It's All About Money

December 2005  
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Embezzlement: What? Who? Why? How? Detection!! Prevention!!
A Three-Part Presentation Exclusively For Our Readers (Part 1 )
by Stephen Linker

I have helped clients prevent and/or detect fraud for thirty years.  One of my first embezzlement discoveries will serve as the example in this series of articles. 

I was a senior accountant working for a small firm in a very quiet community on Long Island.  It started off innocently enough.  I was working on the year-end closing of the books of a small retail heating oil business.  My job was to adjust the books and prepare the client’s financial statements and tax returns for the year end.  During that year, the company was in the process of converting their billing and collection system from a manual to a computerized system.

They had hundreds of home heating oil customers.  When I asked the bookkeeper for the list of customers who owed money to the company, she handed me a forty-eight page listing of accounts receivable.  This was the first year that the list was not handwritten, and it was the first time during my short career that the list of uncollected billing provided to me was not aged. Aging means breaking down the balances due into current amounts due, thirty days overdue, sixty days overdue, ninety days overdue, and more than ninety days overdue.  I flipped through the pages just glancing at the customers’ balances, which were each not more than a few hundred dollars, and I saw the total at the end. 

In my mind this schedule prepared with the use of automated equipment just didn’t add up.  I added the uncollected amounts with my calculator and discovered that the total of the amounts due from customers on the list was higher than the stated total by a little more than $140,000.  I went to my boss, a forty-plus year old CPA, who had no investigative accounting experience, and I asked him what to do.  He said I should just make an adjusting journal entry to reflect the actual money receivable from customers because “…obviously the machine or someone made an error when the client converted from a manual to an automated system.”  When I told my boss that I thought something was wrong, he said impatiently, “The client pays us a monthly retainer,” meaning I shouldn’t spend the time to discover what was wrong. 

To make a long story short, I had recently read about white-collar crime, I performed a few other procedures, did some research that night, and confronted the bookkeeper in a very nice way the next day.  I said, “Mrs. T, the accounts receivable don’t add up.  Will you please explain the difference?”  Mrs. T calmly opened up her desk drawer and actually handed me the detailed analysis of her embezzlement, a lapping scheme, which had been occurring for two years. 

There are dozens of embezzlement schemes.  Lapping is one embezzlement scheme, a classic receivables fraud.  It involves stealing a customer’s payment on an account and concealing the theft by applying subsequent payments from other customers to the first customer’s account.  For example, assume customer X made a payment in the amount of $500.00, which was stolen by Mrs. T, the bookkeeper. Mrs. T would credit future payments from other customers to customer X’s account.  Payments from other customers would also be stolen in whole or in part.  Payments from other customers would be used to credit the customers’ accounts, which had been misappropriated.  As you can see, however, the gap of customers’ unpaid balances keeps increasing as Mrs. T diverts more and more money to her own use.  This can continue as long as adjustments can be made to the books to write off the “uncollected balances (the diverted payments).  In future parts of this presentation, I will relate the fact pattern of my experience with Mrs. T, the bookkeeper who embezzled more than $140,000 using a lapping scheme.

So "what" exactly is embezzlement?

Here are some pertinent definitions.

First let us define fraud.  Black’s Law Dictionary states that fraud is “a generic term, embracing all multifarious means, which human ingenuity can devise, and which are resorted to by one individual to get advantage over another by false suggestions or by suppression of truth, and includes all surprise, trickery, cunning, dissembling, and any unfair way by which another is cheated.”

Next, White Collar Crime – According to Black’s Law Dictionary:  Nonviolent, unlawful conduct committed by corporations and individuals including theft or fraud and other violations of trust committed in the course of the offender’s occupation.

Bear in mind that blue-collar workers can also commit so-called white-collar crime.  Blue-collar workers have access to non-cash assets, such as supplies, tools, inventory, and equipment.

Now Embezzlement is one type of fraud.  According to Black’s Law Dictionary:  The fraudulent appropriation of property by one lawfully entrusted with its possession.  To “embezzle” means willfully to take, or convert to one’s own use, another’s money or property, of which the wrongdoer acquired possession lawfully, by reason of some office or employment or position of trust.

And finally, Defalcation – A defalcation is an embezzlement.  According to Black’s Law Dictionary:  A defalcation is an “act of embezzling;… misappropriation of trust funds or money held in any fiduciary capacity.  Commonly spoken of officers of corporations or public officials.”

The difference between embezzlement and larceny, popularly called theft, is that larceny is the taking of another’s property without the owner’s consent when the thief did not have lawful possession of the property or a position of trust.  So a street criminal who breaks into an office and steals the petty cash is committing larceny, whereas a petty cash clerk who steals the petty cash is committing embezzlement.

Mrs. T, the bookkeeper, was entrusted with the responsibilities of invoicing customers, collecting payments, depositing the money into the company’s bank accounts, etc.  Her taking money from the company by whatever methods she used was considered embezzlement.

Next month I will explain the “Who?” and “Why?” of embezzlement.


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