On the Frontlines: Auditing Overtime Fraud

What is Overtime Fraud?

Overtime is additional pay that employees earn for working beyond their standard hours, typically over 40 hours per week. National and local laws control how overtime is calculated, distributed, and regulated. Auditors should be aware of these requirements in the jurisdictions where they work.

Fraud in overtime is a growing concern for businesses and organizations as economic uncertainty dominates and fiscal contractions in various industries take shape. Individual employees may feel that these factors enable them to take advantage of lax or non-existent overtime oversight.

Typically, overtime fraud is perpetrated by a single employee. However, several recent cases have shown collusion between multiple employees, even supervisors. Often, employees falsify the reasons for the overtime or exaggerate the hours spent working. Employees may also forge approvals from supervisors or dupe supervisors into approving the overtime. Human resources or payroll staff may manipulate various systems to obtain additional funds. Occasionally, kickbacks are provided to supervisors or others to facilitate the fraud.

Auditors need to be aware of the various ways that overtime fraud can occur, so they can be on the lookout for indicators during their internal audit. Being aware of fraud schemes through training and professional development is an important part of ensuring a well-run internal audit program.

Costly in a few Ways

Overtime can be expensive — in 2024, according to Occupational Fraud 2024: A Report to the Nations, published by the Association of Certified Fraud Examiners (ACFE), fraud associated with payroll schemes accounted for 10% of schemes reported, with a median loss of $50,000 per instance. The average loss was over $380,000, dramatically higher than the ACFE’s 2022 report, which was $201,000. Abuse of overtime can also have serious organizational consequences, including legal and reputational damage. Especially for public sector agencies, media reports of overtime abuse can erode public trust and confidence in service delivery.

Excessive overtime can also raise safety and risk issues; for example, if an employee in a healthcare facility is working large amounts of overtime without breaks or rest, they may unintentionally make an error in administering medication. In a public safety role, a firefighter may endanger the lives of other firefighters if they have worked long hours. Errors and shortcuts could have a negative impact on people and the organization.

Developing a Program

Audits of payroll, specifically focusing on overtime, are essential to understanding how an organization may be susceptible to overtime fraud. An effective overtime audit program can detect potential fraud, identify indicators of specific cases that need further investigation, and assess whether internal controls are in place to detect and prevent overtime abuse. It can also test whether the controls are effective and actually being deployed as intended.

Internal auditors need to address five key questions in their audit work when examining the payroll system and how overtime is awarded:

1. Is there a written policy or directive on requesting and approving overtime?
2. Is the policy being followed consistently?
3. Are deviations from the policy being handled appropriately?
4. Are deviations justified and documented in accordance with appropriate internal company policy and professional standards?
5. How frequently does management review overtime expenses across the division/unit or entire organization?

Follow the Timesheets

Data analysis is a critical component of the testing done by internal auditors during a review of payroll and overtime. For example, analyzing payroll and overtime data can help identify outliers, patterns, and trends that bear further scrutiny. It also helps inform management of issues and allows them to address them during the engagement.

An essential component of any payroll audit — especially overtime reviews — is to trace and tie the recorded information on a timesheet or other timekeeping system. Has overtime been properly calculated? Has the required paperwork been completed correctly? Tracing the timesheet through from start to finish is a basic step. It can be helpful to identify the roles or areas of the organization which are more likely to have overtime and do some preliminary assessments to help target the audit.

Some of the most common testing and analysis components are:

• Overtime expenses by department or location.
• Budgeted overtime versus actual overtime.
• Overtime as a percentage of salary.
• Overtime versus leave taken (attempting to identify anomalies).
• Comparing overtime across similar positions/roles.
• Comparing overtime by pay periods for a trend analysis.

Without strong internal controls, oversight, and management involvement, overtime can quickly spiral out of control. Internal auditors can provide the data and analysis to help identify areas of concern for leaders, identify root causes, and serve as a deterrent to prevent overtime fraud from occurring.