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Fraud Prevention and Internal Controls

Jun 24Jeff Matthews

In my last two blog installments, we reviewed how fraud and theft can impact smaller companies.  This week we will focus on payroll controls.

Many of the same exposures inherent to paying vendors exist in payroll but they are often not segregated.  Concerns about confidentiality often lead to a concentration of payroll duties.  I strongly recommend an outside payroll service for companies of all sizes.  The cost of payroll errors is huge, why not outsource them, particularly given the pricing structures in place today.

Payroll tax errors can trigger personal liability for the owner and those with control over the payroll process.  Don’t risk it.  One of my colleagues was pursued by the IRS for tax issues related to his employer for years.  It dominated his life and his only crime was having a fiduciary responsibility to remit the taxes.  The owner had control over the payment of taxes but since my colleague was a check signer, he was considered personally liable.

Payroll controls:

  • Setting up new employees and changing pay rates must require management approval prior to processing.
  • Changes to the employee master file must be approved or reviewed prior to payroll processing.  I once had a payroll clerk tell me that if she wanted to steal she could point every employees direct deposit to her account.  Of course she realized the amount she would get was not enough to stay on the run for the rest of her days.
  • It is best to have someone other than the person generating the payroll hand out checks and remittance advices.  Any person who is not on hand to accept their check should have to come to the office to receive it.  This will help avoid false employees being added to the payroll.
  • As mentioned above, all bank accounts should be reconciled monthly by someone not engaged in the disbursing function.  Any uncleared checks should be investigated immediately.  Don’t let uncleared checks linger as they may be evidence of fraud.
  • Don’t pay payroll from the same bank account that you write checks from and that you deposit into.  Make the payroll account a separate account that you transfer funds into for the payroll, based upon the payroll check run.  Keep a minimal balance in the account so the payroll is isolated from your general funds.
  • See positive pay above and use it for payroll as well as payables.

Stephen Mann, partner in Ossege, Combs, and Mann, LCC, stresses cultural in the organization as a component of fraud prevention.  If the employees feel they are underpaid they are more likely to be able to rationalize theft.  Similarly, if they know the owner is running personal expenses through the company or skimming funds off, they may rationalize that fraud is acceptable in the firm.   He suggested an employee survey to determine the employee’s attitudes toward fraud and theft.  There are third parties that will conduct confidential surveys of your employees on a wide range of cultural and satisfaction measures.  These are worthwhile as they give you feedback that can be used to improve your company culture and identify fraud concerns.

The role of fraud prevention is not to trap the employee or other person stealing, it is to eliminate the temptation and create a true concern about detection.  Therefore, make your employees aware of the controls you have in place.  You want them to believe that theft and fraud will be caught and that it will have consequences.

Finally, I will relate a story I heard from a former employee of Mead Corporation.  At the time, Mead is a major supplier of school and office supplies.  Mead sent an order form to all employees near the end of summer, providing them with an inexpensive way to acquire school supplies for their children.  Mead wanted the employee’s children to have the latest Mead products to help their marketing of the items.  They also wanted to make obtaining those supplies through company channels easy to reduce the risk of employee theft.

I don’t pretend that internal controls are easy nor that they don’t complicate the office work flow.  You want to create a productive environment that minimizes the temptation to steal and increases the thief’s concern of detection.

B2B CFO®

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