Division of Duties - Payroll Preparation and Approving Employee Time Charges

Internal Controls are a critical component of nearly every financial transaction, practice, or procedure. Yesterday we discussed a control regarding the division of duties between those who have responsibility for meeting budgets and those responsible for approving time and attendance records (see Division of Duties - Responsibility for Meeting Budgets and Approving Employee Time Charges). Today we want to discuss another internal control related to labor costs - creating a division of duties between those approving time and attendance records and those responsible for the preparation and distribution of payroll.

As a general rule, contractors should have procedures to provide reasonable assurance that payrolls are prepared by persons independent of those responsible for the timekeeping operation and actual payroll payment.

These procedures should ensure that there is a segregation of responsibilities between timekeeping and payroll. These procedures are necessary to reduce the opportunity for any person to be in a position to both perpetrate and conceal errors or irregularities such as fictitious employees, improper time charges, etc.

A number of years ago, there was a major scandal involving a base maintenance contractor with a cost-type contract. Turned out that the contractor's payrolls were completely fabricated. And these payroll records were the basis for claiming reimbursement from the Government. Not only were fictitious employees on the payroll (the number of employees were overstated by 40 percent) but the rates of pay for the "real" employees were overstated as well. The fraud was uncovered by auditors asking the right questions during a labor floorcheck. Although this fraud was orchestrated by top management, it illustrates where a lack of internal controls can result in overstated costs to the Government and why the Government is so keen on ensuring adequate internal controls.

As we noted yesterday, very small contractors are not going to have sufficient personnel to ensure segregation (or division) of duties in all areas. Contractors (with the Government's "help" at times) are going to have to decide which controls are most important and work to enhance those. From the Government's perspective, controls dealing with labor are always important. We'll explain why tomorrow.