Make no mistake. Payroll fraud is real. Recently, the Association of Certified Fraud Examiners (ACFE) found payroll fraud occurred in 27% of all businesses, nearly twice as often in small businesses. Worsening the outlook, payroll fraud lasts for an average of three years, with businesses taking a median hit of $145,000.00. That’s three years of paying ghost employees or overpaying existing ones. In one recent case, a payroll associate paid herself an extra $50,000.00 in less than one year.
There are several ways in which employees can commit payroll fraud:
Ghost employees. One of the most common types of payroll fraud is the creation of ghost employees (employees who do not exist). The payroll staff either creates the fake employee in the payroll system or continues to pay an employee who no longer works for the company and alters the payment record so the direct deposit or check is made payable to him or her. After the payroll checks are issued, the employee can delete the ghost employee in the payroll software system to conceal the misappropriation.
Timecard Falsification. Another common type of payroll fraud is employees adding extra hours to their timesheets. Often employees add small incremental increases in hours to avoid detection.
Pay check diversion. Employees take the paycheck of another employee who is absent and cash the check for himself or herself.
Pay rate alteration. Employees collude with the payroll clerk to increase the amount of their hourly pay in the payroll system.
Advances not repaid. This method of fraud occurs when an employee requests an advance on his or her payroll and then does not repay the advance. This works when the accounting staff does not record advances as assets or does not monitor repayment.
Buddy punching. An employee arranges to have a fellow employee punch his or her hours into the company time clock while he or she takes the day off.
Employers can take the following simple steps to help prevent or mitigate the loss.
- Reconcile payroll on a regular basis (at least quarterly) with an individual other than the person responsible for payroll.
- Separate duties. An individual who is responsible for processing payroll should not also be responsible for entering changes to employee records. In one recent case, the employee was able to commit fraud because she was responsible for:
- Checking and verifying time cards for employees,
- Posting newly hired employees into the payroll system,
- Preparing payroll for employees and printing payroll checks, and
- Making adjustments in the payroll system.
- An increasing number of small businesses are outsourcing payroll functions to third-party payroll companies. Businesses are able to report payroll information by telephone or email or enter payroll information. Payroll providers should be properly vetted by asking questions including, but not limited to, the following:
- Is it a nationally recognized company?
- Does the company implement high ethical standards?
- Does the company adhere to Securities and Exchange Commission (SEC) regulations?
- Does the company possess a certificate of liability insurance?
Payroll fraud may not be preventable. An employee can steal at any time. But payroll fraud is catchable and employers can minimize their risk.