Types of payroll fraud
/Payroll fraud is the theft of cash from a business via the payroll processing system. There are several ways in which employees can commit payroll fraud, as noted below. Among the more common types of payroll fraud are not paying back an advance, buddy punching, and time sheet padding.
Advance Retention Fraud
The most passive type of fraud is when an employee requests an advance on his pay and then never pays it back. This works best when the accounting staff does not record advances as assets (instead charging them directly to expense), or never monitors repayment. Thus, the non-payment of advances requires inactivity by the recipient and inadequate transaction recordation and follow-up by the accounting staff. A monthly procedure to review advances will eliminate this issue.
Buddy Punching Fraud
An employee arranges with his fellow employees to have them punch his hours into the company time clock while he takes the day off, which is known as buddy punching. Supervisory reviews and the threat of termination are the best ways to avoid this risk. A more expensive alternative is to use biometric time clocks, which uniquely identify each person who is signing into the time keeping system.
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Ghost Employee Fraud
The payroll staff either creates a fake employee (or “ghost employee”) in the payroll records or prolongs the pay of an employee who has just left the company, and alters the payment record so that the direct deposit payment or paycheck is made out to them. This works best in large companies where supervisors have very large staffs and so do not track compensation in sufficient detail. It also works well when a supervisor has left the company and has not yet been replaced, so that ghost employees can be inserted into their departments until a new supervisor is appointed. Periodic auditing of the payroll records is needed to spot ghost employees. Another way to spot a ghost employee is when there are no deductions from a paycheck, since the perpetrator wants to receive the maximum amount of cash.
Paycheck Diversion Fraud
Employees could take the paycheck of another employee who is absent, and then cash the check for themselves. This can be avoided by having the paymaster retain all unclaimed checks in a locked safe, and by requiring that everyone receiving a paycheck prove his identify with a driver's license or some similar document.
Pay Rate Alteration Fraud
Employees collude with the payroll clerk to increase the amount of their hourly pay in the payroll system. A more clever clerk will then return the pay rate to its original level after committing this fraud for just a few pay periods, so that the issue is less easy to spot. This can be detected by matching pay rate authorization documents to the payroll register. Another detection option is to run a report that itemizes all pay rate changes made during the past payroll period, and have the responsible managers review it.
A variation on the concept is possible when a payroll system gives managers access to pay rate changes in the system. In this cases, employees can steal the login information of their managers and alter pay rates themselves.
Unauthorized Hours Fraud
Perhaps the most common type of payroll fraud is the padding of time sheets by employees, usually in small enough increments to escape the notice of supervisors. This is a particular problem when supervisors are known to make only cursory reviews of time sheets. The best control over this type of fraud is the supervisory review.
In short, there are many ways in which the amount of payroll paid out can be fraudulently expanded. This is difficult to spot when the amounts involved are small, so you must consider the cost of prevention activities in relation to the amount of savings that will be generated.