Any company that pays employees, whether by paycheck or direct deposit, is a potential target for payroll fraud. Internal fraud like this can take a serious toll. When perpetrated by an employee, the scheme can go undetected for eight months or more, causing a median loss of $50,000 for employers, according to the latest report from the Association of Certified Fraud Examiners (ACFE).
What Is Employee Payroll Fraud?
The ACFE defines it as “a fraudulent disbursement scheme in which an employee causes their employer to issue a payment by making false claims for compensation.” Put another way, this fraud happens when a dishonest employee manipulates their company’s payroll system so they or another worker can receive wages they didn’t earn.This fraud affects businesses of all sizes and in every industry, but it can especially harm smaller businesses, which have fewer resources and may be unable to spot this crime quickly.
5 Types of Employee Payroll Fraud
This crime takes many forms, and some types are harder to discover than others. Here are some common payroll schemes and ways you can help guard against them.
1. Timesheet Fraud
This is when a worker falsifies their reported hours on their timesheet. They may also misuse the company timeclock by using “buddy punching,” which is when workers clock each other in or out so that an absent worker gets credit for hours they weren’t working. Time theft like this can also happen when an employee takes excessive breaks while they’re on the clock.
Best practices: Require a manager or supervisor to sign off on all timesheets and carefully review overtime pay.
2 . Pay Rate Fraud
This occurs when an employee with access to the payroll system adjusts a pay rate to inflate their paycheck. After payday, they may correct the pay rate to avoid detection.
Best practices: Strictly limit who can adjust data (such as employee wages) within the company payroll and review the activity of people who can access the system.
3. Commission Fraud
A dishonest employee may exploit weaknesses in a company’s commission policy to claim unearned commissions or bonuses.
Best practices: Review your commission program regularly and make sure its policies work as intended and are enforced. For example, sales reps shouldn’t be able to keep commissions for sales that go uncollected. Also, closely monitor your company’s finances to make sure commissions are in line with performance. If commissions are up when sales are down, that’s cause for concern.
4. Ghost Employee Schemes
This happens when someone in HR or the payroll department adds a fictitious employee (or keeps someone on the payroll after they’ve left the company). Payments are sent to the account or address of this ghost employee and collected by the scammer or an accomplice.
Best practices: Periodically audit your payroll and verify Social Security numbers. This fraud is more likely to go unnoticed in larger companies with many staff members.
5. Workers’ Compensation Fraud
This is when an employee files a false workers’ comp claim, which may involve faking an on-the-job injury or claiming they were hurt at work when they were actually injured at home. This directly affects workers’ compensation insurers, but businesses pay the price in the form of higher premiums.
Best practices: Install security cameras to corroborate claims of on-the-job accidents. Also, make sure employees report workplace injuries right away.
Fraud Red Flags
Be on the lookout for:
- Duplicate addresses or bank accounts. If two workers who aren’t family members have the same address or banking information, look into this.
- An employee living beyond their means. When a worker is clearly spending more than they earn, this may be a warning sign of workplace fraud.
- Problems in your payroll. Omissions, unexplained changes or mistakes in your payroll records indicate a lack of oversight as well as possible fraud.
- An employee who hoards responsibilities. If a single worker is responsible for the company payroll and they never take a day off or share their duties with others, it’s possible they’re involved in a payroll scheme and worried that it would be discovered by someone else if they were absent.
Help Prevent Employee Payroll Fraud
Help reduce your internal fraud risk by maintaining detailed policies related to your payroll, timesheets or time clock, and related matters. Empower your team to speak up if they see something concerning. Employees should report fraud to a trusted manager who is not associated with the suspect.
It’s also essential to segregate duties within your accounting or payroll department. One person should be responsible for preparing the payroll and another for verifying and submitting payments. Review your payroll each pay period and during quarterly reconciliations. Also, perform unscheduled audits to help deter misconduct, and take time to review your company’s payroll audit trail.
With strong anti-fraud measures in place, you’ll be better equipped to spot employee payroll fraud and help minimize financial losses (and headaches) for your business.