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By Tom English, PhD, CPA,
Boise State University

One old problem receiving renewed interest is kiting. The Office of the Comptroller of the Currency (OCC) issued an advisory on August 6, 1996, in this regard. It seems prudent to review kiting in light of this new advisory.

The Historical Kiting Problem

Kiting is the use of float to commit an act of fraud. Two major historical uses of kiting have been to inflate earnings or conceal a cash theft. When kiting is used to inflate earnings, the company will transfer funds from one checking account to another. The transfer will occur near year end resulting in the deposit and withdrawal being outstanding at year end. The company will record the deposit in the current year and withdrawal in the subsequent year. The credit side of the deposit entry is to some income statement account, resulting in an increase in earnings. The debit side of the withdrawal entry will reverse the activity in the subsequent year.

Kiting to conceal a cash theft occurs in a similar way. If the thief can generate accounting entries, the theft can be concealed by expensing the activity. If this option is not available, the thief may kite. The problem facing the thief is that the bank account missing funds will not reconcile to the books. This problem can be solved by the thief returning the stolen funds to the bank prior to year or month end. If funds are not available, the thief may simply transfer funds from one company account to the problem account at year end. If the transfer is not recorded in the current year, and the withdrawal is outstanding at year end, the problem account will reconcile. Similar to the type of kiting previously discussed, the activity will reverse itself when the subsequent year entries and bank clearings occur.

Auditors have been aware of these two possible activities for some time and commonly use an interbank transfer schedule to detect either type. The schedule shows all transfers around year end for all company accounts. The scope is adjusted to include all possible outstanding transfers. For example, a client with international accounts will require more days for clearings then a client with local accounts. A simple review of dates will reveal the kiting. If the book dates are in different fiscal years, kiting to inflate earnings may have occurred. If the bank deposit date is in the current year while the other three are in the subsequent year, kiting to conceal a cash theft may have occurred.

An example of an interbank transfer with both types of kiting is as follows:

Type 1 Type 2


Deposit Dec. 31 Jan. 2

Withdrawal Jan. 2 Jan. 2


Deposit Jan. 2 Dec. 31

Withdrawal Jan. 2 Jan. 2

Account 1 $1,000 ($3,000)

Account 2 (1,000) 3,000

Type 1 indicates the company may have inflated earnings by $1,000 while Type 2 may indicate kiting was used to conceal a $3,000 theft in bank account 2.

The Current Kiting Problem in Banks

The current kiting technique is similar to the age old procedure. It involves the use of float to access funds that are uncollected. For example, the perpetrator transfers funds to their account from another financial institution. The funds are then withdrawn prior to collection from the other entity. The depository bank then faces the risk of not collecting after the funds are withdrawn.

The OCC warns that many banks allow customers to access deposited funds before they are collected from the institutions on which they are drawn. Because this activity frequently does not involve fraud, it is easy for management to overlook. But, the OCC warns there have been recent occurrences where banks have incurred significant losses through elaborate schemes to draw against uncollected funds.

Appropriate Bank Response

Banks are required to comply with time frames on availability of funds as outlined in Regulation CC, 12 CFR Part 229. Further guidance, on exceptions to the general rules, is found in Regulation CC, 12 CFR 229.13. In addition to compliance with rules, banks should become aware of warning signals for potential kiting and improve internal control over kiting activities.

The OCC suggests that although warning signals do not indicate that fraud has occurred, they should be monitored to help identify fraudulent activity. The warning signals outlined by the OCC are shown in Exhibit 1. The minimum level of internal control suggested by the OCC is shown in Exhibit 2. *




* Several accounts with similar names, owned or controlled by the same individuals

* Regular or excessive drawings against uncollected funds

* Frequent daily negative ending balances or overdrafts that eventually clear or are covered in a short time frame

* Identifiable patterns of transactions such as deposits, transfers between accounts, withdrawals, and wire transfers, often with similar or increasing amounts

* Deposits of large checks drawn on out-of-area banks or foreign banks

* Frequent requests by the customer for account balances, collected items, or cleared items

* Frequent, large deposits drawn on the same institution

* Deposits drawn on other institutions by the same maker or signer

* Large debits and credits of even dollar amounts

* Frequent check withdrawals to the same institution, with the maker listed as payee

* A low average daily balance in relation to deposit activity

* A low collected fund balance in relation to the book balance

* A volume of activity or large debits and credits inappropriate in relation to the nature of the business of the account holder involved




* Officer approval on drawings against uncollected funds, overdrafts, and wire transfers. Such authority should be strictly enforced and not exceed an
individual's lending authority.

* Daily reports on drawings against uncollected funds, overdrafts, large items, and significant balance changes

* Regular review by a designated individual of internal reports to spot anomalous conduct and ensure proper investigation when warranted

* Secondary level administrative review that is distinct from other lending functions to promote objectivity when granting significant drawings against uncollected funds or overdrafts

* Review of regular overdraft activity reports to the board or an approved
committee thereof

* Periodic review through an independent audit function to assess and report on the adequacy of all established internal controls in this area

Douglas R. Carmichael, PhD, CPA
Baruch College

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