A lapping scheme is a fraudulent practice that hides or obscures missing or stolen cash using the accounts receivable. It typically involves the misapplication of one customer’s payment to the account of another customer, delaying the discovery of embezzlement or theft.
The Mechanics of Lapping
Lapping involves the following steps:
- Initial Misappropriation: A payment from Customer A is stolen by an employee.
- Concealment: The employee then uses a subsequent payment from Customer B to credit Customer A’s account.
- Cycle Continuation: This cycle repeats with payments from Customer C being used to credit Customer B’s account, and so forth.
Example of a Lapping Scheme
- Customer A owes $1,000, and their payment is stolen.
- Customer B owes $1,200, and their payment is used to cover Customer A’s account.
- Customer C owes $1,500, and their payment is used to cover Customer B’s account.
Detection Methods
Regular Reconciliations
Frequent and thorough reconciliation of accounts receivable can uncover discrepancies that may indicate a lapping scheme. Comparing daily cash receipts to customer account credits is an effective way to detect anomalies.
Segregation of Duties
Ensure that different individuals are responsible for receiving payments, recording accounts, and reconciling balances. This reduces the opportunity for an employee to both commit and conceal the fraud.
Audits and Reviews
Conducting surprise audits and reviews can increase the chances of detecting lapping schemes. Auditors should look for unusual patterns of credits and overdue payments.
Prevention Strategies
Strong Internal Controls
Implement robust internal controls, such as requiring supervisory approval for adjustments to accounts receivable and ensuring that deposits are made promptly and independently verified.
Employee Training
Educate employees about the ethical standards and provide training on recognizing and responding to red flags associated with lapping schemes.
Establish a Whistleblower Policy
Encourage employees to report suspicious activity by establishing a whistleblower policy that protects those who come forward with information.
Historical Context
Lapping schemes have been documented for many decades, becoming more sophisticated with advancements in technology. The term “lapping” originated in the early 20th century and continues to be a significant concern for financial institutions and businesses.
Applicability
Lapping schemes can occur in any organization handling cash or credit transactions. They are particularly prevalent in businesses with high volumes of accounts receivable and loose internal controls.
Comparison with Related Fraud Schemes
Kiting
Kiting involves the fraudulent use of checking accounts to create unauthorized funds temporarily. Unlike lapping, which manipulates accounts receivable, kiting exploits the time lag in check processing.
Embezzlement
While embezzlement broadly refers to the theft of company funds by an employee, lapping is a specific type of embezzlement involving the manipulation of accounts receivable.
FAQs
What are common red flags of a lapping scheme?
How can technology aid in detecting lapping schemes?
References
- Albrecht, W. S., Albrecht, C. C., & Albrecht, C. O. (2015). Fraud Examination. Cengage Learning.
- Wells, J. T. (2017). Principles of Fraud Examination. Wiley.
Summary
Lapping schemes represent a significant risk to organizations, demanding diligent detection and prevention efforts. By understanding their mechanics, implementing strong internal controls, and fostering an ethical workplace culture, businesses can effectively combat this form of financial fraud.
