Make no mistake. Payroll Fraud is real. According to the Association of Certified Fraud Examiners, it’s the number one source of accounting fraud and employee theft. Check out these statistics:
- Payroll Fraud happens in 27 percent of all businesses.
- Payroll fraud occurs nearly twice as often (14.2 percent) in small organizations with less than 100 employees than in large ones (7.6 percent).
- The average instance of payroll fraud lasts about 36 months. That’s three years of paying ghost employees or overpaying existing ones. In Delaware, a School District Finance Director paid himself an extra $150,000 over eight years. He also underpaid several school administrators a combined $50,000 in one school year.
The reality is payroll fraud is not preventable, but is catch-able. Anyone can steal at any time. The key is catching it and minimizing the risk. The best way in doing so is to reconcile your payroll at least quarterly with someone other than the person who runs your payroll. Yes, it is that simple, and it probably costs you no more than a few hundred dollars each quarter.
There are two common types of payroll fraud, the first being time-card falsification, which can be easily caught through the reconciliation and employee review process I just mentioned. The second most common type of payroll fraud is “ghost employees.” Ghost employees are just that. They are employees that do not exist. In one case that I heard about, the bookkeeper was paying herself a duplicate paycheck through the name “XYZ” and having the money deposited in her checking account. Nobody said criminals were creative.
The third most common type is one that is self-inflicted by the employer through worker misclassification and workplace fraud. It’s the illegal practice of designating an employee as a “1099 worker” or an independent contractor. Unscrupulous business owners do this to avoid paying payroll taxes, unemployment tax or workers’ compensation insurance and are therefore able to submit lower bids for projects, undercutting responsible companies. Unfortunately, many other business owners may be misclassifying workers without even knowing it, such as if they designate tasks or set time with the contracted employee, if the 1099 employee works only for one company or if he or she is paid a regular amount each week or month. In these instances the company may be misclassifying a W-2 employee as a 1099 employee. In the State of California, worker misclassification will cost an organization $25,000 per occurrence plus back payroll taxes and penalties. Many states have similar harsh penalties.
In all cases, it is simply not worth it. A business can survive and thrive while they classify workers properly. Most importantly, you’ll sleep well at night knowing that they don’t have to worry about the IRS or State taxing authorities knocking on their door.
Are you still not convinced that payroll fraud needs your attention? Here are some headlines I picked off the Internet in less than 15 minutes:
April 14, 2013 – Upper Macungie company loses $54,000 to possible payroll fraud
June 19, 2013 (Reuters) – Three women pleaded guilty on Wednesday to criminal charges arising out of what prosecutors say was a corrupt New York City payroll project that cost the city more than $600 million.
June 19, 2013 – The hearing of former Monroe city engineer Sinyale Morrison has been reset to July 23.
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Entitlement is rampant, and it is ruining America.
Children today are all “special”, and they are all “winners”. They are going to “do great things” and “be somebody special.”
Most people are going to be average. That is the definition of the word, “average.”
Unfortunately, the outsized expectation of quick success versus the reality of requisite hard work and determination (in most cases just to avoid being below average), is causing depression and anxiety in today’s workforce.
The grand canyon of disparity between expectations and reality is manifesting itself in increased employee turnover rates, lower employee morale, an ever-widening gap between the wealthy and the poor, and (for you business owners) a significant increase in employee theft.
In the past three years, according to the Society for Certified Fraud Examiners, the average size of small business fraud has increased by nearly 17%. That should get your attention, because fraud and theft happens to more than 1/3 of all small businesses.
To put it into sharper focus: Do you know two other business owners? If so, odds are that at least one of the three of you is being stolen from right now.
One of the most common types of fraud is accounting fraud, and one of the simplest tactics internal accountants use to steal money is called “double checks.”
Here is the way it works (this is a true story with the names changed):
Suzy is your bookkeeper of 5 years. You trust her. She has never missed a credit card payment. She is extremely organized, and every time you ask for back-up for a charge or a bill, she has it. She is also always hounding you about your receipts (furthering her credibility). You have grown to trust her so much that today she not only pays all of the Company bills but also pays all of your bills at home. You consider her an integral part of the Company and your family. In the past few years she has been to all of your children’s graduations, your friends and family Christmas parties, etc.
Here is where it gets a bit sticky. She is the only one in the Company that knows how to use your accounting system (QuickBooks). The only other person who ever looks at your accounting system is your CPA (who only uses it once per year to prepare the tax return). She runs payroll, reconciles the bank account, and does all of the invoicing. She prints financial statements for you, and has rarely made any mistakes (that you can see).
You are busy selling new business and helping your other staff (who you feel are mostly underperforming) get their jobs done. Suzy is one of your star employees (you think).
Sadly, Suzy always seems short of cash, she always complains about not having enough money, and yet, just a few months ago, she leased a new Mercedes. Four years ago, she got a divorce. You tried to help her with flexible work schedules. You knew it was tough on her, and your kids even helped to babysit her kids (when she was in a pinch).
What you did not know was that Suzy was in major credit card debt after the divorce, and about 4 years ago, she started writing herself checks. How?
Well the first check she wrote herself was the hardest, but she really needed the money, and she came and asked you for a raise, but you really couldn’t pay her more than $50,000 per year. She saw that you were making $200,000 per year, and knew that if she didn’t have that money, she might not be able to pay for her kid’s daycare.
So, she wrote one check to the Electric Company for $850 and one check to herself for $85 (coded to utilities expense with the water and the security system expenses). Then she wrote one check to the Copier Company for $375 and one check to herself for $45 (coded to the Copier Expense under General Office Expense). Then she wrote one check to herself and coded it to office supplies for $129.
That first month she did this 6 more times in various accounts totaling $832 (tax free to her of course). Then, after she had printed the checks, she went back and changed the names on the checks (in the accounting system) to the old Vendors names just in case anybody (like the CPA) ever looked in the accounting file.
“That was hard,” she thinks, and she feels bad, but she really needed the money, and this way, the Company does not really have to give her a raise, that she really deserves anyway…right. I mean, she is entitled to a good life, and her ex-husband really screwed her over. Her kids just can’t stay by themselves. She is really just doing what she has to do to get by.
Here is the end of the story:
Four years after her initial theft, Suzy is in a pretty bad car accident and can’t come to work for nearly two weeks. The Company has their CPA provide temporary help, and the first thing she (the CPA) notices is that the bank account has not been reconciled all year. So, she starts reconciling it, and she sees double payments in almost every expense account. Being curious, she looks for the original bill and quickly uncovers the fraud.
Suzy epitomizes the entitlement mentality, and without the car accident, she would still be getting away with it. Perversely, you would still believe that she is a star employee.
Suzy stole $454,000 over a four year period. The only good news in this story, is that the business is still in business, and Suzy was just convicted of fraud (which almost never happens) and will spend at least 3 years behind bars and have to pay back $250,000 (which she does not have).
If this story sounds like you, and you have a “Suzy” in your organization, get curious. Next month, ask for back-up for all bills. Match up the checks with the bill, and make sure the expense amount matches the expense on the P&L. Then make sure all of your balance sheet accounts are completely reconciled. You probably do not know how to do this, so have an outsider verify that it was done. Repeat this process randomly at least 3-4 times per year.
It is boring. It is tedious. It is accounting. It is not what you are best at. It does not generate any new revenue. It is also mandatory.
This business is your business and your responsibility. You are not entitled, you are not special, you are a hard working business owner, and, to make sure you protect yourself, you have to be engaged in every facet of your business.
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