Types of accounts payable fraud & how to prevent them

Accounts payable (AP) fraud is a significant concern for today’s businesses.

The Association of Certified Fraud Examiners (ACFE) reports that organizations lose an estimated 5% of their annual revenues to occupational fraud, with a median loss of $145,000 per case. Alarmingly, if proper systems to identify fraudulent activities aren't in place, they go undetected for an average of 14 months.

Despite this, AP fraud is often overlooked. This article explores common types of AP fraud and offers strategies to prevent them, safeguarding your organization's financial health.

What is accounts payable fraud?

Accounts payable fraud is a deliberate attempt to exploit a company’s payment processes for unauthorized financial gain. It targets the accounts payable department, which handles vendor payments, making it a key vulnerability in an organization’s financial operations.

This fraud can involve insiders, such as employees with payment system access, or external parties like vendors or cybercriminals. Sometimes, it includes collusion, such as an employee working with a vendor to commit fraud by inflating invoices or approving payments for nonexistent services.

Let’s explore the common types of accounts payable fraud and how fraudsters exploit these vulnerabilities.

Types of accounts payable fraud

Accounts payable fraud can be categorized into two major types: internal AP fraud, committed by individuals within the organization, and external AP fraud, involving external actors.

Each category presents unique challenges and risks, requiring tailored prevention strategies.

Internal AP fraud

Here are the common frauds committed by individuals within the organization:

• Billing schemes: Employees create fake vendors or inflate invoices to divert funds for undelivered goods or services
• Pass-through schemes: An employee sets up a fake vendor to buy goods at market price, reselling them to the company at inflated rates, and pocketing the difference
• Check tampering: Fraudsters perform check fraud by altering payee details or increasing amounts, committing fraud by exploiting access to checks or accounting software
• Expense reimbursement fraud: Employees file false claims—like fake expense reports, travel expenses, or duplicate receipts—draining funds and eroding trust
• Duplicate payments: Invoices are intentionally paid twice, allowing employees or accomplices to divert extra funds. Vendors may also exploit this by submitting repeated invoices.
• Conflict of interest: Employees approve payments to vendors with undisclosed personal ties, leading to inflated costs or poor service
• Kickback schemes: In kickback schemes, employees collude with vendors to obtain personal benefits like cash or gifts in exchange for contracts or inflated invoices

External AP fraud

Additionally, here are the most common types of external AP fraud and how they operate:

• Invoice fraud: Fraudsters submit fake invoices with altered details, like inflated bills or fake bank account information, often impersonating real vendors to misdirect payments
• Overbilling: Vendors inflate invoices or charge for unrendered services, exploiting businesses that don't verify invoices against purchase orders or delivery receipts
• Vendor fraud: Fraudulent vendors register fake entities to receive payments, exploiting weak onboarding processes and lack of payment pattern monitoring
• Ghost vendors: Fictitious supplier accounts are created to receive payments for nonexistent goods or services, often through hacked systems or weak vendor registration processes
• Business email compromise (BEC): Cybercriminals impersonate executives or vendors via email to request urgent payments, using spoofed addresses and social engineering tactics to bypass verification. These scams often exploit social engineering and phishing techniques.
• ACH fraud: ACH fraud happens when fraudsters hack into systems to alter ACH payment instructions, diverting funds to unauthorized accounts, often unnoticed without real-time monitoring
• External techniques: External fraudsters use phishing, malware, and social engineering to infiltrate payment systems, targeting outdated software and weak security measures

AP fraud red flags

Detecting accounts payable fraud early is critical. Here are six key areas to monitor for potential fraud:

• Red flags for vendors: Payments to unfamiliar or unverified vendors, vendor addresses or accounts that match employees’, or inactive vendors suddenly receiving payments
• Red flags for invoices: Duplicate invoices, missing key details like tax IDs, rounded dollar amounts, or invoice numbers in suspicious sequences
• Red flags for payments: Sudden spikes in payments, transactions just below approval thresholds, multiple payments to the same vendor, or unverified changes to bank details
• Behavioral red flags: Employees’ reluctance to share responsibilities or close, undisclosed relationships with vendors

Detecting AP fraud in your business

Preventing accounts payable fraud begins with reliable detection mechanisms and best practices to help identify and address vulnerabilities.

Use Benford’s law for data analysis

Benford’s law is a statistical principle that predicts the frequency distribution of the leading digits in naturally occurring datasets. For instance, in legitimate financial transactions, lower digits (1, 2, 3) appear more often as the leading numbers than higher digits (8, 9). Deviations from this pattern in invoices or payments can indicate fraudulent activity.

Use automated accounting software to analyze payment data against Benford’s law. Irregularities, such as an unusual frequency of high leading digits, should trigger deeper investigations.

Conduct regular audits

Periodic audits of accounts payable processes can reveal discrepancies or irregularities. Focus audits on high-risk areas, such as vendor onboarding, payment approvals, and invoice reconciliations. Surprise audits can be particularly effective in deterring internal fraud.

Designate responsible parties for monitoring

Assign clear responsibility for detecting and managing fraud. Key roles include:

• Accounts payable managers: Oversee daily transactions and ensure compliance with protocols
• Internal audit teams: Conduct detailed investigations and monitor trends for unusual activity when optimizing AP internal controls
• External auditors: Provide independent assessments and identify blind spots in fraud detection systems

Establish a culture where employees understand their role in maintaining financial integrity, encouraging them to report suspicious activities.

Preventing AP fraud in your business

Preventing accounts payable fraud requires a combination of strong internal controls, advanced technology, and a culture of accountability. Here are some practical steps to safeguard small businesses:

• Deploy systems that automatically match purchase orders, invoices, and payment records to flag discrepancies before making payments
• Require thorough vetting of all new vendors, including background checks, address verification, and validating tax identification numbers
• Add multiple approvers for payments exceeding a certain threshold to add layers of oversight and accountability
• Implementing positive pay, a fraud prevention tool that verifies check details with the bank before executing payment, can further reduce risk

Fraud response best practices

• When you detect fraud, immediately halt all associated transactions. Freeze vendor accounts, stop payments, and disconnect compromised systems to prevent further damage.
• Collect transaction records, communications, and system logs. Interview employees and vendors to assess the scope and trace illicit payments using forensic accounting tools.
• Work with banks and payment processors to reverse fraudulent transactions. In cybercrime cases, collaborate with cybersecurity professionals to trace and retrieve stolen assets.

How to avoid fraud risks with Ramp’s AP automation

Fraud prevention becomes simpler and more effective with Ramp’s accounts payable automation.

By streamlining processes, increasing visibility, and leveraging AI-powered tools, Ramp helps businesses safeguard against AP fraud while improving efficiency by:

• Reducing manual data entry: Minimize human errors and opportunities for fraud by capturing invoice details instantly with OCR technology
• Building multi-layer approval flows tailored to your business: Intelligent routing rules ensure every payment is verified and alerts are triggered for errors or overbilling
• Integrating with ERP systems: Ramp seamlessly syncs vendor details, purchase orders, and payment records, ensuring consistency across systems and eliminating data discrepancies

Try Ramp’s interactive demo and learn how AP automation can transform your business processes and improve security.