Fraudulent Overtime

Access to the company’s time recording system enables a local site manager to commit fraud.

peter belloli, cia, cfe
audit manager in Framingham, Mass.

James Bell, the audit manager at Ashmont Cleaning Co., received a tip from the finance department regarding procedural breakdowns in accounts payable at one of the company’s job sites. Although he did not identify any specific indications of fraud, there was enough anecdotal evidence to warrant a trip to the customer’s Georgia manufacturing plant to investigate. Under the guise of a standard operational audit, the audit manager arranged a three-day review of back-office functions at the plant.

The finance department was concerned that Ron Pope, the local site manager, was consistently failing to submit invoices to the corporate accounts payable department before the close of month end. Thus, the finance director was forced to accrue significant amounts to the general ledger every month as he waited for the site manager to send the actual vendor invoices to the accounts payable department for data entry.

Although delaying expense recognition is certainly counter to company policy, many in management considered it a minor infraction and not a serious violation. The benefit to job profit may induce some managers to delay expense recognition, but Bell did not see any evidence of this occurring willfully. Pope had plausible explanations for most of the delays. Many of his explanations pointed to an Ashmont customer, making an investigation of the validity of Pope’s claims politically difficult. However, Bell decided to continue with his review, as he knew that employees who are willing to cut corners in one area may be breaking policy elsewhere.

While undertaking the various audit programs, Bell noticed several instances of sloppy procedures, incomplete files, and ignorance of company policies. The audit revealed that there was plenty of opportunity to help improve the functions and efficiency at the site.

Although this revelation alone would have made the trip worthwhile, what the auditor discovered next was even more compelling. The job site under investigation used an electronic time clock with swipe cards to record employee labor hours. All workers and managers must swipe their cards upon entering and leaving the plant. The time recording system then calculates the hours worked as the basis for payroll. Normally, an administrative assistant at the job monitors the system and makes pay adjustments as needed. Due to frequent office staff turnover, the site manager was given access to the system and was subsequently able to change, add, or delete card swipes from his computer. 

As part of his analysis, Bell ran a report from the portion of the recording system that logs all changes made to swipes. This standard audit procedure recalculates payroll entries for all employees during the week of the review. He then performed a complete history review of any site employee who had access to enter or change clock data. Surprisingly, the swipes for the site manager were altered almost daily. Pope was changing his actual swipe-in to one hour earlier and his actual swipe-out to one hour later. These changes resulted in the system recording a 10-hour workday for Pope, thus giving him 10 hours of overtime for the week. When asked about the swipe changes for the five days during the review period, Pope did not have any explanation, nor was he upset at the obvious implication of a manager altering his pay. This baffled Bell, as it was his experience that innocent people get upset and even indignant when they are implicated in wrongdoing. To avoid putting Pope on the defensive, Bell moved to other topics in hopes of eliciting further information.

Upon return to the corporate office, Bell did some additional digging to verify his findings. He ran additional payroll reports and presented the findings to the director of payroll for confirmation. As a salaried employee, Pope was ineligible for overtime pay; however, the inquiries into the payroll system indicated that he was being paid overtime and this malfeasance had been going on for most of Pope’s period of employment. The manager’s embezzlement amounted to more than US $33,000 in fraudulent overtime.

When Bell sent the draft audit report to Pope and his boss, the regional operations director, Pope’s response regarding the swipe changes were weak and not credible. Pope stated that he extended his swipes to show accountability to the customer for his actual time on site. This response is nonsensical, as workers would not swipe in one hour after they came to work, nor would they swipe out one hour before they were supposed to leave. Pope acknowledged that he was not eligible for overtime, but blamed the time recording system for not being set up correctly. Overtime hours were clearly stated as such on all of his check stubs; therefore, ignorance was not a plausible excuse.

The regional operations director notified Ashmont’s legal department of the findings, and Pope was terminated the next day. The company also filed a complaint with the local police and forwarded copies of payroll documents and reports from the time recording system to the lead detective. The police are now actively investigating the case.

Furthermore, the current contract with Ashmont’s customer was a fixed-price agreement that covered specified maintenance procedures. Any work requests not covered in the contract were considered out of scope and charged on a cost-plus basis. Per the contract language, any employee overtime is billed to the customer on a cost-plus basis. All the illegitimate hours Pope entered had been billed, which meant Ashmont would have to tell the customer what occurred and refund the overbilling. Ashmont hoped the customer would appreciate the company’s vigilance in uncovering the fraud; however, it still posed a delicate moment in their relationship.

The fact that the problem had existed for almost the entire two years of Pope’s employment pointed to several internal control weaknesses in the company’s policies and procedures. The chief financial officer and other senior managers are working with the internal audit, finance, and payroll departments to strengthen internal controls.

LESSONS LEARNED

  • Clear guidelines as to when a salaried employee may earn overtime must be established. Conventional wisdom is that only hourly employees can earn overtime. The discovery of Pope’s malfeasance led Ashmont to query its payroll system for every single salaried employee who was paid either straight time or overtime for any hours over 40 per week. This review uncovered that there were several salaried managers being paid for extra hours. The reasons are currently being investigated to identify control breakdowns and formulate a clear, precise policy. Neither the electronic time clock system nor the main payroll system currently have any controls preventing salaried employees from being paid over 40 hours per week.

  • Pope was able to exploit the payroll system because he had the ability to change his own payroll records. To avoid this scenario, management should review the feasibility of enacting systematic controls within both the time recording system and the payroll programs to prevent employees with data entry access from changing, adding, or deleting any entries related to themselves. Although this may cause operational difficulties, it is a control that should be considered.

  • Regional operations directors should review payroll reports on a periodic basis. By examining the weekly check registers during site visits, regional management would have discovered the overtime codes and caught on to Pope’s scheme.

  • Frequent changes in office staffing levels masked the fluctuations in Ashmont’s overall labor expense. It was these constant variations that contributed to the finance department concentrating attention on other profit and loss line items. These peaks and valleys in staff labor expense caused a lot of “noise” that made trend analysis difficult, and conclusions were drawn that the fluctuations were caused by turnovers. Taking the necessary steps to maintain stable office staffing would have reduced the flux in office labor expense. 

  • Centralized accounts payable systems can provide important safeguards in expense recognition. Ashmont is instituting corporate purchasing cards for small amounts as well as an online purchase order system for large dollar-amount items. These measures will redirect accounts payable invoicing away from the individual job sites and centralize it at the corporate office, thereby reducing the ability for local site management to cause delays in expense recognition.

  • The auditor’s initial concern was timing of expense recognition, but the bigger problem was detected when the standard audit program was followed. Although auditing can be repetitive and even tedious at times, internal auditors should try to avoid tunnel vision when on assignment. Performing the basic tests is a necessary task.

To comment on this article, e-mail the author at peter.belloli@theiia.org.

 

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