How Can Companies Prevent Payroll Fraud?

|Updated on: April 27, 2022

There are many ways corporate fraud is used to steal money from a business or company. While theft of products from inventory or the retail shelf is well known, there are also other ways people steal money. Most corporate fraud schemes manipulate the company's accounting system to steal money. Payroll fraud is a common corporate fraud that involves stealing money through the payroll system. An employee may commit payroll fraud to collect payroll money that they have not earned through the payroll system. An employer may commit payroll fraud and collect government financial support for non-existent employees. An employer may also create incorrect payroll records to evade taxes. A carefully maintained payroll system that is transparent and easy to audit is a good preventive measure against payroll fraud. One must also know what is payroll fraud to understand how to prevent payroll fraud effectively.

Effective Ways of Using a Payroll System Software

How to Process Payroll

What is payroll fraud?

Payroll fraud is manipulating the payroll system by employers or employees to tamper the records for wrongful financial gain. An employee may create a false payroll record and claim money they have not worked for. An employer may modify the payroll records to evade taxes or withhold the wages that should rightfully be paid to an employee. Payroll fraud, if left undetected, can siphon a lot of money out of the company over a period of time. It can also get the company into trouble with the authorities if not detected in time. There are many common ways in which these payroll frauds are committed.

Types of payroll fraud

In an accounting system that does not have transparency, audits or checks and balances, it is easy to manipulate the payroll records. There are some common payroll fraud methods used by employers and employees listed below:

Timesheet fraud

A company that pays employees for their work hours is vulnerable to timesheet fraud. Since the employee is paid as per the timesheet records, manipulating these records for financial benefit is a method of fraud. Employees may find a way to inflate the number of working hours to collect more money than they have rightfully earned. They may also inflate their hourly wage rate in the system to increase the payout beyond their actual due.

This type of fraud is also called buddy punching. In the buddy punching method, an employee gets a co-worker to punch in and out to get wages for hours they have not worked. They may also falsely record their punch in and out times, so the system records a higher number of hours worked. Employees may also include payroll clerks or other personnel in charge of record-keeping in their fraud. Here the clerk pads the number of working hours for a higher payout. The clerk may also be paid a commission from the extra amount that the employee gains.

Timesheet fraud is especially easy or common in companies that use manual or very simple methods of timesheet recording. Payroll management software that does not have security or audit features is also very vulnerable to alteration of the payroll records for payroll fraud.

Falsifying wages

In large companies with a huge workforce, not all personnel know the exact wages that should be paid out to each employee. So, the wages are calculated exactly as per the records in the system. If an employee gains access to the wage records, they can increase the wage rate fraudulently. So, when the payroll is calculated, the employee gets paid a higher wage than he has rightfully earned. This type of fraud is easily committed in a company with either a manual or a digital payroll management system with no security safeguards to prevent unauthorized access.

Employees can also pay themselves a bonus or any other reward that they did not earn simply by creating a false entry in the system. In most payroll fraud cases, timesheet fraud and falsified wages go hand in hand as they are both easy to perform when the payroll records are easy to access.

Ghost employees

The ghost employee payroll fraud is more sophisticated and bold than the timesheet fraud. The fraudster, who is most often a member of the payroll department, creates a record of an employee who does not exist. So, when payroll is processed, the non-existent or ‘ghost’ employee also gets paid. The amount paid is usually directed to the account of the fraudster. Sometimes, the payroll staff manipulates the records and shows the name and details of an employee who has left the company. While the actual employee has left, the payroll staff committing the crime collects the wages in the ex-employee's name.

Ghost employee fraud is difficult to detect in a company with a large workforce and weak supervisory control or when the compensation and payout are not under the purview of the supervisor. This is preventable by regular audits of the employee records and when the supervisors can also view the payouts and spot fake employee names. It is also easy to spot the fraud during audits because the employee would most likely not have any deductions from the paycheck as this would require insurance, tax, and other official information.

Excess PTO

PTO or paid time off is a sanctioned time off for employees who need it for emergencies, vacations, or other reasons. There are usually company policies that strictly govern the use of PTO. An employee can manipulate the payroll records to show the sanction excess PTO and effectively collect wages for days when they have not been working. This fraud is easy to spot when the payroll is monitored and audited but can go under the radar when there is no payroll scrutiny. The amount paid to the employee is similar to other employees’ and will not be detected unless the payroll is carefully compared to the attendance timesheets.

Excess PTO is easy to pull off when the company uses software that has no security controls and no checks and balances to govern leave allowances and PTO. When there are no audit trail capabilities, the fraudster has no fear of illegally accessing the system and manipulating the records.

Commission fraud

Some employees get basic pay and an added commission based on performance. The calculation of the commission may be based on the number of items that are made, sold, or any other target that is set by the company. An employee can commit fraud simply by creating records of great performances to award themselves a bonus that they do not deserve. They may also create records to be paid commissions that they do not qualify for.

Commission fraud can also be committed when the commission rules are not foolproof or clearly stated by the company. So, if the company pays a commission for the orders obtained rather than the orders paid for, the employee may obtain orders for products by extending credit that is not sanctioned by the company. This would help drive the commission payout amounts for the employee. But, if the orders do not get paid for, the company will have a lot of bad debts. The employee may also create records for sales that were never made.

Expense reimbursement fraud

Companies reimburse expenses that employees incur when they are on official duties. This may be a significant amount for employees on the road most of the time. For example, a traveling salesperson representing the company may claim travel, accommodation, and food expenses when traveling on business. The employee may commit fraud by claiming expenses that were never made. Fraud can also be committed by inflating the actual amounts spent.

Some employees even claim expenses for travel and canceled trips, for non-business expenditures, and by claiming the same expenses twice. They may submit fake or manipulated bills to support their claims. Expense reimbursement fraud is easy to commit in a company with no strict rules implemented for such claims and if there is no proper scrutiny of the submitted bills. When there are strict rules and limits on daily expenses, anything out of the ordinary will immediately stand out. There should also be strict scrutiny of the submitted documents and follow-up on suspicious receipts and bills. When there is a lack of a summarized report of each employee's expense claims, tracking their claims and detecting inflated or overlapping claims patterns becomes difficult.


Misclassification of employees is a payroll fraud tactic that is used by employers. In countries with different taxes and payouts for different types of employees, an employer may purposely misclassify them. For example, to avoid paying taxes and insurance for a full-time employee, the employer may record them as a part-time or independent contractor employee. When this misclassification is performed on a larger scale, the company may save a significant amount of money due to the authorities. This may enable the company to quote lower rates to their clients and have higher profit margins than their competitors. This can be an error rather than a deliberate move in rare cases. Employers should fully understand the local laws and regulations and classify their employees correctly. If there is a doubt, they should consult with the authorities and get the classification right. Failure to do so, if detected, can cause the company to face severe penalties from the authorities.

How to prevent payroll fraud

Once we have understood how to prevent payroll fraud, we can study the methods to perfect it.

Set up a system of checks and balances

When only one or two people are given control over payroll transactions, it is easy to commit fraud. An entire team of payroll personnel can commit payroll fraud and share the money. There should be a system of checks and balances that prevents monopoly over payouts. The different parts of payroll processing should be handled by individual teams. Authorization must be a requirement for major payouts and transactions. The payroll preparation and the final payouts should be done by different people. The person who prepares the payout instructions or checks should not be the authorized signatory. In a small business, where all the payroll functions may be performed by a single person, a person must be appointed to thoroughly scrutinize the payroll before the payment is authorized.

A big red flag for payroll fraud is a payroll person who does not take sanctioned time off. This person would be unwilling to take time off if another person looks at the records and notices the anomalies. Time off should be mandatory for accounting and payroll personnel. Alternatively, the personnel preparing and sanctioning the payroll should be frequently changed or rotated.

Switch to a modern timesheet system

Timesheet fraud is incredibly easy to pull off when a company uses manual or outdated timesheet systems. Investing in an accurate and secure timesheet system prevents timesheet fraud and keeps the records safe from manipulation. Biometric systems and payroll software can ensure that only the actual employee can log in and out of work. Secured access to the attendance and timesheet data ensures that they cannot be manipulated. An audit trail will instill fear into employees who are thinking of making any wrongful edits.

Do an internal audit of payroll taxes

Internal scrutiny and audit of payroll records are a must to prevent fraud. The person who is reconciling the accounts for payroll should not be the one preparing the payroll or the one in the accounting department signing off the payments. An independent person is less likely to cooperate with the fraudster. The personnel classification and tax preparation should be audited internally before the tax filing is done for payroll. This ensures no misclassifications even due to carelessness within the company. The person auditing the payroll should also perform unscheduled random checks to verify the payroll records.

The list of employees should be regularly audited and verified to prevent ghost employees from being added to the system. An employee who continually draws pay without any deductions should be cross-verified. Attendance and timesheet records should be safe, randomly compared, and cross-verified. Use software tools such as TallyPrime to ensure secure employee and payroll records, audit trails, and designated access for different personnel. Clear and easy-to-understand reports make it easy for multiple people to view and cross verify payroll data in different departments and at various levels of management.

Install CCTV systems

CCTV systems are a discreet way for employees to know that they are being monitored and can be held accountable. If any timesheet anomalies are detected, the presence or absence of that employee can be verified by verifying the attendance records with the shop floor or punch-in area camera recordings. Employees would be less likely to try and compromise the payroll management system when their actions and attempts are caught on camera. A business management system with a clear audit trail feature will also provide information on any changes to the data.

Regulate employee behavior

A company should be very specific and detailed in setting the rules for acceptable and accepted employee behavior. This includes rules for time off, PTO, commissions, bonuses, attendance, punch-in, employee expenditure claims, etc. Rules are most effective when implemented uniformly and effectively. When employee behavior is subjected to diligently enforced rules, there is less likelihood of fraud. Any laxity in processes, systems, and audits will leave the company open to fraud attempts. Using intelligent payroll software such as TallyPrime makes it easy to verify and audit the actual employee attendance, performance, and payroll records quickly and easily. The comprehensive and transparent nature of the software makes it easy to keep an eye on the payroll records, reports, and payouts. The security features ensure that employees can only access areas of the system they are authorized to. Access on a need-to-know basis prevents fraudulent alteration of payroll data.

Easy payroll management with built-in fraud protection

The simplest answer to how to prevent payroll fraud is to manage it with a comprehensive, secure, and efficient system. TallyPrime payroll software makes payroll management easy and foolproof. Its inbuilt security features protect the payroll data from unauthorized alteration. It allows the employer to set and monitor commissions, bonuses, PTO, and other leave allowances. The payroll reports make scrutiny and approval of payroll easy. The audit features ensure that you can track changes to data in the system, which means that you can hold payroll personnel accountable if they change payroll data.

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