The Association of Certified Fraud Examiner’s states that typical organizations loose a median of 5% of revenues in a year due to fraud. Payroll fraud can affect any business large or small, but the consequences are usually felt more heavily in smaller businesses. Payroll fraud is the theft of funds by an employee using payroll processes. Different payroll fraud schemes are perpetrated by employees, but fortunately there are ways your business can help avoid payroll fraud.

Types of fraud committed by employees:

Buddy Punching: employee one has employee two punch their hours into a time tracking system even though employee one did not work the time.

How to avoid:

  • Thorough supervisory reviews of the time submitted.
  • Describe repercussions of this type of misconduct upfront (e.g. Falsification of time worked may lead to termination.)
  • Use a system that takes the biometric features of an employee into account when clocking in and out (e.g. finger prints, facial recognition, etc.)
  • Routinely perform audits of timesheets vs employee schedules.


Unauthorized hours: this type of payroll fraud is the most common type of fraud that occurs. Employees pad their hours by adding small increments of time to their timesheets. Employees may also “forget” to punch out and falsify their hours when entering time manually.

How to avoid:

  • Thorough supervisory reviews of the time submitted.
  • Frequently perform audits of timesheets vs employee schedules.
  • Explain repercussions of forgetting to clock in and out. Perhaps implement three strikes and you are out policy.


Collusion: Collusion occurs when an employee schemes with an employee in payroll to increase their pay rate. This type of payroll fraud can be committed by any employee in the company.

How to avoid:

  • Perform audits of employee payrates over a period of time.
  • Have executive staff sign off or approve any changes in the payrates in the payroll system or sign paychecks.
  • Switch payroll employee responsibilities randomly to get a different set of eyes on the payroll processes.

Ghost Employee: Payroll staff may either create a ghost employee or prolong the termination of an employee to collect the money for themselves by cutting the checks or direct depositing the money in their name.

How to avoid:

  • Periodic audits need to be performed to spot ghost employees.
  • During the audit look for paychecks with no deductions taken out of the checks.
  • Compare Social Security numbers to names of checks that were cut.

Additional safeguards that can help prevent payroll fraud:  

  • Executive approval of bonus/exception/commission compensation.
  • Mandatory vacations for employees with payroll responsibilities. Have another employee perform the duties to see if discrepancies are found.
  • Segregation of duties (a person performing payroll duties cannot also update employee information in the system), or a granting access to making changes to employee information to a limited number of people.
  • Have whistleblowing mechanisms in place for employees to anonymously report payroll fraud.
  • If financially feasible, add a biometric time clocking system.

Small businesses deeply feel the effect of payroll fraud. To eliminate some of the factors which lead to payroll fraud, small businesses across the United States are utilizing payroll services by Payroll Source Group.




By Betsy Drellack @

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