Payroll Audit: Objectives, Process & Checklist
In many cultures, people don’t talk openly about their pay, but it’s the most important reason people take and leave jobs. Organizations need to make sure that they’re paying their employees correctly and on time and comply with employment laws and payroll regulations. If you don’t have your payroll in order, you won’t have a company much longer. While Payroll is sometimes a different organization than Human Resources, both departments must work together to ensure accuracy. A payroll audit is an excellent way to ensure this.
What is a payroll audit?
Audits can sound scary, and sometimes they are when a government official shows up at your door to do one. But, most payroll audits are internal checks on the accuracy of the data.
A payroll audit helps you ensure that everyone’s pay is correct and that all deductions and reporting are accurate. While some employees will immediately report if they think their pay is so much as one cent off, some people don’t notice any problems for months and even years! You can catch these mistakes with a payroll audit, which should be an indispensable part of your compensation and benefits strategy.
Payroll audit procedures can take a few minutes to a few weeks, depending on the size of your organization and the extent of the audit. Payroll and HR can automate some audit checks for faster responses.
Logically speaking, the payroll department is responsible for running the payroll audits, but HR needs to be involved. First, HR communicates pay to employees, and there can be errors between what HR or a manager tells an employee and what ends up in the payroll system.
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For instance, consider a hiring manager that negotiates a salary for a candidate and settles on a higher amount than in the initial offer letter but fails to notify HR. Second, pay is a sensitive subject, and HR needs to be involved in resolving employee concerns and any necessary communications. If the HR system and the payroll system aren’t connected, it’s critical that HR audit the pay every time someone’s salary changes.
You can do regular internal HR audits to ensure correct data, or you can hire an external auditor to come in. You don’t have to wait until a government official arrives at your door. A third-party auditor can be helpful because they haven’t looked at the data repeatedly. Sometimes, when we spend too much time looking at the same data, we miss important things.
What are the main payroll audit objectives?
Everyone wants accurate pay. Everyone wants taxes withheld properly, health insurance calculated correctly, and all deductions legal and accurate. Here are your main objectives in conducting a payroll audit.
Have accurate tax reporting and deposits in place.
- In the US, for instance, each employee has to fill out a W-4 tax form, which allows payroll to apply the proper tax deductions.
- Make sure that the system matches the employee’s requests. Each state has different tax laws, and in some states, each town has different deductions for payroll taxes.
- One important audit right now is working location. If employees work from home permanently, their state and local tax deductions may differ from what they would be in the office. You need to know not only an employee’s salary but also their working location.
Ensure compliance with employment laws and other regulations.
- Did everyone who was entitled to overtime pay receive it? What about employees who work piece-rate? Do you have both their productivity data and their hours?
- If employees are subject to a tip credit, you want to ensure that their combined tips and hourly pay add up to at least the state minimum wage.
- If an employee has company-provided health insurance, a Health Savings Account, or a retirement plan, you want to make sure that the deductions are correct. You also need to ensure that the money goes where it is supposed to. Is the health insurance company receiving the proper payments? Is the retirement money placed directly in each employee’s 401k account?
- If an employee has a court-ordered garnishment, you will want to ensure that is correct. Garnishments can be for anything from an unpaid debt to child support and can change with court orders. Have you accurately applied all court-ordered garnishments?
Providing accurate data to workers
- Employees deserve accurate pay records. Each paycheck should come with a paystub (either on paper or electronic) that gives them the details of their pay, including hours worked, overtime paid, and explanations of all deductions.
- At year-end, payroll needs to provide tax documents with this information. Employees should conduct a self-audit and notify payroll if anything is amiss, but this doesn’t always happen. Periodic audits throughout the year can prevent many of these problems.
Uncovering potential errors and inaccuracies
- A thorough audit can help you uncover a payroll fraud. Is everyone receiving a paycheck an actual employee? People have embezzled from companies by making ghost employees. Are any terminated employees still on the payroll?
- Is everyone working precisely 40 hours a week? (Or another common number?) It’s unusual for everyone paid by the hour to work precise hours every week. This can indicate that they are not receiving earned overtime or are being paid more than they earned.
- Did an extra zero get added to someone’s paycheck? Typos happen!
How to conduct an effective payroll audit
Here is your payroll audit checklist:
- Determine the timeframe for your payroll audit. This can be a single pay period or the whole year–especially if you’re doing year-end tax forms for your personnel.
- Review employee data. This step of the payroll audit process requires communication between HR and payroll, as you want to ensure that the data payroll matches the information the employee received. If the systems are connected, you will have less chance of error than sending spreadsheets back and forth. You may want to verify against employee offer letters if your Applicant Tracking System (ATS) doesn’t integrate with your HR and Payroll systems. Make sure everyone being paid is an active employee. Ensure people who are on leaves of absence receive the proper pay as well. This can vary from their regular paycheck.
- Review hours worked and paid. Verify hours worked against time cards, ensure that employee hours worked are in line with amounts paid. This is especially important for hourly employees. If you see too many employees with identical time cards, the Human Resources department may need to investigate. That can be a sign that someone is editing the time cards.
- Check variable payment and different types of compensation. Overtime hours pay, bonuses, commissions, and piece-rate information needs to be checked. If you have tipped employees, make sure they report their actual earnings for more accurate data. If your company does vacation pay or shift differentials, this is a crucial thing to check as well. Employees are counting on this extra pay. Remember, overpaying can be just as stressful as underpaying. No employee wants to get asked to repay the money because six months ago, payroll made a mistake and paid them double time when they should have received time and a half.
- Examine and document atypical payroll transactions. This is also an area that has a high potential for fraud. Think signing bonuses, relocation pay, back pay, and previous corrections. If you process reimbursements with payroll, double-check that this is accurate as well. It may require liaising with Finance or whoever handles reimbursements. If an employee receives a lot of reimbursements but doesn’t have a role that involves a lot of travel, this may be a sign of fraud.
- Check tax withholdings and deposits. Are you withholding the correct amount for your employees? Are you paying the right amount of income taxes? These numbers can change, especially if people move or the laws change. Remember, an employee who is classified as working the office may have completely different tax withholdings if they become taxed as if they are working from home.
- Payroll reconciliation. Review bank activity. Do bank statements match your payroll records? Do you have proper documentation for all direct deposit change requests? A common scam now is to get payroll to deposit someone’s paycheck into the spammer’s bank account. Double-check your documentation.
- Consider payroll rules. If you get audited by the government, this will be a critical piece. These vary by state, so make sure you’re compliant with regulations where you operate. Keep in mind the problems with employees who used to work in the office in one state but now work full time from home in another.
- Report the findings. Create a payroll audit report and share it with those who need to see it. This should probably be, at a minimum, the head of HR and the head of Finance. Regular documentation of audits can be beneficial should problems, such as a lawsuit, arise later.
- Identify improvement opportunities. Automation is becoming more and more popular in payroll management, helping to remove inaccuracies and reduce errors. If you have an all-in-one HRIS, payroll system, or accounting software, you’ll cut down substantially on data errors. Always look for ways to make it better.
Over to you
When HR professionals have a fundamental understanding of payroll audit, it allows them to identify opportunities for improvement and ultimately ensure compliance and boost employee experience.
Payroll and HR need to maintain a good working relationship to ensure that everyone is paid fairly and on time. Your employees deserve it.