Lapping fraud is a form of financial deception involving the misapplication of customer payments to conceal theft. Though often overlooked, it can have serious consequences for businesses, including financial loss, reputational damage, and legal liability. This guide explores what lapping fraud is, how it works, how to detect and prevent it, and why organizations must take it seriously.
Understanding Lapping Fraud
In normal operations, customer payments are recorded against their corresponding accounts receivable entries. In a lapping scheme, however, an employee intercepts these payments for personal use and conceals the theft by using subsequent customer payments to credit earlier accounts. The result is a rolling misapplication of payments that conceals the original shortfall—temporarily.
This type of fraud does not generate income. It simply buys time for the fraudster by delaying the inevitable exposure of the missing funds. Because it requires constant manipulation of records, it is difficult to maintain and stressful to execute.
How Does Lapping Fraud Occur?
Lapping fraud is most likely to occur when a single individual is responsible for receiving, recording, and reconciling customer payments—a direct violation of segregation-of-duties principles.
It may start with an employee in financial distress or someone seeking an unauthorized loan. Without strong internal controls, the fraudster can continue the cycle for months or even years.
Conditions That Enable Lapping:
- Lack of segregation of duties
- Weak oversight or absence of periodic audits
- Manual systems with no reconciliation safeguards
- Overreliance on a single employee without cross-training
Steps Involved in a Lapping Scheme
- The employee intercepts a payment from Customer A and keeps it.
- When Customer B pays, the fraudster records that payment under Customer A’s account to cover the discrepancy.
- The next payment from Customer C is used to credit Customer B’s account.
- This misapplication cycle continues until detected or exposed.
To remain undetected, the employee must consistently manipulate incoming payments to fill previous gaps, leaving the company’s accounts receivable in a state of artificial accuracy.
Example: Lapping Scheme in a Municipal Office
In a mid-sized U.S. municipality, an accounts receivable clerk was responsible for handling incoming checks, recording transactions, and reconciling bank statements. With full control over these financial processes, the environment lacked proper checks and balances.
Over a two-year period, the clerk conducted a lapping scheme—diverting over $250,000 by using newer payments to cover up missing funds from earlier ones. The fraud went undetected until the clerk took unexpected medical leave. A temporary replacement was unable to reconcile payment records, which prompted an internal audit. Investigators uncovered the cycle of misappropriated funds hidden through the manipulation of deposit timing.
This example highlights the importance of segregating financial duties and implementing mandatory employee rotation to prevent and detect fraud.
Detecting Lapping Fraud
Detecting lapping requires vigilance, forensic accounting tools, and proactive controls. Red flags include:
- Delayed postings of customer payments
- Frequent adjustments or corrections to receivable accounts
- Customer complaints about payments not being reflected
- High employee resistance to taking vacations or cross-training
Detection Techniques:
- Daily reconciliations between bank deposits and payment ledgers
- Surprise audits and unannounced cash counts
- Rotation of accounting duties and enforced vacation policies
- Use of forensic software to identify suspicious transaction patterns
Preventing Lapping Fraud
Prevention is anchored in strong internal control systems that emphasize transparency, accountability, and oversight.
Key Controls:
- Segregation of duties: Different personnel should handle receipt, recording, and reconciliation.
- Audit trails: Ensure transactions are traceable with timestamps and user IDs.
- Automated systems: Use accounting platforms that flag mismatches between receivables and deposits.
- Regular reviews: Conduct periodic reconciliations and independent audits.
- Mandatory vacations: Rotate staff responsibilities to uncover fraudulent behavior.
Common Misconceptions About Lapping Fraud
One widespread myth is that lapping is harmless because customers ultimately receive credit for their payments. This is false.
Lapping causes internal financial distortion, delays revenue recognition, and can lead to lost business if customer trust erodes. It is also a criminal offense and carries consequences such as termination, prosecution, and civil liability.
Legal and Ethical Implications
Lapping fraud falls under embezzlement and falsification of business records, both of which are prosecutable under criminal law. Convictions may result in:
- Fines
- Restitution
- Prison sentences
- Professional disbarment for CPAs or licensed professionals
Businesses may also face class action lawsuits or regulatory penalties for failing to maintain proper financial controls.
FAQs About Lapping Fraud
Q: How long can lapping fraud remain hidden?
A: It can persist for months or years, especially in environments with poor oversight. Detection often occurs during audits or unexpected employee absences.
Q: Is lapping fraud common in modern organizations?
A: While less common in firms with automated systems and audit controls, it still occurs in small businesses, nonprofits, and government offices with limited staffing or oversight.
Q: Can accounting software detect lapping?
A: Modern ERP systems with reconciliation features can flag anomalies, but human oversight remains essential for identifying intent and patterns.
Key Takeaways
- Lapping fraud is a scheme where customer payments are misapplied to conceal stolen funds.
- It thrives in environments with poor internal controls, especially where one person controls all payment-related tasks.
- Detection relies on audit vigilance, segregation of duties, and automated tools that identify irregularities.
- Prevention requires policy enforcement, mandatory staff rotations, and routine reconciliations.
- It is a criminal offense with significant legal and ethical consequences for both the perpetrator and the business.
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