Buckhoff & Kramer Cardinal Wholesalers, Inc. .docx

Buckhoff & Kramer
Cardinal Wholesalers, Inc. Student Manual Page 1
CARDINAL WHOLESALERS, INC.©
A FRAUD EXAMINATION/AUDITING CASE SIMULATION
By Thomas Buckhoff and Bonita Peterson Kramer
© No part of this work may be reproduced or used in any form
or by any means without the
written permission of the authors.
CASE BACKGROUND1
Bill Carter
Bill Carter had invested the last 22 years of his life working for
Cardinal Wholesalers,
Inc.—a Fortune 500 corporation that operated a grocery store
chain with over 300 locations
nationwide. His job as a purchasing department manager paid
him an annual salary of $60,000
per year, which was sufficient to support his wife and three
children. Now he found himself
unemployed—fired, to be exact—and for what? Jill, who

worked in Bill’s department, had
caught him looking at ‘inappropriate’ websites while he had
some downtime at work. It was all
so unfair. Bill knew others within the company who had done
the same thing and they weren’t
fired. Why? Because they had never been caught by someone
willing to turn them in to
management. After receiving Jill’s formal complaint memo,
management decided to send a
signal to the company’s rank and file that looking at
inappropriate websites on company time
and using company equipment was unacceptable and would not
be tolerated. So Bill was given a
pink slip, told to clear out his desk immediately, and received
two weeks severance pay.
Ashamed to tell his wife and kids the real reason he lost his job,
Bill told them he had
been laid off due to ‘corporate downsizing.’ Whatever the
reason, he had to figure out a way to
support his family before his severance pay ran out. With only
two weeks of severance pay, Bill
needed to find a new source of income right away or he
wouldn’t be able to make payments on
the family’s debts, which included: a $1,980 per month

mortgage payment, $900 per month in
car payments, minimum payments of $450 per month on
outstanding credit card debt totaling
$38,000, and education expenses for his oldest child who was
attending an expensive Ivy-league
university. Over the next few days Bill diligently searched the
want ads, visited the local job
service, sent out resumes, and even had an appointment with the
placement center at State
1 This case is based on an actual fraud investigated by one of
the authors. The names of the
victim organization and the various players involved have all
been changed to protect their
privacy.
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University, where he had obtained a bachelor’s degree in
business administration about 25 years
ago. However, after a week of actively exploring the job
market with no good leads and three
dead end interviews, Bill began to feel increasingly desperate
about his financial situation,

which, in turn, increased his anger towards his former employer
for making him a scapegoat and
putting him in this situation.
Mike Smith
Mike Smith formerly reported to Bill in the purchasing
department of Cardinal. He and
Bill had developed a close friendship working together during
the five years leading up to Bill’s
firing. Mike also felt strongly that management had treated Bill
unfairly. Consequently, Mike
had mixed feelings when he was promoted to fill Bill’s former
position as purchasing department
manager. He felt like a traitor to Bill for accepting the
promotion. However, he could certainly
use the extra $15,000 per year in salary to help pay off some
large debts he had accumulated
during the five years since his graduation from State University.
Even though his $45,000 per
year salary was enough to provide comfortably for a single
person, Mike had not done a very
good job of managing his personal finances. He leased a nice
$1,500 per month condominium as
well as an $800 per month Audi. He had accumulated $15,000

in student loan debt and another
$25,000 in credit card debt, most of which was used to purchase
furniture, a home theater system
with big-screen TV, and other home furnishings. On top of all
this, Mike had foolishly amassed
more than $50,000 in gambling debts, on which he was
obligated to make monthly payments.
Mike loved the night life and especially enjoyed the challenge
and thrill associated with
gambling. Even though he voraciously consumed every book he
could find on how to beat the
odds, somehow the house managed to get the best of him over
the last five years. Mike
continuously believed that someday his luck would change and
he would “hit the big one” and
pay off all his debts.
The Proposition
In his desperation to obtain a new source of income, Bill
thought of an idea that could at
least temporarily provide him with some cash flow until he
secured other employment. As the
former purchasing department manager of Cardinal he was
familiar with the company’s system

of authorizing and processing cash disbursement requests. As
purchasing department manager,
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he had the authority to place vendors on the approved vendor
list, he could initiate purchase
orders for goods and services, and he approved payment on
incoming vendor invoices. Bill
could create a shell company2 and send invoices to Cardinal as
if some goods or services were
being provided, when in fact nothing was provided. This could
provide him with a temporary
source of income until he got another job. All he needed for his
plan to succeed was to get
someone within Cardinal to approve payment on the shell
company invoices. That’s when he
thought of his old friend, Mike. Bill phoned Mike and invited
him to have a drink at their
favorite sports bar after work the next day. Mike accepted.
After getting caught up on company gossip, Bill matter-of-
factly presented Mike with a

proposition: Bill would create a shell company and generate
bogus invoices, which would then
be submitted to Cardinal as if a service was being provided.
Mike simply had to place the
vendor on the approved vendor list and then approve payment
on the incoming bogus invoices.
Accounts payable would send the check to the vendor’s post
office box address. Bill would then
retrieve the check, deposit it into a bank account opened in the
shell company’s name, and they
would split the money fifty-fifty. Bill further explained that the
scheme would not be detected
since Cardinal typically paid hundreds of millions of dollars
annually to tens of thousands of
different vendors. No way would the auditors or anyone else
notice a few thousand dollars paid
periodically to one bogus vendor. Moreover, Cardinal did not
independently verify receipt of
services before paying vendor invoices. Creating a shell
company simply required filling out a
one-page application and paying a $25 registration fee to the
secretary of state, which would then
provide Bill with a ‘doing-business-as’ certificate. The
certificate could then be used to open a

post office box and a bank account in the name of the shell
company. All that Mike needed to
do was approve payment on the incoming bogus invoices. The
scheme was fool proof. And
besides, both of them could use the extra money. Mike agreed
to think about it and get back to
Bill within a week. After thinking it over for a few days, Mike
decided that this was probably
the only way he could pay off his debts and make a fresh start.
He could always back out of the
scheme after his debts were paid off. Mike called Bill back and
accepted the proposition.
2 Shell companies are created for the sole purpose of
committing fraud. They produce no goods
or services; they are businesses on paper only.
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The Tip
The scheme worked so well that neither Bill nor Mike
considered ending it after their
debts had been paid off. In fact, after five years they had each

pocketed almost $1 million
dollars, tax free, from the scheme. Neither the auditors, nor
anyone else, ever questioned any of
the payments being made to the shell company. Bill and Mike
were both enjoying extremely
comfortable, even extravagant, lifestyles. Despite the
fraudulent diversion of funds, Cardinal
was reporting above-average profits. Things couldn’t have been
better; that is until too much
alcohol and a loose tongue resulted in their undoing. One
evening Bill was visiting a local bar
and had a few too many drinks. Consequently, he began
bragging about his fraud scheme to a
stranger sitting next to him in the bar. Bill told the stranger all
of the relevant details of the
scheme: the name of the shell company, the name of the victim
company (Cardinal), his own
name as well as the name of his inside accomplice, and how
much they had stolen over the last
five years. The next morning (January 6) the stranger decided
to cash in on this information and
called Cardinal, the victim company. Eventually the call was
transferred to the office of the
chief loss prevention specialist, Debbie Roberts. The stranger

informed Debbie that “a vendor
scheme is costing your company millions of dollars, and for
$250,000 I will tell you which
vendor it is.” Debbie balked at paying the $250,000 and
counter offered $20,000. The stranger
refused and the phone call ended. Debbie now knew that a
fraudulent vendor existed amongst
the tens of thousands of vendors in Cardinal’s vendor database.
The only problem was how to
figure out which one it was.
Required Assignments
1. After reviewing the background information above, write a
1-2 page memo evaluating
both Bill Carter and Mike Smith in terms of the fraud triangle.
2. Debbie Roberts, Cardinal’s chief loss prevention specialist,
engages you, the aspiring
fraud examiner, to identify the fraudulent vendor. You accept
the engagement. You first
must educate yourself about: (a) how vendor schemes3 work,
(b) how they can be
detected [i.e. identify common red flags], (c) how they can be
investigated, and (d) how

3 These schemes include and can also be called shell company
schemes, fictitious vendor
schemes, billing schemes, pass-through schemes, and/or false
vendor schemes.
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they can be effectively prevented. The Primer on Fraud
contained in the Appendix
provides background information you need to understand before
proceeding to
Requirement 3. Once you have educated yourself on these
topics, write a 2-3 page memo
explaining the four areas above. Submit the memo to your
professor for grading and
continue to Requirement 3. Caveat: A thorough understanding
of the material contained
in the Primer on Fraud is necessary to successfully complete the
remainder of this case
simulation.
3. Your engagement task is to identify the fraudulent vendor in
the vendor database

contained in the Cardinal Vendors Excel file provided on this
CD. However, it would be
too tedious and time consuming to physically inspect the
invoices of 1,000 vendors.
Accordingly, you decide to narrow the list of vendors by
examining red flags that would
be evident in the vendor database. As a result, the computer
can perform much of the
work. Using Excel’s AutoFilter function4, you decide to query
three separate data fields
contained in the vendor database: Taxpayer ID, Address, and
Phone #. After performing
the queries, rank the vendors by how many suspicious
characteristics they possess. For
example, a vendor with either no taxpayer ID number or an
invalid one would possess
one suspicious characteristic. Thus, your queries should result
in four groups of vendors:
(1) those possessing three suspicious characteristics, (2) those
possessing two suspicious
characteristics, (3) those possessing one suspicious
characteristic, and (4) those
possessing no suspicious characteristics. When you are
confident that you have

identified the six most suspicious vendors, explain and defend
your answers in Memo
format and submit to your instructor for grading. Then, you may
proceed to Requirement
4.
4. Generate a list of red flags likely to be present on fraudulent
vendor invoices. Using the
beginning letter of each of the six suspicious vendor names (in
alphabetical order) as the
password, open the “Vendor Invoices” File. Examine the
invoices looking for suspicious
characteristics. Look for items on the invoice that compensate
for suspicious items
identified in the query of the vendor database. For example, if
a certain vendor was
4 For an explanation of how to use Excel’s AutoFilter function,
see Strategic Finance, April 2005, pages 46-49.
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flagged for not having a phone number in the database but the

invoice has a phone
number, then that lowers the level of suspicion with respect to
that vendor. After
carefully examining all of the invoices, select the vendor with
the most suspicious
characteristics. Explain and defend your answer in Memo
format. Submit your answer to
your instructor for grading. Once your answer has been
successfully submitted, you may
proceed to Requirement 5.
5. Vendor schemes can be subcategorized as either fictitious
vendor or pass-through
schemes. With fictitious vendor schemes the victim company
receives nothing from the
fictitious vendor except the bogus invoices. Thus, the fraud
loss is determined by adding
up the total payments made to the vendor. A pass-through
scheme is one in which the
fraudster sets up a shell company as an unnecessary
intermediary between a legitimate
vendor and the victim company and makes an unauthorized
profit on the transaction.
Accordingly, with a pass-through scheme the victim company is

actually receiving
something in exchange for payments made to the shell company.
Thus, the fraud loss is
the amount of the unauthorized profit made by the fraudster.
With pass-through schemes
the victim company receives invoices from the shell company
instead of from the vendor
that is actually providing the products or services listed on the
invoices. Based on your
understanding of how the two schemes work, develop a strategy
for determining whether
the fraudster is perpetrating a fictitious vendor scheme or a
pass-through scheme. Using
the most suspicious vendor’s taxpayer id number as the
password, carefully examine the
“Bank Statement” file which contains the bank statement and
copies of the cancelled
checks. Determine whether the suspicious vendor you have
identified is a fictitious
vendor scheme or a pass-through scheme. Explain and defend
your answer in Memo
format and submit it to your instructor for grading. Note: if the
most suspicious vendor
does not have a taxpayer id number, type “blank” as the

password. You may now
continue to Requirement 6.
6. Open the file ‘Summary’, which contains a spreadsheet
summarizing all of the check
disbursements made payable to the suspicious vendor. The
password for this file is also
the suspicious vendor’s taxpayer id number. Prepare a
professional Memo to the client,
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Debbie Roberts, summarizing the evidence and estimating the
fraud loss suffered as a
result of the fraud scheme you uncovered. Include some
specific recommendations to
Cardinal for preventing this type of fraud in the future. Since
you are billing the client
$10,000 for consulting services rendered, make sure the memo
follows the basic
guidelines for writing professional memos. The professional
quality of your memo, or
lack thereof, will significantly impact your grade. Submit your

memo to your instructor
for grading.
Congratulations! You have just completed all of the tasks that
were required in
conducting the actual fraud investigation. The Epilogue on this
case is as follows:
Epilogue
The investigative report prepared by the certified fraud
examiners was turned over to the
FBI along with the documentary evidence collected (e.g.
fraudulent invoices, cancelled checks,
and spreadsheet exhibits). The FBI successfully charged and
convicted both Mike Smith and
Bill Carter for mail fraud, which is the fraud statute most
commonly used to prosecute fraud
cases. Bill Carter was sentenced to 54 months in prison and
required to relinquish a $300,000
401K plan to Cardinal as restitution. In return for his guilty
plea and testimony against Bill
Carter, Mike Smith received a lesser sentence of 48 months in
prison. Finally, the certified fraud

examiners filed an employee dishonesty insurance claim on
behalf of Cardinal with its insurance
provider. The insurance provider restituted Cardinal for its
maximum coverage amount, $1
million, less a $25,000 deductible. Cardinal then engaged the
certified fraud examiners to
provide anti-fraud training to all of its internal auditors and loss
prevention specialists.
or by any means
without the written permission of the authors.
Buckhoff & Kramer
APPENDIX: PRIMER ON FRAUD
THE FRAUD TRIANGLE
To effectively detect and prevent fraud, we must first
understand what motivates people
to commit fraud. Three essential elements are common to all

types of fraud schemes:
opportunity, pressure, and rationalization. In combination,
these three elements make up what is
commonly referred to as the “fraud triangle.”
The first and most critical element of the fraud triangle is
perceived opportunity.
Fraudsters typically exploit their employment responsibilities as
the means to defraud their
employers. Unfortunately, many organizations unwittingly and
unwisely provide their employees
with a variety of opportunities to commit fraud. The most
common opportunity-providing factor
is the lack of adequate controls for monitoring employee
behavior. For example, a bookkeeper
for a large company was given the responsibility to prepare
checks, sign the checks, and record
the payments in the cash disbursements journal. Not
surprisingly, the bookkeeper soon
discovered an easy opportunity and embezzled about $1,000,000
of the company’s cash.
Adequate internal controls require–at the very least–that these
three responsibilities be
segregated among at least two or more employees. Clearly,
employees possessing such

“incompatible responsibilities” have been provided with an easy
opportunity to commit fraud.
They can simply make out the checks (to themselves or to pay
their own bills), sign the checks,
and then “hide” the fraud by charging it to a variety of expense
accounts.
Not all employees will exploit opportunities to commit fraud.
What is it that induces one
employee to commit fraud and the other to remain honest?
Pressure is the second element of the
fraud triangle. Financial pressure can come from a variety of
sources including:
� Lifestyle–the perceived need to maintain a high standard of
living
� Personal debt–from credit cards, gambling losses, sexual
addictions, drugs, alcohol, or
poor investments
� Business losses–caused by inflation, high interest rates, poor
economy, or lack of
demand.
Employees burdened with financial pressure are desperately
searching for ways to relieve that
pressure. Consequently, they should not be put in a position

that would provide them with an
opportunity to commit fraud. Doing so would be analogous to
employing an alcoholic as a
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bartender–an unwise decision with predictable results.
The third and final element of the fraud triangle is
rationalization, which means that the
fraudster must somehow psychologically justify the fraud as
something less than a crime.
Common rationalizations include:
� “They owe it to me. I deserve to get paid more.”
� “I’m only borrowing the money. I’ll pay it back.”
� “Nobody will miss it. The company can afford it.”
� “Everyone does it. I’m not hurting anyone.”
Those with low integrity generally have little trouble coming up
with rationalizations for
defrauding their employers. Since many people in our society
have placed themselves under
enormous financial pressure and have low integrity–the only

thing they need to commit fraud is
opportunity. Based on our experience as fraud examiners,
where there is opportunity we usually
find fraud. Consider the following case example:
The Fraud Triangle: A Case Example
Victim organization: A medium-sized construction company
Fraudster: A longtime project manager and close personal friend
of the owner
Fraud loss: $165,000 over two years
Opportunity: Lack of adequate internal controls
Pressures: Addition to home, medical bills, daughter in college,
and extramarital affair
Rationalizations: “I intended to provide a real product to my
employer” and “The owner is rich
and can afford it.”
Description of fraud scheme: As a project manager, “Steve” was
in a position to select
suppliers, place orders, and then authorize payment to those
suppliers. He then created two
“shell” companies to perpetrate a fictitious vendor scheme
against his employer. Steve simply
sent invoices from the shell companies to his employer for

supplies provided to projects he
supervised. Since receipt of supplies was not independently
verified, Steve only had to approve
payment on the invoices and the checks were mailed to a post
office box he had set up for both
vendors. As the fraud examiners in this case, we turned over
the incriminating evidence to local
law enforcement and Steve was prosecuted and convicted of
“theft by deception” and sentenced
to 12 months ‘imprisonment’ via electronic monitoring. We
also filed an employee dishonesty
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insurance claim on behalf of the client and recovered the
$165,000 fraud loss plus our fees from
the insurance provider.
People rarely commit fraud thinking they will be caught. The
purpose of internal
controls is to safeguard assets and records, minimize
opportunities to commit fraud, and monitor
employee behavior. Properly designed internal controls
effectively instill in the minds of

employees the perception that fraudulent activity will be
detected. This ‘perception of detection’
can be very effective in preventing fraud in the workplace. In
today’s society of financial
pressure and low integrity, organizations without adequate fraud
prevention programs will
continue to suffer substantial fraud losses and most will not
even realize it.
Fraudsters prefer Cash
For obvious reasons, cash5 is the asset most often stolen by
dishonest employees. In fact,
fraud research indicates that about 93% of all asset-theft fraud
schemes involve cash with median
losses of $98,000 per incident (ACFE, 2004). If controls over
cash receipts are weak, dishonest
employees will steal cash receipts via such schemes as
skimming. If controls over cash
disbursements are weak, dishonest employees will steal cash
disbursements via a number of
disbursement schemes. On-book fraud schemes occur after the
item being stolen (e.g. cash or
inventory) has been recorded by the victim company’s
accounting system. Such schemes can

usually be detected by examining the books and underlying
source documents of the victim
company. Off-book fraud schemes occur before the item being
stolen has been recorded by the
victim company’s accounting system. Off-book fraud schemes
must be detected by using
indirect investigative methods such as financial statement
analysis, surveillances, invigilations6,
and forensic interviews and interrogations.
5 Cash includes any medium of exchange that a bank will accept
at face value, including
currency and coins, company checks, customers’ personal
checks, cashier’s checks, money
orders, and/or bank drafts. It is not difficult for experienced
fraudsters to convert checks to cash.
6 An invigilation is an investigative method whereby the
internal controls over cash are made so
strict that opportunities for fraud are eliminated and a fraud free
profile can be established. For
example, assume a business owner suspects her office manager
of embezzling incoming cash
receipts. The owner takes over all responsibilities for
receiving, recording, and depositing
incoming cash receipts for a period of time. If the office
manager has been stealing, cash flows
should inexplicably increase during the invigilation period.

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When conducting fraud examinations, we must first gain an
understanding of the controls
and/or procedures in place for processing and recording cash
flowing through a business. If
controls over incoming cash receipts are inadequate and those
incoming cash flows are
substantial, then dishonest employees will attempt to divert
some of that cash flow into their own
pockets. If controls over outgoing cash disbursements are
inadequate, then dishonest employees
will attempt to divert some of those cash disbursements into
their own pockets. A thorough
understanding of the controls over cash flows allows examiners
to generate ideas concerning
how someone could steal cash from the organization and not get
caught. These ideas, called
fraud theories, can be categorized as either off-book or on-book
fraud schemes.
Off-Book Fraud Schemes
Skimming, a common off-book fraud scheme, involves the theft
of incoming cash before

its entry into the accounting records. Skimming occurs when an
employee sells goods or
services to a customer, collects the customer’s payment, but
makes no record of the sale. For
example, the servers and bartenders at a local gentlemen’s club
pocketed customers’ payments
for drinks and food, thereby cheating the business out of
$871,000 in revenues. Such schemes
are called “off-book” frauds since no record of the fraud exists
on the victim company’s books.
In these cases, the victim company typically does not know that
a theft has occurred. Off-book
frauds cannot be detected by examining the books and records
of the company and generally
occur at the point where cash enters the business. Accordingly,
those responsible for receiving,
processing, and/or recording cash are the likely perpetrators.
On-Book Fraud Schemes
Cash larceny, an on-book fraud scheme, involves the theft of
cash after it has appeared
on the victim company’s books. For example, a teller stole
$15,000 from the night vault at the

bank where she worked. Such schemes are called “on-book”
frauds since an examination of the
victim company’s records could easily reveal the cash shortage.
In these cases, the victim
company typically knows that a theft has occurred. On-book
frauds can usually be detected by a
thorough examination of the books and underlying source
documents of the company and can be
categorized as follows:
� Billing schemes
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� Payroll schemes
� Expense reimbursement schemes
� Check tampering schemes
� Register disbursement schemes
General Approach to Conducting a Fraud Examination
Since 93% of frauds involve cash, the proper sequence of events
which should be

followed in a typical fraud examination include:
1. Develop a thorough understanding of the controls and/or
procedures in place for
monitoring cash flowing through a business.
2. Generate fraud theories based on existing controls for
monitoring cash flows (i.e.
brainstorm ideas regarding how someone could steal cash and
not get caught).
3. Collect and evaluate evidence for testing the fraud theories.
4. Estimate losses being incurred from the fraud schemes
uncovered.
5. Assist in filing employee dishonesty insurance claims,
criminal, and/or civil charges.
6. Make recommendations for preventing future fraudulent
activity.
Preventing Theft of Cash Disbursements
The most effective way to prevent theft of cash disbursements
is to segregate the duties
of preparing checks and signing checks. Before preparing
checks to pay vendor invoices, the
preparer should verify that the items listed on the vendor
invoice were both ordered and received.

Copies of purchase orders and receiving documents should be
made and forwarded to the person
responsible for preparing checks. Before signing, the check
signer should: (1) review carefully
all information on the check along with the supporting
documentation, (2) mark supporting
documentation as “paid” along with the date and check number,
and (3) control the mailing of
the check (i.e., do not return a signed check to the person who
prepared it). Finally, a third
person should review all cancelled checks for anomalies and
perform monthly bank
reconciliations. Billing schemes involving vendors are possible
due to one or more of the
following internal control deficiencies:
� Victim company does not verify the receipt of items/services
before paying vendor
invoices (i.e., receiving reports were not prepared).
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� Disbursement checks are signed without adequate supporting
documentation (i.e.,

purchase orders are not matched to vendor invoices and
receiving reports).
� One employee can both place vendors on the approved vendor
list and approve payment
on incoming vendor invoices.
� Cancelled checks are not reviewed for endorsement anomalies
(i.e., the backs of the
checks bear handwritten or typewritten endorsements, instead of
the usual stamped
endorsement.)
Adhering to basic controls over cash disbursements could have
easily prevented Bill and Mike’s
fraud. Organizations without organized systems for
safeguarding cash become breeding grounds
for fraudulent activity.
Vendor Schemes
In fictitious vendor schemes, the fraudster establishes a shell
company that does not exist
and therefore, provides no goods or services to the victim
organization. The shell company
periodically submits invoices to the victim organization, which
then pays for the services or

goods never received. Thus, this scheme is possible when the
fraudster can place the shell
company on the victim organization’s approved vendor list,
either through poor internal controls
(e.g., no credit checks performed on new vendors), an inside
accomplice, or both. The scheme is
further facilitated by the victim organization’s failure to
independently verify receipt of
goods/services before paying incoming vendor invoices.
Since the check from the victim organization will be made
payable to the name of the
shell company, the fraudster must establish a bank account in
the shell company’s name.
However, banks typically require a “doing business as” (DBA)
certificate in order to open the
account in the vendor’s name. DBA certificates can be easily
obtained from the Office of the
Secretary of State by completing an application form and paying
a nominal fee. The document
could possibly be forged, but it is more likely that the fraudster
will simply obtain the legitimate
document from the government.
Because the shell company is not a legitimate business, it

typically has no employees, no
physical location, no physical address, no phone number, etc.
Therefore, the perpetrator will
often rent a post office box and use that as the shell company’s
mailing address, although the
fraudster sometimes uses his/her own personal address or that of
an accomplice.
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The bogus invoices can be easily generated from a personal
computer. For example, an
Excel spreadsheet can produce a very professional-looking
invoice simply by clicking on “New”
and then the invoice icon under “Spreadsheet
Solution
s”. However, typewritten or even
handwritten invoices have also been used to generate fraudulent
disbursements.

The key to a successful fictitious vendor scheme is getting the
victim organization to pay
the bogus invoices. The fraudster must be in a position to get
the bogus invoices approved for
payment. This task can be quite easy if the victim company
does not adequately segregate job
responsibilities. Other organizations may simply pay invoices
based on an informal “check
request” that lists the name of the vendor, the amount owed, and
a brief explanation. This, too,
makes perpetration of the fraud quite simple. Even if an
organization has sound internal
controls, the perpetrator with approval authority can still
successfully commit this fraud by
forging the necessary supporting documents (e.g., a purchase
order and receiving report) and
signatures on these documents. This scheme can also be

committed by a fraudster without
approval authority if the individual with that authority pays no
attention to the invoices awaiting
approval and simply “rubber stamps” them. Of course, it is also
possible for dishonest
employees to circumvent the internal controls by colluding or
working together to perpetrate this
scheme. However, about 70% of fraud schemes are perpetrated
by one person acting alone, only
30% involve collusion. Thus, the risk of fraud can be greatly
reduced by simply involving at
least one other person in the transaction. The risk and
opportunity for fraud cannot ever be
completely eliminated. The best we can do is to cost-
effectively manage that risk to acceptable
levels by making the fraud as difficult to commit as possible.

Once the check has been prepared and signed, it is mailed to
the shell company’s address,
which typically is a post office box opened by the fraudster in
the name of the shell company.
The fraudster then retrieves the check, endorses and deposits it
into a bank account opened in the
name of the shell company. At this point, the fraudster has
unrestricted access to the funds and
can spend it however s/he pleases. Red flags common to
fictitious vendor schemes include:
� Vendors without a taxpayer identification number or with an
invalid one. A valid
taxpayer ID number has nine digits with the first two digits
separated by a hyphen, as
follows: 12-3456789.
� Vendors listing a post office box address and no physical
address. Also, vendor

addresses that match employee addresses.
Buckhoff & Kramer
� Vendors with no phone number or those using an answering
service.
� Invoices created using an Excel- or Word-generated invoice
template.
� Invoices with fold mark anomalies. Examples: (1) invoices
without fold marks or
creases, indicating they haven’t been mailed or (2) invoices
with fold marks different
than the tri-fold indentations typical of invoices coming through
the mail.
� Invoices with even dollar amounts, no taxes included, or

other irregularities.
� Invoices from the same vendor that are consecutively
numbered, indicating the vendor
has no other customers.
� Vendor-related cancelled checks that bear handwritten
endorsements on the back.
� Invoices for unspecified consulting or other vaguely defined
services.
� Vendors with company names consisting only of initials.
Fraudsters often use their own
initials when setting up dummy companies (e.g., I. B. Crook
establishes a fictitious
company named “IBC Enterprises”).
A fictitious vendor can often be detected by querying the
vendor database for common
red flags that would be contained therein (e.g., no phone

number, a post office box for an
address, invalid taxpayer ID number, an address that is identical
to an employee’s address).
Such a query can be conducted easily using either Excel or data
mining software such as ACL
(see www.acl.com). Since it is possible a legitimate vendor
may exhibit one or more red flags,
the examiner next must review actual paper invoices from the
narrowed list of suspicious
vendors. While reviewing the invoices, the examiner should
look for red flags evident on the
actual paper invoices (e.g., invoices created using Excel,
invoices with fold mark anomalies,
sequentially numbered invoices, etc.). Once the list of
suspicious vendors has been narrowed
further, the examiner should examine the fictitious vendors’
bank statements along with

cancelled checks. A legitimate business would have cancelled
checks for business-related
purchases. Since a fictitious vendor is only in the business of
defrauding the victim organization,
its cancelled checks would be for personal purchases by the
perpetrator.
To effectively prevent a fictitious vendor scheme from
occurring, the victim organization
needs to implement a strong system of internal controls over its
cash disbursements process.
Ideally, the duties of preparing vouchers and approving
vouchers for payment should be
segregated. Properly approved purchase orders and receiving
reports should be required to
support each invoice. The invoice details should be matched to
the information on the purchase

Buckhoff & Kramer
order and receiving report. Authority to add new vendors to the
approved vendor list should be
restricted to a specific individual. Background checks should
be performed on new vendors
prior to adding them to the vendor list. For example, a credit
check on a fictitious vendor would
reveal the company had no history, or a quick look in the phone
book would reveal the company
had no phone service. Even a strong system of internal control
cannot always prevent or detect
fraud if collusion is present, so to mitigate the risk of this
occurring, the company’s auditors
should periodically review the approved vendor list, looking for

red flags.
or by any means
1
Cardinal Wholesalers, Inc.©
A Fraud Examination/Auditing Case Simulation
by Thomas Buckhoff, Ph.D., CPA/CFF, CFE and Bonita
Peterson Kramer, Ph.D., CPA, CMA, CIA
© 2011. No part of this work may be reproduced or used in

any form or by any means
To Students:
Welcome to Cardinal Wholesalers, Inc.: A Fraud
Examination/Auditing Case Simulation!
Pedagogical research indicates that the best way to learn is by
doing. This case simulation
provides you with the opportunity to learn basic fraud
examination/auditing principles through
hands-on active participation. A brief description of the case is
as follows:
This case simulation replicates the actual investigative steps
that were followed in uncovering a
$1.75 million fraud scheme. The case background is based on
an actual cash disbursements
fraud investigated by my partner, Tom O’Halloran of Forensic

Buckhoff & Kramer Cardinal Wholesalers, Inc. .docx

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