Updated: Dec 6, 2022
No one likes to think about it, much less talk about it. When business finances aren’t making sense or cashflow doesn’t seem to track with expectations, how can you figure out what is going on? Do you need help? Maybe…and then again, maybe not. This series is designed to help you troubleshoot your finances through implementing concrete and specific controls ALL ON YOUR OWN!
This third control in our series is highly effective, requires some discipline, but no additional cost to you.
Review and Approve All Payroll Reports Personally
For most small businesses payroll is the largest expense and represents one of the biggest areas for fraud (and mistakes). According to the Association of Certified Fraud Examiners’ 2020 Report to the Nations, “Payroll fraud results in median business losses of $120,000 (over an average of 24 months) in the United States.” Further, payroll fraud occurs in 27% of small businesses; two times higher than in large businesses. How does this happen? It comes down to lack of internal controls. Internal controls sound complicated but are simple once you know what to do. Consistency is the key and the challenge.
The key to this control is getting your payroll detail report. This report should include all of the following items:
Payroll Period Covered
Hours worked – Including breakdown of regular hours, overtime, sick leave, vacation, etc.
Payrate – Hourly or Salary
Deductions – Including payroll taxes, health insurance, retirement contributions, etc.
Other Pay Types – Commissions, bonuses, etc.
Reimbursements – Travel, supplies, mileage, etc.
Gross payroll amount
Net payroll amount
In most payroll systems, this report is called the Payroll Detail Report. Start with reviewing this report and digging into the details. Below is a list of things to evaluate. Should you find discrepancies in this list, your next actions will be determined by the scope and individual(s) involved. We’ll cover this later in the post.
Does the employee listed exist or are they still employed? For some small business owners, these may seem ridiculous questions, however paying ghost employees is one of the most common tactics to payroll fraud used. So, review the list and make sure no one is listed that should not be.
Are the pay rates correct? Another common form of fraud is to inflate pay rates. As the business owner, you should know what your employees are getting paid, and it should be documented in the employee file in case you can’t remember.
Are the hours reported correctly? Another common fraud tactic is to pad hours, particularly when it comes to overtime – followed by sick or vacation time unreported. If this is your first time, request the timecards for review too. Carefully review the hours reported vs. the payroll detail report for discrepancies. Also review any time-off requests. (NOTE: If you haven’t done this yet, be sure to have a documented process in place for approving time off. This is another helpful control to prevent fraud!) Keep in mind, timecards MAY match the hours entered, but still be wrong or fraudulent. If an employee inflates their time, they may be paid for hours they didn’t actually work!
Do you see employee reimbursements in the payroll detail report? If so, there should be documentation to support these reimbursements AND they should have your signature or approval of them – another important control.
Do you see other income items (like commissions or bonuses) in the report? Review these against reports or documents that should support these payments. This is another area ripe for mistakes and/or deception if not watched carefully.
So, what do you do if you find issues in any one or more of the list above? All situations are unique to their specific circumstances; however, the following recommendations should be applicable.
To the extent the issues turn out to be mistakes or minor policy violations, discussions with the individuals involved usually “right the ship”. Continued personal review and approval of payroll will reinforce right actions.
If you discover deliberate fraudulent activity, you will certainly terminate the individual(s) involved, but we would recommend getting outside input to mitigate potential damages before proceeding. Engage a forensic accountant to uncover the scope of the damages and an attorney to pursue legal action against the perpetrator(s) involved. If the person(s) involved are your sole in-house bookkeeper or accountant, you will also need to engage help immediately to secure the finances of your business moving forward. In these situations, we would recommend hiring a quality outsourced accounting firm like ours.
To recap, payroll fraud occurs in 27% of small businesses for an average loss of $120,000! This does not have to be your business. All it takes is for you to follow the steps above consistently to minimize that risk. By incorporating a daily/monthly review of bank and credit card activities, you will drive that risk down even further.
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