Payroll fraud is one of the most common and costliest forms of asset misappropriation and lasts an average of 30 months before it is detected which can potentially cost hundreds of thousands of dollars.
According to the Association of Certified Fraud Examiners, payroll fraud is defined as “any scheme in which an employee causes their employer to issue a payment by making false claims for compensation.” It’s also fraud that is especially insidious in a company’s accounting department, where bookkeepers or payroll managers have access to bank accounts and checks and an ability to manipulate financial statements. In fact, the median fraud loss in accounting departments is $212,000.
Understanding how to prevent payroll fraud begins with understanding how it occurs. The most common forms of fraudulent payrolls schemes are:
- Falsified wages. This is one of the easiest schemes to perpetrate. An employee claims they worked hours that they didn’t or asks a coworker to punch their timecard when they weren’t even on the clock. People with access to the payroll system can manipulate information to pay themselves more than they should earn by inflating commissions or increasing their wage rate.
- Ghost employees. In some instances, companies are defrauded when payments are issued to former or even fake employees. This type of fraud can easily go undetected in large organizations, or in businesses who hire and furlough workers seasonally, such as farms.
- Benefit schemes. There are several different types of fraudulent benefit schemes, but they all involve the same crime: an employee illicitly receives extra benefits or compensation they did not earn, such as excess PTO.
In sports, it’s often quoted that the best defense is having a strong offense and the same is true for preventing payroll fraud. Having strong internal controls is the best way to deter and detect payroll fraud before it spirals into thousands or even millions of dollars.
Here are 11 practical suggestions for preventing payroll fraud:
1. Set the tone at the top. No procedure or process can replace the importance of management establishing a culture of honesty. This means conducting business ethically and creating an open-door policy for whistleblowers to report fraud without fear of retribution, especially because 40 percent of all fraud is detected by a tip.
2. Require mandatory vacations. That dedicated employee who comes in early and stays late, and never takes a day off may very well be the thief in your company. Make sure employees, especially those who process payroll, take vacations. Doing so means another person will have to run the payroll, which is one of the common ways fraud is detected.