Lapping fraud definition

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What is Lapping Fraud?

Lapping occurs when an employee alters accounts receivable records in order to hide the theft of cash. This is done by diverting a payment from one customer, and then hiding the theft by diverting cash from another customer to offset the receivable from the first customer. This type of fraud can be conducted in perpetuity, since newer payments are continually being used to pay for older debts, so that no receivable involved in the fraud ever appears to be that old.

Characteristics of Lapping Fraud

Here are the key characteristics of lapping fraud:

  • MIs-application of payments. Customer payments are not being applied to the intended accounts. because the fraudster applies payments from one customer to cover up a missing payment from another.

  • Continuous cycle of concealment. Lapping relies on a continuous inflow of payments to cover prior thefts. If payments slow down or stop, the scheme becomes harder to maintain.

  • Perpetrated within accounting. Lapping is often carried out by employees in roles where they handle incoming payments, such as cashiers or accounts receivable clerks. The opportunity arises due to lack of segregation of duties.

  • Exploits record-keeping weaknesses. Lapping exploits weaknesses in internal controls, such as lack of supervision or reconciliation. It is often undetected when there is poor segregation of duties, particularly in payment handling and ledger updating.

Where Does Lapping Occur?

Lapping is most easily engaged in when just one employee is involved in all cash handling and recordation tasks. This situation most commonly arises in a smaller business, where a bookkeeper may be responsible for all accounting tasks. If these tasks are split up amongst several people (known as the segregation of duties), then lapping can only be conducted when two or more employees are involved.

Example of Lapping

As an example of lapping, Smith Corporation receives a customer’s check payment for $1,000. Its accounting clerk, Henrietta Smith, uses her name’s similarity to that of the company to divert the payment into her own bank account. To hide this initial theft, Henrietta then “mistakenly” applies another customer’s payment for $800 to the account of the first customer, leaving $200 of unpaid billing on the first customer’s account. Ms. Smith continues to apply a succession of customer payments to the first customer’s account, and then to the second customer’s account, and so forth in order to hide the fact that she has stolen $1,000 from the company.

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How to Detect Lapping

Lapping can be detected by conducted a periodic review of the cash receipts records, to trace payments to outstanding receivables. If there is ongoing evidence that cash receipts are routinely being applied against the wrong customer accounts, then either the cashier is astonishingly incompetent or there is an active lapping scheme in progress.

Lapping typically requires that the person engaged in the fraud be involved every day, and so is unable to take any vacation time. Thus, having a person refuse to take the vacation time that they have earned can be considered a possible indicator of the existence of lapping.

Controls Against Lapping

There are many controls that can be used to prevent or detect lapping. Consider installing some or all of the following controls:

  • Have someone other than the cashier send statements to customers. Customers know what they paid to the company, so they should be able to detect unusual payments ascribed to their accounts, or note that certain payments were never applied against their accounts.

  • Contact customers and ask if they have received monthly statements from the company. The responsible party may have been intercepting and destroying the statements before they were mailed.

  • Audit cash receipts transactions on a regular basis, as noted above.

  • Require all employees in the accounting area to take all of their vacation time, without exception.

  • Track the days of accounts receivable on a trend line. A gradual increase in this measurement can be caused by lapping.

  • Tightly control the use of credit memos. A party committing fraud may attempt to terminate a lapping situation by writing off a receivable in the amount of the missing funds.

  • Stamp all checks with "For Deposit Only," so that employees cannot deposit these checks to their own accounts.

  • Have customers pay directly to a lock box, so that cash cannot be intercepted and stolen by employees.