What is a payroll audit?

Payroll is governed by a myriad of different rules and regulations, which makes handling payroll compliance a complex task. To make sure there are no errors in their payroll, businesses should conduct regular payroll audits to check everything is in order and to identify any gaps in their processes.

But what exactly is a payroll audit? What are the objectives of auditing payroll? And how to do a payroll audit?

A payroll audit is a thorough assessment of a business’s payroll processes, data and records. The aim of these audits is to spot errors and mishaps and verify that all the processes regarding payroll are compliant and up to date.  

Running a payroll audit is also a good opportunity to verify there are no employees on the payroll that no longer work for the company and that the business’s payroll records are complete and in order. Other aspects to check when auditing payroll include: 

• Payroll costs

• Employee pay rates

• Hours worked

• Variable payments such as bonuses or commissions

• Payroll tax withholdings

• Data security and protection standards

• Overtime

• Off-cycle payments

• Tax forms and reports

• Outstanding tax payments

• Ways to improve payroll efficiency

• Compliance with employment, tax and compensation laws

• Worker classification

• Late payments

• Atypical payroll transactions

Payroll audits are typically conducted by internal staff, but it is also possible for a business’s payroll processes to be audited by an external party such as a federal, state or local tax authority or another government body. Some organizations even engage external audit teams to conduct large-scale analyses of their payroll processes, cash flows and financial statements.

Since payroll audits can take up a lot of time depending on the extent of the review, businesses should look into ways to have parts of the audit process run on autopilot by leveraging payroll automation.

Payroll audits are crucial for ensuring payroll compliance and avoiding trouble with tax authorities and other statutory bodies. Auditing payroll on a regular basis notably helps businesses:

• Avoid external audits by statutory authorities, since errors regarding salary and tax payments can be corrected retroactively before external auditors come in,

• Spot errors in payroll at an early stage, which means that they can be corrected in a timely manner,

• Detect and prevent payroll fraud by verifying former employees no longer receive payments and comparing employee timesheets with actual hours worked,

• Ensure employment law compliance (e. g. regarding overtime regulations),

• Verify they pay the correct amount of taxes for their employees, and

• Have accurate accounts of employee paid time off.

The rules and regulations surrounding payroll are constantly changing. Legal changes that affect payroll can range from changes to the minimum pay level, to adjustments of the applicable income tax brackets, or updates of the percentages based on which payroll taxes are calculated.

Given the high number of legal changes that can have a direct or indirect impact on payroll processing, organizations should make sure to carry out an internal payroll audit at least once every year—but ideally more often than that. At the very least, payroll teams should keep up to date with tax changes and new regulations to avoid compliance issues.

Internal payroll audits should analyze different aspects of payroll to make sure all processes are correct and compliant. The scope of the audit should encompass the following aspects: 

• Setting a timeframe and preparing detailed outlines: In-depth payroll audits take time and should be scheduled and planned in advance. The first step therefore consists in defining a start date for the audit and in mapping out the different process steps that will be followed.

• Checking the list of employees on the business’ payroll: This includes verifying that there are no employees on the organization’s payroll that no longer work for the company—and that no payments have been issued after the day they received their final pay. Similarly, it’s important to check that all new joiners have been added to the payroll system in a timely manner.

• Verifying numbers regarding salary, hours worked, overtime, and more: A central part of the work involved in conducting a payroll audit is the verification of numbers. Important numbers in payroll include employee pay, hours worked and overtime hours/pay. All these numbers have to be correct, meaning that they need to be plausible, accurate and in line with legal regulations.

• Validating and analyzing variable payments and atypical payroll transactions: Variable payments such as bonuses or commissions must be checked for accuracy and timeliness. In addition, a payroll audit should be used to check for any atypical payroll transactions, off-cycle payments and late salary payments.

• Reviewing paid (and unpaid) time off: Paid time off (be it paid vacation days, paid sick leave, paid bereavement leave or any other type of leave) should be recorded as such in the payroll system. Going through the information allows businesses to see which employee has taken how much leave and compare the findings with the amount of accrued leave per employee they have recorded in their HR system.

• Comparing payroll numbers to accounting records: Reconciling payroll is a central part of the payroll audit process. Payroll reconciliation means comparing all the data and numbers recorded in the payroll system to other records showing the business’s financial transactions. This includes accounting systems (notably the company’s general ledger) and bank statements.

• Analyzing tax withholdings, payments and reports: Accuracy is one of the most important payroll KPIs and applies to both salary payments and tax payments. Since withholding the correct amount of payroll tax is a crucial part of payroll compliance, the accuracy of the tax calculations should be verified in every payroll audit.

• Reporting findings and taking action: Conducting a payroll audit is pointless if there are no actions taken afterwards. In order to allow for the necessary changes, the findings of the audit should be documented so that gaps and errors are clearly visible and can be corrected in due time.

• Identifying and implementing necessary improvements: Once the payroll audit process is completed, it’s time to use the results of the analysis to identify potential improvements and make adjustments to the payroll processes to increase efficiency and maybe also bring procedures up to date with the latest regulatory changes.

There are many different tasks involved in conducting a payroll audit. In order to make sure not to miss anything important, businesses should have a payroll audit checklist at hand that provides step-by-step guidance for internal auditors. 

Download a free PDF copy of our complete checklist for auditing payroll and be safe in the knowledge that you check all your payroll processes and data for full compliance.

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