How can you prevent accounts receivable lapping?

There are several types of accounts receiving fraud, but lapping fraud is perhaps one of the most common and easiest to prevent. It’s a form of employee theft that involves stealing or misappropriating accounts receivable payments.

A typical scheme starts with someone who handles the books pocketing a payment made toward an account receivable. The bookkeeper then takes the next payment received for a second account receivable entry and uses it to cover the first receivable. The third payment gets used to cover the second account receivable and so on. This scheme can continue indefinitely until a receivable gets written off as a bad debt, the employee leaves the company, or the employee gets caught.

For example, imagine you’re a bookkeeper for a very small business, and in addition to recording payments, you handle all incoming cheques, and prepare and make bank deposits.

Customer X sends in a cheque for $1,000 to cover invoice 101. Instead of depositing this cheque, you cash it and keep the money. When Company Y sends in a cheque for $1,200 for invoice 102, you apply this money to the amount outstanding from invoice 101. When Company Z sends in a cheque for invoice 103, you use this cheque to cover the amount outstanding from invoice 102, and so on.

Lapping occurs most frequently in smaller businesses when just one employee handles cash and accounting tasks. As an accountant, you’re in the best position to understand this crime and advise clients how to prevent it. Conducting internal audits can reveal irregularities, especially if they’re done on a regular basis, such as monthly. Your firm can also hire a professional auditor or forensic accountant to conduct annual reviews or investigate irregularities.

Instituting controls that prevent lapping from occurring are another solution. These can include:

• Stamping all cheques “For Deposit Only” so they can’t be cashed
• Having someone other than the cashier send statements to customers, or sending automatically generated receipts
• Matching incoming cheques to invoices and imaging the two
• Splitting up receiving, recording, and deposit duties
• Having customers pay directly to a lock box service
• Maintaining tight control over who can write off bad debts

Since some small businesses may operate on a razor-thin margin, your advice and expertise can make all the difference for your client staying in business and continuing to be your client.

The sale has been made, the customer has paid, yet the company receives no revenue. How can this happen?

Accounts receivable fraud, commonly referred to as “lapping,” occurs when an employee is entrusted with processing customer payments but then steals the money for his or her personal needs. Once a lapping scheme begins, subsequent checks are used to cover the missing checks. The employee generally must continually monitor accounts so he or she can steal from one customer to pay others.

Depending on the volume of checks received, a lapping scheme can be initiated and maintained over a number of months or even years. The losses can be significant. Not only will the company be a victim of fraud, your customers can also become involved. In order to reconstruct the fraud and ensure that all payments are appropriately recorded, the company might be forced to enlist the help of their customers by requesting canceled checks or other documents.

Below is a list of questions about accounts receivable. If you answer “yes” to one or more of them, it should send up red flag that fraud could be occurring at your company:

• Is only one employee responsible for processing accounts receivable payments? Is the person protective of his or her work area and won’t take regular vacations or only takes a day or two off at a time?
• Do customers consistently complain that payments have been misapplied, posted late, or not posted at all?
• When customers’ payments are reconciled against the general ledger and sub ledgers, are there unexplained differences?
• Do sales appear to be increasing but the dollar amount of receivables is remaining flat or declining?
• Are written-off amounts associated with accounts receivable balances increasing? And yet, there has been no discernible change in the economy, or customer payment habits.
• Is accounts receivable turnover declining over an extended period? Here is the calculation to find this number: Accounts Receivable Turnover Ratio = annual credit sales / average accounts receivable.

Seven Steps to Help Prevent Lapping

1. Assign more than one employee to process accounts receivable payments and post them to the accounts receivable sub ledger

2. Rotate employees frequently.

3. Mandate vacation time.

4. Audit the accounts receivable collection process at least every six months. Your accountant can provide expert guidance in this area.

5. Conduct a regular review of write-offs, credits and adjustments to the accounts receivable sub ledger.

6. Reconcile the sub ledger and general ledgers frequently.

7. Review the accounts receivable aging analysis to ensure that all accounts are aging appropriately.

Example: Consider the fraud involving a bank employee responsible for processing customer mortgage payments. Over the course of a two year period, the employee who was responsible for receiving and posting customer payments converted more than $195,000 for her own use. The volume of customer payments was significant, so the employee had the ability to cover the missing payments with newer ones. The crime only unraveled when the employee was forced to take medical leave and the fraud was discovered by her replacement. Many of the red flags listed above were present; however, the bank neglected to audit the accounts receivable collections and posting processes for more than four years. Bank managers explicitly trusted the employee because she worked there for more than thirty years.

Accounts receivable fraud is not difficult for employees to perpetrate, but it can be exceptionally difficult to uncover. Given the nature of the fraud, the volume of documentation that must be reviewed can be considerable. Even worse, the impact on customers can be significant.

How can lapping schemes be prevented?

Which of the following control would best prevent the lapping of account receivables?

Which of the following would best protect a company that wishes to prevent lapping?

Which of the following control procedures would best minimize the occurrence of lapping of cash collections?