Accounts Payable Fraud: Definition, Types, Detection and Prevention Methods

Companies of all capacities should be hyperaware of their financial transactions and take steps to limit and respond to fraudulent payments and activities to safeguard their financial assets and security. A lack of attention to this could put companies at risk for accounts payable fraud, which could have a negative affect on their reputation and financial health. This blog on "10 Ways to Identify Accounts Payable Fraud" uncovers a few kinds of stuff you can try to tighten up your AP audit.

What is Accounts Payable Fraud?

The accounts payable services, responsible for paying suppliers and other vendors, is a common target for this fraud. Employees and vendors can commit fraud in the accounts payable department, the two working together, or by an outside party who wants to access the company's accounts payable systems.

Every business feels the effects of fraud. The Association of Certified Fraud Examiners (ACFE) says a typical organization loses 5% of its revenue annually to fraud, with a median loss of $125,000. (ACFE). An average of $8,300 a month is lost due to fraud that goes unknown for 14 months.

What Are the Mechanisms of Accounts Payable Fraud?

ACFE's fraud tree classifies accounts payable fraud as "asset misappropriation." Most typical forms of occupational fraud include these.

Payment schemes, check to tamper, and expenditure reimbursement schemes are the most typical fraudulent disbursements in the accounts payable services.

An employee running a billing scheme under the guise of a fictitious company could submit false invoices. For non-physical items, like consulting services, this can be a simpler scam to pull off. Employees can keep the money stolen from their employer's bank account by forging checks. Overbilling or double billing for services is a fraud that suppliers might do to pocket the extra money.

‍**AP frauds are numerous, but firms can take preventative measures to minimize their exposure. So our first stop should examine some ways to identify accounts payable fraud.

Accounts Payable Fraud Schemes/Types in an Organization

Accounts payable fraud in organizations can take various forms, often exploiting weaknesses in internal controls and processes. Here are some common accounts payable fraud types:

• Fictitious Invoices: Perpetrators create invoices for nonexistent goods/services and process them for payment. They exploit lax controls to slip these through unnoticed, pocketing funds intended for non-existent vendors.
• Billing Schemes: Collaborating with vendors to submit inflated invoices or duplicate bills, diverting excess funds to personal accounts. They manipulate billing systems to deceive auditors and exploit weak oversight.
• Check Tampering: Altering or forging checks meant for legitimate vendors, rerouting funds to personal accounts. Perpetrators exploit loopholes in payment approval processes, using forged signatures or altering payee details undetected.
• Expense Reimbursement Fraud: Fabricating or inflating expenses with false receipts to claim reimbursement. They exploit decentralized approval processes, submitting fictitious expenses or inflating legitimate ones for personal gain.
• Kickbacks: Receiving bribes or kickbacks from vendors in exchange for inflating contract prices or granting preferential treatment. Perpetrators manipulate procurement decisions, enriching themselves while compromising fairness.
• Ghost Employees: Adding nonexistent employees to the payroll, diverting their wages to personal accounts. They exploit weak HR controls, creating phantom employees to siphon funds unnoticed, often in collusion with payroll administrators.

Ways to Identify Accounts Payable Fraud

1. Duplicate Payments

Duplicate payments are a common form of accounts payable fraud that can significantly impact a company's financial health. This is one of the severe risks in accounts payable and occurs when the same invoice is processed and paid multiple times, either intentionally or due to errors in the payment system. Detecting duplicate payments requires meticulous scrutiny of financial records and transaction history. Implementing automated invoice matching systems, where invoices are cross-referenced with payment data, can help identify discrepancies and flag potential duplicates.

• Medicare: Medicare's Inspector General determined that Medicare paid out $89 million in duplicate payments in 1998.
• Cingular: We have observed that electronic funds payments for TDMA accounts have been debited twice from the customer's checking account when done online.
• Medicaid: It is projected that as much as $31.1 million in further duplicate payments may have been made by Medicaid during our two-year audit period. We found at least $9.7 million in such payments.

Overpaid invoices have prompted many new businesses, including A/P Recap, Automated Auditors, AP Recovery, and ACL and Cost Recovery Solutions. These companies are growing because many people still make the mistake of paying for the same thing repeatedly.

Many software packages can control duplicate invoices, but finding them all requires extensive searching. For example, if you enter the same vendor's invoice number twice in an accounting program, you'll get an error message. A simple "A" in the invoice number or the change of one cent can lead to a payment being made twice. In vendor files, the most typical mistake is to have multiple vendor numbers for the same vendor; this is the most prevalent cause of double payments.

Regularly reconciling bank statements and conducting thorough audits are essential preventive measures. Employees should be educated on the importance of accuracy in invoice processing to minimize unintentional errors. By maintaining a vigilant approach and leveraging technology, businesses can fortify their defenses against duplicate payments and safeguard their financial integrity.

2. Benford's Law: What Is It and Why Is It Important?

Benford's Law is a mathematical principle that can be a powerful tool in uncovering anomalies and one of the potential accounts payable fraud schemes. The law states that in many naturally occurring datasets, the first digit of numerical values is not uniformly distributed but follows a logarithmic pattern. Specifically, smaller digits like 1 occur more frequently than larger digits like 9.

Benford's Law can be applied to analyze the distribution of invoice amounts, payment figures, or other financial data in the context of accounts payable. If the distribution significantly deviates from what Benford's Law predicts, it may indicate irregularities or fraudulent activities, prompting further investigation. This statistical method acts as a red flag for potential fraudulent manipulations of financial data. Implementing Benford's Law analysis as part of routine audits enhances the ability to detect anomalies early and strengthens the overall integrity of financial processes.

Certified fraud examiners utilize various technologies to enhance their ability to detect fraud. Benford's Law, for example, is one of the most common. This mathematical theory says that even if a sequence of numbers appears random, it is likely to be part of a pattern.

‍Alternatively, there is a chance that a particular number will be used in a particular position. For example, 30.1 percent of the time, the number 1 will appear first in payment, such as $1XX. The normal trend is more likely to be broken by payment fraud.

‍AP departments can use Benford's Law to examine their payouts, but it isn't perfect.

3. Splitting the Purchase Orders and Approving the Payments

Splitting the purchase orders and approving the payments is a common method employed in accounts payable fraud schemes. In this fraudulent practice, individuals within an organization manipulate the purchase order and payment approval process to exploit vulnerabilities. Perpetrators may divide a large purchase into smaller, less conspicuous parts to avoid triggering scrutiny thresholds. By submitting multiple smaller invoices, they can bypass the usual approval channels without attracting attention.

Assume an employee has the authority to approve purchase orders and invoice payments totaling $2,000, for example. They are fully aware that no one other than themselves is necessary to sign off on the project. Anything over $2,000 necessitates the approval of higher-level executives. So, how do they handle large fraudulent payments? You can get around the restriction by dividing them into $2,000 chunks.

To combat this type of accounts payable fraud risk, companies should implement robust controls and approval workflows. Automated systems that flag irregularities in the size or frequency of payments can serve as effective deterrents. Additionally, enhancing the segregation of duties, where different individuals are responsible for approving and processing payments, adds an extra layer of security.

‍Data analytics makes it simple to catch this type of scam. Check for any PO approvals or payments within, say, 5% of an individual's authorization limit and are made within a specific time window.

4. Purchases of Goods and Services

It is another avenue susceptible to accounts payable frauds in small businesses and large enterprises. Fraudulent activities may occur when individuals collude with external vendors or create fictitious companies to issue invoices for goods or services that were never delivered. To mitigate this risk, organizations should implement stringent vendor management protocols.

When a manager with purchasing authority orders items or services for their use rather than the organization's, they engage in employee fraud.

‍Searching for consumer or household goods keywords is a simple data analysis test. First, add all the words you think are suspect (e.g., "Home Depot" or "Amazon") and item descriptions (e.g., "garage shelving") to a data table.

Conducting thorough invoice reviews and cross-referencing them with supporting documentation can reveal anomalies. Look for discrepancies in quantities, prices, or suppliers that deviate from established norms. Additionally, implementing a robust vendor management system can help authenticate the legitimacy of suppliers and detect potential fraud. Regularly reconciling purchase orders with received goods and services ensures alignment and can expose any mismatches.

5. Changes to Vendor Master Files That "Flip Flop"

It is a sophisticated accounts payable fraud tactic where malicious actors manipulate vendor information to divert payments. In this scheme, fraudsters make unauthorized alterations to vendor master files, such as bank account details or contact information. They may then submit invoices with the modified details to reroute payments to fraudulent accounts.

Data analytics for fraud detection need not be limited to purchases and payments. Using a vendor's master record, for example, an employee might enter their bank account information. The employee's bank account is credited as a result of this. The employee then goes into the vendor master file and undoes the transaction.

Vendor master change data can detect changes that are reverted within a short period using data analytics. Automated alerts for unusual changes and periodic audits of vendor data can serve as preventive measures. A thorough analysis of historical vendor records and communication channels with vendors can further expose inconsistencies. By remaining vigilant to abrupt alterations in vendor master files, organizations can fortify their defense against fraudulent activities aimed at exploiting vulnerabilities in the accounts payable process. According to a recent study by KPMG, approximately 20% of vendor details in a typical Vendor Master File may be inaccurate. Further analysis by ‘eftsure’ suggests this figure could be as high as 25%.

6. Invoices That Do Not Have Corresponding Receipts

It is a red flag for potential accounts payable fraud, as it suggests discrepancies in the goods or services received compared to what is being billed. Fraudsters may submit invoices for fictitious or non-existent transactions, hoping to exploit weaknesses in the payment approval process.

It's when an employee conspires with a vendor to submit bills for items and services that never existed in the first place. Once the employee has approved, the vendor is paid, and the employee receives a percentage of the proceeds.

The failure to match an invoice with the goods received system can be detected by data analytics in organizations that track the receipt of items using a well-received system. If necessary, a three-way match between a purchase order, goods received data, and an invoice can be performed.

To counteract this risk, companies should implement robust three-way matching procedures, reconciling invoices with both purchase orders and receiving documentation. Automated systems can help flag invoices lacking corresponding receipts for manual review. Regularly reconcile accounts payable records with physical inventory or service delivery reports to identify discrepancies promptly. Additionally, scrutinize the timing of invoice submissions and payments. Delays or inconsistencies in the timeline between invoicing and receipt documentation may signal fraudulent activities. Forbes survey findings indicated that 95% of firms were aware of invoice fraud; however, 25% of finance professionals were unable to estimate its financial impact on their organizations.

7. Products and Services Are Priced Abnormally Expensive

Another critical indicator of accounts payable fraud is when products and services are priced abnormally high. This anomaly often suggests collusion between vendors and internal staff to siphon off funds or inflate expenses for personal gain. Fraudsters might submit invoices with inflated prices for goods or services, hoping to slip through the payment approval process unnoticed.

An employee can work with a vendor to approve inflated purchases in exchange for a bribe from the vendor. A company noticed an invoice for office supplies with a unit cost of $500, significantly higher than the usual $50. Investigating further, they found the vendor inflated prices on multiple invoices. This alerted the accounts payable team, preventing a potential loss of $45,000 before payments were processed.

Analysis can compare the average prices paid for goods and services among a wide range of vendors that offer identical products. To address this risk, companies should establish clear and standardized pricing benchmarks for products and services. Regularly compare invoices against these benchmarks to identify any significant deviations. Implementing automated systems that flag unusually high-priced items for manual review can serve as an effective preventive measure.

8. Rounding Is a Common Practice in Accounting

While rounding is a common practice in accounting for the sake of simplicity and efficiency, it can also be exploited as a subtle means of accounts payable fraud. Fraudsters may manipulate rounding practices to skim small amounts from multiple transactions, accumulating substantial illicit gains over time. For such accounts payable fraud detection, establish clear rounding policies and guidelines within your accounting procedures, specifying acceptable rounding thresholds.

Fraudsters, as we already stated, are often clever. Now we must add the qualifier "not always" to that. For example, they may process an invoice or payment in a way that isn't consistent with normal business practices, such as rounding the amount. Transactions can, of course, be rounded to the nearest whole number. However, rounding up in payment systems is rare in the real world, especially when considering sales tax and other factors.

‍Using the "round amount" data analytic, you can rapidly identify any amount that finishes in an unusually long string of zeros. A MOD function is often used to check whether a remainder is zero.

Regularly scrutinize financial records, paying attention to patterns in rounding amounts. If disproportionate or consistent rounding anomalies surface, it may indicate fraudulent activities. Implement automated systems that track and flag deviations beyond acceptable rounding limits, triggering thorough reviews.

9. Sequential Invoices

Sequential Invoices are a potential red flag for accounts payable fraud when fraudsters submit invoices with sequential or suspiciously consistent invoice numbers. This tactic may indicate fabricated invoices or irregular billing practices.

It's not uncommon for fraudsters to commit some incredibly foolish errors. As a case study, consider an employee who creates a phantom vendor account, invoices phony items and services, and does not consider how invoice numbers develop in the real world.

To detect and prevent such fraud, companies should implement automated systems that flag unusual invoice numbering patterns for manual review. Regularly scrutinizing invoice sequences, cross-referencing with purchase orders, and conducting thorough audits can help uncover discrepancies and enhance fraud detection mechanisms.

10. Vendors Who Have Returned or Canceled Checks

One key indicator of potential accounts payable fraud is monitoring vendors who have returned or canceled checks. Unusual patterns in check returns or cancellations may signal fraudulent activities within the accounts payable process. If a vendor consistently returns or cancels checks without providing a valid explanation, it could indicate attempts to manipulate payment records or divert funds.

During a typical month in accounts payable, canceled and returned checks are not unheard of. Vendors have an unusually high number of bounced checks, or a trend of bounced checks should be avoided at all costs. As long as the check is returned to the correct person, it's usually a lawful transaction.

For each vendor, divide the number of returned or canceled checks by the total number of checks. Then, to find the most suspect merchants, sort this list by descending percentage.

To identify such discrepancies, businesses should maintain a vigilant reconciliation process, cross-referencing canceled checks with corresponding vendor communications. Additionally, implementing regular communication channels with vendors and promptly addressing any discrepancies in payment records can help mitigate the risk of fraud. Monitoring these anomalies is crucial for maintaining the integrity of the accounts payable system and preventing financial losses due to fraudulent activities.

Conclusion

The ten AP fraud detection analytics listed above are a decent start for most companies. However, it is common to alter processes once a series of very simple analytics have been completed and evaluated for their worth.

Newer ones can replace analytics that doesn't work in practice. I don't mind at all! You can anticipate regularly using a suite of automated analytics within a short period, establishing an important core of an ongoing fraud detection program.

In addition to implementing internal analytics, delegating accounts payable (AP) functions to a trusted third party can fortify fraud detection measures. By leveraging their expertise, businesses can supplement in-house efforts with external scrutiny, enhancing overall fraud detection capabilities.

Invensis, a distinguished accounts payable outsourcing company, stands out for its specialized services in managing and optimizing financial processes. We specialize in invoice processing, vendor management, payment processing, and reconciliation services. Our dedicated team employs advanced technologies to enhance accuracy, efficiency, and compliance in your financial processes. Contact us today to streamline your accounts payable process through advanced technologies!

Frequently Asked Questions

1. How to quickly detect an AP fraud?

Quickly detecting Accounts Payable (AP) fraud involves implementing robust monitoring and detection mechanisms. Regularly reconciling invoices with purchase orders and receipts, conducting surprise audits, scrutinizing vendor records for unusual patterns or changes, and implementing segregation of duties to prevent collusion are the best ways to detect fraud quickly. Automated systems for anomaly detection in transactions, such as unexpected changes in payment amounts or duplicate invoices, can also help swiftly identify and mitigate potential AP fraud.

2. Why are account payables high risk entities?

Accounts Payable (AP) departments are considered high-risk due to their susceptibility to fraud and errors. They handle large transaction volumes, making it challenging to detect fraudulent activities like invoice fraud or unauthorized payments. AP processes involve multiple manual steps, increasing the potential for mistakes or manipulation. Moreover, AP interacts closely with external vendors, posing risks of fictitious vendors or kickback schemes. Effective controls and monitoring are crucial to mitigate these risks and ensure financial integrity.