Construction Business Owner, March 2007

Can your company afford to lose 5 percent of its revenues?  Can it afford to lose $500,000?

Payroll fraud is one type of occupational fraud. This type of fraud can also be classified as asset misappropriation-cash that is disbursed in a fraudulent manner. There are several schemes associated with payroll fraud and the most prevalent include ghost employee schemes, falsified hours and salary schemes and commission schemes.

Ghost Employee Schemes

The ghost employee refers to an individual on the company payroll who does not work for the company. The ghost may be real or fictitious. The perpetrator of the scheme may add a friend or relative to the payroll or invent a "new" employee. Several steps are needed to successfully carry out this fraud:

1. The perpetrator adds the ghost or facilitates the addition of the ghost to the payroll.
2. Timesheets or other timekeeping documents are created and submitted by the perpetrator.
3. A paycheck is generated for the ghost.
4. The check or electronic deposit is received by the perpetrator or an accomplice and converted to their use.

Steps to Carry Out Ghost Employee Fraud

1. The perpetrator adds the ghost or facilitates the addition of the ghost to the payroll.
2. Timesheets or other timekeeping documents are created and submitted by the perpetrator.
3. A paycheck is generated for the ghost.
4. The check or electronic deposit is received by the perpetrator or an accomplice and converted to their use.

Adding the ghost can be accomplished by different means. Depending on the internal controls in place, the ghost could be added by an employee within or outside the payroll department. Any payroll department employee with access to the payroll records and/or payroll software could potentially create ghost employees. In many companies, payroll clerks enter new employee information and distribute paychecks. Managers outside the payroll department may have hiring authority and may also distribute paychecks to their respective departments. Both scenarios create a climate that is conducive to creating ghost employees.

A recently publicized payroll fraud used ghost employees who had the same name as real employees; however, the social security number or gender had been changed. Another case in the news detailed the use of ghost employees as young as two years old. In this case, the workers filed timesheets for their sons and daughters to enable the children to earn a union card so they could earn higher wages when they became adults. A "new" worker would work at least once a year to keep the union card active. Finally, in a scheme using a former employee as the ghost employee, the fraud was discovered when the former employee received her W-2 showing higher wages than the former employee had been paid.

Internal controls that would help mitigate ghost employees range from simple precautions to detailed procedures. For the payroll fraud mentioned earlier involving children of the perpetrators, simply requiring the employees to show identification when picking up their paychecks could expose ghost employees. Frequently changing passwords for payroll access can help prevent fraudulent entries as well as requiring payroll employees to take an annual vacation. Additionally, print a list of all new employees each week, and have a person not responsible for initiating new employees confirm those names with the employee's supervisor. More sophisticated controls can be implemented in a computerized payroll system by customizing the module to reject duplicate bank accounts for direct deposit payroll.