Payroll Fraud: What Is It and How to Overcome It

“An honest day’s pay for an honest day’s work” Is a sentiment that most of us hold. Unfortunately, there are unscrupulous individuals out there that take advantage of company payment systems for their own gain. From outright time clock fraud to more esoteric examples that we will explore later in this article, payroll fraud can take many forms. In this blog article, we will explore what is payroll fraud, and what are the potential steps that can be taken to circumvent it in your multi-country payroll operations, which can save your company millions.

How do you define payroll fraud?

Payroll fraud is the theft of money through the payroll process. Oftentimes, payroll fraud may be so well hidden that standard audits won’t uncover these discrepancies and can be committed by the employee themselves, by team effort or by accounting or payroll staff. If you manage global payroll, you have to be even more meticulous in assessing the possibility of fraud taking place.

What are the different ways in which payroll fraud can occur? Below are some common examples:

  • Advance Retention Fraud

    This is the most passive form of payroll fraud. An employee can ask for an advance on their pay check, however neglecting to repay the advance constitutes fraud. Negligent accounting staff can also inadvertently contribute to fraud by not recording advances or monitoring repayments.

  • "Buddy Punching"

    One of the more common types of fraud, buddy punching occurs when an employee has their co-worker punch in at work for them without actually working those hours.

  • Paycheck Diversion

    Employees claiming the paycheck of another employee and cashing it in for themselves.

  • Unauthorized Hours

    Padding the time sheet of an employee, usually in small enough increments that seem insignificant and will usually go unnoticed by supervisors.

  • Pay Rate Alteration

    Unfortunately, sometimes the ones committing fraud are the ones in charge of payroll. In this case, an employee colludes with payroll staff to increase their pay rate. The alteration is usually only in place for a few pay cycles, during which, the employee is remunerated at a rate above their award rate.

  • Ghost Employees

    Much harder to detect in larger firms, payroll staff can either create a fake employee or prolong the pay of one that has left. The difficulty of having large staffs is that it becomes near impossible to scrutinize the details of every employee, making ghost employees one of the hardest types of payroll fraud to expose.

  • Employees Misclassification

    Employee misclassification is the sometimes accidental, oftentimes deliberate misclassification of workers in a way that allows them to either avoid paying payroll taxes, insurance, overtime or any other employee entitlements.

All of these are methods of payroll fraud that can cut into a company’s profits. Though the idea of curbing fraud that is easily hidden can seem daunting, there are actions that can provide immediate results and prevent future occurrences to prevent payroll fraud. Some of these steps include:

  • Establishing A Whistleblowing / Confidential Reporting System

    The most common way payroll fraud is uncovered is through employee tips, so make it easy for them! Providing a mechanism for your employees to provide information confidentially can reduce the cost of fraud by half, so if your organization hasn’t implemented one yet, take the time to create one soon.

  • Implementing Timesheet Checks

    More rigorous clocking requirements such as requiring an ID card or biometrics can vastly reduce your risk of suffering from buddy punching or unauthorized hours. Assigning managers to review timesheets every pay period also heavily discourages timesheet fraud.

  • Separating Payroll Functions & Personnel Functions

    When possible, separate functions such as time sheet approval, payroll cutting and personnel recording. This reduces the risk of payroll fraud on the backend, especially in avoiding ghost employees and pay rate alteration.

  • Conducting External Audits & Using Payroll Analytics

    Payroll audits can be both time consuming, expensive and if done internally, sometimes may fail to reveal fraudulent behaviour. External auditors are often less biased and more experienced than internal auditors, though they might uncover a lot more than you might expect. Alternatively, if you outsource your payroll, requesting your vendor provide an audit and payroll analytics reveal fraudulent transactions.

  • Avoid Misclassification

    Employee misclassification can result in severe consequences; therefore, it is paramount to research employment laws and avoid giving contractors work that might classify them as full-time employees.

Though fraud has the potential to take place in any organization, extending security measures and being vigilant can help reduce the possibilities of it taking place. Knowing the potential methods of fraud helps one to identify it when it occurs and assists in designing preventive measures and policies. Whether payroll is performed in-house or with a trusted payroll outsourcing vendor, preventing payroll fraud is a joint effort for all involved in the payroll process.

Contact us to discuss how Frontier e-HR can partner you to prevent payroll fraud.

Yes, I would like a free demo