CONSTRUCTION Accounting ARTICLE - Construction Fraud: How Does It Happen?

Target Audience: Construction Industry Professionals, General Contractors, Construction Accountants

Many construction business owners think they know their employees too well to fall victim to fraud. Or perhaps they focus on only one or two vulnerable areas. But there are many ways you could lose hard-earned money, and employees — even trusted, long-term ones — may be more prone to committing fraud during these difficult economic times.

Payroll is vulnerable

Let’s start with the payroll process, which for construction companies is often complex and, therefore, vulnerable.

One example: A foreman uses his position to create a “ghost” employee to work on his crew. He records all of the hours this fake worker puts in and, with or without the help of someone in your payroll department, receives and cashes the ghost’s paycheck.

One way to expose the presence of ghosts is to, at least twice a year, hand out paychecks yourself. Or, if you use direct deposit, work with your bank to fight payroll scams. Many offer a “positive pay” service to fight fraud.

Another measure to consider is making sure one person doesn’t have exclusive control of payroll duties over a long period of time.

Accounts receivable could tempt

In some cases, a fraudster may make off with your cash before it even hits the books. A typical scheme of this fashion is known as accounts receivable “lapping.”

An example might be an accounts receivable clerk who periodically pockets a payment from one of your monthly service contract customers. Then, when the next monthly payment comes in, she applies that payment to the previous month’s invoice. This can go on undetected for months — years even.

To prevent lapping and other like schemes, segregate banking responsibilities from accounts receivable and accounts payable functions. It’s harder for fraudsters to conceal their actions if they can’t cover their tracks in the bank reconciliation process.

In addition, enforce mandatory vacations of at least one week per year. Dishonest employees tend to dislike taking time off, knowing that, if someone else handles their responsibilities while they’re out, their dishonest activities may come to light.

Supplier scams common

As money almost constantly changes hands between construction companies and their suppliers, plenty of opportunities for fraud arise. One typical scam involves a fraudster who sets up a shell company that outwardly appears legitimate but doesn’t provide any products or services.

For example, you receive an invoice from XYZ Lumber for job supplies. Unbeknownst to you, the lumber supplier doesn’t exist — one of your employees has made up the company and created the invoice, and he deposits the check into his own account.

How do you break the shell game? One way is to establish a policy of signing every check (or at least any check above a certain amount). Also require that key documentation, such as the original invoice, purchase order and receiving report, accompany each check.

Additionally, appoint an employee who isn’t involved in the accounts payable function to mail checks. Another approach to consider: Having an approved vendor list that must accompany each distributed check. Compare vendor addresses to employee addresses as well.

Some fraud not surprising

Some forms of fraud aren’t surprising. Take kickbacks, for instance — a corrupt employee forms a “partnership in crime” with an outside vendor rep. The vendor rep quotes a higher price than she otherwise would, and then the insider arranges for payment in full. When you pay the bill, the disreputable rep kicks back a percentage of the difference (or another form of compensation, such as a gift or event tickets) to the accomplice.

To stamp out kickbacks, review invoices periodically to determine whether any orders or prices seem unusually high. Also, insist on the solicitation of competitive bids for contracts over a certain threshold and regularly confirm that such bids were actually sought and received.

Many ways, and counting

As you can see, there are many ways fraud can strike. And, unfortunately, fraudsters are thinking up new schemes all the time. Make sure you’re paying attention to all of your construction company’s vulnerable areas.

Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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