6 Strategies to Recognize and Prevent Payroll Fraud

6 Strategies to Recognize and Prevent Payroll Fraud

You might think that payroll fraud will not get past you, that it’s an apparent detection.

But the Association of Certified Fraud Examiners say that it takes more than two years before a business owner realizes they’ve fallen victim to these underlying scams.

With over 25% of businesses experiencing the devastation of this financial loss, it’s evident that falsifying employee payment information is more common than business owners dare to imagine.

In 2019, the FBI said that $8.3 million was the amount of money in losses reported to their Internet Crime Complaint Center due to payroll scams. With the theft and manipulation of payroll systems rising, it’s crucial to know how to recognize and prevent it in your company.

What is payroll fraud?

Essentially, payroll fraud is when an employee steals funds under the radar that they’re not entitled to. Instead, they’re embezzling money through the payroll processing systems and the functions to track an employee’s time and work.

It’s one of the most common offenses of corporate fraud and presents itself in various ways when there are errors and gaps within a company’s internal systems.

Some are aware, some are oblivious, but either way, it has the potential to cause tragic financial damage to your business.

And small business owners, beware. This applies to you, too.

Four major types of payroll fraud to recognize are:

Timesheet Fraud: When an employee manipulates their timesheet to represent more time worked. These unauthorized hours are generally done in small increments to derail supervisors from noticing.

It can also look like an employee clocking in for an absent colleague or engaging in personal activities during office time. Almost 75% of business owners experience this form of theft.

1. Falsifying Wages:

When an employee adjusts their pay rate, logging a dishonest expense or reimbursement in the form of bonuses and other commissions. If it is a commission-based business, employees may boost their numbers and units sold to increase their pay.

2. Ghost Employees:

When a non-existent employee receives a paycheck without your knowledge by creating a fake employee profile, this can be done as a scam, but an oversight by payroll companies can occur regarding previous employees.

3. Misclassification:

When an employer labels someone as an independent contractor instead of an employee, it majorly affects their payroll taxes. This could also result from filing someone as a full-time employee when they’re a part-timer.

Six strategic ways to prevent payroll fraud from happening to you:

1. Develop a checks and balances system:

Having a stable system of checks and balances in place will make it much more difficult for employees to commit theft. Consider assigning a supervisor to review and sign off on the analytics month-to-month and practice separation of duties.

Keep track of check and time logs and regular audits that promote the integrity of your accounting information. Consider assigning a supervisor to review and sign off on the analytics month-to-month and practice separation of duties.

“Procure an understanding of the language behind internal financial affairs and be sure controlling the arrangements you make for those operations is your sole focus,” is excellent advice from Founder and CEO of Choice Mutual, Anthony Martin.

2. Set up separate payroll tax functions:

Keep track of your payroll tax as a separate function and process when going through your system of checks and balances every month. Gain the required knowledge about the difference between a W-2 employee and a 1099 independent contractor, so you’re secure in knowing the designated payroll tax that needs to be taken out.

Limit payroll access to selected supervisors and encourage direct deposit. There are many opportunities for outsourcing these responsibilities or working with payroll software to guide you through the experience.

3. Create clear policies:

Mark Pierce, CEO of Cloud Peak Law Group, says, “If you want to protect your assets, you must develop a plan to optimize your company’s security before a lawsuit or claim arises.” First, establish an employee handbook that sets the groundwork for a clear no-tolerance policy that exemplifies a proper HRMS system.

You want to set the standard for performance and the tone for behavioral standards and business practices. Designing a handbook will help hold them accountable and provide guidance for consistency in their position.

4. Modernize your timesheet system:

Utilizing electric time sheets or an attendance management system will make for smoother operations you can monitor effectively. Be sure the settings for employees are limited, so manipulation opportunity is avoided, and provide identity verification measures assigned to workers.

You want to be proactive with reinforcing your company policies about payroll to avoid accidental errors that could lead to significant issues down the line. Timesheet systems are valuable tools that provide more transparency in the work process.

5. Conduct adequate background checks:

“Design a screening program that fits your needs, so you’re making fully informed decisions about the candidates and can improve the quality of the hiring process,” says the CEO of Goodhire, Mike Grossman. Providing an employee background check will ensure you know as much as you can about the history of those you’re potentially adding to your team.

Conducting these screenings avoids liability issues and a significant loss for your company in the long run. It also provides your employees with a safe working environment that prevents problems between your team members. It’s essential to reduce the risk of hiring someone with adverse goals to your company’s values.

5. Practice employee appreciation:

Increasing employee happiness will essentially lay the foundation for workplace appreciation that makes sure your employees respect their job and you, so they don’t consider an act of theft. In addition, boosting company morale and staying connected will build a more trustworthy, collaborative relationship between employer and employee.

6. Integrate payroll software:

Payroll systems automatically assign employees the identification numbers,

therefore, tracking gets much easier. Furthermore, suspicious actions and possible fraudulent activity get

easily recognizable on payroll reports built into the system. Besides, having excellent payroll software contributes to numerous other business goals, along with fraud prevention.

Well-paid, negotiable salaries and required paid time off also support job satisfaction. David Patterson-Cole, CEO & Co-Founder of Moonchaser, believes that “In today’s job market, it’s important for employees to know their value in the workplace and follow industry salary trends while feeling secure that employers will meet the needs of their expertise.”

Payroll fraud can feel infuriating because of how preventable it is. Most times, business owners are so consumed with the many hats they wear that things slip through the cracks when they’re not taking preventative measures to assist them.

The payroll process should be efficient and compliant with long-term results that elevate your business’s growth and keep your employees honest. Take charge with preventative measures so detection is high and risk is low.

It’s up to you to remain vigilant and informed on all protocols involving these types of corporate fraud. It’s a costly crime you can avoid.

About the author

Guest Author

I share technology, business, and personal development insights as a guest author. With a background in computer science and tech industry experience, I offer practical tips and actionable advice to enhance skills and achieve goals. Whether it's optimizing productivity, improving mental health, or navigating the digital world, I'm committed to helping others succeed. When not writing, I explore new technologies, read about industry developments, or enjoy the outdoors.

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