Chapter 8: Payroll and Expense Reimbursement Schemes

Payroll Schemes

What is Payroll Fraud? Employee fraudulently generates overcompensation on his/her own behalf Three common schemes: Ghost employees Falsified hours and salary Commission schemes

Payroll Schemes Payroll frauds make up 17% of fraudulent disbursements; 8% of all occupational fraud cases. 121 payroll frauds were reported, with a median loss of $50,000.

Payroll Fraud – Breakdown of Cases 121 payroll fraud cases were reported in the 1993 study. Over half of these involved the falsification of hours worked or pay rate. Ghost employee scams made up approximately 10%.

Payroll Fraud - Median Losses

Ghost Employee Schemes Ghost employee: someone on the company payroll who does not actually work for the company Four steps to ghost employee scheme: Add ghost to payroll Document time worked Issue paycheck Deliver paycheck

Ghost Employee Schemes Adding the ghost to the payroll Perp either has hiring authority or access to payroll records Common methods: Add completely fictitious person Leave former employee on payroll Add relative or friend of current employee

Ghost Employee Schemes Documenting time worked Only required for hourly employees Time must be calculated and approved Perp usually has authority to approve timecard Approval can also be forged Once timecard approved, paycheck issued

Ghost Employee Schemes Delivery of paycheck On-site delivery of paychecks: perp physically misappropriates check Checks mailed: perp uses home address or mail drop for ghost Direct deposit: perp uses own account or shell account to collect deposits If ghost is an accomplice, checks delivered directly to ghost

Ghost Employee Schemes - Countermeasures Separate hiring function from other payroll duties Maintain personnel records independently of payroll, and periodically compare the two Look for employees with no ssn, withholding taxes, or other deductions from paychecks Periodically check for employees with same address, ssn, bank account, etc.

Ghost Employee Schemes - Countermeasures Keep paychecks secure until distribution Distribution of paychecks should be independent of those with hiring authority Investigate any returned paychecks with dual endorsements Conduct proper background and reference checks for all new hires

Falsified Hours and Salary Overstate hours worked Underreport leave time Overstate salary/rate of pay

Falsified Hours and Salary Manually prepared timecards Perp overstates hours worked Must get timecard approved: Forge supervisor’s signature Conspire with supervisor, kickback Supervisor “rubber stamps” timecards Poor custody procedures: Perp gets timecard back after it is signed Alters timecard to reflect extra hours

Falsified Hours and Salary Automated timekeeping systems (usually very simple schemes) Accomplice “clocks in” absent employee Employee clocks in, then leaves work Instead of overstating hours, employees may increase rate of pay Requires alteration to payroll records Perp or accomplice has access to payroll

Falsified Hours and Salary – Countermeasures Separate functions of payroll preparation, distribution, and reconciliation Transfer of funds from general accts to payroll should be handled independently of other payroll functions Look for individuals with excessive overtime Look for payroll expenses that exceed budget projections or prior years

Falsified Hours and Salary – Countermeasures All wage rate changes must be verified by designated official and administered through central hr department No sick leave/vacation without management approval Compare payroll to production schedules

Commission Schemes Salesperson fraudulently increases commissions by overstating sales generated Create fictitious sales Alter price on existing sales Claim sales made by other employees

Commission Schemes - Countermeasures Verify linear correlation of sales to commission Look for high levels of uncollected sales Track commission earned per salesperson; investigate unreasonably high levels Randomly contact customers to verify sales Commissions should be handled independently of sales department

Payroll Controls Separate the following duties: Payroll preparation Payroll disbursement Payroll distribution Payroll bank reconciliation Human resources Payroll accounting should be independent of general ledger function

Payroll Controls Background checks on all new hires Appropriate approval for time worked, overtime, rate of pay, commission rates, etc. Employee payments should be classified to appropriate expense accounts Individual employee earnings should be tracked Cancelled payroll checks should be compared to payroll, personnel records

Expense Reimbursement Schemes

What Is Expense Reimbursement Fraud? Employees overstate business expenses to generate inflated reimbursements Very common type of fraud Difficult to detect

Expense Reimbursement Schemes 109 expense reimbursement schemes were reported, with a median loss of $20,000.

Common Expense Reimbursement Schemes Mischaracterized expenses Overstated expenses Fictitious expenses Multiple reimbursements

Expense Reimbursements – Breakdown of Cases Mischaracterized expenses were the most common scheme, followed by fictitious and altered expenses.

Expense Reimbursements - Median Losses Median loss for expense reimbursements as a whole is $20,000, among the lowest for any category of occupational fraud.

Mischaracterized Expenses Employee claims reimbursement for non-business expenses by classifying them as business-related Personal travel, vacations Personal meals Dates, etc.

Mischaracterized Expenses – Countermeasures Clearly communicate company policy on reimbursable expenses Require detailed expense reports with date, time, purpose for expense Independently spot-check with customers Compare dates and times of expenses with employee’s work schedule

Mischaracterized Expenses – Countermeasures Compare expense reimbursements to budgeted levels and to prior years Analyze expense reimbursements per employee Require all expense reports to be approved by a supervisor

Overstated Expenses Employee pads reimbursement by overstating actual business expenses. Common way to funnel $ to slush funds Common scenarios: No support required for reimbursements Employee alters receipts

Overstated Expenses “Overpurchasing” Variation of overstated expenses scheme: Buy two plane tickets, One cheap, one very expensive Fly on the cheap ticket Return expensive ticket, keep receipt for expense report

Overstated Expenses – Countermeasures Require original support for all reimbursements – no photocopies Obtain vendor records to verify questionable expenses Compare the cost of similar expenses incurred by different employees (e.g., A & B both fly to Atlanta; A’s ticket $400 more) Look for department-wide trends of excessive reimbursements – indicator of slush fund

Fictitious Expenses Employee submits nonexistent expenses Produce fictitious receipts Obtain copies of blank receipts from restaurants, bars, etc. Claim expenses paid by clients or other parties

Fictitious Expenses - Countermeasures Track expense reimbursements per employee; look for: Expenses that always end in round numbers Expenses consistently for same amount Expenses that tend to fall just below reimbursement limit Employees who pay cash for high-dollar items (no audit trail)

Fictitious Expenses - Countermeasures Compare credit card statements to employee expense reports Look for counterfeit receipts – poor quality, no phone or address, no logo, etc. Compare mileage claims to travel actually incurred Look for consecutively numbered receipts in support of expenses

Multiple Reimbursements Employee requests more than one reimbursement for the same expenses Submit several types of support for same expense (e.g., travel agency invoice and airline ticket stub for same flight) Submit several copies of the same support through different departments or budgets Submit expense, wait a month, submit it again

Multiple Reimbursements – Countermeasures Do not accept photocopies as support Run reimbursement reports per employee, look for duplicate amounts, support, etc. Do not reimburse old expenses (e.g., 60 day limit) Investigate expense reports approved by supervisors outside requestor’s department

Expense Reimbursement Controls Expense reports should require the following information: Original support documentation Explanation of business purpose Time and date Place of expenditure Amount Any deviations require independent verification

Expense Reimbursement Controls Detailed review of all expenses by a supervisor Regular comparison of expenses with historical and budgeted amounts Spot-check expenses with employee work schedule, client records, service provider,etc.