Question

Stuart P. Harber, a certified public accountant, has worked for the past eight years as a payroll clerk for Southeast Industries, a small furniture-manufacturing firm in the Northeast. Stu recently experienced unfortunate circumstances. His newborn baby girl, Stuann, required major heart surgery and the medical bills not covered by Stu's insurance have financially strained his family. Stu is a hard worker and a model employee. Although he received regular performance raises during his first few years at the company, his wages have not increased in the past three years. Stu recently asked his supervisor, Rufus Johnson, for a raise. While Rufus agreed that Stu deserved a raise, he told Stu that he could not currently approve of one because of "sluggish sales." Stu continued his accounting duties and the financial pressures in his life continued. When salesperson Jenna Green quit suddenly over a dispute with management, Stu came up with a plan. Since he processed employee terminations, time card approval, and paycheck distribution, he decided to delay Ms. Green's termination, forge the weekly time cards with his signature and then cash Jennas checks for himself. (Since he distributes the paychecks every two weeks no one would find out anyway.) In fact, no one ever discovered his scheme and Stu continued the practice for two full years, "earning" Stu an extra $200,000. 1. How does Stu's scheme affect Southeast's balance sheet (specifically Cash and Retained Earnings) for the year? Ignore income taxes. 2. How does Stu's scheme to continue to pay Jenna affect the income statement (specifically Revenues, Expenses and Net Income)? 3. Use the fraud triangle from (Chapter 4 Exhibit 4.5) to identify the three elements of the fraud triangle and to explain how Stu's situation meets each of these elements. Write two to three sentences to explain each fraud element. 4. What internal controls could have been put in place to prevent Stu's paycheck scheme in the first place? (Name at least three. Don't make these up; use specific internal controls outlined in Chapter 4.)

Answer 1

1.Both Cash & retained earnings will be understated(than what it should be) by the amount fictitiously charged by Stu, recorded as having been given to a no-more existent employee.

2.Revenues will not be affected.

Expenses will be over-stated with the wage bill & other payroll tax expenses .

Consequently net income will be less than what it should be.

3.Fraud is an unethical behaviour , which needs the presence of certain instigators, that form the fraud triangle. They are:

The three factors that make the individual to commit the fraud can be broadly categorised as:

1. Pressure. Most fraud-commiters are under some form of pressure to act fraudulently.They are fully aware , but justify their predicament, which need not be palatable to others, but it exists .Examples of such pressing circumstances are money problems,mounting debts, alcohol /abuse or rising medical expenses for self or near& dear ones.In this case,Stu was pushed to this end by the mounting medical bills for his new born baby-girl.

2.Opportunity--In most cases, the person grabs the opportunity that comes his way , usually a temporary situation , when one can commit fraud , with little chances of being exposed. In the above case, the sales person Jenna Green quit suddenly , Stu decided to take advantage of the situation --which was made even more easier , as he himself handled employee terminations,time card approval as also paycheck distributions --all by himself--- decided to delay her termination & was encashing all checks , seemingly paid to Jenna-- that too over 2 solid years.

3.Rationalisation.-- The person normally justifies his act of fraud with his own logical reasoning as some compulsions of circumstances or playing any victim of the employers for low pay or even ,this-wealthy-employer-can-afford-this-loss type of arguments---ie. rationalising the act---here, Stu reasons out with his baby-girl's life-or-death medical condition & subsequent financial strains.

4.Internal control that could have prevented this from happening:

1.Separation & Segregation of duties

As said above, Stu decided to take advantage of the situation --which was made even more easier , as he himself handled employee terminations,time card approval as also paycheck distributions --all by himself--- decided to delay Jenna's termination & was encashing all checks , as seemingly paid to her-- that too over 2 solid years.

This would not have happened this easily , if the above said duties were entrusted to more than one person , who act as a check for the other, in performing their day-to-day functions.

2. Personal Indentification

The payment system should be made to require employees to identify themselves. In case of an electronic card-swipe system, it should be monitored ,if the same employee swipes the cards at the same time--which indicates that he is swiping for someother non-existant person .

If this had been in place, Stu would not have been able carry on this way, for this long a period of 2 years.

3. Payroll register checks

Once in a while, no.of employees on payroll regiters , should be tallied by head-counts of people , in all sections of the company, by an unconnected person who is responsible and reliable.

This will do away with fictitious /ghost employees.