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Cash Register Fraud Schemes

March 21, 2017

A false balance is an abomination to the Lord, but a just weight is his delight. Proverbs 11:1

We are at the end of our discussion of fraudulent disbursements per the Certified Fraud Examiners fraud tree. Please see : http://www.acfe.com/fraud-tree.aspx for an image of the fraud tree. So far we have covered four of the five categories under ‘fraudulent disbursements’ including billing schemes, payroll schemes, expense reimbursement schemes and check tampering. This newsletter, we cover register disbursements.

If you want to earn CPE credit for reading these articles, please check out the full text at: https://yellowbook.ideamakr.com/product/auditors-responsibility-for-fraud

Register Disbursements

Government agencies that transact with the public (licensing departments, toll collection booths, and courts) need cash registers. For instance, the ferry in Seattle is run by King County as of 2011. Plenty of cash changes hands on ferries. An audit in 2011 shows that King County didn’t have systems in place to monitor whether revenue is meeting expectations or if ridership equals dollars collected. In some instances, the cash fares were being stolen.[1]

False Voids

Anthony Grande, 36, a cashier at the Stop & Shop supermarket was arrested in 2009, accused of skimming more than $102,000 from the cash registers over the prior year. Grande was accused of deleting cash transactions from his register, then pocketing the customers’ money. That would be about $392 per day for a five-day workweek. Cash sales were rung in the cash register, held, and then deleted.[2]

The problem most skimmers have with cash registers is the registers’ paper receipts. Traditional skimmers take cash equal to the amount of a sale that they either don’t enter into the register or void after the fact.

Because stealing from the cash register is common in business, owners and managers know to look out for a high number of voids. Skimming without voiding receipts can lead to imbalances on the receipts, which also alerts managers and auditors.

Most registers maintain electronic sales records rather than keeping receipt rolls. Fraudsters use a device called the ‘zapper’ to workaround the electronic sales records. Also known as automated sales suppression devices, zappers are able to change registers’ sales records.

Talal Chahine, who owned a small chain of 12 Lebanese restaurants in Detroit, skimmed over $20 million over four years using a zapper. This allowed him to avoid taxation as well as benefit him personally. Chahine sent a portion of the money he stole from his restaurant La Shish to Hezbollah, an Islamic extremist group.[3]

False Refunds

Refund fraud is a system that allows individuals and employees to refund merchandise and profit from the returns. Cash is typically used in refund frauds because no paper trail exists.

Fraudsters might lift products from a store and then return the stolen products to the same store from which they shoplifted. This works in stores that do not have a policy against returning products without a receipt. When required to give personal information to the store clerk, these fraudsters supply false information.

Another refund fraud involves buying products while they are on sale and then returning them at full price after the sale ends.

Some fraudsters purchase merchandise, use it, and then return it for a refund. For example, an employee might purchase a semi-formal dress, wear it to a party, and then return it to the store for a full refund. Because the product loses quality and value, there’s a risk to the store that it won’t sell. I had a girlfriend in high school that did this! Her favorite target was Neiman Marcus!

In yet another scam, employees might process refunds for items that were not actually returned by customers. Some use legitimate receipts of sales to other customers to refund items on the receipt for cash, or sometimes credit cards. Others may refund items without having a receipt.

In a very creative refund scheme, fraudsters in New Mexico used loadable credit cards at Walgreens. The loadable credit cards don’t have names attached to them, but they do create unique bank accounts. This allowed the fraudsters to file fake income tax returns with the state and request that the tax refund be deposited into these nameless bank accounts. The state obliged and the fraudsters promptly went out and made anonymous purchases using the loadable credit cards. The identities of the frausters were completely anonymous because the fraudsters bought the initial cards with cash at Walgreens.

[1] “Audit of King County Ferries Raises Questions about Gregoires State Plan.” By Chris Egart. Eyewitness News [Seattle]. KIRO 7. January 6, 2011.

[2] Rebecca Baker. “Dobbs Ferry cashier accused of skimming $100,000.” The Journal News [Lower Hudson Valley, NY]. July 7, 2009.

[3] Roy Furchgott. “With software, till tampering is hard to find.” New York Times. August 29, 2008.

Check Tampering Fraud Schemes

March 6, 2017

One who is faithful in a very little is also faithful in much, and one who is dishonest in a very little is also dishonest in much. If then you have not been faithful in the unrighteous wealth, who will entrust to you the true riches? And if you have not been faithful in that which is another’s, who will give you that which is your own? Luke 16:10-13

We are working through the five possible cash disbursement schemes described by the Certified Fraud Examiners on their very helpful fraud tree. We are on category four – check tampering. So far, we have covered three of them: billing schemes, payroll schemes, and expense reimbursement schemes. Next time we will discuss register disbursement fraud.

And although checks are more rare these days, the Certified Fraud Examiners have included check tampering schemes on their tree. The fraud tree does need to be updated, and we will bring in some more contemporary frauds regarding electronic payments in a later newsletter. All of the newsletters in this series are excerpts from the self study book called “An Auditors Responsibility for Fraud in the Government Environment” that is available here https://yellowbook.ideamakr.com/product/auditors-responsibility-for-fraud

Check Tampering Schemes

Check tampering is a type of fraudulent disbursement that occurs when an employee converts an organization’s funds by either:

fraudulently preparing a check drawn on the organization’s account for his own benefit, or
intercepting a check drawn on the organization’s account that is intended for a third party and converting that check for his own benefit.

Here the fraudster diverts or alters checks written by the organization. The Association of Certified Fraud Examiners breaks check tampering into five categories:

Forged maker
Forged endorsement
Altered payee
Concealed check
Authorized maker

The fraudster then might try to conceal the check-tampering scheme by doing a “forced” reconciliation. In this fraud, the bank reconciliation is manipulated to make the bank balance and the book balance match.

Forged Maker

Forgery occurs when someone signs another person’s name to a document or alters an original document. I admit to signing my husband’s name on credit card bills at restaurants and stores when he is otherwise engaged. In this case, I am the “maker”; I am the person who forges the document.

In a forged maker scheme, an employee misappropriates a check and fraudulently affixes the signature of an authorized maker on the check.

Have you ever seen that facinating Leonardo DeCaprio movie “Catch Me If You Can” based on the real life story of Frank Abagnale? If you have, you will remember Leonardo in a dark European barracks forging checks. Abagnale passed over $4.5 million in forged checks in the 60s. He was not the authorized maker!

We are not even safe from moms on the PTA!

The 37-year-old former treasurer of the Cold Spring School PTA was charged with possessing and cashing two forged checks from the PTA account. A recent audit of the PTA’s books showed several checks written to cash with no receipts. Also, two checks were determined to have forged signatures.[1]

Twenty thousand dollars won’t even pay the rent in Chicago! She was probably just getting started…

Former City Worker Indicted for Theft of Tourism Funds
Chicago Inspector General’s Office Exposes Abuse of Funds[2]

Today prosecutors announced the indictment of a former project administrator with the City of Chicago’s Department Of Cultural Affairs for stealing $20,000 that was intended to promote tourism according to the Office of Cook County State’s Attorney Anita Alvarez.

Ming Liu, 38 of 2302 Shurt Circle in Urbana, IL, has been indicted on two counts of theft and one count each of official misconduct and forgery. If convicted she faces up to seven years in prison. Lui worked for the City of Chicago from 1997 through June 2006.

“Corruption and fraud at any level of government is outrageous and unacceptable,” said Alvarez. “Employees who blatantly disregard the public’s trust for their own gain will be prosecuted and held accountable.”

The indictment alleges that Liu’s work responsibilities with the Department of Cultural Affairs included performing accounting and banking functions for the Chicago Tourism Fund. Within that capacity, Liu had access to the fund’s checking account.

In July 2008, the Inspector General’s Office discovered a copy of a $20,000 check and began investigating because the check’s signature was inconsistent with others issued by the tourism fund. The evidence was forwarded to the Cook County State’s Attorneys Office.

In August of 2004, Liu created a $20,000 check from the fund’s checking account payable to herself. Liu then altered the payee of the check in the Chicago Tourism Fund’s electronic accounting system so that it appeared as if the check was payable to the United States Postal Service. Liu forged the signature of the Chicago Tourism Fund’s executive director on the check, and then deposited the check into her personal checking account.

How is this for creativity?
The Association of Certified Fraud Examiners shares the story of a woman using her boss’s business correspondence and the company copy machine. First, she made transparencies of his signature. These transparencies were then placed in the copy machine so that when she ran checks through the machine the boss’s signature was copied onto the maker line of the check. She made the fraudulent checks payable to herself, but falsified the check register so that the checks appeared to have been written to legitimate payees.

Forged Endorsement

The forged endorsement scheme is a check tampering scheme in which an employee intercepts a company check intended for a third party and converts the check by signing the third party’s name on the endorsement line of the check.

The biggest drawback to the scheme is that once it is uncovered, the documentation (the endorsement on the check) reveals who committed the fraud.

In City Of Anadarko Caddo County Special Audit July 2003 Through May 2007,[3] the State Auditor of Oklahoma tells of a very busy and very creative city employee. She had her hands in everything! Because the report is very lengthy, I’ve included only excerpts from the report.

On May 22, 2007, District Attorney Bret T. Burns requested the State Auditor and Inspector to conduct an investigative audit into concerns of possible misappropriation of money. Prior to the conclusion of our audit, on June 20, 2007, Katrina Pickens, Personnel and Payroll Director, was charged, in Caddo County District Court, with one count of embezzlement.

The State Auditor and Inspector conducted a special audit of the records of the City of Anadarko, primarily those records relating to the request of the District Attorney. The results of the special audit are in the following report.

CONCERN AND FINDINGS
Although the focus of the concern, and this report, centers on funds missing from the court clerk and utility billing deposits, during the course of our fieldwork, we identified what appears to be a pattern of attempts, some successful and some not, by Katrina Pickens to obtain money fraudulently. This pattern begins in 2003 and continued through 2007. The methods and amounts are listed in the table that follows.

July 2003: Questionable payments for back pay totaling $2,085.60
On July 14, 2003, Katrina Pickens issued a letter to then City Manager, Alan Riffle requesting a salary increase. The letter stated, in part:

I thank you for the opportunity to serve the City of Anadarko. In the past nine months, I have proven myself a valuable employee. The Personnel office has been able to assume more responsibility easing the load that was assumed in the Finance offices. Completing more tasks that were neglected by my predecessor, I have saved the City money by not allowing individuals to linger on City paid benefits. I have complied with your request to obtain more knowledge of personnel, by attending various seminars. I know that I can continue to be an instrumental part of saving the City time and money. That is why I ask you now to move to a salary more appropriate to my knowledge, skills and abilities. Taking into consideration that I receive no overtime pay, no uniform allowance and workers compensation insurance is at a lower rate because of job position. I believe this to be a fair proposal for wage increase with respect to job title and responsibilities. I appreciate your serious consideration to this proposal.

On February 3, 2004, Robert Brooks (the then Finance Director) denied the request and, in a letter to Pickens, stated that she was to remain at $14.34 per hour and her next increase would be on September 30, 2005.
We obtained a personnel action form, originally dated 11/15/04 and changed to 11/22/04, providing for a salary increase for Pickens and providing for back pay totaling $2,085.60.

Cash Missing From Utility Billing Deposits = $160,961.36
Unauthorized Family Medical Leave Benefits = $11,215.58
Questionable Compensatory and Vacation Time Payments = $8,361.67
Cash Missing From Court Clerk Deposits = $6,028.00
Questionable Back Pay = $2,085.60
Total = $188,652.21

Although Finance Director Robert Brooks stated, in response to Pickens request, that she was not due for a pay raise until September 2005, it appears Pickens was able to obtain a raise from then City Manager Roy Rainey.

December 2004: Questionable payments for compensatory and vacation time.
We found one personnel action form apparently authorizing the payment for 80 hours of compensatory time. The form was dated December 20, 2005; however, it was not approved. We found no other authorization for the payment of compensatory time or vacation time.

July 2006: Unauthorized family medical premiums.
Interviews with David Edwards, Chief of Police, and Richard Bennett, Chief of the Fire Department, indicated that Pickens continuously expressed her discontent over the police and fire department employees receiving family medical coverage. According to both Chief Edwards and Chief Bennett, Pickens did not think it was fair that these departments were provided family benefits while she was not.

We obtained the payroll history for Pickens beginning in 2002. Starting with the January 6, 2006 payroll period, Pickens began receiving employer contributed medical coverage for her family.

Of the $889.40 total premium, the employee’s responsibility is $596.10 for medical, $45.98 dental and $17.66 vision. For the period January 6, 2006 through May 11, 2006, Pickens received unauthorized family medical coverage benefit totaling $11,215.58.

In the video taped interview with Stephen Campbell (DA investigator), Pickens indicated that City Manager Robert Williamson verbally authorized the family medical coverage. On June 12, 2007, Robert Williamson denied that he had authorized the change to Pickens family medical plan.

Upon reviewing Pickens personnel file, we found no written authorization for family medical coverage.

October/November 2006: Unauthorized attempt to withdraw retirement funds.
Cheri Weber provided us with a form she had found in which Pickens was attempting to withdraw her retirement funds. The form reflected that Pickens was terminated on November 9, 2006. Pickens; however, was not terminated until May 14, 2007.

Upon finding this form, Weber contacted Hedy Devero-Beal at DeMars, the city’s pension company, concerning this form. Hedy sent Weber the request forms Pickens had faxed to them.

The first request was submitted on October 25, 2006. According to Weber, Hedy contacted the City and asked if Pickens was still employed with the City of Anadarko. Hedy subsequently contacted Pickens who stated that she had been rehired. The request to withdraw funds was denied.

A second request to withdraw pension funds was faxed on November 9, 2006 reflecting that Pickens was terminated the same date. The form was ‘approved’ using the City Manager’s signature stamp. On June 12, 2007, the City Manager indicated that he knew nothing about the retirement form.

This attempt to withdraw retirement funds was also denied since Pickens was still, at the time, employed by the City of Anadarko.

Although Pickens continued her employment through May 14, 2007, we noted that retirement contributions were not withheld from her check after October 13, 2006.

June 2007: Unauthorized salary increase.
We obtained the “employee management” reports, which show changes in employee compensation. According to Cheri Weber, all salary increases require the approval of the City Manager on a “personnel action form”.

While reviewing Pickens’ personnel file, we noted she received a salary increase from $17.44 per hour to $19.88 per hour effective March 26, 2006. On June 12, 2007, City Manager Robert Williamson stated that he was not aware of this salary increase.

October 2007: Pickens assumes the duties of depositing money.
The City collects funds, through utility billing, for services such as water and sewer, electric service, garage sale permits, and business licenses. These funds are collected by the utility billing clerks at city hall.

At the close of each business day, the utility billing clerks reconcile the funds collected, and determine which funds should be placed in each account (General, APWA, AEDA).
A daily closeout report (“DCR”) is then created. The DCR reflects, among other things, the amount of cash and checks taken in by utility billing for each business day.

The DCR also reflects the amounts and composition of cash, checks and credit cards taken in for each individual till as well as the combined totals for the day. In addition to the total amounts of cash, checks and credit cards, the DCR also reflects any till shortages or overages as well as pre-deposits (direct deposits).

Once the tills have been reconciled, the funds are placed into a deposit bag and taken to a local bank where the deposit bag is locked up for the night. The following business day, the deposit bag is retrieved from the bank, the deposit slips are prepared and the funds are then deposited.

In October 2006, Katrina Pickens, Personnel and Payroll Director, informed Tracey Harris, deputy city clerk, that she would be taking over the task of making the deposits. According to Harris, Pickens stated that the reason she was taking over the deposits was because both Cheri Weber and Linda Howell, Finance Director and City Clerk, respectively, had complained about how she was doing the deposits. Both Weber and Howell denied making such statements.

We asked the City Manager if he was aware of Pickens taking over the deposits and he stated that he was not. According to the City Manager, Pickens was the de facto second-in-command for the City and she had, more or less, placed herself in the position of making the deposits.

Since we could not determine the exact date in October when Pickens took over the deposit duties, we performed a receipt to deposit test for September 2006 to determine if any shortages occurred immediately prior to Pickens assuming the deposit duties. We found no errors in the cash/check composition of the deposits nor did we find any errors in the deposit amounts.

For the period from October 2006 though May 18, 2007, it appears $160,961.36 in cash was receipted by utility billing but was not deposited into the City and Trust Accounts. In addition, we noted the City Court Clerk collected $6,028.00 in cash; however, those funds were not deposited into the City General Fund account. In total we identified $166,989.36 in cash that appears to be missing.

Cheri Weber, the City’s Finance Director, advised us that beginning in about November 2006, she had trouble getting the DCR’s from Pickens. When Weber told Pickens that she needed those reports in order to reconcile the bank statements, Pickens responded, according to Weber, by saying that she (Pickens) needed to learn how to reconcile the bank statements.

During the course of our audit, we identified what appears to be a cash/check replacement scheme. A cash/check replacement scheme involves using checks from an outside source to supplement a deposit, allowing cash to be removed, and having the deposit total balance match the expected amount of the deposit.

We cite the following as an example of how a check/cash replacement scheme works:

A person is expected to deposit $250.00 consisting of $100.00 in cash and $150.00 in checks. Rather than depositing the $100.00 cash, the person removes the $100.00 in cash and inserts a $100.00 check, from another source, into the deposit. Although the composition (amount of cash, amount of checks) has changed, the total amount of the deposit has not changed. $100.00 in cash was simply replaced with $100.00 in checks and the deposit remains $250.00.

The key element in a cash/check replacement scheme is having checks from a source other than the deposit being altered. During our audit fieldwork, we identified the following:

• Checks withheld from a single deposit were then used to replace cash in several
subsequent deposits.
• Checks from the court clerk deposits were used to supplement APWA deposits.
• False payroll checks were used to supplement APWA deposits.
• Checks were put in deposits that had not been processed through utility billing.

On May 3, 2007, Linda Howell was late arriving to work. When Howell arrived to City Hall she found that Pickens had already done the deposit and had already taken the deposit to the bank. During our testing, we found this deposit was short (May 2, 2007 DCR) $510.49 in cash and had an addition $510.49 in checks.

On May 11, 2007, the City Clerk, Linda Howell, was examining the deposits because the utility clerks had accepted a credit card payment on behalf of the court clerk. During this process, Howell discovered a discrepancy in the cash/check composition of the deposit. Howell found that a U.S. Treasury check, issued to the City of Anadarko, was in the deposit bag although utility billing had not receipted the check.

Subsequent to that discovery Linda Howell, Cheri Weber and Katrina Pickens met with City Manager Robert Williamson. During that meeting, Pickens allegedly stated that she had cashed a payroll check for someone. When Williamson was provided with a copy of the U.S. Treasury check, he questioned the validity of Pickens statement. This meeting occurred late Friday afternoon. The following Mondaymorning (May 14, 2007) Pickens was suspended from her duties.

Questionable payroll checks used to supplement deposits.

In a taped interview with District Attorney investigator, Stephen Coleman, Pickens indicated she had generated false payroll checks and used those checks to substitute for cash in the deposits. She stated that she issued the false payroll checks using employees who had left the employment of the City.

Checks issued by the City require the signatures of the City Clerk and Mayor. During an interview with Cheri Weber, she stated that Pickens had the signature stamps in her possession that were required on the checks.

For the purpose of further illustrating the check for cash substitution scheme, we selected a test sample of deposits in order to identify the specific checks used to conceal cash shortages. This was accomplished by obtaining the deposit composition for a particular day and tracing the checks to the daily postings to determine which checks were deposited and not posted.

A payroll check was issued to Eric Harlan, on December 22, 2006, in the amount of $1,024.19. This check was issued subsequent to his leaving the City’s employment and subsequent to him having received a final check for his vacation and compensatory time.

We obtained copies of additional checks issued to Harlen and compared the endorsement signatures of the additional checks to the questioned check. The endorsements signatures appeared to be different.

On June 21, 2007, we met with Eric Harlan at City Hall in Anadarko. Harlen was shown the questioned check and the endorsement on the check and asked if the signature was his. Harlen signed a sworn statement indicating the endorsement was not his.

This check was included in the deposit composition for the deposit on December 22, 2006 (December 21, 2006 DCR). Our testing for the December 21, 2006 daily report reflects that $1,024.19 cash was missing from the deposit.

On December 8, 2006, a payroll check was issued to Lehman Ware in the amount of $1,145.58. City records reflect that November 5, 2006 was Ware’s last day of employment with the City. We obtained copies of previous checks issued to Ware and compared those endorsement signatures to the endorsement signature on this check. The endorsements do not appear to be the same.

This check was included in the deposit composition for the deposit on December 11, 2006 (December 8, 2006 DCR). This deposit was missing $1,145.58 in cash and had an additional $1,145.58 in checks deposited.

On April 27, 2007, a payroll check was issued to Lynzee Shane in the amount of $510.49. Shane’s last date of employment with the City was April 5, 2007.

We obtained copies of checks previously issued to Shane and compared the endorsement signatures of those checks to the endorsement signatures of this check. The endorsements do not appear to be the same.

This check was included in a May 3, 2007 deposit in which cash, in the amount of $510.49, was missing and an additional check, in the amount of $510.49 was added to the deposit.

In addition to the above checks, we noted other payroll checks that, based on the documentation provided by the City, and the check endorsements, appear questionable. These checks included a payroll check issued to John Sage in the amount of $1,334.33 and a payroll check issued to Mitchell Valazquez in the amount of $469.61. We noted the check issued to John Sage was generated subsequent to his last day of employment.

We have provided our report to the District Attorney to determine if further action should be taken.

Altered Payee

Here, the fraudster changes the payee on the check so that he can deposit the check into his own account. An employee intercepts a company check intended for a third party and alters the payee designation so he or an accomplice can convert the check.

Using a pencil is an option!

Over seven years, Gayle Tatman stole over $200,000 from the Grove City food pantry for which she was treasurer. The food pantry helps the needy by providing food and paying bills.

Tatman wrote checks, in pencil, to fake individuals whose financial-aid worksheets she created. Once other volunteers at the organization approved the checks, she erased the pencil marks and wrote out the check to her creditors. When the organization began restructuring its finance operations in 2009, the board discovered falsified checks.

She also deposited pantry donations into four separate bank accounts, at least one of which was previously a legitimate account that the food pantry believed was closed.

Personal credit cards, house and car payments, as well as other personal expenses were paid for using the stolen money.[4]

Or you can wash the ink off with water

Greed prompts fraudsters to take risks that get them caught.

A 31 year-old Oregon man stole two checks from a residential mailbox, washed the checks, and made himself the payee. He rewrote one check, originally made out for $24.56, for $500. Then, on the memo line, he wrote “landscaping.”

When the man tried cashing the check, the bank employees recognized the fraudster and the scam. Earlier that day, the same man using the same technique had cashed a check at the bank. He made one too many appearances at the bank! The fraudster ran away when police arrived, but they caught him as he was scaling a fence.[5]

Don’t use acronyms

Ever notice that the IRS wants you to write checks to the US Treasury and not the IRS? That is because an employee was caught changing checks written to the IRS to I.R. Smith and depositing them to his own account![6] When I hand write a check I make sure to fill up the entire payee line with something – even if it is a horizontal line.

Concealed Checks

This is when an authorized signer is tricked into signing a check that she really doesn’t see or scrutinize. Imagine a secretary stacking checks for her boss and the boss signing everything in turn without looking at it. It could happen!

Authorized Maker

The authorized maker scheme is a check-tampering scheme in which an employee with signature authority on a company account writes fraudulent checks for his own benefit.

Although this doesn’t relate directly to checks, the authorized maker scheme reminds me of the vulnerability of my bank account from those corporations who are authorized to automatically withdraw funds from my account. My mortgage company and my insurance company always ask me to pay them directly and give them a voided check with all of my account information to set up the withdrawals. They may have all of this information without me sharing it with them intentionally, but I would much rather make the payment myself. I would never want to give a mortgage company this ability – especially given how many times my mortgage has been sold and reassigned over the years. Who are these people, and will they really protect my data?

The Association of Certified Fraud Examiners seems a little stuck in the 80s with their fraud tree. It left out the fraud that must be occurring with direct deposits of payroll checks, electronic bill pay, and electronic funds transfers. We’ll cover these frauds in a later chapter when we talk about the “Internet Fraud Tree.” For a preview of the Internet Fraud Tree, look here: https://www.safaribooksonline.com/library/view/internet-fraud-casebook/9780470643631/pr03.html

[1] “PTA Treasurer Cashed Forged Checks.” North Country Gazette, [Upstate New York]. September 8, 2010.

[2] United States. Cook County State’s Attorney’s Office. Communications Dept. Former City Worker Indicted for Theft of Tourism Funds Chicago Inspector General’s Office Exposes Abuse of Funds. Alvarez, Anita. Press release. Chicago, Illinois. August 19, 2009.

[3] Oklahoma State. Office of the Auditor and Inspector. City Of Anadarko Caddo County Special Audit July 2003 Through May 2007. Anadarko: State of Oklahoma, 2007.

[4] Dean Narciso. “Pantry embezzler guilty.” The Columbus Dispatch [Columbus, OH]. January 8, 2011.

[5] John Snell. “Hillsboro police say man tried to cash washed check.” The Oregonian [Portland]. September 3, 2008.

[6] Stephen Barr. “Audit of IRS Finds Fraud By Workers,” Washington Post. November 15, 1998.

Possible changes to the GAO’s Yellow Book

February 17, 2017

As of this writing, in February 2017, the Yellow Book is in flux. First the GAO will issue an ‘exposure draft’ of their government audit standards (a.k.a. the Yellow Book) to allow for public comment. After taking the public’s comments into consideration, they will issue a final version sometime in 2017.

For now, let me give you a short list of what the GAO intends to do. This is based on a presentation given by the GAO at the Association of Government Accountants Professional Development Conference in July of 2016. The GAO plans on:

Changing the format – The GAO is planning to revamp the format of the book to be similar to the AICPA’s clarified auditing standards format. This should not change the content or the meaning of the standards, but it may shed light on areas that were a little muddied or obscured in previous versions of the standards. In other words, I expect a lot of questions as users see the standards from a new perspective.

Tweaking ethics and independence – In the 2011 version, the ethics guidance in chapter 1 provided context for the independence requirements in chapter 3. In the 2017 version the two chapters will be merged.

Currently, the contents of the ethics chapter is soft. By soft, I mean the content is philosophical and conceptual and does not contain any requirements that a peer reviewer can confirm or deny. For example, the ethics chapter says “1.16 A distinguishing mark of an auditor is acceptance of responsibility to serve the public interest.” (Thankfully, this was not a requirement that auditors have to take literally – auditors do not have to got get a tattoo on their bicep that says “Public.” Get it? Distinguishing mark, tattoo?) But in chapter 3, the independence chapter, the GAO takes that soft guidance and puts teeth to it; in chapter 3 auditors are required to apply and document their application of a three step process called the ‘conceptual framework’ whenever they encounter a situation that will threaten their ability to serve the public interest.

Also, in this go round, the GAO is promising to toughen up independence requirements by asking that auditors confirm their compliance with independence standards, in writing, at least annually. And while they are at it, they are going to add in some requirements (not soft concepts) regarding ethics.

Enhancing guidance regarding SKE – When an auditor decides to take on a non-audit service, he must first ensure that the client has someone on their side who has the skills, knowledge, and experience (SKE) to evaluate the quality of the results of the non-audit service. The 2011 version of the Yellow Book introduced the concept of SKE, but didn’t spend a lot of space explaining how to document and prove a client’s SKE. The AICPA’s Government Audit Quality Center came up with a much more robust list of ways to prove SKE which, I am sure, the GAO is going to borrow from.

Defining how investigations fit into the standards – Yellow Book standards have never been a good fit for investigations. In this version, the GAO will define investigations as a non-audit service.

Requiring prophylactic CPE – The 2011 standards allow auditors to work on a Yellow Book engagement without any knowledge of government auditing. As a matter of fact, an auditor may perform government audits for a year without getting any CPE at all! The GAO is now proposing that auditors receive four hours of government audit training before they are assigned to an audit project.

Tweaking peer review requirements – Peer review teams will now need to choose a team captain and write a letter regarding the scope of the review to the audit shop undergoing peer review. Peer reviewers will also have to consider prior peer review results and include terminated engagements in their sample population.

Adding to internal control responsibilities – The GAO is promising to give auditors more guidance regarding their responsibility to gain an understanding of internal controls in order to plan the audit. Maybe they will reference the Green Book more specifically? I’ll be watching this one closely.

Stay tuned to my newsletter at Yellowbook-CPE.com to stay current on the 2017 revision.

Charging “Other Services” to the Federal Grantor

January 24, 2017

Please enjoy this chapter from “The New Uniform Guidance” self-study course by Sefton Boyars and Bill Allen.

This chapter focuses on whether grantees can charge legal and lobbying expenses to the federal government. Boyar and Allen also cover how grantees should handle donated services and assets.

Objectives:

Judge which professional service costs are allowable under a federal award
Judge which legal costs are allowable under a federal award
Distinguish between lobbying costs and normal operating costs of a program
Determine how to treat services donated in support of a federal award

Professional Services Costs

The costs of professional and consultant services rendered by persons who are members of a profession, or possess a special skill and who are not officers or employees of the nonprofit or governmental unit, are generally allowable.

For instance, a not-for-profit may engage a tax accountant to prepare its tax return or might hire an engineer to look over its plans for a facility expansion.

The costs are allowable when reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the federal government.

§200.459 Professional service costs.

(a) Costs of professional and consultant services rendered by persons who are members of a particular profession or possess a special skill, and who are not officers or employees of the non-Federal entity, are allowable, subject to paragraphs (b) and (c) when reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the Federal government. In addition, legal and related services are limited under §200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements.

The cost principles offer several factors to consider when determining the allowability of costs related to professional services, including:

The nature and scope of the service rendered,
The necessity of contracting for the service,
The past pattern of such costs,
The impact of federal awards on the governmental unit’s or nonprofit organization’s business,
Whether the service can be performed more economically by direct employment,
The qualifications of the individual, and
The adequacy of the contractual agreement for the services.

§200.459 Professional service costs.

(b) In determining the allowability of costs in a particular case, no single factor or any special combination of factors is necessarily determinative. However, the following factors are relevant:
(1) The nature and scope of the service rendered in relation to the service required.
(2) The necessity of contracting for the service, considering the non-Federal entity’s capability in the particular area.
(3) The past pattern of such costs, particularly in the years prior to Federal awards.
(4) The impact of Federal awards on the non-Federal entity’s business (i.e., what new problems have arisen).
(5) Whether the proportion of Federal work to the non-Federal entity’s total business is such as to influence the non-Federal entity in favor of incurring the cost, particularly where the services rendered are not of a continuing nature and have little relationship to work under Federal awards.
(6) Whether the service can be performed more economically by direct employment rather than contracting.
(7) The qualifications of the individual or concern rendering the service and the customary fees charged, especially on non-federally funded activities.
(8) Adequacy of the contractual agreement for the service (e.g., description of the service, estimate of time required, rate of compensation, and termination provisions).

In order to be allowable, retainer fees must be evidence of bona fide services available or rendered. Note that services do not necessarily have to be rendered, so long as they are available.

§200.459 Professional service costs.
(c) In addition to the factors in paragraph (b) of this section, to be allowable, retainer fees must be supported by evidence of bona fide services available or rendered.

Legal Defense Costs

Definitions Used for Legal Defense Costs

Paragraph (a) of §200.435 provides specific definitions of “conviction,” “costs,” “fraud,” “penalty,” and “proceeding” to be used for purposes of determining the allowability of costs related to legal defense and prosecution.

§200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements

(a) Definitions for the purposes of this section.
(1) Conviction means a judgment or conviction of a criminal offense by any court of competent jurisdiction, whether entered upon verdict or a plea, including a conviction due to a plea of nolo contendere.
(2) Costs include the services of in-house or private counsel, accountants, consultants, or others engaged to assist the non-Federal entity before, during, and after commencement of a judicial or administrative proceeding, that bear a direct relationship to the proceeding.
(3) Fraud means:
(i) Acts of fraud or corruption or attempts to defraud the Federal government or to corrupt its agents,
(ii) Acts that constitute a cause for debarment or suspension (as specified in agency regulations), and
(iii) Acts which violate the False Claims Act (31 U.S.C. 3729-3732) or the Anti-kickback Act (41 U.S.C. 1320a-7b(b)).
(4) Penalty does not include restitution, reimbursement, or compensatory damages.
(5) Proceeding includes an investigation.
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Permissible Legal Defense Costs

In general, legal expenses[1] required in the administration of federal programs by non-Federal entities are allowable. However, the federal government does impose limitations on legal expenses involved with defense of civil or criminal charges.

Under the cost principles, legal costs are a little tricky, but not if you think about things from the federal government’s perspective. For instance, you can’t use federal grant monies to fight the federal government in court. Why would they hand you the stick with which to beat them?

Section 200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements establishes the rules applicable to the recovery of legal costs related to grant administration. Because the rules are complex and obviously written by lawyers, we strongly recommend that, if the issue arises, you confer with legal counsel before deciding which costs would be permissible in any specific case. In general, to be able to claim the costs of a legal defense, the defendant needs to be exonerated. Any determination against the defendant, or a negotiated agreement, will normally render cost incurred as unallowable.

Section 200.435 provides the following with regard to legal costs:

§200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements

(b) Costs.
(1) Except as otherwise described herein, costs incurred in connection with any criminal, civil or administrative proceeding (including filing of a false certification) commenced by the Federal government, a state, local government, or foreign government, or joined by the Federal government (including a proceeding under the False Claims Act), against the non‑Federal entity, (or commenced by third parties or a current or former employee of the non-Federal entity who submits a whistleblower complaint of reprisal in accordance with 10 U.S.C. 2409 or 41 U.S.C. 4712), are not allowable if the proceeding:
(i) Relates to a violation of, or failure to comply with, a Federal, state, local or foreign statute, regulation or the terms and conditions of the Federal award, by the non-Federal entity (including its agents and employees); and
(ii) Results in any of the following dispositions:
(A) In a criminal proceeding, a conviction.
(B) In a civil or administrative proceeding involving an allegation of fraud or similar misconduct, a determination of non-Federal entity liability.
(C) In the case of any civil or administrative proceeding, the disallowance of costs or the imposition of a monetary penalty, or an order issued by the Federal awarding agency head or delegate to the non-Federal entity to take corrective action under 10 U.S.C. 2409 or 41 U.S.C. 4712.
(D) A final decision by an appropriate Federal official to debar or suspend the non‑Federal entity, to rescind or void a Federal award, or to terminate a Federal award for default by reason of a violation or failure to comply with a statute, regulation, or the terms and conditions of the Federal award.
(E) A disposition by consent or compromise, if the action could have resulted in any of the dispositions described in paragraphs (b)(1)(ii)(A) through (D) of this section.
(2) If more than one proceeding involves the same alleged misconduct, the costs of all such proceedings are unallowable if any results in one of the dispositions shown in paragraph (b) of this section.
(c) If a proceeding referred to in paragraph (b) of this section is commenced by the Federal government and is resolved by consent or compromise pursuant to an agreement by the non‑Federal entity and the Federal government, then the costs incurred may be allowed to the extent specifically provided in such agreement.
(d) If a proceeding referred to in paragraph (b) of this section is commenced by a state, local or foreign government, the authorized Federal official may allow the costs incurred if such authorized official determines that the costs were incurred as a result of:
(1) A specific term or condition of the Federal award, or
(2) Specific written direction of an authorized official of the Federal awarding agency.
(e) Costs incurred in connection with proceedings described in paragraph (b) of this section, which are not made unallowable by that subsection, may be allowed but only to the extent that:
(1) The costs are reasonable and necessary in relation to the administration of the Federal award and activities required to deal with the proceeding and the underlying cause of action;
(2) Payment of the reasonable, necessary, allocable and otherwise allowable costs incurred is not prohibited by any other provision(s) of the Federal award;
(3) The costs are not recovered from the Federal Government or a third party, either directly as a result of the proceeding or otherwise; and,
(4) An authorized Federal official must determine the percentage of costs allowed considering the complexity of litigation, generally accepted principles governing the award of legal fees in civil actions involving the United States, and such other factors as may be appropriate. Such percentage must not exceed 80 percent. However, if an agreement reached under paragraph (c) of this section has explicitly considered this 80 percent limitation and permitted a higher percentage, then the full amount of costs resulting from that agreement are allowable.
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(h) Costs of legal, accounting, and consultant services, and related costs, incurred in connection with patent infringement litigation, are unallowable unless otherwise provided for in the Federal award.
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(i) Costs which may be unallowable under this section, including directly associated costs, must be segregated and accounted for separately. During the pendency of any proceeding covered by paragraphs (b) and (f) of this section, the Federal government must generally withhold payment of such costs. However, if in its best interests, the Federal government may provide for conditional payment upon provision of adequate security, or other adequate assurance, and agreement to repay all unallowable costs, plus interest, if the costs are subsequently determined to be unallowable.

Unallowable Legal Costs

When a non-Federal entity incurs legal expenses to prosecute a claim against the federal government, the related costs are unallowable. Under 2 CFR 200, some legal costs are always unallowable:

Costs of legal, accounting, and consultant services, and related costs, incurred in connection with defense against federal claims or appeals, antitrust suits, or the prosecution of claims or appeals against the federal government;
Costs for prosecution of claims against the federal government; and
Costs of legal, accounting, and consultant services, and related costs, incurred in connection with patent infringement litigation.

Legal costs include expenses incurred before, during, and after commencement of a judicial or administrative proceeding that bears a direct relationship to the proceedings. Costs include:

Administrative and clerical expenses,
The cost of legal services (in-house or private counsel),
Services of accountants, consultants, or others retained by the organization to assist it, and
Costs of employees, officers, and trustees.

§200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements

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(f) Costs incurred by the non-Federal entity in connection with the defense of suits brought by its employees or ex-employees under section 2 of the Major Fraud Act of 1988 (18 U.S.C. 1031), including the cost of all relief necessary to make such employee whole, where the non‑Federal entity was found liable or settled, are unallowable.
(g) Costs of prosecution of claims against the Federal government, including appeals of final Federal agency decisions, are unallowable.
(h) Costs of legal, accounting, and consultant services, and related costs, incurred in connection with patent infringement litigation, are unallowable unless otherwise provided for in the Federal award.
(i) Costs which may be unallowable under this section, including directly associated costs, must be segregated and accounted for separately. During the pendency of any proceeding covered by paragraphs (b) and (f) of this section, the Federal government must generally withhold payment of such costs. However, if in its best interests, the Federal government may provide for conditional payment upon provision of adequate security, or other adequate assurance, and agreement to repay all unallowable costs, plus interest, if the costs are subsequently determined to be unallowable.

We should point out that all of these issues relate to costs incurred in criminal or civil proceedings. Researching data to refute an audit finding, for example, is perfectly acceptable, although we must remember that the general cost principles always apply. If the costs are unreasonable or unnecessary, they will be unallowable.

Lobbying Expenses

Lobbying Costs (Governmental Grantees)

Under the cost principles for governmental units, the costs of certain activities associated with obtaining grants, contracts, cooperative agreements, or loans are unallowable.

If a governmental unit incurs costs trying to implicitly or explicitly “improperly influence” an executive branch employee or officer for the purpose of considering or taking action on a “sponsored agreement or a regulatory matter,” then the costs are unallowable. What is meant by “improperly influencing” is not allowing the substance’s intrinsic value to be the basis of the decision, but instead using another means to persuade the employee or officer. The concern, of course, is with bribery, political pressure, and any other corrupting influence.

§200.450 Lobbying.
(a) The cost of certain influencing activities associated with obtaining grants, contracts, cooperative agreements, or loans is an unallowable cost. Lobbying with respect to certain grants, contracts, cooperative agreements, and loans is governed by relevant statutes, including among others, the provisions of 31 U.S.C. 1352, as well as the common rule, “New Restrictions on Lobbying” published at 55 FR 6736 (February 26, 1990), including definitions, and the Office of Management and Budget “Governmentwide Guidance for New Restrictions on Lobbying” and notices published at 54 FR 52306 (December 20, 1989), 55 FR 24540 (June 15, 1990), 57 FR 1772 (January 15, 1992), and 61 FR 1412 (January 19, 1996).
(b) Executive lobbying costs. Costs incurred in attempting to improperly influence either directly or indirectly, an employee or officer of the executive branch of the Federal government to give consideration or to act regarding a Federal award or a regulatory matter are unallowable. Improper influence means any influence that induces or tends to induce a Federal employee or officer to give consideration or to act regarding a Federal award or regulatory matter on any basis other than the merits of the matter.
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The lobbying rules for state and local governments are much less stringent than the rules for nonprofits. That is probably because state and local governments are political in their nature. We all expect that our governor, city supervisors, representatives, etc. will be trying to secure additional funding for their constituents.

Lobbying Costs (Non-Governmental Grantees)

Unallowable Lobbying Costs

Under the cost principles for nonprofit organizations, far more lobbying activities associated with obtaining grants, contracts, cooperative agreements, or loans are unallowable[2]:

Costs incurred in trying to implicitly or explicitly “improperly influence”[3] an executive branch employee or officer for the purpose of considering or taking action on a “sponsored agreement or a regulatory matter”;
Costs incurred in trying to influence, through in-kind or cash contributions, endorsements, or publicity, the outcomes of any federal, state, or local election, referendum, initiative, or similar procedure;
Costs incurred for the purpose of forming, running, contributing to, or paying the costs of a political party, campaign, political action committee (PAC), or other organization established with the intention of influencing the outcomes of elections;
Costs incurred to lobby or influence the introduction of federal or state legislation;
Costs incurred to influence the enactment or modification of any pending federal or state legislation; and
Costs for distributing or using publicity or propaganda, or urging members of the general public or any segment thereof to contribute to or participate in any mass demonstration, march, rally, fundraising drive, lobbying campaign or letter writing or telephone campaign.

§200.450 Lobbying.
(c) In addition to the above, the following restrictions are applicable to nonprofit organizations and IHEs:
(1) Costs associated with the following activities are unallowable:
(i) Attempts to influence the outcomes of any Federal, state, or local election, referendum, initiative, or similar procedure, through in-kind or cash contributions, endorsements, publicity, or similar activity;
(ii) Establishing, administering, contributing to, or paying the expenses of a political party, campaign, political action committee, or other organization established for the purpose of influencing the outcomes of elections in the United States;
(iii) Any attempt to influence:
(A) The introduction of Federal or state legislation;
(B) The enactment or modification of any pending Federal or state legislation through communication with any member or employee of the Congress or state legislature (including efforts to influence state or local officials to engage in similar lobbying activity);
(C) The enactment or modification of any pending Federal or state legislation by preparing, distributing, or using publicity or propaganda, or by urging members of the general public, or any segment thereof, to contribute to or participate in any mass demonstration, march, rally, fund raising drive, lobbying campaign or letter writing or telephone campaign; or
(D) Any government official or employee in connection with a decision to sign or veto enrolled legislation;
(iv) Legislative liaison activities, including attendance at legislative sessions or committee hearings, gathering information regarding legislation, and analyzing the effect of legislation, when such activities are carried on in support of or in knowing preparation for an effort to engage in unallowable lobbying.
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Permissible Lobbying Costs

Under the cost principles for nonprofit organizations, some costs related to influencing the decisions of federal and other officials of governmental units are allowable. Costs are allowable when grantees:

Present, in response to a documented appeal, technical and factual data on an issue directly related to a grant’s, contract’s or other agreement’s performance through hearing testimony, statements, or letters to the Congress or a state legislature, or subdivision, member, or cognizant staff member thereof;
Lobby or attempt to influence state legislation in order to directly reduce the cost, or to avoid material impairment of the organization’s authority to perform the grant, contract, or other agreement; or
Conduct an activity specifically authorized by law to be carried out using funds from the grant, contract, or other agreement.

§200.450 Lobbying.
(c)(2) The following activities are excepted from the coverage of paragraph (c)(1) of this section:
(i) Technical and factual presentations on topics directly related to the performance of a grant, contract, or other agreement (through hearing testimony, statements, or letters to the Congress or a state legislature, or subdivision, member, or cognizant staff member thereof), in response to a documented request (including a Congressional Record notice requesting testimony or statements for the record at a regularly scheduled hearing) made by the non-Federal entity’s member of congress, legislative body or a subdivision, or a cognizant staff member thereof, provided such information is readily obtainable and can be readily put in deliverable form, and further provided that costs under this section for travel, lodging or meals are unallowable unless incurred to offer testimony at a regularly scheduled Congressional hearing pursuant to a written request for such presentation made by the Chairman or Ranking Minority Member of the Committee or Subcommittee conducting such hearings;
(ii) Any lobbying made unallowable by paragraph (c)(1)(iii) of this section to influence state legislation in order to directly reduce the cost, or to avoid material impairment of the non-Federal entity’s authority to perform the grant, contract, or other agreement; or
(iii) Any activity specifically authorized by statute to be undertaken with funds from the Federal award.
(iv) Any activity excepted from the definitions of “lobbying” or “influencing legislation” by the Internal Revenue Code provisions that require nonprofit organizations to limit their participation in direct and “grass roots” lobbying activities in order to retain their charitable deduction status and avoid punitive excise taxes, I.R.C. §§501(c)(3), 501(h), 4911(a), including:
(A) Nonpartisan analysis, study, or research reports;
(B) Examinations and discussions of broad social, economic, and similar problems; and
(C) Information provided upon request by a legislator for technical advice and assistance, as defined by I.R.C. §4911(d)(2) and 26 CFR 56.4911-2(c)(1)-(c)(3).
(v) When a non-Federal entity seeks reimbursement for indirect (F&A) costs, total lobbying costs must be separately identified in the indirect (F&A) cost rate proposal, and thereafter treated as other unallowable activity costs in accordance with the procedures of §200.413 Direct costs.
(vi) The non-Federal entity must submit as part of its annual indirect (F&A) cost rate proposal a certification that the requirements and standards of this section have been complied with. (See also §200.415 Required certifications.)
(vii) (A) Time logs, calendars, or similar records are not required to be created for purposes of complying with the record keeping requirements in §200.302 Financial management with respect to lobbying costs during any particular calendar month when:
(1) The employee engages in lobbying (as defined in paragraphs (c)(1) and (c)(2) of this section) 25 percent or less of the employee’s compensated hours of employment during that calendar month; and
(2) Within the preceding five-year period, the non-Federal entity has not materially misstated allowable or unallowable costs of any nature, including legislative lobbying costs.
(B) When conditions in paragraph (c)(2)(vii)(A)(1) and (2) of this section are met, non‑Federal entities are not required to establish records to support the allowability of claimed costs in addition to records already required or maintained. Also, when conditions in paragraphs (c)(2)(vii)(A)(1) and (2) of this section are met, the absence of time logs, calendars, or similar records will not serve as a basis for disallowing costs by contesting estimates of lobbying time spent by employees during a calendar month.
(viii) The Federal awarding agency must establish procedures for resolving in advance, in consultation with OMB, any significant questions or disagreements concerning the interpretation or application of this section. Any such advance resolutions must be binding in any subsequent settlements, audits, or investigations with respect to that grant or contract for purposes of interpretation of this part, provided, however, that this must not be construed to prevent a contractor or non-Federal entity from contesting the lawfulness of such a determination.

Donated Services

Donated or volunteer services (professional and technical personnel, consultants, and other skilled and unskilled labor) are not reimbursable either as a direct or indirect cost. However, the value of donated services may be used to meet cost sharing or matching requirements in accordance with the provisions of the administrative rules.

If significant, the value of donated services should be considered in the determination of the governmental unit’s indirect costs or rate(s) and, accordingly, shall be allocated a proportionate share of applicable indirect costs. However, our experience indicates that this occurs very infrequently.

§200.434 Contributions and donations.
(a) Costs of contributions and donations, including cash, property, and services, from the non-Federal entity to other entities, are unallowable.
(b) The value of services … donated to the non-Federal entity may not be charged to the Federal award either as direct or indirect (F&A) cost. The value of donated services … may be used to meet cost sharing or matching requirements (see §200.306 Cost sharing or matching)….
(c) Services donated or volunteered to the non-Federal entity may be furnished to a non‑Federal entity by professional and technical personnel, consultants, and other skilled and unskilled labor. The value of these services is not allowable either as a direct or indirect cost. However, the value of donated services may be used to meet cost sharing or matching requirements in accordance with the provisions of §200.306 Cost sharing or matching.
(d) To the extent feasible, services donated to the non-Federal entity will be supported by the same methods used to support the allocability of regular personnel services.
(e) The following provisions apply to nonprofit organizations. The value of services donated to the nonprofit organization utilized in the performance of a direct cost activity must be considered in the determination of the non-Federal entity’s indirect cost rate(s) and, accordingly, must be allocated a proportionate share of applicable indirect costs when the following circumstances exist:
(1) The aggregate value of the services is material;
(2) The services are supported by a significant amount of the indirect costs incurred by the non-Federal entity;
(i) In those instances where there is no basis for determining the fair market value of the services rendered, the non-Federal entity and the cognizant agency for indirect costs must negotiate an appropriate allocation of indirect cost to the services.
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(f) Fair market value of donated services must be computed as described in §200.306 Cost sharing or matching.
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The following addresses the treatment of the indirect costs related to donated services:

§200.434 Contributions and donations.
(e)(2)(ii) Where donated services directly benefit a project supported by the Federal award, the indirect costs allocated to the services will be considered as a part of the total costs of the project. Such indirect costs may be reimbursed under the Federal award or used to meet cost sharing or matching requirements.
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Donated Property

Like donated services, the value of property contributed to a grant program cannot be claimed as either direct costs or indirect costs. However, it can be claimed as cost sharing. Generally, the amount that can be claimed as cost sharing is the fair market value of the items at the time of the contribution. However, the new rules contain a limitation on value that had not existed previously.

(g) Personal Property and Use of Space.
(1) Donated personal property and use of space may be furnished to a non-Federal entity. The value of the personal property and space is not reimbursable either as a direct or indirect cost.
(2) The value of the donations may be used to meet cost sharing or matching share requirements under the conditions described in §§200.300 Statutory and national policy requirements through 200.309 Period of performance of subpart D of this part. The value of the donations must be determined in accordance with §§200.300 Statutory and national policy requirements through 200.309 Period of performance. Where donations are treated as indirect costs, indirect cost rates will separate the value of the donations so that reimbursement will not be made.

For contributions of buildings or land, the value of the property for cost sharing purposes is the lesser of:

The book value in the contributor’s accounting records at the time of the donation; or
The fair market value of the item at the time of donation.

Because most real property has significantly increased in value over the years, any real property that is contributed to meet cost sharing requirements might be valued at far less than the current fair market value. My house would constitute a graphic example. My wife and I purchased it over 40 years ago. Its current market value is close to 20 times what I paid for it all those decades ago. However, its book value would be almost zero. It would be considered almost fully depreciated, so the book value would be miniscule.

The rules do permit the federal agency, with sufficient justification, to use the fair market value at the time of donation even if that value exceeds book value. This text is being written before the new rules become effective, so we do not know at this point how the federal agencies will handle such contributions. Although, if they do limit the amount of cost sharing to book value, real property contributions may decline substantially.

The regulations make it clear that if the contributed real property is not to be used as cost sharing, but rather is included in general inventory and depreciated, then this limitation will not apply. In such a case, the value would be the fair market value at the time of donation.

§200.306 Cost sharing or matching
(d) Values for non-Federal entity contributions of services and property must be established in accordance with §200.434 Contributions and donations. If a Federal awarding agency authorizes the non-Federal entity to donate buildings or land for construction/ facilities acquisition projects or long-term use, the value of the donated property for cost sharing or matching must be the lesser of paragraphs (d)(1) or (2) of this section.
(1) The value of the remaining life of the property recorded in the non-Federal entity’s accounting records at the time of donation.
(2) The current fair market value. However, when there is sufficient justification, the Federal awarding agency may approve the use of the current fair market value of the donated property, even if it exceeds the value described in (1) above at the time of donation.
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Chapter 6 Summary

Grantee organizations may require services that are not available within the organization itself. Thus, the costs of professional services are generally permissible. The costs are allowable when reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the federal government.

In general, legal expenses required in the administration of federal programs are permissible. However, legal expenses for prosecution of claims against the federal government are unallowable. Legal expenses involving the defense of criminal or civil prosecution are unallowable when a proceeding is settled by consent or compromise, unless specifically provided for in the settlement agreement.

Lobbying costs incurred by either a governmental unit or nonprofit in an attempt to improperly influence an employee or officer of the executive branch of the federal government are unallowable. Under the cost principles for nonprofit organizations, far more lobbying activities associated with obtaining grants, contracts, cooperative agreements, or loans are unallowable. In addition to the above restriction, costs for the following activities are unallowable:

Attempting to influence the outcomes of election, referendum, initiative, or similar procedure;
Establishing, administering, contributing to, or paying the expenses of a political party, campaign, or political action committee;
Lobbying or influencing the introduction of federal or state legislation; and
Influencing the enactment or modification of any pending federal or state legislation.

Under the cost principles for nonprofit organizations, costs are allowable to:

Provide a technical and factual presentation of information on a topic directly related to the performance of an award;
Lobby or attempt to influence state legislation in order to directly reduce the cost, or to avoid material impairment of the organization’s authority to perform the grant, contract, or other agreement; or
Conduct an activity specifically authorized by statute to be undertaken with funds from the grant, contract, or other agreement.

Donated goods or services may not be claimed as either direct costs or indirect costs. However, they may be allowable as cost sharing or matching requirements in accordance with the provisions of the administrative rules.

[1] Costs include all costs related to the proceedings.

[2] When an organization seeks reimbursement for indirect costs, total lobbying costs shall be separately identified in the indirect cost rate proposal, and thereafter treated as other unallowable activity costs.

[3] Improper influence is defined the same for both governmental units and nonprofit organizations.

Expense Reimbursement Fraud Schemes

December 28, 2016

We are still working through the cash disbursement schemes mentioned in the fraud tree. For a picture of the fraud tree, see this link: http://www.acfe.com/fraud-tree.aspx. Last time we discussed the categories of fraudulent disbursements, we covered payroll schemes and billing schemes. This time we will cover the third out of five schemes classified by the Certified Fraud Examiners as cash disbursement schemes and expense reimbursement schemes.

Go tell that long tongue liar,
Go and tell that midnight rider,
Tell the rambler, the gambler, the back biter,
Tell ’em that God’s gonna cut ’em down.
Run on for a long time
You can run, Lord, for a long time.
You can run, Lord, for a long time
But let me tell you God Almighty’s gonna cut you down.
Traditional folk song

Expense Reimbursement Schemes

Another way to falsely extract money from your employer is to make up fake or inflated business expenses. Under this section of the tree, the Association of Certified Fraud Examiners lists four components:

Mischaracterized expenses
Overstated expenses
Fictitious expenses
Multiple reimbursements for expenses

Mischaracterized Expenses

When I was in college, I worked as an accounts payable clerk at a high tech company for a summer. One of my jobs was to review travel expense reports for compliance with corporate policy.

The company did not pay for movies in the hotel room – especially not adult movies. Adult movies are more expensive, so I knew that one executive was being – shall we say ‘creative’ – with his entertainment charges. The phone call was a little tense, “Your film is not allowable, sir…”

Robert Half International, a professional recruiting firm, asked 150 senior executives with some of the nation’s largest companies, “What is the most outrageous thing that an employee has tried to pass off as a work-related expense?” It turns out creative employees have tried to expense tropical fish, traffic tickets, the cost of transporting a pet gerbil overseas, ‘lodging’ at a storage facility, expensive silk sheets and silverware, excursions to Europe and the Masters, health care coverage for a pet, and my personal favorite, divorce costs. I can see the reasoning there: employers expect so much nowadays, they probably trigger most divorces in the US.[1]

Overstated Expenses

I enjoyed working with a Medicare audit group in 2008. They were responsible for finding fraud, waste, and abuse in the Medicaid program. That is quite an undertaking since so many people and so many systems are involved, and so many folks are in need. Doctors, hospitals, nurses, pharmacies, suppliers, patients, and families can be mighty creative in getting just that little extra from the federal government by overstating expenses. Here is another executive summary from a GAO audit.

Medicare Fraud, Waste, and Abuse: Challenges and Strategies for Preventing Improper Payments[2]

Summary

GAO has designated Medicare as a high-risk program since 1990, in part because the program’s size and complexity make it vulnerable to fraud, waste, and abuse. Fraud represents intentional acts of deception with knowledge that the action or representation could result in an inappropriate gain, while abuse represents actions inconsistent with acceptable business or medical practices. Waste, which includes inaccurate payments for services, also occurs in the Medicare program. Fraud, waste, and abuse all can lead to improper payments, overpayments and underpayments that should not have been made or that were made in an incorrect amount. In 2009, the Centers for Medicare & Medicaid Services (CMS) – the agency that administers Medicare – estimated billions of dollars in improper payments in the Medicare program. This statement will focus on challenges facing CMS and selected key strategies that are particularly important to helping prevent fraud, waste, and abuse, and ultimately to reducing improper payments, including challenges that CMS continues to face. It is based on nine GAO products issued from September 2005 through March 2010 using a variety of methodologies, including analysis of claims, review of relevant policies and procedures, stakeholder interviews, and site visits. GAO received updated information from CMS in June 2010.

GAO has identified challenges and strategies in five key areas important in preventing fraud, waste, and abuse, and ultimately to reducing improper payments. GAO has made recommendations in these areas. CMS has made progress in some of these areas, and recent legislation may provide the agency with enhanced authority. However, CMS faces continuing challenges. 1. Strengthening provider enrollment process and standards. Checking the background of providers at the time they apply to become Medicare providers is a crucial step to reduce the risk of enrolling providers intent on defrauding or abusing the program. In particular, GAO has recommended stricter scrutiny of providers identified as particularly vulnerable to improper payments to ensure they are legitimate businesses. 2. Improving pre-payment review of claims. Pre-payment reviews of claims are essential to helping ensure that Medicare pays correctly the first time. GAO has recommended that CMS further enhance its ability to identify improper claims through additional automated pre-payment claim review before they are paid. 3. Focusing post-payment claims review on most vulnerable areas. Post-payment reviews are critical to identifying payment errors and recouping overpayments. GAO has recommended that CMS better target claims for post payment review on the most vulnerable areas. 4. Improving oversight of contractors. Because Medicare is administered by contractors, overseeing their activities to address fraud, waste, and abuse is critical. GAO found that CMS’s oversight of prescription drug plan sponsors’ compliance programs has been limited. However, partly in response to GAO’s recommendation, CMS oversight of these programs is expanding. 5. Developing a robust process for addressing identified vulnerabilities. Having mechanisms in place to resolve vulnerabilities that lead to improper payment is vital to program management, but CMS has not developed a robust process to specifically address these. GAO has recommended that CMS establish an adequate process to ensure prompt resolution of identified improper payment vulnerabilities.

Here in Austin, the directors of an electric co-op, the Pedernales Electric Cooperative (of which I am a member), paid themselves ten times the salary of the nation’s second largest co-op! Board members were reimbursed for about $700,000 in expenses between 2002 and 2006 for everything from first-class airfare to top-tier hotel stays to costly purchases of meals, furniture and concert tickets, according to court records. All of these board members were, thankfully removed in shame, but not before they lived the high life for a good long while.[3]

Fictitious Expenses

Yes, another Medicaid story! The plethora of Medicaid stories shouldn’t be too surprising since over 20% of our federal budget is spent on Medicaid.[4]

The number one crime in Miami isn’t drug trafficking; it is Medicare fraud. A 60 Minutes investigation uncovered hundreds of tiny pharmacies and doctors’ offices in South Florida that weren’t staffed or open; some were really just storage facilities!

One fraudster shared with 60 Minutes how easy it is to set up a fake supplier or pharmacy and bill the feds using names and social security numbers of real patients. Hackers steal the names and social security numbers from legitimate doctors’ offices and pharmacies and sell them for up to $10 a name to these illegitimate ‘suppliers.’ One retired judge’s social security number was used to charge for a prosthetic right and left arm. Only problem is, he still has both arms and they work just fine!

Medicaid auditors are understaffed and overwhelmed. And most scammers are able to operate without any trouble – quietly ripping off $20-40 thousand a day.[5]

An aversion to IT Cost a New Zealand Company $1.7 million!

A simple fraud, using Microsoft Excel templates to create the 350 bogus invoices, lasted six years and made Trevor Uialatea Esera richer by $1,758,193. As the company’s IT manager, he was responsible for signing off expenditures, preparing the IT budget, and ordering equipment and computer software.

He created fake invoices from three companies. Two of the companies – Intergra Images and Software Plus – were bogus, and the third had no idea what he was doing. Court documents described the fake firms as “companies of his own invention.”

Esera’s bosses were oblivious to his fake invoicing because senior staff at Rinnai, a water heater manufacturer, had little or no experience in IT.[6]

Multiple Reimbursements for Expenses

Have you seen the website that lets you create fake receipts? Just Google ‘fake receipts,’ and Google lists pages and pages of sites. One of the sites is generic, but for a small fee you can upgrade to get better logos for well-known companies. Here is an image of what you can create using one of these sites:

Looks pretty good, doesn’t it?

If you think you can get away with it, why not submit the same expense more than once! You’d score extra points for commiting two frauds at once – a fake receipt and double payment on the same receipt. You over-acheiver you!

I receive ridiculous proposals and promises of riches every day via email. “Please let me introduce myself. I am blah blah from X, Africa seeking to transfer funds to the United States. I will share the proceeds with you, blah blah.” A CPA in my class confessed that one of his elderly clients fell for this scam and lost $50,000 because he gave the scammers his bank account number.

I have heard of (but can’t tie down with a news story) scammers creating hundreds of fake invoices and sending them to every corporation they can find. Even if only 2 out of a hundred pay, they still have something with which to buy that coveted wide-screen TV!

I can easily see this happening, because when I worked as an accounts payable clerk the summer of my junior year in college, one of my horribly boring tasks was to match up the vendors’ monthly statements to their invoices. It was hard to reconcile the two because the vendors would call complaining that we weren’t paying them in a timely manner and the accounts payable supervisor would often pay whatever was in front of her… It was a mess. Several times, we decided to pay whatever the came in through the mail because we were getting so backed up. We wrote a check, crossed our fingers and hoped for the best.

[1] Robert Half International. Can You Expense a Tropical Fish? What Workers Try to Put on the Company Dime. September 24, 2009.

[2] United States. Govt. Accountability Office. Medicare Fraud, Waste, and Abuse: Challenges and Strategies for Preventing Improper Payments. June 15, 2010. GAO-10-844T.

[3] Claudia Grisales. “Settlement Reached In Pedernales Co-Op Lawsuit.” Austin American Stateman. March 11, 2008.

[4] Policy Basics: Where Do Our Federal Tax Dollars Go? Center for Budget and Policy Priorities. April 14, 2010.

[5] Ira Rosen and Joel Bach. “Medicare Fraud: A $60 Billion Crime A.G. Holder Tells 60 Minutes More Oversight Is Needed; Scammer Explains How Easy It Is To Steal Millions.” Sixty Minutes. WCBS. October 25, 2009. Television.

[6] Kerry Williamson. “Bogus invoices got IT chief $1.75 million.” The Dominion Post [New Zealand]. December 12, 2009.

Cash Register Fraud Schemes

Register Disbursements

False Voids

False Refunds

Check Tampering Fraud Schemes

Check Tampering Schemes

Forged Maker

Forged Endorsement

Altered Payee

Concealed Checks

Authorized Maker

Possible changes to the GAO’s Yellow Book

Charging “Other Services” to the Federal Grantor

Professional Services Costs

Permissible Legal Defense Costs

Unallowable Legal Costs

Lobbying Expenses

Lobbying Costs (Non-Governmental Grantees)

Permissible Lobbying Costs

Donated Services

Donated Property

Chapter 6 Summary

Expense Reimbursement Fraud Schemes

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Register Disbursements

False Voids

False Refunds

Check Tampering Schemes

Forged Maker

Forged Endorsement

Altered Payee

Concealed Checks

Authorized Maker

Professional Services Costs

Permissible Legal Defense Costs

Unallowable Legal Costs

Lobbying Expenses

Lobbying Costs (Non-Governmental Grantees)

Permissible Lobbying Costs

Donated Services

Donated Property

Chapter 6 Summary

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