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Payroll Fraud Is Real And Why SMEs Are Most At Risk

Broadly defined, payroll fraud is the theft of cash from a business via the payroll processing system. Contrary to popular belief, payroll fraud is a widespread issue that is not defeated by technology. Rather, technology is the main perpetrator of payroll frauds.

With the rapid advancements in technology today, payroll frauds these days go beyond a case whereby an employee requests for a cash advancement and fails to pay back the company. In fact, payroll crimes have evolved alongside technology, becoming more stealth and difficult to nab.

An article from “Coronavirus Pandemic Is a Perfect Storm for Fraud” shows that fraud proliferates during economic instability. According to the Association for Certified Fraud Examiners (ACFE), the average case of payroll fraud lasts two and half years and results in losses upwards of $63,000. Moreover, cheque tampering is considered the most costly type of fraud case, with companies incurring a median cost of approximately USD158,000 per instance! Additionally, the study also reported that the occurrence of cheque tampering and payroll fraud were twice as common in small organisations as opposed to large organisations.

However, payroll fraud can take any form – from creating a ghost employee to photographing cheques with a smartphone for deposit purposes. Moreover, organisations of all sizes are susceptible to the various types of payroll fraud. This could ultimately result in hefty revenue losses, sky-high legal fees, reputation damage and in worst cases, closure of a business.

Nevertheless, there are various strategies that can be implemented to combat payroll fraud. Here are some ways that can help to prevent and detect payroll fraud.

Payroll analytics reports

Engaging a payroll outsourcing vendor to help generate audit and payroll analytics report can assist in spotting any fraudulent activity and ghost employees. For instance, it can help to identify any duplicate employees or analyse monthly overtime pay or employee claims.

Direct salary deposits through a vendor

Most small businesses might still be issuing traditional salary cheques to employees. Disbursing salary to employees through a vendor might mitigate risks of unapproved or unauthorised wire transfers. While it might impose additional costs to the organisation, it could help reduce the number of hefty losses due to payroll frauds in the long run.

Beef up security on the payroll system

Employees in the payroll department should impose strict security and password protocols. Access to the payroll department should be controlled and printers as well as copiers should be kept in secured areas. Similarly, organisations that engage a payroll vendor should reach out to find out about their payroll system security protocols as well.

As mentioned, all companies are prone to payroll fraud, from both internal and external sources. As the payroll schemes continue to evolve, organisations should always be on the ball to defend against fraudulent activity by understanding the potential weaknesses within their payroll processes or systems. That way, organisations can always be one step ahead in preventing opportunities for these perpetrators to commit payroll crimes.

Things you can do to limit its impact

1. Conduct background checks

Pre-employment background checks are the first defense against payroll fraud, shedding light on everything from prior offenses to overwhelming financial debt. However, background checks in the APAC region present a number of challenges, ranging from incomplete infrastructure and databases to legal limitations. Before conducting background checks, it’s important to understand the regulatory environment for each area in which you’ll be operating.

2. Perform regular audits

A primary method of payroll fraud is through the creation of “ghost employees” – a scheme in which money is paid to employees who either don’t exist or have left the company. In Singapore, for instance, one employee kept submitting time sheets for more than six months after he was dismissed. It was happenstance that the employer finally caught on: The man submitted a timesheet for a date that was a federal holiday. A payroll audit would have alerted the employer that they were sending checks to someone who was no longer an employee. Audits are also good for identifying warning flags like direct deposits for two different employees going to the same bank account.

3. Limit access to payroll data

Use password protection to limit access to those employees who have a job-related need to view payroll information. Even then, don’t give blanket access. Narrow the focus to only that information that is necessary to perform the job.

4. Provide checks and balances

“Keeping the honest person honest,” is a well-established process of checks and balances can often eliminate opportunistic payroll fraud. In other words, with lax controls, committing fraud is so easy that even employees who are otherwise honest are tempted into taking advantage of the system. It’s like leaving your car running with the keys in the ignition. Effective checks and balances include things like making sure the employee who enters payroll data into the system is not same employee who processes the checks. Requiring management approval to add a new employee. Have a well-established weekly routine for deleting employees who are no longer with the company.

5. Encourage employees to use direct deposit

While there have been cases where employees committed payroll fraud through direct deposit, physical checks make it a lot easier. Where possible, move employees to direct deposit. If you must continue relying on physical checks, never allow an employee to pick up a check for someone else. At least once a month or so, require an ID before handing over a check.

Nobody likes to think that their employees are stealing from them. But it happens – and ignoring the problem won’t change that. You can reduce your risks by implementing time-tested controls designed to eliminate the loopholes. That make it easy for employees to commit payroll fraud.

Any business looking for ways to cut costs should carefully consider targeting payroll fraud. According to Forbes, 27% of all businesses are victims of payroll fraud, and small companies are at the greatest risk. In one survey of businesses in India, 55% of the respondents stated that their organizations had experienced fraud.

The average case of payroll fraud lasts about three years, and the amounts can be staggering. One Australian employee, for example, stole $19 million in just two years through payroll fraud. That’s discouraging news, but it also represents a significant opportunity when it comes to cost reductions.

Here are some things employers can do to minimize their risk:

  • Timecard discrepancy/falsification: Some timecard fraud is unintentional: employees write a time in incorrectly, or payroll personnel read it incorrectly. Other timecard fraud is deliberate: not recording breaks, padding hours, claiming shifts that were never worked, etc. And then there are cases where employees who leave the company continue getting paid past their termination date.
  • Rate manipulation: This occurs when employees with access to the payroll system increase their rate of pay (and maybe that of their co-workers, too). This incurs at both the managerial and administrative levels, depending on who has access.
  • “Ghost” employees: Ghost employees are just what they sound like: made-up employees who don’t really exist. An employee creates a false identity and routes that person’s compensation to themselves. This is more common in larger companies with multiple locations where there are many employees who don’t know one another.

Fraud prevention steps

Payroll fraud is much easier to pull off in smaller companies that still use a manual system. Fortunately, thanks to cloud computing, even small companies can now afford the type of technology that identifies and prevents fraud. They perform payroll functions in-house or outsource them. In addition, even with low-tech payroll systems, employers can reduce their risk with just a few common-sense procedural changes.

  • Use all available reporting functions:

    Today’s payroll technologies usually have embedded analytics that can “slice and dice” payroll data in several different ways. Warning signs include things like names of terminated employees showing up in reports, checks for more than one employee being sent to the same address or bank account, a sudden increase in hours worked, a sudden increase in total compensation, etc.

  • Limit access to master files:

    There’s no need for payroll employees at the clerk level to be able to add employees, change pay rates, or adjust hours worked. Such changes should only be made by department managers and/or senior payroll managers.

  • Increase security:

    Employees who do have access to the master files should be educated on good security practices and required to change passwords frequently. It’s also important to update the software program as new versions become available.

  • Assign various parts of the process to different employees:

    It’s risky to put too much power in the hands of a single employee, but this is a practice that’s common in smaller companies with limited staff. A division of labor provides a system of “checks and balances,” making it more difficult for employees to commit fraud.

  • Verify identity:

    Companies that distribute checks in person should require a photo ID. This makes it more difficult for anyone to pull off a successful ghost employee fraud.

  • Outsource payroll functions:

    Outsourcing payroll functions practically eliminates the opportunity to commit payroll fraud, as an employee would need to have an accomplice on the provider’s staff. In addition, third-party providers are specialists, trained in fraud detection. They also often have access to proprietary software with embedded fraud-detection capabilities.

Instituting common-sense safeguards can go a long way toward preventing payroll fraud. But today’s affordable technology solutions can practically eliminate the risk. Whether you run your payroll in-house or outsource it, let technology make payroll fraud a thing of the past.

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