Lapping does not actually involve the misappropriation of funds but is a fraud that may be committed by an employee to conceal a misappropriation of funds, usually funds paid by a customer of the employer. The employee conceals the misappropriation by applying funds subsequently paid by a second customer to conceal the deficiency in the first customer's account. However, this means that the accounting records would show an amount owing by the second customer that had in fact been paid. The employee then uses funds paid by a third customer to conceal the deficiency in the second customer's account. The employee continues this "lapping" of customer's funds until the fraud is ultimately discovered, which may be some months after the initial misappropriation and perhaps after the employee resigns his/her employment from the entity.
Lapping can occur in entities which do not record details of customer cheques when the mail is opened, and/or entities in which employees are not required to take regular annual leave, and/or entities in which the employee responsible for handling customer cheques is also responsible for preparing bank deposit advices.
Warning signals that lapping may have occurred include complaints by customers of the entity that the customer statements they have received show the credits to their account some days after the payment should have been received by the entity, or that their statement has missing credits, or shows unusual credits, or that they have not received customer statements (the statements may be withheld or destroyed by the dishonest employee) and a frazzled look on the face of the employee responsible, as it can be a very testing time keeping track of which customers' accounts have been misappropriated and by how much.
Audit procedures that may detect this fraud include (i) the confirmation of accounts receivable, with particular attention being given to replies to the auditors from customers disputing the timing of their payments and (ii) the comparison of the original bank deposit advices with cash receipt records. (Auditors prefer to use original bank deposit advices, as the copies retained by the client may have been altered by the employee).
See Journal of Accountancy article Lapping it up.
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