Backdoor payroll theft is not common, but it is a real threat. Many auditors are unaware of this possibility. So they don’t look for it. In this article, I explain how the theft occurs.
Gertrude, the payroll clerk, intentionally overpays company state withholding taxes by $25,000. She then amends her own W–2 so that it includes the excess payment (the $25,000 is added to her state withholding total). Once Gertrude files her personal state tax return, she receives an extra $25,000. In effect, she is using the state government as a funnel for theft.
In this business, Gertrude processes payroll and files all related payroll tax reporting information. Additionally, she makes payroll withholding payments and records payroll entries in the general ledger. Not uncommon in a small entity. Also, no second person reviews the W-2s before they are mailed.
One person is performing all payroll functions, so her actions are not visible to anyone else. Also, no second person is reviewing the W-2s before they are mailed.
Have someone outside the payroll department review and mail the W-2s. Or add an additional person in payroll to create additional segregation of duties.
See my article titled Auditing Payroll: The Why and How Guide. I provide information about payroll walkthroughs, risk assessment, and substantive procedures. So check it out.
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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