Auditing Accounts Payable | Detecting Fraud & Ensuring Vendor Compliance

Effective auditing accounts payable fraud should be a priority to safeguard your company from financial loss and maintain integrity.

Here we delve into the critical steps and red flags to watch for when scrutinizing your accounts payable processes and the common types of AP frauds with examples. 

Common Types Of Accounts Payable Fraud

Accounts payable fraud is a prevalent issue that can harm businesses financially and reputationally. Here are the most common types of accounts payable fraud:

Billing Schemes: 

These involve manipulating invoices for personal gain. Examples include:

• Duplicate Invoices: Creating a copy of a real invoice and getting paid twice for the same service or product.
• Fake Vendors: Setting up fictitious companies and submitting invoices for non-existent services or goods.
• Double Payment: Paying an invoice twice and retrieving one of the checks through deception before it’s cashed.

Check Fraud: 

This involves altering or forging checks for personal benefit. Examples include:

• Check Washing: Removing the original ink from a check and rewriting it with a higher amount.
• Check Forgery: Creating fake checks resembling legitimate ones from the company.
• Payee Manipulation: Changing the name of the payee on a real check to an account under the perpetrator’s control.

Automated Clearing House (ACH Fraud): 

This is when electronic payments are diverted illegally through the ACH system. Examples include:

• Vendor Impersonation Fraud (VIF): Hacking into the company’s system and modifying a legitimate vendor’s account details to redirect payments to the fraudster’s account.
• Unauthorized Employee Access: An employee with access to the system uses it to initiate fraudulent ACH transfers.

Expense Reimbursement Fraud: 

This involves manipulating expense reports for personal gain. Examples include:

• Personal Expenses: Claiming reimbursement for personal purchases using fabricated receipts or inflated costs.
• Duplicate Reports: Submitting the same expenses for reimbursement multiple times.
• Fictitious Expenses: Creating fake receipts and expense reports for items never purchased.
• “Buy and Return”: Purchasing items with a personal card, claiming reimbursement, and then returning the items for a refund.

Kickback Schemes: 

This involves an employee colluding with a third party for personal gain, often influencing business decisions like vendor selection in exchange for bribes. Examples are: 

• Vendor Collusion: Receiving cash bribes from a supplier to approve inflated invoices.
• Fake Consulting Fees: Paying excessive consulting fees to a vendor, with a portion secretly returned to an insider.
• Ghost Vendor Scheme: Setting up a fake vendor and approves payments, sharing proceeds with an accomplice.
• Duplicate Invoice Payments: Vendor submitting duplicate invoices, splitting the excess funds with an insider.
• Non-Existent Services: Billing for services never rendered, with a portion of the payment given as a kickback.

Document Fraud: 

This involves forging or altering invoices and other documents to steal money. Examples include:

• Altering Invoices: Changing the amount, vendor information, or other details on existing invoices.
• Creating Fake Documents: Fabricating invoices or receipts entirely.
• Digital Manipulation: Tampering with digital documents like scanned invoices or images.

How to Detect Accounts Payable Fraud in Your Enterprise?

Detecting accounts payable fraud within an enterprise can be a complex task, but there are several methods that can help:

1. Monitor Employee Behavior: Unusual employee behavior, such as living beyond their means, forming close relationships with vendors, or being unwilling to share duties, can be indicative of fraudulent activity.
2. Monitor Invoice Amounts: Rapid increases in invoice volume may indicate legitimate business growth, but they could also be a sign of fraudulent activity. For example, a sudden increase in the number of invoices from a vendor should raise suspicions and prompt further investigation.
3. Leverage Automation: Accounts payable automation software can help prevent fraud by detecting unusual activities. This software can automate vendor onboarding, invoice reconciliations, identify duplicate payments, and detect errors. It also provides a comprehensive audit trail, making it easier to track and investigate suspicious transactions.

6 Ways To Prevent Accounts Payable Fraud

Here are some fraud prevention controls that businesses can implement in their accounts payable processes:

Automation of AP Systems: 

Manual approval and payment processes can leave room for errors and fraud. Automated AP systems can reduce human error, minimize tampering, and provide real-time alerts for suspicious activity.

Constant Review of KPIs, Red Flags, and Alerts: 

To effectively combat fraud, it’s crucial to continuously monitor key performance indicators (KPIs), red flags, and alerts. 

These 13 key performance indicators can help you identify potential fraudulent activities:

1. Order Approval Rates: Monitor the percentage of orders approved automatically. A significant decline might indicate missed fraudulent activities.
2. Manual Review Rates: Track the number of orders requiring manual review. A sudden increase could point towards suspicious activity.
3. Chargeback Rates: Keep an eye on the percentage of transactions disputed by customers. High chargebacks could indicate fraud or dissatisfied customers.
4. Average Time for Order Reviews: Monitor the average time spent reviewing orders. Unusually long review times might suggest thoroughness, but also potential delays in identifying fraud.
5. Checkout Abandonment Rates: Track the percentage of customers abandoning their carts before completion. High abandonment rates could be due to various factors, including potential fraud concerns.
6. Automatic Decline Rates: Monitor the percentage of orders automatically rejected due to suspected fraud. A sudden increase in declines might warrant further investigation.
7. Total Decline Rates: Track the overall rate of rejected orders, encompassing both automated and manual decisions.
8. False Decline Rates: Monitor the percentage of legitimate orders mistakenly flagged as fraudulent. A high rate indicates a need to refine your fraud detection system.
9. Average Confidence Rating of Order Decisions: Track the average confidence level assigned to each order decision (approve/decline). This helps assess the system’s certainty in its classification.
10. Cost Per Analysis: Track the average cost for manually analyzing flagged orders. This can help optimize resources and identify cost-effective approaches.
11. Account and Value Detection Rates: Monitor the success rate of your system in identifying fraudulent accounts and transactions.
12. Fraud to Sales Ratio: Track the percentage of fraudulent transactions compared to total sales. This helps assess the overall impact of fraud on your business.
13. ROI of Fraud Tool: Calculate the return on investment of your chosen fraud prevention tool by measuring the cost savings achieved against the tool’s cost.

Be on the lookout for red flags like:

• Gaps in invoice numbers
• Round numbers in transactions
• Unusual transactions outside typical customer behavior
• Frequent transactions from the same location or device
• Significant discrepancies in order amounts

Vendor Checks: 

Implementing rigorous checks on vendors, both before and after onboarding, can ensure that the business only deals with compliant and trustworthy vendors.

Regular Audits: 

Regular audits of AP processes can help identify any unusual transactions. These audit trails can then be used to pinpoint the suspected source of fraud and investigate it further.

Employee Training: 

Educating employees about fraud prevention, including how to recognize phishing or social engineering schemes, can significantly reduce the risk of fraud.

Standardized Processes: 

Standardizing and regulating the vendor setup process can simplify invoice processing, payment, and information modification requests, thereby reducing the risk of fraud.

Frequently Asked Questions

1. What is accounts payable fraud?

AP fraud occurs when individuals manipulate vendor payments, invoices, or financial records to misappropriate funds. It may involve practices such as fake vendors, inflated invoices, duplicate payments, or kickbacks.

2. What role does an auditor play in detecting accounts payable fraud?

An auditor reviews financial records, investigates discrepancies, tests internal controls, and recommends corrective actions to prevent fraud. They assess compliance with company policies and regulatory requirements.

3. Are there any legal consequences for AP fraud in India?

Yes, fraud involving financial misappropriation can lead to penalties under the Indian Penal Code (IPC),  Prevention of Corruption Act,, and Companies Act. Offenders may face fines, imprisonment, and disqualification from holding directorships.

4. How often should companies conduct an accounts payable audit?

Regular audits, at least annually or semi-annually, are recommended. High-risk businesses should ideally consider continuous auditing with automated fraud detection systems.

5. What are the best tools for auditing accounts payable fraud?

Popular tools to detect accounts payable fraud in India include:

• SAP Audit Management – For transaction monitoring

• ACL Analytics – For data analytics and fraud detection.

• Tally ERP 9 – For financial tracking

• CaseWare IDEA – For forensic analysis