to catch.

“Some fraud is so hard to detect, that external Auditors use a disclaimer stating they might miss it. Good internal controls reduce chances of fraud. Don’t leave barn door open.”
- Gary Bode, fraud CPA

Example 2, an IT scam

• Your IT department can’t handle everything in-house. Some circumstances require service from a specialist. Maybe these services are performed remotely, making the trail murky.
• Secondary to the mysterious nature of IT maintenance, other employees don’t have a clue on what IT does.
• The head IT creates a shell company to set up a false vendor.
• S/he produces invoices for services s/he performs themselves. Or creates problems for the false vendor to fix.

Examples of fraud detection and prevention

• Compare IT costs to the budget. Ask IT about variances.
• Compare invoices from the consultant. Sequential numbering? Always the same problem being serviced?

Ask your CPA to help you prevent fraud through internal controls. If you don’t have a CPA that worries about fraud, consider calling us for a free meet and greet phone call. We’ve got a virtual office to serve your company wherever it’s located. (910) 399-2705.