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Accounts Payable Fraud Detection - Our Guide to AP Fraud and How to Detect It

Thursday, January 20, 2022

5 minute read

Accounts Payable Fraud Detection - Our Guide to AP Fraud and How to Detect It

Organizations lose up to 5% of their revenue to occupational fraud each year, 86% of which can be linked to accounts payable (AP) processes. While checks and wires continue to be the most accessible methods for fraudsters due to the manual processing inefficiencies, they also target electronic invoices.

However, there are many ways to combat this rising problem. A combination of improved human processes and accounts payable automation can both limit opportunities for fund misappropriation and enhance fraud detection.

Before an AP department can map out its solution, it's essential to understand what techniques are being used today.

 

What is accounts payable fraud?

AP fraud tends to fly under the radar, and for a good reason. Essentially, accounts payable fraud deals with asset misappropriation, primarily through fraudulent expenses. Most organizations tend to scrutinize their employees since they have the most access and opportunity, but third-party vendors and even malicious actors can commit AP fraud. Sometimes, multiple parties may work together to siphon money from company accounts. The fraud may be entirely accidental in other cases, such as miscalculating a service cost on an invoice.

Before we can touch on types of accounts payable fraud prevention, it's essential to understand the most common methods of payments fraud. This makes it easier to detect red flags and invest in solutions to reduce fraud risk.

What are the most common types of accounts payable fraud?

The Association of Certified Fraud Examiners (ACFE) keeps a pulse on fraud cases and offers insights into the most widespread fraud methods across industries. When it comes to accounts payable, there are several different ways an individual can steal money from the company:

  • Billing Fraud - In this case, an employee sets up a fake supplier, generally through a shell company, to accept payments from the company through invoice fraud. They may also use duplicate invoices to real suppliers to siphon off money. The goal is to pay themselves the stolen funds and any other accomplices through this fake account.

  • Check Fraud - Check tampering is one of the most common ways to commit AP fraud. While it can be challenging to catch, investigators can trace the fraudulent activity to its source if the checks are poorly altered.

  • ACH Fraud - In this case, the employee will use their ACH bank account as the recipient to intercept funds meant for the company.

  • Reimbursement Fraud - Employees can also take advantage of the expense reporting process by inflating their expenses, claiming costs that aren't covered by company policy, or creating fake receipts.

  • Bribery and kickbacks - Corporate bribery, often called a kickback, is also a possibility. In this case, the employee receives a gift, either in cash or another form, for signing on a specific supplier.

Employees decide to commit fraud for several reasons. Dissatisfaction with their salary or pressing financial matters can both push an individual to commit payments fraud.

Guidance on investigating AP fraud

When investigating potential accounts payable fraud, it's critical to conduct both an internal report and bring on an external auditor. According to the ACFE, most organizations learn about fraudulent activity from whistleblowers. While internal audits may detect potential fraud cases, an external auditor is far more likely to be unbiased.

If you suspect potential fraud, the first thing to do is preserve evidence. This means collecting checks, invoices, contracts, journal entries, bank statements, and other relevant documentation.

To further investigate potential fraud schemes, setting up a fraud control committee or bringing in an external auditor to review the files would be wise. They may also want to take additional steps, such as:

  • Verify suppliers

  • Reconcile accounts

  • Investigate transactions

  • Review checks before cutting them

As you evaluate the AP department employees and AP process, it is important to have someone new come in to review suppliers and check payments. This can be an auditor or someone from another part of the accounting office.

AP fraud detection tips

The good news is that there are ways to prevent fraud cases. While no single approach can completely eliminate the threat of fraud, it's certainly possible to come close.

Some steps an AP department can take today for fraud prevention are:

  • Employee rotation - It can help to rotate employees through different tasks in the AP process, even though this may require additional training for each employee. However, employee rotation reduces the likelihood that one employee or supplier will attempt fraud and makes it easier to notice red flags.

  • Mandatory vacations - Prompting employees to take a vacation means that another team member will need to cover their regular tasks. Having fresh eyes review the documentation can pick up fraudulent activity.

  • Random audits - Checking the AP process during an unscheduled audit can deter potential fraudsters and make it easy to spot issues.

  • Automation - The best way to avoid internal fraud is to prevent it with technology. Accounts payable automation matches invoices, scans for duplicate payments, uncovers errors and leaves a clear audit trail. It's even possible to set approval restrictions on specific accounts with some solutions.

  • Set clear reimbursement policies - In many fraud cases, the employee doesn't intend to cause trouble. They just don't know the company policy. It can help to work together with human resources to ensure that employees understand the company policy around reimbursements.

  • Update supplier master data regularly - Long-term fraud requires some sort of invoice or supplier falsification. Ensuring that the supplier list is updated frequently is one way to prevent lengthy fraud schemes.

  • Open a tip network - Sometimes, an employee may notice something off, but they aren't sure who to talk to. Organizations that already have a hotline benefit more from taking tips, as they are 10% more likely to detect fraud via tip than those without one.

However, no matter how proactive an AP department is, they should still be alert for potential fraud risks. Technology makes it easy to detect a possible case of fraud.

What Is Benford's Law?

To enhance fraud detection, certified fraud examiners use an array of tools. But one of the most common is Benford's Law. Basically, this mathematical principle suggests that numbers in a sequence are likely to be part of a pattern, even if they seem random.

In other words, for each number, there is a probability it will be used in a certain slot. For example, the probability of the number 1 being used in the first position in payment, such as $1XX, is 30.1%. Payment fraud is more likely to break the natural pattern.

While it isn't foolproof, Benford's Law provides a simple tool for an AP department to evaluate its payments.

Improvements in accounts payable fraud technology

Over the past few decades, accounts payable automation has evolved tremendously. The use of OCR (Optical Character Recognition) to extract data from invoices makes it faster to review both electronic and paper documents. Furthermore, artificial intelligence has largely automated the matching process.

These state-of-the-art AP automation systems immediately alert users of a red flag - whether that be a duplicate invoice, missing tax IDs, or an incorrect receipt. As a result, automation helps to mitigate fraud risk while streamlining the AP process for the entire team.

More on fraud prevention

Identifying potential fraud cases begins with asking the right questions. Check out this downloadable ebook, Detect and Prevent Fraud in Procure-to-Pay Through Real-time Auditing.