Investigation of Asset Misappropriation Schemes


In this chapter:

  • Cash Receipts Schemes
  • Disbursement Schemes
  • Noncash Schemes

One common type of asset misappropriation scheme is payroll fraud. From the book:

Inflating hours worked, benefits earned, or pay rates are some of the most common and straightforward ways of committing payroll fraud. Manual timekeeping obviously creates more risks for overstatement of hours worked. Computerized timekeeping systems make manipulation more difficult, although not impossible.

Paid leave time is ripe for abuse, because so many companies simply do not have procedures in place to prevent employees from taking time off but getting paid regular wages for that time, instead of using their sick leave or vacation time. It is not uncommon for employees to use paid leave during a week but then get paid overtime hours later in the week, even if their actual work hours haven’t exceeded 40 hours. Controls should be in place to flag these instances and prevent them.

In a properly controlled environment, a supervisor would be required to sign off manually or electronically on the hours worked by employees. Failure to verify the hours or weaknesses in the sign-off process allows fraud to occur at this point in the payroll function. It is, of course, possible for a supervisor to collude with an employee to inflate her or his payroll. It is harder to detect a fraud in which employees are colluding, especially when a management member is involved. The parties to the fraud are going to jointly cover up for each other, and that will make many frauds difficult to find. Random checks by people outside of the payroll or supervisory function may help cut down on collusion. If the supervisor knows that auditors are going to periodically test the records and look for irregularities, she or he may be less likely to engage in fraud.

Ghost employees are an age-old type of internal fraud, in which a perpetrator has a nonexistent employee receive a paycheck from the company. The ghost employee might be a real person who cashes the check at her or his bank with no problems, or the ghost employee could be a fictitious person altogether, requiring a little more work in order to cash the paycheck.

In theory, it should be difficult to issue a paycheck to someone who is not an employee. In an environment with good controls, an employee could not be added to the accounting system without proper documentation and authorization by one or more levels of management. These controls are aimed at determining that the company has hired a real person, for an authorized position, at a proper pay rate, and in the proper department. However, not all companies follow such procedures to verify the existence of the employee and the job. In many cases, it is relatively easy for a payroll processor to add someone to the payroll, and as long as the amounts do not get too large, it can go undetected for a long time.

Ghost employees could be detected at the point of payment if a company had the right procedures in place. Requiring direct deposit of payroll checks discourages ghost employees, because it creates a verifiable paper trail that is often easier to trace than with paper checks. If a company is insistent on using paper checks, it is advisable to make employees receive checks in person, to reduce the risk that a fake employee could receive a check. Payroll records and personnel records should be maintained by different people or departments. The personnel department should verify any changes to payroll, and new hires should be verified through reference checks and background checks.

Commission and bonus schemes are centered around inflating sales figures so that compensation that is based on company revenue is also increased. By creating fictitious sales or by causing sales to be recorded early, an employee can receive higher pay. Commissions are often paid as a percentage of sales, and bonuses can be calculated in a similar fashion, although sometimes they are also based on whether a certain threshold is passed.

The detection of payroll fraud schemes will largely be based on a detailed examination of records to determine whether hours and pay rates are being properly recorded and paid. Other procedures that can help detect payroll schemes include:

  • Examine payroll records in detail to verify the existence of employees.
  • Look for missing data in payroll records, such as missing social security numbers or addresses, which could indicate ghost employees.
  • Search for employees with unusually low income tax withholding, suggesting the potential for a ghost employee with a scheme to make the net paycheck as high as possible.
  • Examine and verify all pay rate changes for the year.
  • Look for anomalies in overtime pay, specifically looking for employees who have unusually high overtime compared to others or as a percentage of base pay.
  • Conduct occasional audits of paychecks, including both leave pay and overtime pay, looking for instances of improper overtime pay.
  • Compare budgeted payroll to actual, looking for unusual variances.
  • Examine commissions and bonuses paid as a percentage of revenue, looking for unusual variations.
  • Inspect aged receivables by salesperson or other commissioned employee, to determine whether old unpaid balances are more frequently related to one or two employees.
  • Review uncollectible accounts receivable to determine whether any of the sales may have been fictitious and related to a payroll scheme.
  • Look for unusual spikes in sales for certain regions, salespeople, or product lines, which could be related to a payroll fraud scheme.