Payday Prowlers

Occupational Fraud – (Part 6 of 7)

By Mark Palmer, President e:countable, LLC

Payday is one work day usually liked by employees more than others, for obvious reasons.  However, for business owners it may be a recurring day every two weeks where a certain amount of funds are being inappropriately (and illegally) siphoned out of his or her account.  The amount may be a little, or may be significant.  Either way, theft is theft and business owners should understand how this type of embezzlement can occur.  Taking a few precautions can help mitigate the risk of fraud, and provide for better sleep at night.  Even if you fully trust your bookkeeper it’s good practice to take steps to safeguard your bank account.  Here are some examples of payroll fraud and tips on how you can prevent it.

Invisible Employees – Similar to what was discussed in Part 3, Vapor Vendors, your bookkeeper could easily set up an Invisible Employee (aka Ghost Employee) if you’re not keeping an eye on who’s being paid and how much.  An Invisible Employee is a name on your payroll register that’s being paid, even though the person doesn’t work for your company or may not even exist at all.  The person processing payroll– it could be your bookkeeper or someone outside your bookkeeping function, perhaps HR– creates an Invisible Employee in the payroll system, pays the unseen one, then pockets the amount being paid.

Paying a non-existent person is only a little trickier than paying a real person, even if the real person doesn’t work for your company.  This is true especially if your company processes payroll manually in house.  The reason has to do with social security numbers and compliance reporting. Eventually the IRS detects bogus social security numbers.   However, if a fraudster obtains the social security number of a recently deceased person, the decedent’s name and social security number could be used for quite some time before being detected. That’s one of the reasons dead people are so wealthy. After all, many dead people vote, why shouldn’t they be paid too?

It’s not unusual for the Invisible Employee to be a real, living person.  In this case it’s usually a friend or relative of the fraudster bookkeeper.  It could even be a former employee who left the company, but was never removed from the payroll.  The friend or relative is paid and the fraudster bookkeeper gets a kickback. While this type of fraud usually occurs when there are enough employees to easily “hide” the Invisible Employee, I’ve seen this type of fraud committed in companies with as few as 9 employees.

Time For A Raise – Another, more subtle way for a bookkeeper to embezzle money through payroll is to give himself or herself a raise without telling the owner.  I’ve seen this occur where the bookkeeper was paying herself more than twice what the owner thought she was being paid.

Bookkeepers can also collude with existing employees and receive kickbacks from them for paying more than authorized.  This is sometimes very easy to hide if the bookkeeper is responsible for calculating commissions or bonuses which aren’t being reviewed by the owner.

A Trip On The Company – It’s one thing for your employees to benefit from frequent flyer miles when they’re traveling on business, it’s another for them to pad their expense reports, or to submit expense reports for trips that never really occurred.  This is an extremely prevalent problem, especially when there are no receipts or backup.  Sometimes it is amazing to see how many miles it takes to get from point A to point B when an employee submits for reimbursement for mileage.  Perhaps they mistakenly think the IRS standard rate applies to yards, not miles.

Some Suggestions – here are a few actions you can take to reduce the risk of Payroll Fraud:

  • If you own/manage a larger company and you don’t know each individual employee, have an organization chart developed and have your managers introduce you to their subordinates if practical. Compare a payroll report directly out of the payroll system to the chart. It used to be the owner could hand deliver pay checks to each employee periodically, but that’s not the case when everything is electronic.
  • Segregate payroll duties if possible as follows:
    • Allow one employee to add and make changes to the payroll system, but not have the ability to process payroll or reconcile the bank account
    • Another employee can only process payroll
    • A third employee can only reconcile the bank accounts involved
  • Require expense reports along with receipts or other backup and have them approved by supervisors and managers
  • Develop budgets from the ground up and get monthly reports comparing actual results to budget. Understand all of your financial statements.  Embezzlement can and often is hidden in balance sheet accounts
  • Be engaged with your finances

Some reasons why we recommend using outsourced bookkeeping or a payroll service:

  • Outsourcing some or all of the payroll function to a reputable accounting / bookkeeping firm with their own internal controls will reduce your risk of payroll fraud
  • A reputable outside payroll service will be responsible for impounding and paying taxes, and handling all city, state and federal reporting requirements. This can also keep you out of hot water for not properly paying taxes and complying with the government
  • While your bookkeeper may provide a payroll report for you to review and approve before processing payroll, the bookkeeper can always make changes after you approve payroll, but before payroll is actually processed. A payroll service can automatically provide a report directly to you of what was actually paid so you can quickly detect fraudulent payroll activity.
  • A good outside payroll service can generate reports on a regular basis (at least monthly) reflecting all changes such as new hires, terminations, changes in pay rates, etc.

NEXT ISSUE:     Assets & Inventory – When Your Merchandise Grows Legs.   In the seventh and final part of our series on Occupational Fraud, we address physical inventory theft. What do you do when your inventory starts to disappear and you don’t know where it went? Learn how you can protect your business from this type of fraud in the next issue.  Want to know now?  Contact us at:  (757) 962-1080

Mark Palmer: Bio