In summary, the payroll and personnel cycle encompasses all activities related to employee

compensation, benefits administration, and personnel records management. This cycle starts with
hiring and extends to payroll processing, benefits management, and personnel recordkeeping.
Implementing strong internal controls and adhering to relevant regulations ensures accuracy,
compliance, and transparency in the organization's payroll and personnel processes.
1. Frauds involving Payroll – Frauds involving payroll refer to deceptive practices that occur within
an organization's payroll system, leading to financial losses and misrepresentation of employee
compensation. Payroll frauds can take various forms, each resulting in unauthorized financial gains
for the fraudsters. These fraudulent activities can occur in both large and small businesses and can
involve collusion among employees or individual acts of deception.
a. Fictitious Employees
- Adding fictitious employees to the payroll is one of the most common defalcations. It
allows perpetrators to divert funds from the organization for personal gain.
● Unauthorized Payments: By creating fictitious employees, fraudsters can set up
payroll accounts and authorize payments to these individuals. The payments are
then directed to the fraudster or an accomplice, effectively siphoning off funds from
the organization.
● Embezzlement: Fictitious employees provide a means for embezzlement.
(Embezzlement is a type of financial fraud where someone takes money or assets
that were entrusted to them and uses them for a different purpose than for what they
were intended.) Fraudsters may manipulate payroll systems to generate regular
paychecks or bonuses for these non-existent employees. The fraudulent payments
are often deposited into accounts controlled by the perpetrators.
● Ghost Employees: Ghost employees refer to individuals who do not actually work
for the organization but are listed on the payroll. Perpetrators may create ghost
employees and divert their salaries or wages to themselves. These payments can go
unnoticed if proper controls and verification processes are not in place.
● Kickback Schemes: Fictitious employees can be used in kickback schemes where
employees collude with vendors or contractors. The fraudster adds non-existent
employees to the payroll, and these employees receive paychecks. The kickback is
then shared between the fictitious employee and the vendor or contractor, providing
an illicit source of income for both parties.
● Padding Payroll Expenses: Fictitious employees may be added to inflate payroll
expenses, allowing fraudsters to manipulate financial statements. By artificially
increasing the number of employees, the organization's payroll expenses appear
higher, which can help mask other financial irregularities or manipulate performance
metrics.
● Tax Evasion: Creating fictitious employees can also be used as a means to evade
taxes. Fraudsters may generate false payroll records, including withholding taxes,
for these non-existent employees. This can result in a lower tax liability for the
fraudster or allow them to claim fraudulent tax refunds.
 Real-life situation: One notable real-life example of fictitious employees in the
Philippines is the "PhilHealth ghost dialysis scam" that was uncovered in 2019.
PhilHealth is the Philippine Health Insurance Corporation, a government-owned and
controlled corporation responsible for providing health insurance coverage to Filipino
citizens. In this fraud case, it was discovered that a dialysis center in Quezon City,
Metro Manila, was involved in creating fictitious patients and claiming reimbursements
from PhilHealth for non-existent dialysis treatments.
The dialysis center was allegedly colluding with PhilHealth officials to facilitate the
fraudulent scheme. The scheme involved the creation of fake patients who were
enrolled in the PhilHealth system, allowing the dialysis center to submit
reimbursement claims for dialysis treatments that were never provided. The center
would receive payment from PhilHealth for these fictitious patients, resulting in
significant financial losses for the insurance agency. Investigations revealed that the
dialysis center had been operating the scam for several years, with an estimated
amount of around PHP 154 million (approximately USD 3 million) fraudulently claimed
from PhilHealth.

Prevention: It's important for organizations to implement strong internal

controls, such as segregation of duties, regular audits, and thorough verification
processes, to mitigate the risk of payroll fraud involving fictitious employees.

b. Excess Payments to Employees

- Increasing the rate above the approved or paying employees for more hours that they
worked are the most common ways of paying employees more than they are entitled to
receive. Frauds involving payroll often include excess payments to employees because
they provide an opportunity for the perpetrator to siphon off funds from the organization.
● Inflated Overtime: Fraudsters may manipulate overtime payments, granting
excessive overtime hours to employees who are not actually working the extra time.
This allows the fraudster to generate higher payments to these employees and
pocket the difference.
Real-life Situation: One real-life situation involving excess payments to employees
in the Philippine government is the Priority Development Assistance Fund (PDAF)
scam, also known as the "Pork Barrel Scam." This scandal emerged in 2013 and
involved several lawmakers and government officials diverting public funds intended
for development projects to their own pockets through a complex web of corruption.
In this case, excessive payments were made to fake non-governmental
organizations (NGOs) that were set up by the main orchestrator of the scam, Janet
Lim Napoles. Lawmakers allocated their PDAF or discretionary funds to these NGOs
for supposed development projects, but the funds were actually misappropriated.
The excess payments were made by inflating the project costs and submitting
fraudulent documentation to support the payments. These inflated amounts would
then be transferred to the bank accounts of the involved lawmakers and government
officials or funneled back to them through a series of transactions. The PDAF scam
was one of the largest corruption scandals in Philippine history, involving billions of
pesos of public funds. It led to widespread public outrage, mass protests, and
 investigations by government agencies. Several high-ranking officials, including
senators and members of the House of Representatives, were charged and
convicted for their involvement in the scam. (Janet Lim Napoles, Juan Ponce-Enrile,
Jinggoy Estrada, Bong Revilla)
Prevention:
➔ Strong Internal Controls: Establish and enforce robust internal controls within
the organization. This includes clearly defined segregation of duties, regular
audits, and strict oversight of payroll processes. Proper checks and balances can
help detect and prevent unauthorized excess payments.
➔ Segregation of Duties: Separate the responsibilities related to processing
payroll, approving payments, and reconciling financial records. By assigning
different individuals to these tasks, it becomes harder for any single person to
manipulate the system and initiate excess payments without detection.
➔ Regular Audits and Reviews: Conduct regular internal and external audits of
payroll records and processes. Audits help identify irregularities, discrepancies,
or suspicious activities. Independent reviews of payroll data and financial records
can provide additional safeguards against excess payments.
➔ Employee Verification: Implement strict procedures for hiring and onboarding
employees. This includes verifying employee information, conducting background
checks, and ensuring that all employees are properly registered and authorized
to receive payments.

c. Failure to Record Payroll

- Companies having difficulty meeting profit targets or not-for-profit entities having difficulty
managing costs and expenses might fail to record a payroll. Frauds involving payroll can
occur due to various reasons, including intentional actions or negligence. One common
type of fraud involving payroll is the failure to include certain employees or payments in the
payroll system.
● Ghost employees: This occurs when fictitious employees are added to the payroll
system, and payments are made to them. The person responsible for the fraud then
collects these payments. By not including these ghost employees in the payroll
records, the fraudster can divert funds without raising suspicion.
● Manipulation of hours or salaries: Perpetrators may manipulate the recorded
hours worked or salaries of certain employees to increase their pay. By
underreporting hours worked or inflating salaries, the fraudster can receive excess
compensation without detection.
● Omission of terminated employees: When an employee leaves an organization,
their payroll record should be updated to reflect their departure. However, in some
cases, the record may not be properly updated, allowing the terminated employee to
continue receiving payments.

● Real-life Situations: One notable real-life example involving the failure to include
payroll in the Philippine government is the case of the Priority Development
Assistance Fund (PDAF) scam, also known as the "Pork Barrel Scam." The PDAF
was a government fund allocated to members of the Philippine Congress for various
 development projects. One aspect of this fraud involved the manipulation of payroll
records. The ghost projects created the need for non-existent personnel, who were
added to the payroll system. Payments were made to these fake employees, and the
funds were then funneled back to the conspirators. In this case, the failure to include
legitimate payroll records allowed the fraudulent payments to go undetected for an
extended period. The absence of proper verification and oversight mechanisms
enabled the manipulation of the payroll system, facilitating the embezzlement of
public funds.
d. Inappropriate Assignment of Labor costs to Inventory
- A company having difficulty meeting profit targets might assign inventory labor costs that
should have been charged to expense.
● Manipulating labor costs: In this scheme, individuals within an organization may
manipulate the recording and reporting of labor costs. They may inflate or
misrepresent the hours worked by employees, their pay rates, or other factors that
impact labor costs.
● Misclassifying labor costs: The perpetrators might misclassify labor costs by
falsely categorizing them as inventory costs rather than recognizing them as
expenses. By doing so, they shift labor costs from the income statement, where they
would typically appear as expenses, to the balance sheet as part of inventory.
● Capitalizing labor costs: Typically, direct labor costs are expensed as incurred and
are not included in the cost of inventory. However, in this fraudulent scheme,
individuals might capitalize labor costs by adding them to the value of inventory. This
artificially inflates the inventory's cost and can lead to an overstatement of the
organization's assets and profitability.
● Impact on financial statements: By manipulating labor costs and misassigning
them to inventory, the fraudulent actors can distort the organization's financial
statements. The inflated inventory value can lead to an overstatement of assets,
increased net income, and improved financial ratios, such as inventory turnover or
gross profit margin.
● Concealing other fraud or financial issues: Frauds involving the inappropriate
assignment of labor costs to inventory can serve as a cover-up for other fraudulent
activities or financial problems within the organization. By manipulating the financial
statements, individuals may attempt to hide other irregularities or create a false
impression of the company's financial health.

Real-life Situations: In 2017, the Commission on Audit (COA) found that the
Department of Social Welfare and Development (DSWD) had inappropriately assigned
labor costs to inventory. The COA found that the DSWD had charged labor costs for
activities that were not related to inventory, such as training and supervision. The COA
also found that the DSWD had not properly documented the labor costs that were
assigned to inventory. The COA's findings resulted in a disallowance of P1.2 billion in
government funds. The COA also recommended that the DSWD take corrective
measures to prevent the recurrence of this issue.
● Let's consider a manufacturing company in the Philippines that produces electronic
devices. The company's management is under pressure to meet revenue targets
and increase profits. To achieve these goals, they decide to manipulate the financial
statements by inappropriately assigning labor costs to inventory. In this scenario, the
company may engage in the following fraudulent activities: (a) Overstating labor
hours: The management instructs supervisors to inflate the reported number of
labor hours worked by employees. They may ask supervisors to report additional
hours or manipulate time records to overstate the amount of time spent on
manufacturing products. (b) Manipulating labor rates: The management may
instruct employees responsible for payroll to manipulate the reported pay rates for
workers involved in manufacturing. They could falsely increase the hourly rates,
resulting in inflated labor costs. (c) Misclassifying labor costs: Instead of recording
labor costs as expenses on the income statement, the management directs the
accounting team to misclassify these costs as part of the inventory. They may falsely
categorize direct labor costs as part of the manufacturing overhead or the cost of
goods sold. (d) Capitalizing labor costs: In violation of generally accepted
accounting principles (GAAP), the company capitalizes labor costs that should be
expensed immediately. By adding these inflated labor costs to the value of inventory,
the company artificially inflates the cost of goods sold and overstates the value of its
inventory on the balance sheet. (e) Concealing the fraud: The fraudulent activities
are aimed at distorting the financial statements and creating a false impression of
profitability. By inflating the inventory value, the company may present improved
financial ratios and higher net income, which could attract investors or satisfy the
requirements of lenders.
● Prevention: Here are some of the key controls that government agencies can
implement to prevent inappropriate assignment of labor costs to inventory: (a)
Segregation of duties: Employees should not be allowed to perform both the
timekeeping and inventory management functions. This helps to prevent fraud and
errors. (b) Use of authorizations: All changes to inventory should be authorized by
a supervisor or manager. (c) Review of inventory reports: Inventory reports should
be reviewed by a supervisor or manager to ensure that they are accurate. (d) Use of
a software system: A software system can help government agencies to track labor
costs and inventory more efficiently and effectively.