Do You Know Your Employee?

READ ARTICLES FROM 2016 INTERNATIONAL FRAUD AWARNESS WEEK

Preventing or limiting payroll fraud begs the question: Do you know your employee? This fraud occurs when inputs into the payroll system are manipulated. The victims of this manipulation are the individuals or entities that are affected directly or indirectly by the profitability of the business.

When internal controls are lacking in the payroll area, multiple schemes can exist. The most common manipulations are classified into three types: overpayment schemes, “ghost” employee schemes, and bonus or commission schemes. Payroll schemes are not always perpetrated by someone in the payroll department. Employees from other departments may submit falsified records to the payroll department, resulting in fraudulent payments.

• Overpayment schemes occur when hours and/or rates are manipulated. Falsified timesheets are often submitted.
• Ghost employee schemes occur when wages are paid to someone, through payroll, who doesn’t actually work for the company.
• Bonus or commission schemes occur when performance data or commission rates are manipulated.
• Reimbursement schemes, which are classified as expense schemes, can also be perpetrated through the payroll system.

Proper internal controls and segregation of duties can prevent many of these schemes. However, co-conspirators in multiple departments make the discovery of payroll schemes more difficult. Personnel records should be maintained separately from the payroll function so comparisons can be made between the human resources and payroll systems. The employee master file should be reviewed for certain flags such as changes in rates or salary, multiple employees with the same social security number, multiple employees with the same address, and P.O. Box or Mail Drop addresses. Expense reports should attach original receipts and reimbursements for prepaid expenses should be revisited after the expense event occurs. 

However, sometimes these schemes are perpetrated by owner(s); the victims being co-owners, the government, and employees whose compensation is tied to profitability.

Example – No Show Ghost Employee Scheme

Sam had inherited a family business co-owned and managed by a relative, Tom. Sam had remained an inactive owner for a number of years. Sam became concerned when he questioned Tom about the operations and direction of the business and was met with hostility. Sam eventually brought suit and an expert was hired to review the income of the business and value the business in the context of a shareholder dispute. Besides the numerous personal living costs expensed as operating expenses, the expert discovered numerous ghost employees through the review of the payroll records. Certain employees were flagged due to duplicate addresses, multiple individuals with related last names, and employees with addresses out of the area. In addition to children and grandchildren, Tom had been paying for his father’s nurse and his housekeeper through payroll.

Example – Terminated Ghost Employee Scheme

Megan was an administrative assistant that was terminated from the company. Instead of terminating Megan in the payroll system, Joy, an employee in the payroll department, simply directed Megan’s paycheck be printed rather than direct-deposited. Joy then took possession of the physical checks and endorsed them for her own benefit for two pay periods. If there had been no cross-check from human resources, this fraud may have gone undetected due to its short life.

Example – Reimbursement Scheme

An expert was hired, in the context of a matrimonial dispute, to value a family-owned business for the purpose of equitable distribution (fairly dividing marital assets). A review of expense reports submitted by the owners showed multiple reimbursements for the same expense. The expense was submitted one month with the credit card receipt and the next month with the detailed invoice. Both related owners committed this scheme with the other’s knowledge. The victims in this case were the employees with bonuses tied to the company’s profitability and the IRS.

As the year comes to a close, ask yourself: Do I know my employees? Cross-check personnel records to payroll reports. Could that nice girl in payroll have given herself a raise during the year? If you feel that your organization may be vulnerable to payroll fraud, call an experienced consultant to help you design proper internal controls. And if you think payroll fraud may have occurred in your organization, consider hiring an experienced fraud examiner or forensic accountant to investigate the magnitude of damage.

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FRAUD WEEK ARTICLES

• Preventative and Detective Fraud Controls in Accounting Software
• Fraud in the Workplace
• Do You Know Your Employee
• Important Considerations when Conducting an Effective Fraud Risk Assessment
• Expense Reimbursement Fraud
• Recognizing Vendor Fraud
• Occupational Fraud Prevention in Construction
• Excess Benefit Transactions and Their Impact on Not-for-Profit
• Health Care Fraud 
• Ponzi Schemes
• Occupational Fraud and Abuse Statistics