Question

Sherman Company employs 400 production, maintenance, and janitorial workers in eight separate departments. In addition to supervising operations, the supervisors of the departments are responsible for recruiting, hiring, and firing workers within their areas of responsibility. The organization attracts casual labor and experiences a 20 to 30 percent turnover rate in employees per year. Employees clock on and off the job each day to record their attendance on time cards. Each department has its own clock machine located in an unattended room away from the main production area. Each week, the supervisors gather the time cards, review them for accuracy, and sign and submit them to the payroll department for processing. In addition, the supervisors submit personnel action forms to reflect newly hired and terminated employees. From these documents, the payroll clerk prepares payroll checks and updates the employee records. The supervisor of the payroll department signs the paychecks, which are drawn on the general cash account, and sends them to the department supervisors for distribution to the employees. A payroll register is sent to the cash disbursements department where it is filed.

Required:

1. Discuss the risks for payroll fraud in the Sherman Company payroll system.

2. What controls would you implement to reduce the risks

Answer 1

1. Risks for payroll fraud in the Sherman Company payroll system:
Sherman Company’s Payroll System is subject to following fraud risks:
a) Improper Segregation of Duties: Supervisors of each department perform the personnel function as well as employee’s timekeeping function. It may be possible that a supervisor either do not report the correct time of termination of an employee or submit fake time cards for non-existent employees and retain the unclaimed checks with himself instead of returning it to payroll department and possibly encash it fraudulently.
b) Improper Supervision of Clock Machine: As the machine for recording the attendance of employees of each department is located in a non-attendant room away from the main production area. There is a possibility that an employee clock in for another employee who is actually absent or late or left early.

2. Controls to Reduce the Risks:
Sherman Company should implement the following controls to reduce the risks of fraud:
a) Segregation of Duties: The personnel function and the timekeeping function should be segregated and given to different independent persons instead to the supervisor of the concerned department.
b) Separate Post for Distribution of Checks: The responsibility of distribution of paychecks should be taken away from the supervisors of the department and given to a different person, who should be independent of all payroll processes.  
c) Proper Place of Clock machines: Clock machines for recording attendance of employees should be kept at the gate of each production department and under direct supervision to ensure that every employee should punch the attendance while entering and leaving the department.