Finance insights 5 min read

Payroll fraud: guide to recognition and prevention

Erika Rykun

Payroll fraud is a significant issue in the world of business. It can take many forms, and the methods used to perpetrate it are constantly evolving. In fact, according to PwC, 47% of all companies experienced at least one fraud event sometime in the past 24 months.

There are many reasons why payroll fraud occurs. It can be motivated by personal financial gain, or it can be done to manipulate a company's financial statements. In either case, payroll fraud can have serious consequences.

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What is payroll fraud?

Payroll fraud happens when someone illegally obtains payment from an employer by providing false information or documents. Payroll fraud can happen in several ways, such as using a fake social security number, providing false documentation to show that they are entitled to work in the country, or using someone else's identity information.

Payroll fraud can also happen when an employee exaggerates their hours worked or claims expenses that they are not entitled to. This type of fraud can be challenging to detect, but it can severely impact a company's bottom line. It results in the loss of money, but it can also lead to liability issues if the employees involved are not legally entitled to work in the country.

Types of payroll fraud

There are several different types of payroll fraud, each with its own set of consequences. It's essential to understand each type to take steps to prevent it from happening at your company.

Payroll 'ghosts'

One type of payroll fraud is payroll 'ghosting.' This happens when employees get paid for work they have not done. Ghosting is different than merely not knowing how to send an invoice or similar oversight.

In payroll ghosting, the payment is often made using false documents or someone else's identity and social security number. This type of fraud is common in industries where employees are paid cash, such as the restaurant industry. However, it can also happen in other industries where employees are paid through payroll services.

Falsified wages

Another type of payroll fraud is falsifying wages. This happens when an employee lies about the number of hours they have worked or the amount of money they are owed. This type of fraud can also be challenging to detect, as it often relies on the employee's word against the employer's. In addition, this type of fraud can also lead to liability issues if the employees involved are not legally entitled to work in the country.

Timesheet fraud

Timesheet fraud is another common type of payroll fraud that happens when employees fake their timesheets to get paid for hours they have not worked. While this type of fraud is more common in hourly jobs, it can also happen in salaried positions.

Unfortunately, this type of fraud is often difficult to detect, as it requires a close inspection of the timesheets. However, suppose your company relies on an in-out badging system. In that case, you can easily detect this type of fraud once all the timesheets are reviewed and compared against the employee's actual entry and departure time.

Expenses and reimbursement fraud

Expenses and reimbursement fraud occurs when an employee submits false or inflated expense reports to be reimbursed for more money than they spent. This type of fraud regarding reimbursement expenses is more common in jobs where employees are required to travel and incur expenses for work.

It can be difficult for the employer to verify expenses if no documentation is needed after the trip. However, any company can prevent this type of fraud by implementing a system where employees must submit receipts for all expenses.

5 actionable strategies to prevent payroll fraud

While payroll fraud is a problem, there are several things that companies can do to prevent it. Below are five strategies that can help:

1. Solid system of checks and balances

One of the best ways to prevent payroll fraud is to have a solid system of checks and balances in place. This means that multiple people should be involved in the payroll process, and each person should have a specific role.

This process will help to ensure that no one person has too much control over the process and that all payments are properly authorized.

Ouriel Lemmel, CEO & Founder of Winit, says, "Having a clear process in place with multiple people involved helps ensure that all payments are properly authorized and reduces the chances of fraud."

2. Written policy and procedures

Another way to prevent payroll fraud is to have a written policy and procedure. This policy should outline the procedures for processing payroll and the consequences for employees who commit payroll fraud.

In addition, this policy should be reviewed and updated regularly to ensure that it is up-to-date and effective.

David Aylor, Founder & CEO of David Aylor, advises, "If you can't trust your employees, you can't run a business. Establishing a culture of honesty is essential to creating a productive and positive work environment."

3. Modern timesheet system 

Roy Morejon, President & Co-Founder of Enventys Partners, suggests that "Using a modern timesheet system helps prevent payroll fraud by tracking employee hours and ensuring that all hours worked are properly authorized and approved."

A modern timesheet system will help to track employee hours and ensure that all hours worked are appropriately authorized. At the same time, it prevents employees from falsifying their timesheets and being paid for hours they have not worked.

4. Regulation of employee behavior

Another way to prevent payroll fraud is to regulate employee behavior (especially when controlling employee expenses). This means that employees should be required to adhere to a code of conduct that outlines the expected behaviors and consequences for violating the code. This code of conduct should be reviewed regularly and updated to ensure effectiveness.

Some of the ways to regulate employee behavior could include:

  • Instituting a no-tolerance policy for payroll fraud
  • Establishing guidelines for acceptable behavior
  • Providing training on the importance of ethical behavior

5. Surprise payroll audits

Finally, Founder & CEO of Uplift Legal Funding, Jared Stern, states that when you incorporate surprise payroll audits, "you will be able to quickly identify any potential fraud and take the necessary steps to prevent it from happening again."

Surprise payroll audits are the best way to catch payroll fraudsters. By conducting regular, unannounced audits of your payroll processes and records, you can deter would-be fraudsters and detect any suspicious activity that may be taking place. These audits can take place monthly, quarterly, or even yearly, depending on the size and complexity of your payroll.

While no system is perfect, these five strategies can help to significantly reduce the chances of payroll fraud happening in your company. By taking the time to implement these safeguards, you can protect your business and your employees from the harmful effects of payroll fraud.

All companies can prevent payroll fraud 

Payroll fraud is a severe problem that can hurt businesses of all sizes. However, there are several things that companies can do to prevent it.

By implementing a solid system of checks and balances, writing a policy and procedure manual, using a modern timesheet system, regulating employee behavior, and conducting surprise payroll audits, businesses can effectively prevent payroll fraud.

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Erika Rykun

Erika Rykun is a career and productivity copywriter who believes in the power of networking. In her free time, she enjoys reading books and playing with her cat, Cola.