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CHAPTE R 3 Ethics, Fraud, and Internal Control 127

inflated invoices, or invoices for personal purchases. Three examples of billing scheme are presented
here.
A shell company fraud first requires that the perpetrator establish a false supplier on the books of the
victim company. The fraudster then manufactures false purchase orders, receiving reports, and invoices in
the name of the vendor and submits them to the accounting system, which creates the allusion of a legiti-
mate transaction. Based on these documents, the system will set up an account payable and ultimately issue
a check to the false supplier (the fraudster). This sort of fraud may continue for years before it is detected.
A pass through fraud is similar to the shell company fraud with the exception that a transaction
actually takes place. Again, the perpetrator creates a false vendor and issues purchase orders to it for in-
ventory or supplies. The false vendor then purchases the needed inventory from a legitimate vendor. The
false vendor charges the victim company a much higher than market price for the items, but pays only the
market price to the legitimate vendor. The difference is the profit that the perpetrator pockets.
A pay-and-return scheme is a third form of vendor fraud. This typically involves a clerk with check-
writing authority who pays a vendor twice for the same products (inventory or supplies) received. The
vendor, recognizing that its customer made a double payment, issues a reimbursement to the victim com-
pany, which the clerk intercepts and cashes.
Check Tampering
Check tampering involves forging or changing in some material way a check that the organization has
written to a legitimate payee. One example of this is an employee who steals an outgoing check to a ven-
dor, forges the payee’s signature, and cashes the check. A variation on this is an employee who steals
blank checks from the victim company makes them out to himself or an accomplice.
Payroll Fraud

Payroll fraud is the distribution of fraudulent paychecks to existent and/or nonexistent employees. For
example, a supervisor keeps an employee on the payroll who has left the organization. Each week, the
supervisor continues to submit time cards to the payroll department as if the employee were still working
for the victim organization. The fraud works best in organizations in which the supervisor is responsible
for distributing paychecks to employees. The supervisor may intercept the paycheck, forge the former
employee’s signature, and cash it. Another example of payroll fraud is to inflate the hours worked on an
employee time card so that he or she will receive a larger than deserved paycheck. This type of fraud of-
ten involves collusion with the supervisor or timekeeper.

Expense Reimbursements
Expense reimbursement frauds are schemes in which an employee makes a claim for reimbursement of
fictitious or inflated business expenses. For example, a company salesperson files false expense reports,
claiming meals, lodging, and travel that never occurred.
Thefts of Cash

Thefts of cash are schemes that involve the direct theft of cash on hand in the organization. An example
of this is an employee who makes false entries on a cash register, such as voiding a sale, to conceal the
fraudulent removal of cash. Another example is a bank employee who steals cash from the vault.
Non-Cash Misappropriations
Non-cash fraud schemes involve the theft or misuse of the victim organization’s non-cash assets. One
example of this is a warehouse clerk who steals inventory from a warehouse or storeroom. Another exam-
ple is a customer services clerk who sells confidential customer information to a third party.
Computer Fraud
Because computers lie at the heart of modern accounting information systems, the topic of computer
fraud is of importance to auditors. Although the fundamental structure of fraud is unchanged by com-
puters—fraudulent statements, corruption, and asset misappropriation—computers do add complexity