Payroll fraud is not limited to global enterprises with thousands of employees. In fact, Forbes estimates that 27% of all companies are impacted by payroll fraud and that it takes place in small companies twice as often as larger ones (those with over 100 employees).
Although it may not always be possible to stop payroll fraud completely, there are ways to minimize risk and discover it sooner. The earlier fraud is detected, the less the financial impact.
Why Is Payroll Fraud So Prevalent in Manufacturing?
Often manufacturing accounting departments have a small number of employees and rely on the same individual to be responsible for multiple tasks. That could include verifying payroll amounts and reconciling bank deposits, tasks that would be fulfilled by separate individuals at a larger business. These small manufacturing companies have a difficult time implementing a clear segregation of duties, one of the best practices for preventing payroll fraud.
Office managers at small manufacturers are responsible for hiring services such as cleaning or maintenance, and often approve payments for these services, which can give them an opportunity to commit embezzlement by issuing checks to dummy contractors or companies.
Types of Payroll Fraud
Some of the most common methods of committing payroll fraud include:
1. Timecard Falsification
Time reporting fraud can be accomplished in multiple ways:
Employees clock in for friends who are not yet on the job, who then collect pay for hours not worked. They may have a relationship to cover each other on different occasions to each benefit from ‘free pay’. Or they may split the extra pay after collecting bonuses.
Employees conveniently “forget” to clock in which results in a manual entry for their hours worked, which can be falsified.
Still another method is an agreement between a worker and a member of the payroll department to add extra hours or pay to the employee and split the proceeds.
Timecard frauds are often discovered through regular audits, implementing requirements for supervisors to approve time cards, or installation of time clocks with physical verification such as retinal scans or fingerprint validation.
2. Ghost employees
This is a common scenario where employees that don’t exist are set up in the system and paid as legitimate employees. Another approach is for payroll staff to simply not deactivate terminated employees and continue paying them—diverting the payment into their own account.
Payroll audits can reveal this type of fraud.
3. Worker Misclassification
This involves misclassifying employees as independent contractors instead of employees. Whether intentional or simply from an error in classifying the payee, this fraud is typically committed by the company itself. The intention is often to avoid paying insurance premiums, paying payroll taxes, or collecting and reporting withholding taxes.
This can result in significant penalties to the business.
Payroll Reports Can Provide Insight to Fraud
Reporting from accounting software systems, like Cougar Mountain Software’s Denali, ensure that manual overrides and unauthorized entries are not ‘hidden’ from the eyes of internal or outside auditors. Restrictions incorporated into such systems provide controls over who has access to make manual entries, ensure secure audit trails are maintained, and provide reports to see who made changes and when.
Join Cougar Mountain Software’s complimentary Fraud Risk & Forensic Accounting, webinar! Register below today. What are some of your best practices to handle payroll fraud? Please share your comments below.