How to Conduct a Lapping Audit and Detect Fraudulent Activity

Fraudulent activities such as lapping pose significant threats to an organization’s financial integrity. Lapping involves manipulating accounting records to conceal stolen funds, often by using incoming payments from one customer to cover misappropriations in another account. This type of fraud not only undermines trust but also complicates financial tracking.

Conducting a thorough audit is critical for detecting lapping and maintaining strong financial controls. Identifying specific indicators and employing strategic auditing techniques can help uncover these deceptive practices.

Unusual Timing Differences in Customer Payments

Timing discrepancies in customer payments often signal potential fraudulent activity. These discrepancies might arise when payments are recorded earlier or later than expected. For example, recording a payment before it is received may indicate efforts to conceal a shortfall elsewhere, while delayed postings could suggest unauthorized diversion of funds.

Auditors should rigorously analyze payment records against established timelines and customer payment histories. Data analytics tools can highlight deviations from typical payment patterns. A sudden shift in timing from a particular customer warrants further examination. Cross-referencing payment dates with bank deposits may uncover inconsistencies.

Collusion within an organization can complicate detection. Implementing internal controls, such as segregation of duties and regular independent reviews, mitigates risks and enhances the identification of timing irregularities.

Patterns of Steady Overdue Balances

Consistent overdue balances without valid reasons may indicate lapping schemes. Accounts showing frequent overdue balances, despite regular payment activity, suggest payments are being redirected to cover discrepancies elsewhere.

Auditors should compare aging reports of accounts receivable with historical payment behaviors. Analyzing the average days sales outstanding (DSO) metric can identify abnormalities. Consistently high DSO may signal intentional delays or misapplied payments. Specific customers disproportionately affected by overdue balances should be closely examined.

Industry norms must also be considered. While longer payment cycles might be typical in some industries, anomalies outside these norms deserve scrutiny. Advanced data analytics can reveal subtle trends indicative of fraudulent activity.

Excessive Adjustments or Write-Offs

Frequent and unexplained adjustments, such as large write-offs or recurring credit memos, can point to fraudulent activity, including lapping. These adjustments may be attempts to obscure discrepancies.

Auditors should evaluate the rationale behind each adjustment to ensure compliance with established accounting policies and standards like IFRS or GAAP. For instance, standards such as IFRS 9 and ASC 326 require entities to assess expected credit losses, which should align with write-offs. Unusual patterns, such as spikes in credit memos or adjustments concentrated in specific accounts, should be investigated.

Reconciliation Discrepancies Between Receipts and Deposits

Discrepancies between recorded receipts and bank deposits may signal financial mismanagement or fraud. These arise when amounts recorded in the accounting system do not match deposits reflected in bank statements.

Auditors should thoroughly compare entries in the cash receipts journal with bank deposit slips and statements. Understanding internal controls, such as who handles cash and records transactions, is essential. Weak segregation of duties increases the risk of unnoticed discrepancies. Forensic accounting techniques, like applying Benford’s Law, can help detect irregularities in numerical data.

Confirmations That Reveal Conflicting Payment Dates

Confirmations are a critical tool for uncovering lapping schemes. By contacting customers directly to verify payment details, auditors can identify conflicting dates between when payments were reportedly made and when they were recorded. Such discrepancies often indicate manipulation.

To ensure effectiveness, auditors should use a combination of positive and negative confirmation requests. Positive confirmations, requiring a response regardless of accuracy, are ideal for high-risk accounts. Negative confirmations, requiring responses only if information is incorrect, are less effective for detecting fraud. Non-responses should not be dismissed, as they may indicate attempts to avoid scrutiny. Follow-up actions, such as additional written requests or phone calls, can improve response rates.

Responses to confirmations should be analyzed for more than date discrepancies. Inconsistencies in payment amounts, methods, or invoice references require further investigation. A customer referencing an invoice number that doesn’t match company records may indicate deliberate obfuscation. Auditors should also be alert to forged confirmations, particularly in cases of suspected internal collusion. Cross-referencing customer responses with bank records and other documentation provides a comprehensive view of financial practices and helps identify fraudulent activity.