Do you know how to prevent payroll fraud? Today we take a look at how you can protect your business.
Direct deposit of payroll checks can open the door to theft. Also when one person is in control of payroll processes, danger lurks.
I was teaching a fraud prevention class this past Friday, and one of the participants, a school payroll clerk named Dawn, asked me to address how fraud might occur in her department. So I asked her a series of questions.
“Does your school use direct deposit?” She answered yes.
“Do you fully control the issuance of W-2s?” Dawn said yes.
“Who adds the direct deposit information to your payroll software?” She answered, “I do.”
“Can anyone else change the direct deposit file?” Her answer was no.
“Who controls the master pay rate file?” Here again, she was the only one who had rights to this payroll function.
Then I asked Dawn if she reconciles the bank statement. She said that Randy, a gentleman sitting in front of her, reconciles the account. I was also told that they have hundreds of employees.
I told the class that a person in Dawn’s position could steal in multiple ways. Here are a few:
After pointing out the flaws in internal control, I asked the class how they would reduce these threats. Angela (another student) sang out: “Create transparency by allowing another person to review or see what the payroll clerk is doing.” (This made me smile since I had been preaching this idea all morning.)
To lessen the threat of fraud, always ask, “how can I create transparency?” The answer will almost always involve allowing another individual to monitor the work of the primary persons in the process. And I am not proposing that this observing person be present 24/7—just that she periodically review the activity of the primary person (e.g., payroll clerk).
The monitoring person can be someone that works with the entity or someone from the outside (e.g., external CPA). Here are sample fraud prevention measures for the above-described threats:
By the way, the payroll clerk was the only person with access to the payroll master file. This is not necessarily a bad thing. You want to limit the number of persons with access to payroll master file, but a second person should monitor the payroll clerk’s inputs into the payroll software.
So how can you prevent payroll fraud? Think about your own payroll system. Are there any potential threats to your payroll system? Also, be aware of ghost employees.
If you’ve seen payroll fraud, please share a comment about how it happened.
If you are interested in more information about white-collar crime, check out my other fraud prevention articles.
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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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Dave, good eye. Fraud is usually not detected during write-up work.
Good reminder of IC to have on payroll. I had a client that trusted his newly hired controller too much. During my quarterly write up, I discovered she gave herself a $3000 bonus, among other significant embezzlements. Of course, she had left the company by the time I came in. Don’t make it easy to steal!