How to Audit Your Payroll in 7 Steps
Payroll is likely your organization’s biggest expense. It’s also complicated, and mistakes make payroll even more costly. But you don’t have to wait till an employee complains or the government calls to make corrections and stay compliant.
Here’s how to conduct a payroll audit, including why it’s important in the first place and seven steps to get you started. By the end, you’ll have a better understanding of how to hold yourself accountable when paying your employees.
Why You Need to Conduct a Payroll Audit
First, let’s consider why you need to conduct a regular payroll audit.
Simply put, the stakes are high. You’re managing how people get paid—their livelihood, in fact. The government takes it seriously, too, which is why compliance mistakes can be so costly. More specifically, a regular payroll audit will help you improve accuracy, stay compliant, and find fraud.
To be clear, errors are much more likely than fraud, but both can still hit your organization where it hurts. According to the Association of Certified Fraud Examiners, the rate of billing fraud in 2020 was nearly twice as high in businesses with fewer than 100 employees than in larger ones, and the rate of check and payment tampering was almost four times higher! And of course, relatively speaking, these losses hurt smaller businesses with tighter budgets much more.
A payroll audit can uncover such schemes before they can inflict even more damage, but more likely, you’ll find mistakes to correct and better ways to pay your people more efficiently and correctly.
An audit is an opportunity to ensure that tax withholding and benefits deductions are up to date and correct. It’s also important to revisit your processes for calculating overtime pay and tip credits.
Employees will often let you know the moment they notice an error on their pay stub, and the government will eventually notice repeated or egregious inconsistencies on tax returns. But you shouldn’t have to wait for someone else to bring payroll mistakes to your attention.
HR pros must be proactive, and a payroll audit can help you hold yourself accountable.
How to Conduct a Payroll Audit in 7 Steps
It’s recommended you seek help from your bookkeeper or CPA, especially for a more thorough audit that would require payroll accounting. The seven steps we’ll cover are intended to help you conduct a more limited, internal audit for the purpose of improving your processes.
Having said that, here’s how to audit payroll in seven steps:1. Limit Your Scope:
First, depending on the size of your organization, it may be impractical to audit every employee’s pay for every pay period of the year. Instead, sample a percentage of your workforce to review, and establish a time frame for your audit. After all, payroll is ongoing, but your audit cannot afford to be.
Consider basing your time frame on two or more consecutive pay periods and conducting an audit at least once a year.
2. Review Employee Information:
Much of payroll can be automated, but that means incorrect inputs will lead to incorrect paychecks and tax deposits…over and over. Mistakes in employee information are exacerbated by automation. Look out for changes in pay rates due to a promotion, changes to W-4s due to life events, and changes in residency that may affect taxes.
3. Verify Hours Worked and Days Off:
For hourly workers, you should confirm that their time and attendance are correct for the pay periods you’re auditing. Don’t forget to account for any sick or vacation time that hourly or salaried workers used that may affect their pay. Misclassification of workers and miscalculating hourly and overtime pay are two of the most common payroll issues investigated by the Department of Labor’s Wage and Hour Division.
4. Note Any Variable Pay, Atypical Payments, or Off-Cycle Payrolls
Your payroll audit should also include making sure that any overtime is compensated at one-and-a-half times the regular hourly rate. Other variable pay to review may include bonuses, commissions, shift differentials, hazard pay, signing bonuses, relocation pay, and corrections from previous payroll mistakes.
Many employers choose to process supplemental wages by running an off-cycle payroll, so you’ll need to keep that in mind as well.
5. Recalculate Withholdings and Deductions
Calculating withholdings and deductions can be complicated enough when everything goes right. If you noticed any W-4 or residency changes earlier in the process, you’ll need to update your calculations to reflect those changes.
It’s also important to double check benefits deductions based on enrollment as well as any changes to HSA, FSA, and 401(k) contributions—which many employers allow employees to make at any time, not just during enrollment.
6. Reconcile Payroll with Accounting, Bank, and Tax Records\
As mentioned earlier, you might want to consider working with your bookkeeper or CPA, especially for this step. Many employers find it easier to manage payroll through a bank account separate from their general business account. To reconcile payroll with accounting and bank records, verify that payroll transaction totals are reflected in your organization’s general ledger and in your bank statements.
You should also double check that your tax deposits were correct and timely using Form 941, the IRS’s quarterly tax return for employers.
7. Analyze, Report, and Improve
Once you’ve audited all of the payroll steps we’ve covered, you need to take what you’ve discovered and make meaningful changes. Analyze your findings, and report on them to leadership. Have some ideas for improvement when you present the audit results, such as updating how timesheets are approved or how bonuses are authorized.
When you implement these changes, clear and specific communication will go a long way in getting your workforce on board.
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Every HR pro should familiarize themselves with accounts receivables.