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April 15, 2022

What Is Payroll Fraud

Reading Time 5 mins

Payroll fraud is damaging for any business, let alone a small company. It’s critical to spend time on detecting and preventing fraud. The very first step is to figure out what types of payroll fraud exist.

After detecting payroll fraud types, you can apply mechanisms to prevent fraudulent activity or minimize existing damage. In our article, we have prepared tips on how to detect and prevent payroll fraud.

Understanding Payroll Fraud

Payroll fraud occurs when employees or employers wrongfully manipulate payroll mechanisms to get an advantage in the form of payment they haven’t earned. Because of different types of fraud, it can be difficult to detect money loss. Let’s take a look at different fraud types to get a better understanding of the problem.

Payroll Fraud Types

There are numerous types of payroll fraud. Moreover, new schemes keep occurring. However, there are a few most common types. Keep reading to learn more.

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Timesheet Fraud

One of the most common situations when companies lose profit, is when employees manipulate their timesheets. They add hours they didn’t work and, as a result, get laid more.

Sometimes employees ask their colleagues to clock in and out for them when they aren’t actually working. One more common occurrence under this fraud type is when payroll clerks manually add hours to an employee’s timesheet to increase payment.

Worker Misclassification

The most common worker type is a salaried employee. But employers often use the independent contractors service. These employees are classified differently in payroll.

Sometimes employers unintentionally make a mistake when classifying a worker. But sometimes, it’s intentional and is classified as fraud.

Employers must pay:

  • unemployment taxes;
  • payroll;
  • Medicare and Social Security taxes;
  • workers’ compensation,
  • insurance, etc.

Intentional misclassification of salaried employees as independent contractors is a fraud since it’s an attempt to avoid paying above mentioned taxes and compensation.

Pay Rate Changes

In this case, employees collaborate with the payroll department. An employee asks a payroll official to change the amount of their hourly pay in payroll records. Some employees change the rate right before payday and then switch back to normal numbers to avoid being caught.

Boosting Work Hours

It’s one of the most common payroll fraud types. Employees often add small amounts of hours or even minutes to avoid attention and audit. This practice is quite often in workplaces where managers don’t pay enough attention to regular expectations of timesheets.

What Is Payroll Fraud

Unpaid Advances

It’s common for employees to ask for advance payments, but they have to pay back. If they don’t pay back, the employee commits payroll fraud. It’s sometimes difficult to notice unpaid benefits since accountants add these payments to “expenses.”

Such fraud types are common in lax accounting systems. Businesses must develop a clear process to set internal accounting rules and avoid fraud.

How To Detect Payroll Fraud?

It’s easy to detect and prevent some of the mentioned types of payroll fraud. However, sometimes employees go to great lengths to hide their wrongdoings, and their schemes go unnoticed.

The Association of Certified Fraud Examiners (ACFE), the world’s biggest anti-fraud organization, claims that the average duration between the beginning of a payroll fraud scam and its detection is 24 months. This information proves that there is enough time to cause significant damage to a business.

The business world hasn’t come up with one tool to fix the fraud problem, but there are factors to consider. Pay attention to a few red flags that tell you to watch out:

  • Payroll records carry data of employees who list identical or similar information (bank account numbers, SSNs, etc.).
  • Unexpected emails related to payrolls you didn’t affirm or emails from email addresses you don’t recognize.
  • Unrecognizable changes in payroll records.
  • Errors or gaps in records.

Consider keeping an eye on the lives of your employees. It might sound like something that came up from George Orwell’s novel, but it’s something to consider. If an employee’s salary doesn’t match the lifestyle they lead, it could be a warning sign.

These are a few signs to pay attention to, but there are a few things a business may do to prevent fraud.

How To Prevent Payroll Fraud?

The best way to avoid losses is to prevent payroll fraud. Take a look at some of the most successful methods to prevent schemes.

Buddy Clocking

It’s a method often called “buddy knocking.” According to buddy knocking, employees ask someone else to clock in and out for them to boost work hours. The simplest and most effective way to prevent buddy clocking is to use time tracking software with authentication methods like passwords, fingerprints, ID, etc.

Pay Rate Changes Prevention

To avoid pay rate changes, use accounting software protected with a password. Limit access to accounting software so only those responsible for the payroll can add changes. Ensure to match pay rate authorization documentation to the payroll register.

Preventing Boosting Hours

Set clear rules about clocking in and out so that workers know how to register. Then synchronize accounting and tracking software. Some software even enables businesses to prevent registering outside a specific period.

You may also consider manual approval of overtime hours. Conduct regular audits to prevent boosting work hours. Consider letting your employees know that regular audits are just a normal practice in the company.

Outstanding Advances

Sometimes unpaid advances get unnoticed due to poor accounting, but it’s easy to prevent such fraud. Unpaid advances often occur simply because of the confusion of employees. They don’t know whether they have to repair overpayment, especially when it’s a mistake in the payroll department. Create a company policy explaining what to do with advances or overpayments.

But unpaid advances may be intentional. Enforce effective accounting practices and audits to prevent intentional fraud. Consider software that automatically detects unpaid advances. Such type of software will automatically deduct any unpaid advances or overpayments from the following paychecks.

Ghost Employees

You’ve probably heard about ghost employees — fake workers. Such fraud often occurs when someone with access to payroll adds a fake worker to the records. In some cases, employees don’t delete terminated employees, which leads to spending resources.

Conduct regular audits to detect ghost employees. Watch out for non-contractor paychecks without deductions attached. And the most obvious tip: make sure to delete employees from payroll as soon as they leave the company, get fired, or retire.

How To Report Payroll Fraud?

Payroll fraud can be devastating to all businesses, but especially to small companies. That’s why it’s critical to detect and report the fraud to get compensation by filing a lawsuit.

Report the payroll fraud to a state attorney general’s office. Contact your state attorney general’s office and provide them with such information as individuals involved in the fraud, fraud’s nature, its duration, amount of money involved, etc.

It’s crucial to audit payroll records to detect fraud while it’s not too late. And as you see, it’s important to have proof. Some businesses use the help of payroll provider companies. Payroll providers take care of payroll and monitor the records to prevent all schemes.

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Author: Charles Lutwidge

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