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Payroll fraud myths and realities

Ghost employees. While the phrase may conjure up ideas for a new mystery novel, the reality isn’t at all glamorous. These “ghosts” (fictitious employees who receive paychecks) constitute a common type of payroll fraud. Essentially, payroll fraud occurs when someone uses a payroll system to gain unauthorized funds; other typical forms of this crime include false wage claims and false expense reimbursements.

While the Association of Certified Fraud Examiners reports that payroll fraud accounts for close to 12 percent of workplace fraud cases in the U.S., many of us are still sadly misinformed about it. To help clear up the confusion, this article explores some common misconceptions about payroll fraud.

Myth 1: Payroll fraud is discovered quickly.

Reality: The average instance of payroll fraud lasts about 36 months. That’s three years of paying ghost employees or overpaying existing ones. In Delaware, a School District Finance Director paid himself an extra $150,000 over eight years. He also underpaid several school administrators a combined $50,000 in one school year.

Myth 2: People who commit payroll fraud are creative in hiding their misdeeds.

Reality: Payroll fraud is often so thinly disguised it makes outsiders shake their heads in disbelief. Take the case that occurred a few years ago at the Brooklyn Museum. The museum’s Payroll Manager embezzled $620,000 by wiring 38 paychecks to ghost employees named “Brooklyn,” “Brooklyn Museum,” and even “ZXY”! He wired these paychecks directly into a joint account he shared with his wife. Despite a stunning lack of imagination seen in the names of fictional employees, this fraud continued for over three years.

Myth 3: Payroll fraud mostly happens in large organizations.

Reality: Payroll fraud occurs nearly twice as often (14.2 percent) in small organizations with less than 100 employees than in large ones (7.6 percent), according to the Association of Certified Fraud Examiners. This is usually due to poor or nonexistent internal controls in small organizations. When no one is checking your work, it’s easy to give yourself a raise, a bonus or – like the enterprising manager from Brooklyn – add a few people to the payroll.

The question is, how can payroll fraud be prevented? The basic answer: oversight. Sound internal controls speed the discovery of honest errors and dishonest actions, and reduce the financial effects of fraud.

In small companies where it’s difficult to separate duties among three or more people, the best internal control against payroll fraud is periodic review, preferably by an independent reviewer or outside accountant. It doesn’t have to be done every month. This oversight is most effective when employees who process payroll know someone will review their work in detail, but they don’t know exactly when the reviews will occur, which periods will be reviewed or what tests will be performed.

At minimum, a business owner or independent reviewer should perform these three tests:

1. Verify that each employee actually exists. Most small business owners can determine this with a glance at the payroll register or direct deposit listing.

2. Verify that the final paycheck made to a terminated employee is calculated properly and that extra paychecks were not issued after vacation and other benefits were paid.

3. Verify that pay rate changes, bonuses, commissions and the like are properly authorized, documented, calculated and paid.

If your organization doesn’t have a process in place for this kind of review, it’s time to create one. According to an ACFE report, this type of oversight reduces losses by almost 60 percent and the length of fraud schemes by more than 40 percent.

Trust, but verify.

Denise McClure, CPA, CFE is a forensic accountant and the owner of Averti Fraud Solutions, LLC in Boise. She is a frequent author, speaker and trainer on preventing and deterring embezzlement and fraud. Her ideas on fraud risk management have helped organizations improve efficiency, profitability and security. For more information, visit www.AvertiFraudSolutions.com or e-mail Denise@AvertiFraudSolutions.com.

About Denise McClure