What Is Lapping Fraud and How Does It Work?

Lapping fraud is a form of embezzlement where an employee misuses customer payments to cover a prior theft of cash. This deceptive practice involves taking money from one customer’s payment and applying it to an earlier customer’s account to conceal a shortage. The fraud relies on a continuous cycle of misdirection, creating a growing discrepancy that must be perpetually hidden.

Understanding Lapping Fraud

Lapping fraud primarily targets accounts receivable, which are amounts owed to a business by its customers. The scheme involves an employee, typically one who handles both cash receipts and accounts receivable records, diverting a payment from one customer for personal use. To prevent the first customer from being notified of an overdue balance, the employee then takes a payment from a second customer and credits it to the first customer’s account. This “robbing Peter to pay Paul” method creates a chain where each new payment covers the theft from an earlier one.

Executing Lapping Fraud

Lapping fraud begins when an employee intercepts a payment, such as a check for $500 from Customer A, and keeps it without recording. To prevent Customer A from complaining, the employee waits for a payment from Customer B, say $600. The employee then records $500 of Customer B’s payment as a credit to Customer A’s account, making it appear Customer A’s payment was received. This leaves Customer B’s account with an uncredited balance of $500.

To cover this shortage, the employee waits for a payment from Customer C. When Customer C pays, perhaps $700, the employee credits $500 of that payment to Customer B’s account. This continuous process of applying new customer payments to older, previously shorted accounts creates a rolling deficit that requires meticulous tracking to avoid detection.

Concealing Lapping Activities

Fraudsters employ various techniques to hide lapping activities from discovery. A common method involves altering accounting records, such as adjusting ledgers or creating fictitious entries, to make it appear that all payments have been correctly applied. This might include manipulating the dates payments are posted or making small, unidentifiable adjustments to account balances. Another technique is delaying the posting of payments, holding checks for several days or weeks before applying them, which creates a temporary float to cover the stolen funds.

Manipulating customer statements is also a frequent concealment tactic, where the fraudster might intercept and alter statements before they are mailed, or create entirely false statements to show correct balances. The goal is to prevent customers from noticing discrepancies between their records and what the company has recorded.

Detecting Lapping Fraud

Several red flags can suggest the presence of lapping fraud within an organization. Frequent customer complaints about incorrect account balances, especially concerning payments that were made but not credited, often point to discrepancies. Delays in depositing cash receipts into the company’s bank account, particularly if significant amounts are held back for extended periods, can also be a warning sign. An employee who insists on handling all aspects of accounts receivable, including receiving, recording, and depositing payments, without any oversight is another indicator. Discrepancies between internal accounts receivable records and customer statements may also reveal the fraud.

Implementing strong internal controls, such as the segregation of duties where different individuals handle cash receipts and record-keeping, is a general deterrent. Mandatory employee vacations can also help uncover such schemes, as a substitute employee might notice irregularities during the fraudster’s absence.