Risk: Lending a Hand

Regardless of the circumstances, an employer-employee loan is a delicate matter that must be appropriately managed. While employee loan receivables are not usually materially significant to an organization’s finances, employee loans should be on internal audit’s radar, given that their inadequate or inconsistent treatment can introduce risks that have repercussions both for the company and the employees.

A Mixed Bag

Although employee loan programs are not new, current financial constraints are prompting more employees to turn to their employers to request a loan in lieu of, or as a complement to, obtaining financing from traditional lending institutions. Increases in employee turnover, inflation, and interest rates, along with the need to look more generous than competitors, are prompting companies to reconsider their compensation and benefits packages.

Multinational organizations often have multiple loan programs, with each tailored to the needs and requirements at the specific location. International entities are subject to a variety of employment practices, labor law requirements, and even labor unions that may include loans as part of their bargaining negotiations. Some employers are required to have a range of special purpose loans. In addition to generic loans, for example, companies may offer loans to cover unexpected medical expenses or to assist in purchasing a home.

In certain countries, employers are required to conduct credit checks on all loans, while others have such requirements only when loans are over a specific amount. Countries, including the U.K. and South Africa, require employers to register or file reports with a specific government agency. The mere fact that the employer grants a loan to an employee triggers a set of requirements and periodic regulatory reporting to the government. In other cases, employers must carefully keep track of payroll deductions, as regulations limit monthly and annual aggregate amounts deducted.

In companies that operate in one country, requirements may vary by state or province. Most states allow companies to deduct loan installment payments through automated payroll deductions if the employee’s wages do not fall below federal minimum wage. Most require that employees agree to these deductions in writing. Some states, like California, specifically prevent employers from recovering most unpaid loan amounts via lump sum deductions from former employees. These country-by-country and even state-by-state differences complicate the employer’s ability to grant, manage, and collect employee loans.

Assessing the Risks

When it comes to employee loans, internal auditors can provide assurance or advisory services in several areas.

Governance. There should be written policies and procedures for loan programs. The program should have clearly defined terms delineating circumstances under which a loan will be provided, as well as details on key items such as:

• Minimum and maximum loan amounts.
• Loan durations.
• Interest rates.
• Installment payments.
• Early repayment options.
• Number of loans outstanding.
• Recourse and credit checks.

In some instances, an internal committee is formed to review and decide on loan applications and to monitor the loan program.

Record management. Similar to other company records, organizations need discipline around their records management on all loan applications and supporting documentation, decisions to grant or deny loans, and executing agreements for each loan granted with clearly defined terms.

Taxes. There are many tax implications for the employer and employees and, in some cases, former employees. Complications are triggered by matters such as interest rates (e.g., providing loans without specifying the rate or at below market rates) or potential forgiveness of balances.

Accounting and finance. Accounting items to address include correct recording, disclosing, and reconciling measures. Areas to consider include:

• Correct accounting and classification for loans over one year as compared to those one year or less.
• Controls around granting, funding, and collection activity.
• Approvals for financial losses resulting from various events, including instances where employees leave their jobs and the entity is limited or prohibited in its efforts to collect loan balances. This may require companies to write off such loans.
• Mechanisms to prevent commingling of bank accounts used for granting and collecting loans with other accounts that the organization may have. Or, if applicable, commingling of multiple loans with various terms granted to the same employee.

Payroll. Organizations should have processes and procedures for collecting the right amounts with the correct periodicity and ensure these follow any minimum or maximum regulatory monetary thresholds. 

Fraud. Employee loans may be vulnerable to fraud. Segregation of duties around loan approval, funding, recording, reconciling, collection, and write-offs must be in place to detect and prevent abuses or irregularities.

Regulations. Certain statutes prohibit companies from providing loans to specific individuals. In the U.S., publicly traded companies are not allowed to give loans to directors and officers. It also is imperative to consider related-party transactions. Discrimination risks can arise if it is not clear why loans are provided to certain employees but not others.

Administration. Loan programs require time and effort to maintain and manage. There may be opportunities to automate certain tasks or processes in the overall employee loan cycle.

Weighing the Options

Some companies choose not to provide loans or point employees to other options such as loans under company or government-sponsored retirement plans. However, offering loans can demonstrate a focus on socially responsible initiatives. Companies must be aware of the risks employee loans present. Internal auditors need to focus on the right risks to strategically audit or review the governance, risk management, and controls over this area.

IIA Resources:

Auditing Anti-corruption Activities
Auditing Culture
Auditing Conduct Risk