No employer wants to suspect his or her employees of dishonesty. But the fact remains that payroll fraud could happen at any organization.
And without the proper controls in place to keep tabs on the payroll process, companies are leaving themselves vulnerable to everything from “ghost employees” to falsified hours and salary schemes.
“Aside from damage to a company’s reputation and the embarrassment, the main issue is the depleted assets, which could be quite substantial,” says Rob Wilson, president of Employco Group Inc., a division of The Wilson Companies. “In some cases, it could even cause bankruptcy.”
Smart Business spoke with Wilson about how to prevent payroll fraud from happening at your company.
How does payroll fraud happen?
It happens when unscrupulous individuals are allowed to have access to the company processes that generate payment transactions or company assets, and they’re able to do this without proper managerial oversight or controls in place to limit their access.
In many cases, it depends on the size of the company and whether it has the ability to hire people who are specialized in certain departments. In smaller companies, you may have one clerical person who is doing everything from answering the phones to doing payroll and accounting. Each company is unique in that respect.
When you downsize, it creates a situation where you might have had good controls in place, but because you’re eliminating people who had segregated duties, you now only have one person where you once had three. You can create a new exposure for yourself.
How can companies approach their payroll processes to prevent fraud?
One tactic is to establish segregation of duties, where the people preparing the payroll are independent of other payroll and personnel duties, such as the timekeeping, distribution of checks and hiring.
Also, you want to restrict access to other payroll data and actual cash. And the payroll accounting should be separated from the general ledger function.
One useful tool is Positive Pay. Basically, you send a file to your bank that lists out all the checks that you’re cutting that day, and when someone presents a check to your bank for payment, it compares that to the file that you sent to make sure that the dollar amount, the person’s name, the date, etc., are the same.
That eliminates the risk when someone takes a company’s payroll check, scans it into a computer and generates a whole set of checks with the owner’s signature on the bottom.
Companies should also restrict access to their blank payroll stock. And if you use a facsimile signature plate, you want to restrict the number of people who have access to that.
Also, require employees with payroll responsibilities to take vacations and have somebody else step in to do their job. That way, if there are any irregularities in the way that person does payroll, it comes to light at that point.
Other things you can do to prevent fraud:
- Limit access to computerized payroll records.
- Audit your pre-numbered checks to make sure all checks that haven’t been used are still accounted for and are in sequence.
- Have complete documentation of procedures regarding changes in employment, including additions, terminations, salary and wage rates, payroll deductions, authorizations and approvals.
- Make sure there are adequate authorization and approval procedures regarding vacations, holidays and sick leave.
- Ensure prompt reporting of personnel data changes, adequate time-keeping and attendance records, and comparison of current records with prior history. Investigate any significant changes.
- Before distributing checks, make sure that all transactions are authorized and match originating reports, that all pay and deduction rates have been authorized, and that paychecks agree with payroll records.
- Especially in a larger company, when you pass out the checks, have employees sign that they received that check. You might even want to ask for the person’s I.D.
- Be sure that your employee dishonesty insurance limits are adequate to cover any assets that may be embezzled by employees.
How can using a payroll service ensure stronger protections?
The payroll service becomes an extension of your payroll department. Especially if you’re winding down the number of employees that you have, it helps to create more of a segregation of duties. It can be used to complement the accounting function while also guaranteeing the independence of the payroll and personnel duties.
When the payroll checks are drawn by a payroll service, in many cases, that checking account is owned by the payroll service, so any fraudulent checks against the account would be a concern for the payroll service, not the client.
What you’re buying into is a system of controls and processes, which is especially useful for smaller companies that don’t have the wherewithal to get involved in all the new technology needed to safeguard their assets.
Also, with a payroll service, you’re paying probably a fraction of the cost that you would pay if you implemented all these systems and the necessary personnel on your own.
ROB WILSON is president of Employco Group Inc., a division of The Wilson Companies, which handles human resources outsourcing, staffing and insurance for 400 small and medium-sized Midwest companies. Reach him at (630) 286-7345 or firstname.lastname@example.org.