A lapping scheme is a type of accounts receivable fraud in which an employee pockets a customer’s payment and then covers the theft by applying a later customer’s payment to the first customer’s account. The stolen shortfall rolls forward from one account to the next, growing harder to conceal each week the scheme continues.
How the Scheme Works
It starts with an employee who handles incoming payments intercepting a check or cash remittance from Customer A. Instead of depositing the money, the employee takes it. On paper, Customer A’s account still shows an outstanding balance even though Customer A already paid.
To keep Customer A from receiving a past-due notice, the employee waits for a payment from Customer B and credits those funds to Customer A’s account. That clears A’s balance but leaves B’s account looking unpaid. When Customer C pays, that payment goes to B, and the cycle continues. The employee is always one step behind, shifting the hole from account to account. That constant juggling is where the name comes from.
The longer it runs, the worse it gets. The original stolen amount never shrinks, and the employee often takes additional payments because the scheme creates both the temptation and the cover to do so. Eventually the gap between what the books show and what the bank holds becomes difficult to explain, especially at month-end reconciliation or during an external audit.
Why It Works in the First Place
Lapping only works when one person controls two functions that should never overlap: receiving cash and posting payments to the accounts receivable ledger. That dual access lets the employee steal money with one hand and hide the theft with the other. In accounting terms, separating these responsibilities is called segregation of duties, and its absence is the structural flaw behind virtually every lapping scheme.
A properly designed system splits cash handling into at least three roles: one person opens the mail and logs incoming payments, a second person posts those payments to customer accounts, and a third person reconciles the bank statement to the general ledger each month. When those jobs sit with three different people, no single employee can both take the money and cover the trail.
Signs a Lapping Scheme May Be Running
In the Books
The most telling sign is a gap between when a payment arrives and when it hits the bank. A lapping employee needs time to rearrange the books before depositing the next round of payments, so deposits run a day or two late. If your company tracks the mail-receipt date separately from the deposit date, a pattern of delays is worth investigating.
Unusual patterns on the accounts receivable aging report are another giveaway. Watch for long-standing overdue balances on accounts that are still actively placing orders. A customer who buys from you every month shouldn’t suddenly show a 60- or 90-day past-due balance if they’re paying on time.
Customer complaints about receiving overdue notices despite already sending payment are a strong signal that funds are being misapplied. You may also see frequent, small adjustments or write-offs to customer accounts that lack clear documentation. These adjustments are how the employee tries to shrink the growing gap without drawing attention.
Cross-checking is straightforward. Compare the names on bank deposit slips to the customer accounts credited in the ledger. If a deposit slip shows a check from Customer B but the ledger shows Customer A’s balance was reduced that day, something is off. Confirming balances directly with customers is another reliable method. When a customer reports paying on a date that doesn’t match your posting date, you’ve likely found the fraudulent lag.
In the Employee
Lapping requires the employee to be at their desk every day, manually moving payments around. That creates predictable behavioral patterns. According to the Association of Certified Fraud Examiners, the most common red flags across occupational fraud cases include living beyond one’s means, personal financial difficulties, unwillingness to share duties or let anyone else handle the work, and unusual defensiveness when questioned about processes.1ACFE. The 6 Most Common Behavioral Red Flags of Fraud
The “won’t share duties” flag matters most here. An employee running this scheme will resist cross-training, avoid taking vacation, and get visibly anxious when someone else covers their responsibilities. That protectiveness isn’t dedication. It’s self-preservation.
Controls That Prevent It
Separate the Three Cash-Handling Jobs
Splitting cash-handling responsibilities is the single most effective prevention measure. The person who opens the mail and logs receipts should never post payments to customer accounts. A third employee, independent of both, should reconcile the bank statement to the general ledger monthly. Any one employee would need a co-conspirator to pull off a scheme under that arrangement, which sharply reduces the risk.
Take Employees Out of the Payment Chain
A lockbox arrangement removes employees from payment handling entirely. Customers mail payments to a post office box controlled by your bank. The bank opens the envelopes, deposits the funds, and sends your accounting team only the remittance data needed to update the ledger. No employee ever touches the check. Encouraging customers to pay via ACH transfer or wire achieves the same result by eliminating physical check handling altogether.
Restrictive Endorsements and Daily Deposits
Every incoming check should be stamped “For Deposit Only” the moment it arrives. Under the Uniform Commercial Code, a restrictive endorsement that includes terms like “for deposit” or “for collection” requires any transferee to handle the instrument consistently with that endorsement.2Legal Information Institute. Restrictive Endorsement In practice, this prevents an employee from cashing the check at a bank window. Pair that with mandatory daily deposits, and any stolen payment creates a same-day discrepancy that’s hard to hide.
Require Vacations
Forced time away from the desk is one of the most underrated fraud controls. Lapping requires constant daily intervention. If the employee is gone for even a week, the replacement will notice payments that don’t match up, or overdue notices will start reaching the wrong customers. The Federal Reserve Bank of New York has noted that mandatory absence policies enhance internal controls because “most internal frauds or embezzlements necessitate the constant presence of the offender to prevent the detection of illegal activities.”3Federal Reserve Bank of New York. Required Absences From Sensitive Positions – Circulars The absence should be long enough for pending transactions to clear and for the covering employee to process the daily work independently.
Use Software That Logs Every Change
Modern accounting software can log every action taken on a customer account, including who posted a payment, when, and whether the original entry was later modified. Immutable records of invoice creation, payment application, manual overrides, and credit memo approvals, combined with role-based access and change logs that preserve the original state of every modification, make it far harder for an employee to quietly rearrange payments without leaving a digital trail. If your accounts receivable module doesn’t produce this kind of audit log, that’s a gap worth closing.
Legal Consequences for the Employee
Lapping is embezzlement, and the consequences are serious. Every state treats it as theft, with penalties that scale based on the amount stolen. Most states draw a felony line somewhere between $500 and $2,500. Because these schemes grow over time, the cumulative amount often pushes well into felony territory, carrying potential prison sentences measured in years rather than months.
Federal charges can apply when the scheme involves a bank, a federally funded organization, or interstate commerce. An employee at a bank or credit union who embezzles funds faces up to 30 years in prison and a fine of up to $1,000,000 under federal law.4Office of the Law Revision Counsel. 18 USC 656 – Theft, Embezzlement, or Misapplication by Bank Officer or Employee Embezzlement from organizations receiving federal funding can carry up to 10 years. Beyond criminal penalties, the employee typically faces a civil lawsuit for restitution and will almost certainly be terminated and reported to industry databases that make future employment in finance extremely difficult.
Recovering the Loss
Deducting the Theft on Your Tax Return
A business that suffers an embezzlement loss can deduct the unrecovered amount under the general rule allowing a deduction for any loss sustained during the taxable year that isn’t compensated by insurance or other recovery.5Office of the Law Revision Counsel. 26 USC 165 – Losses The theft loss is treated as sustained in the year you discover it, not the year the theft began. That distinction matters for lapping schemes, which often go undetected for months or years before unraveling.
To claim the deduction, you’ll need to establish that the loss qualifies as theft under your state’s laws and that you have no reasonable prospect of recovering the full amount. Any portion covered by insurance or a fidelity bond must be subtracted. One boundary worth noting: for individuals and sole proprietors, personal theft losses are generally limited to federally declared disasters under changes that remain in effect through at least 2025. Business theft losses reported on a trade or business return face no such restriction.5Office of the Law Revision Counsel. 26 USC 165 – Losses
Filing on a Fidelity Bond
A fidelity bond or employee dishonesty endorsement on a commercial property policy can reimburse the business for stolen cash, forged checks, unauthorized transfers, and other losses caused by employee fraud. Coverage pays up to the policy limit for actual losses, though it typically excludes indirect costs like the expense of investigating the fraud or lost future business.
Timing matters when filing a claim. Most bonds require you to notify the surety as soon as you become aware of the dishonest act, and each policy sets its own deadline for submitting a formal proof of loss. Waiting too long can jeopardize coverage entirely. If the bond pays out, the insurer will usually pursue the employee directly through subrogation to recover the funds.
If You’ve Already Found One
The instinct is to confront the employee immediately. Resist it. The first priority is preserving evidence. Collect and secure all relevant financial records, both physical and electronic, including deposit slips, payment logs, customer correspondence, and system audit trails. Acting quickly reduces the risk of the employee destroying or altering records once they sense the investigation is underway.
Bring in outside help early. A forensic accountant can trace the full scope of the scheme, quantify the loss, and produce documentation that holds up in court or an insurance claim. Your attorney should advise on reporting obligations, potential civil recovery, and how to handle the employee’s termination without exposing the company to additional liability.
Report the theft to law enforcement. Some businesses quietly terminate the employee and move on, hoping to avoid embarrassment. That approach forfeits any chance of criminal restitution and may complicate your insurance claim, since many fidelity bonds expect cooperation with law enforcement. It also signals to other employees that fraud has limited consequences.
After the immediate crisis, figure out which control failure made the scheme possible and fix it. In most cases the answer is a segregation-of-duties gap that grew organically as the company added responsibilities to a trusted employee without adding oversight. The trust was the vulnerability.