Advance to go, collect $800,000: a controller's embezzlement scheme almost destroys an established manufacturing company

Internal Auditor, June, 2005 by Donald McConnell, Jr., Robert Montgomery

DAVE HAS OWNED A SMALL, successful manufacturing company for more than 50 years. Until recently, business had been booming, but current year sales had fallen dramatically, leaving the company barely profitable. Cash flow had become a major problem, and the company was borrowing from its line of credit almost weekly to keep operations running smoothly. Because Dave was so focused on decreasing sales and earnings he failed to consider the real reason his cash was shrinking--embezzlement.

Dave had hired Tony as controller two years earlier, when revenues were at all-time highs. Tony was well-liked and respected by his co-workers; he was especially kind to Bill, whom he promoted to assistant controller.

When Tony suddenly announced that he was leaving the company, most people were sad to see him go. However, Dave saw his departure as a cost-cutting opportunity. By promoting Bill and leaving the position of assistant controller vacant, the company could save thousands of dollars annually. Dave offered Bill the controller position on a trial basis.

Bill was expecting to spend a lot of time with Tony learning the procedures and details that he would need to know as controller. However, Tony only gave Bill vague answers to his questions and was often unavailable, which left Bill feeling uneasy.

The company outsourced its payroll function. Bill had assisted in entering payroll for the last two years and clearly understood the process, so he was surprised when Tony wanted to help him one last time. They entered most of the payroll data together but were waiting on information from Dave. Because the payroll could only be transmitted from Tony's office computer, he told Bill he'd finish it later.

Payroll checks and reports were always delivered the morning after payroll was transmitted. When Bill hadn't received them by noon, he went to the receptionist, who informed him that they had been sent to Tony. Upon inquiry, Tony told Bill he had them locked in his file and would bring them to him later.

When Tony left without delivering the payroll reports, Bill confided in Sherry, an accounting co-worker, that he thought Tony was trying to conceal something. Together, they went into Tony's office and searched for the missing reports. His files were unlocked, but they couldn't find the reports. Sherry remembered seeing Tony at the shredder earlier and sensed that the documents being shredded were payroll reports. Opening the shredder door, she carefully removed the top layer of shredded documents. Amazingly, the payroll company's name still could be pieced together.

Additional reconstruction of the shredded documents revealed that the total amount transferred to the payroll account was about US $50,000 higher than transfers from recent weeks. Bill called the payroll company to request a copy of the payroll register. On the 17th page of the report, Tony's name appeared along with a check number showing an amount of $47,000.

Bill also asked the payroll company to fax a listing of every check made out to Tony in the last year. He couldn't believe his eyes. Though Tony had a salary of about $70,000, payroll checks exceeding $800,000 had been issued to him in the past 12 months. Bill knew he had to notify Dave.

Dave was surprised by these findings, as he had never worried much about embezzlement. No one in accounting or purchasing had check-signing authority. Every check had to be approved by accounting and countersigned by an officer other than the controller. Dave personally viewed almost every check issued and examined support for large disbursements. Tony received and reconciled the bank statements each month. Because he trusted Tony and felt satisfied with these controls, Dave never examined the bank statements closely.

Dave was also under the misconception that the payroll system was safe. Even though payroll checks had a computer-generated copy of his signature, he was careful to check all of the employees' year-end wage reports and tax forms. If there were any fictitious employees or excessive salaries, he felt confident he would catch them. He hadn't realized that the outsourced payroll system could be manipulated to issue checks with amounts that wouldn't appear in year-to-date earnings reports. However, after the payroll company faxed copies of the missing payroll reports, Bill began to piece together Tony's scheme.

After Tony and Bill entered the payroll data, Tony would pretend to transmit the information. Once Bill left his office, however, Tony would make an adjustment to his own pay, adding an amount for an advance. He would then add information for a second payroll check to himself, entering a negative amount in the "advance" field to offset the advance on his check. His paycheck would be issued including the amount of the advance. However, because the second entry had a negative advance amount, a second check wasn't generated. Further, the information was processed reporting Tony's year-to-date advance amount at zero. Because taxes are not deducted from payroll advances, he never had to adjust his withholdings, and his accumulated totals always appeared to be reasonable. The checks and amounts were all electronically verified by the payroll computer system rather than by individuals, who likely would have been alarmed by the transactions.