Beware of Ghost Employees – and Other Payroll Fraud

Any employee can commit payroll fraud. An employee could submit false hours, claiming they worked overtime when they didn’t. On the extreme end, someone in your payroll department could create a ghost employee (an employee that does not actually exist) keeping those false wages for themselves.

Learn more: 7 Behavioral Flags for Internal Fraud

Below we discuss four actual cases of payroll schemes that could cause your business to lose big dollars at the hands of a fraudster and steps you should take now to deter payroll fraud. The cases are real, the names are not.

  • First, meet Pamela. Pamela is the payroll specialist and sole payroll employee at a small, family-owned construction company with about fifty employees. As construction work ebbs and flows, not all fifty employees get paid every paycheck as employees come and go. Oversight by management is weak to nonexistent. This allows Pamela to add a fake employee to the payroll software and add her own bank account information and pay herself an additional salary. With the lack of oversight from management, no one even noticed.

According to a 2022 study conducted by the Association of Certified Fraud Examiners (ACFE), payroll fraud schemes can be especially costly because they typically take about eighteen months to detect. Payroll fraud schemes have been seen most prevalently in construction companies, food service and hospitality, and government and public administration industries. Most commonly the perpetrator works in the payroll department.

  • In our second example, John, the controller of a small medical practice, took it upon himself to increase his own salary by writing himself additional checks during the pay period, in effect, paying himself two to three times his salary. On the books, he wrote an “adjustment check” so that the books would balance and make it seem like the salary being paid to him agreed to his salary contract. However, this caused a discrepancy between the payroll register and what left the bank account as payroll expenses. He got away with it for some time as he altered the electronic payroll reports that he generated and sent to the external accountant. Additionally, the controller reversed employee withholdings on those fraudulent checks, which then caused the company to pay his healthcare premiums and state withholdings. This part of his scheme is what caused his demise. An external auditor reviewed the expenses paid by the company and found the fraud.

What allowed this fraud to happen? No segregation of duties and no oversight. John had sole responsibility for payroll. No one performed a monthly reconciliation of the payroll register to the bank statement. If they had, they would have noticed that the payroll register stated the appropriate salary (due to the controller’s falsifying the books), but the bank statement would have shown that more money was being paid for salary expense than what was on the books.

Segregation of duties is necessary to help deter fraud. Segregation of duties requires more than one person to complete a task. That is, one person should not possess the ability to complete a decisive business process without the oversight of another individual. Whoever cuts the check should not also sign it. Handwritten checks should be written by one party and signed by an owner/executive. For direct deposits, all checks should go through an approval process at the same level.

  • In a third case, the perpetrator, Veronica, worked as the third-party payroll processor for multiple transportation companies. She was charged with overpaying certain employees and then receiving part of the overpayment back. The employees agreed to the overpayments and therefore were also charged in the fraud. Veronica went even further and added people to the employee payroll that were not employed by the companies. Again, Veronica would then receive part of the payment to these fake/ghost employees.

Using a third-party payroll processing company does not alleviate the need for strong and effective internal control. There was a lack of oversight at these companies to review employees on payroll registers and to verify that payroll expenses agreed to employee expenses actually performed for the company.

  • In a fourth case, an account specialist of a small business, Ms. Smith, used her access to the payroll system to inflate her own payroll over a two-year period. Ms. Smith compiled the timesheets and weekly payroll information for approval by the CFO. After approval, Smith then altered her hours in the payroll system to receive higher compensation. The CFO was unaware of the fraud because it occurred after his approval. The missing control in this scenario is, again, the lack of a subsequent reconciliation of the bank statement to the approved payroll information.

What can you do to help prevent or deter payroll fraud in your business?

  • ·Verify employee overtime; make sure it was approved and properly supported.
  • Verify all employees on the payroll register do indeed exist by comparing a list of active employees to the payroll register.
  • Look for signs of a ghost employee, such as a timecard submitted without an employee’s signature.
  • ·Scrutinize lists of part-time, seasonal, and temporary employees and verify often that they are in fact current employees.
  • Review lists of recently terminated employees to determine if they are continuing to receive payroll checks (one final check after termination is common).
  • Perform monthly reconciliations of payroll reports to bank statements.

If you need help ensuring your business’s internal control is as effective as it needs to be, contact the professionals at R&A.

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