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Why And How To Audit Payroll

QUICK SUMMARY

Payroll gone wrong is never a pretty sight. Use this guide to help you conduct a payroll audit and ensure an efficient, accurate and compliant payroll process.

TABLE OF CONTENTS What Is A Payroll Audit? Why Conduct A Payroll Audit? How To Audit Payroll Common Payroll Issues Best Practices How Payroll Software Can Help

It goes without saying that payroll is one of the most critical business functions and therefore should be closely monitored and appraised.

Use this guide to learn everything you need to know about payroll audits so you can ensure your payroll process is efficient, accurate, and compliant.

What Is A Payroll Audit?

A payroll audit is a systematic review of an organization's payroll processes, records, and systems to ensure accuracy, compliance, and efficiency. The purpose of a payroll audit is to verify that employees are being paid correctly, payroll taxes are properly calculated and remitted, and that the organization is adhering to relevant laws and regulations.

Why Conduct A Payroll Audit?

Periodical payroll audits are important for the following reasons:

Accuracy: Helps ensure that employees are paid the correct amounts, including wages, overtime, bonuses, and deductions. This prevents underpayments or overpayments, which can lead to employee dissatisfaction and financial discrepancies.
Compliance: Verifies adherence to federal, state, and local labor laws and tax regulations.
Fraud Prevention: Detects and mitigates payroll fraud, such as ghost employees, unauthorized pay rate changes, or improper expense reimbursements. Strong internal controls identified through audits help in preventing such activities.
Financial Accuracy: Ensures accurate financial reporting, which is crucial for budgeting, financial planning, and reporting to stakeholders. Accurate payroll records contribute to the overall financial health and transparency of the organization.
Operational Efficiency: Identifies inefficiencies in the payroll process, enabling the organization to streamline operations, reduce processing time, and lower administrative costs.
Risk Management: Identifies and addresses potential risks related to payroll, such as data breaches, unauthorized access, and system errors. This helps protect sensitive employee information and maintain the integrity of the payroll system.
Improved Decision Making: Provides accurate and reliable payroll data, which is essential for informed decision-making by management. It supports strategic planning and human resource management.

How To Audit Payroll

So, now you’re aware of why auditing payroll is important, how can you actually do it? Follow this detailed step-by-step guide to perform a comprehensive payroll audit.

1. Define the scope and objectives

Determine what you want to achieve with the audit e.g. efficiency and effectiveness of workflows, data accuracy, fraudulent behavior, and compliance adherence.
Decide whether the audit will cover all employees, specific departments, or certain aspects of payroll (e.g., overtime, bonuses, tax withholding).

2. Gather necessary documents

Collect payroll records, time sheets, pay stubs, tax filings, employee contracts, and any other relevant documentation.
Ensure you have access to the relevant software and systems.

3. Review payroll policies and procedures

Examine your organization's payroll policy and procedures and ensure they are up-to-date and comply with relevant laws and regulations.
Remember that there is a mix of federal and state payroll regulations to comply with.

4. Verify employee information

Check that employee records in your HR system are accurate, including names, addresses, social security numbers, and employment status. Common issues to look out for:
- Are employee classifications (e.g., full-time, part-time, exempt, non-exempt) correct?
- Are there any employees no longer working at the organization?
- Is someone missing?
- Are there names you don’t recognize?

5. Validate earnings and deductions

Review pay rates, hours/days worked, and overtime calculations and ensure that all earnings, including bonuses, commissions, vacations, and even tips are accurate.

6. Check for any atypical transactions

Drill into payments such as signing bonuses, relocation pay, back pay, and previous corrections, reimbursements and expenses. For example, is someone requesting reimbursements for travel expenses when their role doesn’t normally necessitate any travel?

7. Check payroll tax compliance

Ensure payroll taxes are correctly calculated, withheld, and remitted.
Verify that tax filings are accurate and submitted on time.
Check for any outstanding tax liabilities or discrepancies.

8. Examine benefits administration

Ensure employees are enrolled in the correct benefit plans and that contributions are accurately calculated.
Review the accuracy of benefit deductions (e.g., health insurance, retirement contributions).

9. Assess internal controls

Evaluate the effectiveness of internal controls related to payroll processing.
Ensure there are checks and balances in place to prevent fraud and errors.

10. Analyze payroll reports

Compare payroll reports with general ledger entries to ensure they match.
Look for any discrepancies or unusual entries.

11. Conduct employee interviews

Speak with employees to confirm that their payroll records are accurate.
Address any concerns or discrepancies they may have noticed.

12. Document findings

Record any issues or discrepancies found during the audit.
Note any areas where policies or procedures need improvement.

13. Make recommendations

Provide recommendations for correcting any errors or improving payroll processes.
Suggest updates to policies and procedures to enhance compliance and efficiency.

14. Implement changes

Work with your payroll team to implement the recommended changes.
Ensure that any errors are corrected and that improved processes are put in place.

15. Follow up

Schedule regular follow-up audits to ensure ongoing accuracy and compliance.
Continuously monitor payroll processes and make adjustments as needed.

Primary Payroll Issues

As mentioned above, here are some of the main issues to look out for when auditing payroll:

Incorrect employee information

Inaccurate personal details (e.g., name, address, social security number).
Incorrect employment status (e.g., full-time vs. part-time, exempt vs. non-exempt).

Payroll calculation errors

Incorrect calculation of wages, overtime, and bonuses.
Errors in timekeeping, such as missed hours or incorrect recording of hours worked.

Improper deductions

Incorrect or missing deductions for taxes, benefits, and other withholdings.
Unauthorized or incorrect deductions affecting net pay.

Tax compliance issues

Errors in calculating, withholding, and remitting payroll taxes.
Late or incorrect tax filings resulting in penalties and interest charges.

Overpayments and underpayments

Instances of employees being overpaid or underpaid due to errors in payroll processing.
Ensuring that any overpayments are recovered and underpayments are corrected promptly.

Benefit errors

Incorrect calculation and deduction of employee benefits (e.g., health insurance, retirement contributions).
Failure to enroll employees in the correct benefit plans or process benefit changes accurately.

Compliance with labor laws

Ensuring adherence to federal, state, and local labor laws, including minimum wage, overtime, and meal/rest break regulations.
Compliance with leave policies, such as family and medical leave, sick leave, and vacation pay.

Payroll fraud

Detection of fraudulent activities, such as ghost employees, unauthorized pay rate changes, falsified time records, and fraudulent expenses.
Ensuring robust internal controls to prevent and detect fraud.

Data security and privacy

Ensuring payroll data is securely stored and protected against unauthorized access and data breaches.
Compliance with data protection regulations, such as GDPR or HIPAA, if applicable.

Inconsistent payroll practices

Inconsistencies in payroll practices across different departments or locations.
Ensuring standardized and consistent payroll procedures throughout the organization.

Documentation and record-keeping

Inadequate or incomplete payroll records, which can lead to audit trails being unclear.
Ensuring proper documentation of payroll changes, approvals, and adjustments.

System and process inefficiencies

Identifying bottlenecks or inefficiencies in the payroll process that can be streamlined.
Ensuring that payroll software and systems are up-to-date and functioning correctly.

Payroll Audit Best Practices

Auditing payroll is an important task that may involve multiple departments. Here are some best practices so that, when it comes to auditing time, the auditing process is as effective and efficient as possible.

Here are some payroll auditing best practices to ensure a thorough and effective audit:

Regular audits. Conduct payroll audits on a regular schedule, such as quarterly or annually, to identify and address issues promptly.
Make sure of automated systems. Utilize automated payroll systems to minimize manual errors. Ensure the software is regularly updated to reflect current laws and policies.
Segregation of duties. Separate payroll processing, authorization, distribution, and auditing duties among different staff members (likely from HR and finance) to reduce the risk of fraud and errors.
Detailed documentation. Maintain comprehensive and accurate records of all payroll transactions, changes, and approvals. Ensure documentation is easily accessible for audits.
Internal controls. Implement strong internal controls, including authorization and approval processes, to safeguard against unauthorized changes and payments.
Employee verification. Periodically verify employee information, such as personal details, tax status, and bank account information to ensure accuracy. Again, payroll software can help here by automating this process.
Reconciliation. Regularly reconcile payroll records with bank statements, general ledger entries, and tax filings to ensure consistency and accuracy.
Compliance monitoring. Stay updated on changes in labor and tax laws. Ensure payroll practices comply with all relevant regulations to avoid legal penalties.
Training and education. Provide ongoing training for payroll staff on best practices, system usage, and regulatory changes. Ensure they are knowledgeable about compliance requirements.
Clear policies and procedures. Develop and document clear payroll policies and procedures. Ensure all staff are aware of and adhere to these guidelines.
Audit trail. Maintain an audit trail within the payroll system that records all changes, approvals, and transactions. This helps in tracking and verifying payroll activities.
Use of checklists. Utilize checklists to ensure all aspects of the payroll process are reviewed during audits. This helps in covering all critical areas systematically.
Feedback mechanism. Establish a mechanism for employees to report discrepancies or issues with their pay. Address these concerns promptly and transparently.

How Payroll Software Can Help Employers Improve Audits

Payroll software can significantly aid you in conducting a payroll audit by automating processes, ensuring accuracy, and providing comprehensive data and reports.

Here are several ways payroll software can help with your payroll audit:

Centralized data. All payroll information is stored in a single, centralized system, making it easier to access and review data during an audit.
Error detection tools: Built-in tools to flag potential errors and fraudulent activities.
Detailed reporting: Generate detailed payroll reports that provide insights into payroll transactions, tax filings, and employee earnings, facilitating thorough reviews.
Audit trails: Maintains an audit trail of all payroll-related changes and transactions, including who made changes and when aiding in tracking and verifying activities.
Data accuracy: Minimizes the risk of errors by validating data entry and performing consistent calculations across all payroll periods.
Customizable checklists and alerts: Allows you to create customizable checklists and set up alerts for important payroll tasks and deadlines, ensuring nothing is overlooked during the audit.
Historical data access: Easily access historical payroll data for comparison and trend analysis, which can help identify anomalies or discrepancies.
Backup and recovery. Ensures data is regularly backed up and can be recovered in case of system failures, protecting against data loss.

For more information, check out our pick of the best payroll software.

Tools	Price
Deel	Flat rate user pricing, with a free version for businesses with up to 200 people	Website
Papaya Global	From $15/employee/month	Website
Rippling	From $8/user/month (billed annually)	Website
Remofirst	From $25/user/month	Website
OnPay	From $6/user/month	Website
Paychex Flex	Pricing upon request	Website
Bambee	From $99/month	Website
Trinet	Pricing upon request	Website
ADP Workforce Now	From $62/month	Website
ADP TotalSource	Pricing upon request	Website

Compare Software Specs Side by Side

Use our comparison chart to review and evaluate software specs side-by-side.

FAQs

Is auditing payroll a requirement?

How often should you conduct a payroll audit?

The frequency of payroll audits can vary depending on the size and complexity of the organization, industry standards, and regulatory requirements. However, here are some general guidelines for how often you should audit payroll:

Quarterly Audits:
- Conducting payroll audits quarterly is a good practice for most organizations. This frequency allows you to catch and correct errors and discrepancies before they accumulate, ensuring ongoing accuracy and compliance.
Annual Audits:
- At a minimum, a comprehensive payroll audit should be performed annually. This annual audit can be more thorough and review the entire year’s payroll data, policies, and procedures.
Monthly Reviews:
- For larger organizations or those with more complex payroll systems, monthly reviews of payroll data can help maintain accuracy and compliance. These reviews don’t have to be as comprehensive as quarterly or annual audits but can help identify and correct issues promptly.
After Significant Changes:
- Conduct a payroll audit after any significant changes, such as updates to payroll software, changes in tax laws or regulations, mergers or acquisitions, or major organizational restructuring. This ensures that the changes have been implemented correctly and that payroll processes remain accurate and compliant.
Random Spot Checks:
- Implementing random spot checks throughout the year can help deter and detect fraud. These spot checks can be less formal and focus on specific areas of payroll, such as overtime calculations, benefits deductions, or compliance with new regulations.
Event-Driven Audits:
- Conduct audits in response to specific events or issues, such as a complaint from an employee about their pay, discrepancies noticed in financial statements, or as part of an internal investigation.
Internal Control Reviews:
- Regularly review internal controls related to payroll processing to ensure they are effective. This can be done quarterly or semi-annually as part of broader financial or operational audits.

How long does it take to do a payroll audit?

What happens if you fail a payroll audit?

Failing a payroll audit can have several significant consequences, depending on the severity and nature of the issues discovered. Here are some potential outcomes and actions that might follow a failed payroll audit:

Financial Penalties:
- Regulatory authorities may impose fines and penalties for non-compliance with labor laws, tax regulations, or other legal requirements. The amount can vary based on the extent and severity of the violations.
Back Payments and Corrections:
- The organization may be required to make back payments to employees if they were underpaid due to errors in payroll calculations. This can include unpaid wages, overtime, and benefits.
Legal Action:
- Employees or regulatory bodies might take legal action against the organization. This could result in lawsuits, further financial penalties, and potentially costly settlements.
Reputational Damage:
- Failing a payroll audit can harm the organization’s reputation, leading to a loss of trust among employees, customers, and stakeholders. This can affect employee morale and retention, as well as the organization’s public image.
Operational Disruptions:
- Addressing the issues identified in the audit may require significant time and resources. This can disrupt normal business operations as the organization works to rectify errors and implement corrective measures.
Increased Scrutiny:
- Regulatory bodies might increase their scrutiny of the organization, leading to more frequent and rigorous audits in the future. This can increase the administrative burden and require ongoing compliance efforts.
Internal Changes and Improvements:
- The organization will need to implement corrective actions to address the issues identified in the audit. This could involve updating payroll systems, revising policies and procedures, and providing additional training for payroll staff.
Loss of Certifications or Licenses:
- In some cases, failing a payroll audit can result in the loss of certain certifications or licenses necessary for operating in specific industries or regions.
Employee Relations Issues:
- Discovering payroll discrepancies can lead to strained relations with employees. Transparent communication and prompt resolution of any payment issues are crucial to maintaining trust and morale.

Actions to Take After Failing a Payroll Audit:

Identify and Correct Errors:
- Immediately address and correct any errors identified in the audit. This may involve recalculating wages, taxes, and benefits, and making necessary adjustments.
Implement Corrective Measures:
- Develop and implement a plan to rectify systemic issues that led to the audit failure. This could include updating payroll software, revising policies, and enhancing internal controls.
Communicate with Employees:
- Inform employees about the audit findings and the steps being taken to resolve any issues. Transparency is key to maintaining trust and morale.
Seek Professional Advice:
- Consult with payroll experts, legal advisors, or external auditors to help address compliance issues and implement best practices.
Schedule Follow-Up Audits:
- Plan for follow-up audits to ensure that corrective measures have been effective and that payroll processes are now compliant and accurate.