My wife was amazed by the simple 'Accounts Receivable Fraud' possibility!

One evening, I and my wife were discussing something about the latest electronic TReDS system launched by Reserve Bank of India to facilitate the discounting of Trade Receivable of MSME enterprises and help them tide over liquidity crunches. But, with new opportunities, come new threats as new entrants will jump into the factoring market, and being an Internal Auditor, working closely for fraud analytics, a question crossed my mind.

What are the financial frauds related to this industry or accounts receivables and as auditor, how will I be able to point out the same, especially in a factoring company?

I went back to my experience and did some research to come out with an interesting fraud related to accounts receivables. There can be a simple fraudulent investment or fundraising scheme by using fake accounts receivable balances or invoices or relevant documents. There is also a possibility of fake factors being entering into the market and offering high returns to their investors and other stakeholders.

The key to better prevent and detect the type of fraud, in this case, our knowledge and inquisitiveness. Although there has been a way-out for companies to handle uneven revenue cycles, accounts receivables, and debts since the early 1400s, few people outside the manufacturing sector are aware of the related procedures and risks of fraud. A website says that 7 NBFC factors were registered with RBI and did a total business of about INR 36,100 crores. Internal auditors and investors must focus on two aspects to learn more about factoring.

Learn about market factoring, expected profit sources, and associated risks. The highly concentrated banking system in India would seem promising on the surface. The increase in credit in India in the last twenty years has left real interest rates and credit rates among the top in the world. Small and medium-sized businesses have historically paid 10 percent of their funding per month.

Understand the legal, regulatory, and structural framework of the factoring industry. As in other sectors, the wide range of relevant laws and regulations in the different countries accentuates major legal, regulatory, and tax threats. In certain cases, the government/ RBI has intervened to regulate the industry of factoring.

Also, The International Factoring Association of the sector further addressed the need, for instance by applying rating caps for certain or all of its debit transactions, to mitigate risks associated with smaller or higher risk factoring companies. These parties should also do better to collaborate, exchange information and data, and maintain better cross-border legal and regulatory continuity to deter these crimes.

Auditors will search for two warning flags armed with more business knowledge:

1. The auditee generally hesitates to provide essential information on the debtors and customers they deal with. Ask for examples of invoices or debt reports on which the company's factoring profit is based. One common fraud tactic is to create a false or inflated invoice for the factoring company and the client. This is easy with cheap digital printers. Invoices appear to have been given by a legal debtor identical to other invoices which the client or the factoring firm had previously made. Fake invoices are attached to the stack of legitimate accounts receivable which the customer takes into account in the expectation that nobody pays attention or reviews each particular invoice. If the producer can't prove that it verifies every single invoice, this is a red flag as well. Collusion can also take place concurrently between the applicant and the customer supplying the factoring firm with false verifications.
2. The unwillingness of client to provide key business/trade documents including :

• Articles of Incorporation.
• Tax returns from previous years.
• Balance Sheet / Statement of Affairs/ Financial Statements.
• Previous accounts and financial statements of the organization.
• Contracts signed between the debtor and the customer. Disclosure with debtors and customers of any contractual dispute.
• Proof that only licensed brokers are treated by the factoring company.

Accounts receivables fraud is wide-spread across the globe and is very obvious at a macro level.

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