March 10, 2022
Payroll fraud is the No. 1 source of accounting fraud and employee theft,which happens in 27% of all businesses. In fact, occupational fraud—or fraud committed by an employee on an employer—causes more financial loss to organizations than those committed by third parties.
Oftentimes, schemes committed by dishonest employees last an extended periodof time as they attempt to hide their theft while continuing to work for theiremployer. According to the Association of Certified Fraud Examiners, payrollfraud schemes tend to last 30 months with occurred losses reaching $63,000.Unfortunately, the losses from payroll fraud have double-impact onbusinesses—from the initial theft and then again as penalties from the IRS.
In-house international payroll systems that are harder to police, like those in largeorganizations with high employee turnover or a dispersed workforce, are aneasy target for theft. But, small businesses are also at risk, especially iftheir payroll system is managed or overseen by one person. Typically, when anycompany’s payroll function is centrally managed in-house, and there are nointernal control measures in place to detect, track and report fraud, adishonest employee is more likely to take advantage of the opportunity.
There are several ways in which payroll fraud is committed and concealed, sohere are some examples of the most prevalent types of in-house payroll fraud:
When a non-existent employee (also known as a ghost employee) is getting apaycheck, you have a payroll ghost. Sometimes employees who leave theorganization are never removed from payroll and become ghosts—an oversightmore likely in multinational companies with no comprehensive offboardingprocess. But more often, this type of fraud happens when a trusted employeeblatantly manipulates payroll, so they can pocket the paycheck of a fakeemployee. This person is typically a payroll manager with access to thepayroll system, who is authorized to add and delete employees from theregister.
Exactly how ghost employees are created varies depending on the type ofpayroll system in place, but they are often achieved by leveraging internalcontrol weaknesses. Large organizations with high employee turnover aregenerally at greater risk since there is less chance of a fictitious employeebeing recognized on the system.
Recently at the Indianapolis Bond Bank, two employees falsified their wagesand stole nearly $400,000 in unauthorized pay and benefits over nine years.
Payroll fraud through falsified wages can happen when an employee manipulatestheir wage rate, tampers with their actual paycheck or increases their salesnumbers for more commission pay. Wage rates can be adjusted when a workerfinds a way to avoid paying mandated deductions. Or like in the case example,employees can claim inappropriate benefit leave payouts or unauthorizedbonuses to enhance their wages.
Employees who have access to your payroll system might also be able to altercheck amounts or issue themselves unauthorized checks, since physicalpaychecks are easier to steal and forge than digital payment methods.
Finally, fraudsters could take advantage of a company with a weak commissionpolicy by claiming commission sales they didn’t earn. When certain employeeshave increasing commission earnings even as sales across your company aregoing down, that’s a big red flag for potential payroll fraud.
According to the American Payroll Association, almost 75% of businesses inthe U.S. are affected by “time theft” .Timesheet fraud happens when an employee increases their pay by claiming tohave worked more hours than they actually did. This type of offense may seemminor in the moment, but can lead to significant costs if it becomes a commonoccurrence over long periods of time.
Workers are able to steal time in a variety of ways including: recordinginaccurate times, soliciting a colleague to clock them in, conducting personalactivities while on the clock, or taking frequent breaks. Most of theseactivities result from blurred lines between professional and personal timerather than blatant theft—making this type of fraud more nebulous to identify.
Unless there is a protocol in place for managers to track and report timetheft, it will likely go unreported. And since 43% of hourly workers admit toexaggerating the amount of time they work at least once, tracking theseoffenses should be top of mind for employers.
For many employers, fraud could be hiding in plain sight in the form of falseexpense claims. This commonly overlooked type of payroll scheme occurs when anemployee gets paid back for expenses claims that are:
Dishonest reimbursement claims may be authorized by someone in yourorganization with little experience or knowledge. Or perhaps approving expenseclaims is a minor “side of the desk” task, which is not given proper attentionand consideration. Without procedures in place to verify and control employeeexpense claims, you are at risk of incurring significant losses.
Each of these employee fraud schemes are a risk to companies who conduct theirpayroll in-house, but improving internal controls, processes and policy cansignificantly reduce your risk of damages. Below are a few examples of how todetect and prevent payroll fraud.
Surprise audits contribute to the largest reductions in fraud loss andduration and only 32% of fraud cases in the U.S. use them as an anti-fraudcontrol. By leveraging the power of surprise, you are more likely to catch any payroll discrepancies or fraudulent activity before they have the chance to escalate.
At the very least, your payroll processing system should be reconciledquarterly with someone other than the person who runs your payroll.
A “Code of Conduct” is the most commonly used anti-fraud control, butemployers who go beyond best practices by implementing an anti-fraud policycan better ensure protection.
Most payroll schemes are initially detected through employee “tips”, soideally your policy will reward and encourage whistleblowing through a fraudhotline. This hotline can help identify suspicious employee behavior, like anoverly controlling manager who does not share payroll duties or take paid timeoff.
An anti-fraud policy is also helpful for informing offboarding procedures andreducing your risk of payroll ghosts. And with regard to expenses andreimbursements, a detailed company policy helps keep employees accountable forthe claims they submit.
Even with a reimbursement policy in place, manager reviews and audits areneeded to check the authenticity of expense requests. By having a managerroutinely review payroll, employees are less likely to overstep ethicalboundaries and managers will be able to detect company-widepatterns—potentially identifying when reimbursements are abnormally aboveaverage.
You should also require manager review and signature for overtime requests andwhen changes are made to timesheets in order to avoid time theft.
The payroll staff member responsible for processing should not also beresponsible for entering changes or amending employee records, and vice versa.In fact, the segregation of employee duties is the cornerstone of a solidinternal control system. Ideally, your global payroll system is managed by threeseparate functions: someone handling payroll authorization, another handlingdistribution and a third person handling reconciliation.
As a business owner, outsourcing payroll responsibilities can alleviate amajority of your risk for employee theft—as end-to-end processes are managedby an external party. With clear validation and reporting, a payroll providercan quickly reconcile any discrepancies that might arise betweendepartments—whether HR, Accounting or Payroll. Multinational companies who arestruggling to improve their internal controls and standardize their processesacross many locations can especially benefit from outsourced payroll services.
Want to learn more about how Payroll 360 can help reduceyour risk of employee payroll fraud? Contact us today.