31 Ways to Prevent and Detect Payroll Fraud

Strong oversight and controls are key to combatting payroll fraud and keeping your employees honest.

Posted by Dawn Lomer in on April 12th, 2017

Who’s to blame when a company is a victim of a devastating payroll fraud scheme? Aside from the fraudster(s), of course, there are others in the company in positions to ensure this doesn’t occur and finger-pointing isn’t going to solve anything. But knowing all the different schemes and how to prevent and detect them might.

Payroll fraud schemes are among the most damaging to a company because they tend to take place over a long period of time. According to the Association of Fraud Examiners (ACFE) the median duration between the start of a payroll fraud scheme and its detection is 24 months — enough time to do some significant financial damage to a company. And some experts estimate that almost a quarter of businesses are affected by payroll fraud each year.

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What is Payroll Fraud?

It’s often long-term, trusted employees who carry out these frauds, and companies with lax or non-existent controls are most often targets.
Payroll fraud is theft of funds using a company’s payroll system. It’s most often carried out by managers and senior employees of the payroll department who have access to the systems through which employees are paid and can use that access to issue false payments. It can also be carried out by employees who make false claims for payment and by employers who classify full-time employees as independent contractors to avoid paying payroll taxes and insurance.

Payroll fraud is a form of asset misappropriation, one of the most common types of fraud to affect businesses. And it’s often long-term, trusted employees who carry out these frauds, and companies with lax or non-existent controls are most often targets.

Types of Payroll Fraud

Some common payroll fraud schemes and methods include:

  • Timesheet fraud
  • Falsifying wages
  • Commission fraud and bonus fraud
  • Expense reimbursement fraud
  • Ghost employees
  • Misclassification

Timesheet Fraud

When an employee “punches in” for another employee, they both commit timesheet fraud.
Employees who inflate their hours on timesheets are committing timesheet fraud. But this type of fraud is not only committed by employees on their own timesheets. When an employee “punches in” for another employee, they both commit timesheet fraud.

A payroll officer or manager can also commit timesheet fraud by inflating the hours on another employee’s timesheet or altering the rate of pay and then transferring the extra money to his or her own account before issuing the employee’s pay.

There are several effective ways to prevent and detect timesheet fraud and they all revolve around auditing and controls:

  • Use electronic timesheets to eliminate the opportunity for an employee to change information after they are submitted.
  • Have supervisors approve timesheets before they are submitted to payroll.
  • Require that timesheets be completed and submitted on schedule to avoid delays after which a supervisor may not remember the hours an employee worked.
  • Schedule periodic audits by someone outside the department to compare timesheets to work schedules to spot anomalies.
  • Require a supervisor’s approval for any changes to employee pay rates or employee types.
  • Use data analytics to spot anomalies in pay records.
  • Compare pay data with payroll budget to spot inconsistencies.

Dive deeper into payroll fraud. Watch the archived webinar: Detecting and Preventing Payroll Fraud.

 Falsifying Wages

A payroll department employee commits fraud when he or she falsifies wages of another employee. This can be done in collusion with the other employee, who then shares the extra pay with the payroll employee, but it is also sometimes committed alone.

When done alone, the payroll department employee transfers the extra pay to another account before issuing the employee’s paycheck for the correct amount. The employee doesn’t know about the fraud, even while unknowingly participating.

To prevent and detect falsified wages:

  • Reconcile the check register against payroll records each month.
  • Separate the duties of processing payroll and issuing checks.
  • Use data analytics to spot anomalies in pay records.
  • Compare pay data with payroll budget to spot inconsistencies.

Commission Fraud and Bonus Fraud

Look at the percentage of revenue paid out to commissions and bonuses to see if it is above the projection.
Commission fraud or bonus fraud occurs when an employee whose pay is partially or fully based on commissions or bonuses inflates sales to collect higher commissions or bonuses or posts non-existent sales which are later reversed. Fraudsters might also post sales before they are finalized in order to collect commissions or bonuses earlier or even collude with another person to create a sale that is later reversed.

Payroll managers also commit commission fraud when they change the rate of commission for an employee, often in collusion with the employee.

To prevent and detect commission fraud and bonus fraud:

  • Conduct random audits of payroll records.
  • Compare the check register with payroll records.
  • Compare budgeted payroll to actual payroll.
  • Look at the percentage of revenue paid out to commissions and bonuses to see if it is above the projection.
  • Allocate aging unpaid receivables by employee to see whether a particular employee has more than others.
  • Examine write-offs to see if a particular employee has more than others.

Expense Reimbursement Fraud

Employees commit expense reimbursement fraud when they claim reimbursement for fictitious expenses or when they inflate actual expenses when submitting them for reimbursement.

There are many ways employees can commit expense fraud. The most common methods are claiming reimbursement for non-business expenses, claiming reimbursement for travel that was cancelled, submitting fake invoices for reimbursement, submitting more than one claim for the same expense and altering a receipt to increase the reimbursement.

To prevent and detect expense reimbursement fraud:

  • Have an expense reimbursement policy.
  • Require receipts to back up every claim submitted.
  • Examine receipts to ensure they are authentic.
  • Implement a formal review process for employee expense reports.
  • Check dates and locations to ensure receipts match travel.
  • Follow up with the issuer of receipts that don’t look authentic.
  • Note claims with missing receipts and run comparisons to see if a particular employee has significantly more missing receipts than other employees.

Ghost Employee Schemes

Require documentation and authorization from management before an employee can be added to the payroll.
Ghost employee schemes are perpetrated by payroll employees who either create synthetic identities (“ghost employees”), complete with fake SSN, address, phone number, etc, or continue to issue payments to employees who have left the company, diverting the pay to themselves.

A ghost employee can also be a real person, such as a family member, who doesn’t work at the company but who collects pay and either shares it with the fraudster or keeps it.

To detect and prevent ghost employee schemes, companies should implement controls, including:

  • Require documentation and authorization from management before an employee can be added to the payroll.
  • Use direct deposit for payroll checks to create a paper trail.
  • Separate the duties of maintaining payroll records and personnel records.
  • Conduct background checks and reference checks on new hires.

Misclassification of Employees

This type of fraud is carried out by employers, sometimes accidentally, but often deliberately. It occurs when employers classify a full-time, salaried employee as an independent contractor (“1099 worker”) to avoid paying payroll taxes and workers compensation insurance. This lowers staffing costs and allows the company to submit lower bids than other companies who are classifying employees correctly.

To avoid misclassifying employees:

  • Know the laws that govern whether a worker is a W-2 employee or a 1099 worker.
  • Be careful when setting tasks, pay and working hours for contractors to avoid establishing regular duties, hours that would apply to a W-2 employee.
  • Consider carefully the classification of “contracted” workers who do not work for any other companies.

 

 


Dawn Lomer
Dawn Lomer

Managing Editor

Dawn Lomer is the managing editor at i-Sight Software and a Certified Fraud Examiner (CFE). She writes about topics related to workplace investigations, ethics and compliance, data security and e-discovery, and hosts i-Sight webinars.

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