A former Virgin Media payroll administrator stole €870,000 from the company over a 10-year period. This is not the only costly payroll mistake a business can make, highlighting the importance of conducting effective payroll audits. Is it time to review your payroll processes?
Written by Suzanne Lucas Reviewed by Monika Nemcova 10 minutes read
Maintaining accurate payroll records is a key HR responsibility. However, one in four employees have received a paycheck with errors, and 29% of employers say they only uncover these mistakes when running a payroll audit.
Organizations must make sure they’re paying their employees correctly and on time, and comply with ever-changing employment laws and payroll regulations. Although Payroll is sometimes a separate department from Human Resources, they must both work together on payroll audits to ensure accuracy and compliance.
In this article, we’ll explore what a payroll audit is, different types of payroll audits, their purpose, and how to conduct one. We’ve also included a handy downloadable payroll audit checklist.
A payroll audit is a regular review of all payroll records to ensure all employees are paid correctly, all deductions and reports are accurate, all information is up to date, and the organization is compliant with tax laws. Sometimes, mistakes can continue for months or even years without discovery, which can result in legal issues or incorrect financial statements. The good news is you can catch mistakes early with a payroll audit, which should be an indispensable part of your company’s compensation and benefits strategy.
While audits may sound intimidating, most payroll audits are simple internal checks on the accuracy of the organization’s data. 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. For faster responses, Payroll and HR can automate some audit checks.
Although the Payroll department is typically responsible for running payroll audits in larger organizations, HR must also be involved. Why? Because 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. For instance, a hiring manager may negotiate a higher salary for a candidate than stated in the initial offer letter but fail to notify HR. Pay is also a sensitive subject, so HR must be involved in resolving employee concerns and ensuring all necessary communications take place.
There are different types of payroll audits, each with different purposes. The two main types are:
An organization’s staff conducts an internal payroll audit to assess and improve payroll processes. This lets the business know where it stands, and helps it to identify and rectify problems as early as possible.
In this case, an organization hires third-party auditors to conduct an external payroll audit to provide an independent assessment of the its payroll practices. Having fresh eyes can be beneficial for spotting errors internal employees may have overlooked. Typically, the company’s management, board of directors, or audit committee hires these external auditors to ensure compliance, accuracy, and integrity in payroll processing.
Everyone wants accurate pay, properly withheld taxes, correctly calculated health insurance, and legal, accurate deductions. Let’s dive deeper into the main objectives of conducting a payroll audit.
Here are some steps to help you prepare for a payroll audit.
Although you can conduct a payroll audit at any time, most companies complete this at the end of their financial year. The “lookback” period is typically one year, though this varies from one business to another. The longer the audited period, the longer the payroll audit will take to complete.
If you are about to conduct your first payroll audit or experiencing issues with your current payroll processes, you could benefit from conducting an audit quarterly or semi-annually so you can diagnose and resolve problems sooner.
The next step is to decide who will conduct your payroll audit. Businesses with a dedicated payroll, HR, accounting and executive management team will likely complete the audit themselves. Smaller businesses may enlist help from an external auditor.
If you have a combination of people from different departments involved in the auditing process, make sure deadlines are set for everyone’s separate tasks to keep the process on track.
If you have some problems in your current payroll processes, you should focus on key areas like your payroll systems, tax contributions, financial ledgers, and time and attendance records.
You should be able to get most of this information from your payroll or ERP software.
Follow these steps in order to run a comprehensive payroll audit in your organization:
This step requires communication between HR and Payroll to ensure the data payroll matches the information the employee receives. Unlike sending spreadsheets back and forth, connected systems minimize the chances of error and make this step more efficient.
If your Applicant Tracking System (ATS) is not integrated with your HR and Payroll systems, you should verify the relevant information against employee offer letters. Check whether everyone on the payroll is an active employee and whether they are classified correctly (exempt vs. nonexempt, full-time vs. part-time, etc.). Ensure people who are on leaves of absence receive the correct pay as well, especially if this differs from their regular paycheck.
Verify hours worked using timesheets and ensure they’re in line with the amounts paid. This is especially important for employees earning hourly wages. Too many employees with identical time cards can mean someone is editing the time cards, in which case, HR should investigate potential time theft. Watch out for indications of buddy punching, too.
You must thoroughly check overtime pay, bonuses, commissions, and piece-rate information. If the organization hires tipped employees, make sure they report their actual earnings for more accurate data. If your company does vacation pay or shift differentials, be sure to check this as well.
Remember, overpaying can be just as stressful as underpaying. No employee wants to have to repay money they may have already spent or saved because of mistakes on Payroll’s part six months ago that led to employees being overpaid.
This is another area with high fraud potential, and usually invovles signing bonuses, relocation pay, back pay, and previous corrections. If you process reimbursements through the company’s payroll, double-check that this is accurate. It may require liaising with the finance department or whoever handles reimbursements.
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 rules change. Keep in mind that due to differences in work locations, an employee who is classified as working at the office may have completely different tax withholdings from an employee who is classified as working from home.
Review your organization’s bank activity. Do its bank statements match its payroll records? Do you have proper documentation for all direct deposit change requests? Double-check all your documentation and make sure everything adds up.
Payroll rules are especially critical if the government audits your company. These rules vary by state and country, so make sure your organization is compliant with the regulations where it operates. Of course, these rules are even more complex for multinational organizations. Failure to adhere to these regulations can result in significant fines and legal repercussions.
Create a payroll audit report and share it with key members of staff, including the heads of HR and Finance. Keeping documentation of audits can be useful in case problems, such as a lawsuit, arise later.
Think about how you can improve your payroll processes going forward. What has your payroll audit taught you? What are you doing well, and what can be improved? Automation is becoming increasingly popular in payroll management as it helps minimize inaccuracies and errors. An all-in-one HRIS (Human Resources Information System), payroll system, or accounting software can substantially reduce data errors.
Once you know which improvements must take place, create a plan of action for making those improvements. Consider timelines, budget, and key stakeholders who need to sign off on proposed changes. Implement improvements based on order of priority, beginning with the most pressing changes that will make the biggest impact.
Based on the payroll audit process outlined above, we’ve created a payroll audit checklist template in Excel to follow so you can stay on track and ensure you conduct a thorough, effective audit for your organization:
Here’s the full payroll audit checklist, which you can adapt to suit your organization’s needs:
Internal payroll audit checklistA fundamental understanding of payroll audit allows HR professionals 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.
Use our downloadable payroll audit checklist to stay on track, ensure your payroll audit procedures are effective, and remain compliant.
A payroll audit is a review of all payroll records to ensure your data is accurate, employees are paid correctly and on time, and your company is compliant with tax laws.
What happens if you fail a payroll audit?If you fail a payroll audit by a government agency, it can result in financial penalties, interest, and forced payment of any employment taxes your company didn’y pay due to worker misclassification. This can have a negative impact on your reputation and employer brand, and damage the trust among employees, customers, and key stakeholders.
What are the 3 main types of payroll audits?The three main types of audits are:
Internal audit: Carried out by in-house staff to assess current payroll processes, identify problems, and make improvements.
External audit: An assessment of payroll processes carried out by third-party auditors.
Government audit: Checks carried out at random by government agencies to ensure every business is paying the correct amount of tax.
