different types of payroll fraud and how to prevent them

Payroll Fraud: 5 Must Know Types and How to Prevent Them

As businesses evolve with technological advancements, so do the tactics of malicious individuals. One of the most prevalent and costly issues organizations face is payroll fraud. This form of white-collar crime has a significant impact on businesses, both small and large, with the Association of Certified Fraud Examiners estimating that the average organization loses 5% of its revenues to fraud each year, with payroll fraud constituting a significant portion of this.

Understanding Payroll Fraud

Payroll fraud is any deceptive act that results in the unjustified disbursement of funds in the payroll process. It typically involves the manipulation of payroll systems or processes by employees within an organization. This can take many forms, including:

Ghost Employees:

This occurs when a person not employed by the organization appears on the payroll. The fraudster, often an employee, will create a fictitious employee and collect the unearned pay.

Timesheet Fraud:

This form of fraud occurs when employees claim to have worked more hours than they actually did, or when managers authorize unworked overtime.

Commission Schemes:

These involve the manipulation of sales records to inflate commissions or bonuses.

Pay Rate Alteration:

Here, an employee or manager unlawfully increases their own or another employee’s wage rate.

Advance Fraud:

This happens when an employee requests a payroll advance and fails to pay it back or leaves the organization without settling the advance.


Implications of Payroll Fraud


The implications of payroll fraud are wide-ranging and extend far beyond financial losses. Below are some of the main areas impacted by such fraudulent activities:

Financial Impact:

The most immediate and apparent consequence of payroll fraud is financial loss. This can range from minor discrepancies to significant amounts that can threaten a company’s financial stability. For smaller businesses or startups, sustained payroll fraud could even lead to bankruptcy.

Operational Disruption:

Payroll fraud can disrupt the normal functioning of a business. When fraud is detected, operations may need to pause while a thorough investigation is conducted. This can lead to delays in delivery of service or product, impacting both the bottom line and customer satisfaction.

Employee Morale and Trust:

Payroll fraud, especially when committed by employees, can create a toxic workplace environment. The trust between employers and employees, and among the employees themselves, can be severely affected. This can lead to a drop in morale and productivity.

Legal Consequences:

Depending on the severity and nature of the fraud, there could be legal ramifications. Companies could face fines for lack of oversight or proper control mechanisms. Individuals involved in the fraud can face penalties, including imprisonment.

Reputation Damage:

The reputational damage from payroll fraud can be significant and long-lasting. News of such fraud can impact a company’s relationship with its customers, partners, and investors. It could lead to loss of business, difficulty in attracting investments, and challenges in forging new partnerships.

Increased Costs:

Finally, the costs associated with resolving payroll fraud can be substantial. This includes costs for conducting investigations, legal expenses, implementing new control measures, and training staff. If a company needs to pay back stolen funds or compensate for losses, the financial burden can be even higher.

Therefore, preventing payroll fraud is not just about safeguarding finances; it’s about protecting the overall health and sustainability of the business. Implementing robust internal controls, regular audits, and fostering a culture of honesty and transparency are key to minimizing the risk of such fraud.


Preventing Payroll Fraud

Despite the challenges, organizations can employ various strategies to combat payroll fraud:

Implement Strong Internal Controls

Segregation of duties is crucial. The person who processes payroll should not be the same person who authorizes it. Likewise, the person writing the checks should not be the one reconciling the bank statements.

Perform Regular Payroll Audits

Regular audits, both internal and external, can help detect discrepancies. Additionally, a surprise audit can deter potential fraudsters as it adds an element of uncertainty.

Use Robust Payroll Systems

Technological solutions can make it more challenging for fraudsters. Biometric systems like ClockIt can prevent timesheet fraud, while AI-based solutions can detect anomalies in payroll data.

Employee Education to Avoid Payroll Fraud

Employees should be made aware of the repercussions of payroll fraud. Transparency about the company’s zero-tolerance policy towards fraud can serve as a deterrent.

Whistleblower Protection Policies

Encourage employees to report suspicious activities. Provide protection to whistleblowers to prevent retaliation.

Background Checks

Comprehensive background checks during the hiring process can help identify potential employees with a history of fraudulent activities.


Examples of payroll fraud in the past

Below are some real-world examples illustrating various types of this fraudulent activity:

Ghost Employees:

This type of fraud occurred at the City of Philadelphia’s Office of Fleet Management in 2006. The office manager added a fictitious employee to the payroll, over a period of three years, he managed to collect about $400,000 in payments. The scheme was discovered during an audit which revealed that the “employee” never existed.

Timesheet Fraud:

A case of timesheet fraud was recorded in the Washington Metropolitan Area Transit Authority (WMATA) in 2014. A group of supervisors and employees falsely reported over 20,000 hours of overtime, leading to the loss of over $800,000. The scheme was uncovered by a tip from another employee.

Commission Schemes:

In 2017, a large-scale commission scheme was uncovered at Wells Fargo, where thousands of bank employees created over 1.5 million unauthorized bank accounts and around 500,000 credit card accounts. They did this to earn extra commissions and meet sales targets. This massive fraud led to a public scandal and resulted in a fine of $185 million for the bank.

Pay Rate Alteration:

In 2015, the CEO of a Seattle-based company Gravity Payments, faced a lawsuit by his brother who was also a minority shareholder. The brother accused the CEO of paying himself “excessive compensation” after he had dramatically increased his pay rate. Although the case was eventually decided in the CEO’s favor, it serves as an example of how pay rate alteration can lead to allegations of fraud.

Advance Fraud:

In a 2012 case, the CFO of a Louisiana-based company requested a six-figure payroll advance to cover the costs of his divorce. The advance was granted, but the CFO left the company without repaying the funds, leading to a major loss for the company.

These examples highlight the wide variety of tactics used in payroll fraud and underscore the importance of strong internal controls, regular audits, and a culture of ethical conduct within an organization.




Payroll fraud is a significant threat to organizations worldwide. As businesses increasingly rely on automated systems and remote work, the risk of fraud only escalates. However, with a robust control system, regular audits, state-of-the-art technology, and an informed workforce, companies can effectively mitigate these risks and safeguard their assets. Vigilance and proactive measures are key to creating a secure and trustworthy payroll system.

Basil Abbas

Basil is the Founder and CTO at ClockIt. With over 10 years of experience in the products space, there is no challenge that is too big in front of him be it sales, marketing, coding, etc. A people person and loves working in a startup for perfection.