Description of lapping schemes and internal controls to help avoid them

2. Measures (internal controls) to limit lapping schemes

There are a number of ways which can help limit or eliminate lapping schemes.  We will review them below.

  1. One of the ways to reduce the risk of lapping schemes is to prepare and mail statements to customers.  Such statements will tell customers what charges they had, what payments were received from them and what other adjustments to their balances were made.  Customer statements can be sent out month, quarterly, etc.  Preparation and mailing of customer statements should be done by employees not directly involved in handling cash payments and accounts receivable.  If there are lapping schemes, customers may note inaccurate information on their statements and inform the company about that.  The department handling customer complaints should also be segregated from employees involved in receiving customer payments and working with accounts receivable.
  2. If possible, it may be a good idea to rotate employees within the accounting/finance department among different positions (e.g., accounts receivable, accounts payable).  This may help uncover lapping schemes (and increase employees’ competencies).  It may also be a good idea to note what employees never take vacation and investigate why.
  3. Independent periodic review of financial information is also important.  For example, when an accounting manager, controller or CFO reviews accounts receivable aging, he or she may note that certain receivables are “aging” (i.e., getting old).  Among other reasons, this may indicate that there is a lapping scheme and further investigate is warranted.  Another example is review and approval of credit memos.  If there are unusual adjustments to accounts receivable, such as an increase in credit memos, there is a chance that somebody is engaged in a lapping scheme and is using credit memos to write off (remove) accounts receivable for which payments have been stolen.
  4. When accounting system functionality is sufficient (and most modern accounting systems do have such functionality), it is a good idea to use and record individual invoices instead of keeping rolling customer balances.  When rolling customer balances are used, it is more difficult to uncover a lapping scheme because there is no immediate visibility of when customers were charged and what customer payments have been received.  On the other hand, when a customer balance is comprised of a number of separate invoices, it’s easier to see when certain invoices have not been paid for a while or when there are short payments.  Using invoices in the system also works great in conjunction with periodic review of accounts receivable aging described above.
  5. Using lock-boxes to receive customer payments is another great way to reduce the risk of lapping schemes.  When customer payments are received in a lock-box they are processed by a financial institution (e.g., bank) and potential fraud perpetrators have fewer options to put their hands on such payments.
  6. As noted earlier, it may be helpful to ensure proper segregation of duties between those responsible for receipt of cash and clearing receivables.   Unfortunately, especially in small- and mid-sized companies this may not be feasible due to the small number of accounting employees.
  7. Finally, performing periodic independent matching of daily deposits to accounts receivable postings may help uncover lapping schemes because misapplied or stolen payments will result in unreconciled differences.

There may be other ways to deal with lapping schemes, but the measures described above will provide a good starting point.

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