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Payroll Frauds

What is occupational fraud?

Occupational fraud, or employee fraud, is fraud committed by an employee on an employer. They are more common and cause more financial loss to businesses than other third party frauds. As employees will continue to work at the business, they will generally try to hide these frauds permanently.

What is payroll fraud?

This is fraud that attacks the payroll system of a business. It includes schemes against salaries and wages payment systems and expense reimbursement systems. Payroll frauds can be categorized into three general areas;

1. ghost employee frauds
2. false wage claim frauds
3. false expense reimbursement frauds

The first two frauds attack the actual wage payment system, the third type attacks the expense reimbursement system.

Who commits payroll fraud?

Any employee can commit payroll fraud, but how they would do so will depend upon the role they have within the business.

• To commit a ghost employee fraud, the employee will need to be able to add the ghost employee to the payroll register and collect payments to it.
• False wage claim frauds are generally committed by employees working on an hourly or a piecemeal basis. It is difficult for salaried workers to make such claims as their pay is not dependent upon any one variable factor.
• False expense frauds can be committed by any employees entitled to make claims for reimbursement of expenses or by people processing these claims.

GHOST EMPLOYEE FRAUDS

What is a ghost employee?

A ghost employee is someone recorded on the payroll system, but that does not work for the business. The ghost can be a real person that (knowingly or not) is placed into the system, or a fictitious person invented by the fraudster.

The aim of the fraud is to have a wage paid to the ghost and collected by the fraudster. The system does not require an accomplice but, depending on the method of payment (cash, cheque or direct deposit of wages), an accomplice may make the fraud easier to conduct, as it will eliminate the need to convert the payment from the ghost to the fraudster.

How is this fraud done?

There are four basic steps to a ghost employee fraud.

1. Add the ghost to the payroll system;
2. Generate false time sheet or wage information to create a payment to the ghost;
3. Issue a wage payment to the ghost;
4. Collect the payment and if necessary converted it into a useable form.

Adding ghost employees to the register may be as simple as using the 'Add Employee' function in the payroll system, where these employees may be added without the normal authorization paperwork.

Ghost employees may be paid by salary - not requiring any time sheets or other wage information - or by wage where this information will have to be created as required. It is easier to make the ghost a salaried employee or similar so that constant maintenance of the fraud is not required. Once the ghost has been added to the system, the wage payment should be automatically generated.

The payment needs to be collected in a way that does not raise suspicion. If the payment cannot be collected, the fraud cannot work. Cash payments may be difficult to collect but are also difficult to trace after the fact. Cheques may be mailed to the fraudster, but they leave a paper trail that may be followed. A lot of businesses pay employees by direct deposit into bank accounts. While this is the easiest way for the fraudster to get the money, it leaves the most direct paper trail.

How do you prevent this fraud?

Six controls may reduce the likelihood of ghost employee frauds. They will not guarantee the frauds will not be committed but will reduce the opportunity for them to start and increase the chance of detection.

1. Do not make cash payments to employees as these are easily taken and leave no trail to the fraudster once the scheme is detected.

2. Have non-payroll supervisors approve payroll payments to their direct employees on a random basis. This should highlight names on the payroll register that nobody recognizes.

3. Add and remove employees only with approval and verification by a number of people, or at least someone outside the payroll department. Ideally this person will be the manager under which that the employee will or did work.

4. Organize performance reviews to occur personally with all employees on the payroll register, not organized for particular sites. Ghost employees do not work on a site and therefore will be missed by this review process. Not all businesses require performance reviews but similar checks should be implemented.

5. Rotate responsibility for payroll functions.

6. Have management check the payroll listing from time to time looking for suspicious names and addresses, and randomly meet employees on the payroll register.

FALSE WAGE CLAIM FRAUDS

What is false wage claim fraud?

False wage claim fraud is falsely adding extra hours or other relevant factors to wage information to increase remuneration. Some employees are paid on an hourly rate, or have to clock in and out from work. They are remunerated for the standard hours worked and any overtime that they undertake. Casual employees are only paid for hours worked. These employees may add extra hours to their time sheet to get extra pay.

Some employees are paid on another piecemeal basis (e.g. number of parts produced). They may have the opportunity to falsely record extra work performed. The fraud is rteh same as false hours fraud, but just use another type of standard to calculate remuneration.

How does the fraud work?

The fraud is done simply by altering time sheets, the time recording system directly, or any other factor that determines the level of remuneration. The initial factor to consider is how the hours of other factors are recorded.

Some employers use time clocks that record the start and finish times. Some do not record the normal working week, but only record overtime. Hours are recorded by the employee themselves on the honor system, and some by supervisors who may or may not be present when the work is done. Some overtime must be requested by management, some can be done on the authority of the employee themselves. It is important to determine the method of recording the hours to know how the system can be manipulated.

This fraud can be transposed to other systems of remuneration. Employees that are remunerated by sales commissions may have the opportunity to falsify sale records to increase commissions. In effect, any employee that is remunerated against a standard may be able to manipulate that standard to increase their remuneration.

How do you prevent this fraud?

Salaried employees generally do not have the opportunity to commit this fraud. It may be possible to move some non-salaried employees to salaries to reduce that opportunity.

The fraud has two variances, that may be used together. The first is to add overtime hours to the time sheet when those hours are not worked. Stricter control over overtime will make this scheme harder to perpetrate. Requiring all overtime to be authorized beforehand and having the employee clocked off by management immediately thereafter will lessen the opportunity, but will add a layer of cost to the business. The method of recording the hours must be controlled in a manner appropriate to the business.

The second variance is to record the normal hours, but not work them. This can be done by having someone else clock an employee out at the usual time, when the employee is not there. The method of recording the hours actually worked has to be controlled in a manner appropriate to the business.

The same approach may be taken with recording any other standard used to pay employees.

FALSE EXPENSE REIMBURSEMENT FRAUDS

What is false expense reimbursement fraud?

False expense reimbursement fraud is the making of improper claims for the reimbursement of business expenses. There are four major types this fraud.

(a) Mischaracterized expenses,
(b) Inflated expenses,
(c) False expenses, and
(d) Multiple claims.

How does this fraud work?

The different variances of the fraud work as follows:

1. Mischaracterized expenses are non-business expenses that the employee claims as a business expense. They could be dinners with friends that are claimed as client dinners, holidays that have been claimed as business trips, etc.

2. Inflated expenses are legitimate business expenses that have been inflated in size. The increase is the profit kept by the employee. This can be done as easily as having the person issuing the receipt make it out to an inflated amount, or the fraudster may falsify the receipt themselves.

3. False expenses are purely fictitious expenses made up by the employee to obtain a reimbursement when there has been no expenditure, business related or not. Receipts can be generated or stolen by the employee.

4. Multiple claims are making the same business expense claim more than once, through different people or against a client's account and again against the business. They double the payment for the one expense.

Who commits these frauds?

Any employee that has the right to claim for reimbursement of business expenses may commit these frauds. Also the people that process these claims have the opportunity to process false or inflated claims under the names of other (innocent) employees.

LESSONS TO BE LEARNED

1. Not all frauds involve employees directly stealing money or assets. Payroll frauds occur when employees have the business pay them amounts to which they are not entitled, and have the payment recorded as a legitimate expense.

2. Not all frauds occur once and in large amounts. Payroll frauds are generally continuous and for small amounts. The business will generally not miss smaller amounts of money as quickly as larger amounts, but will eventually add up to a significant amount.

3. Employees charged with protecting the payroll system are best placed to defraud the system and hide the evidence.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Acknowledgment
The material in this Fact Sheet was sourced from various publications including those listed in the Reading List on the Fraud Awareness page on this website.

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Last Updated: 8.4.2008