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Payroll audit checklist

For the majority of businesses, payroll accounts for around 15-30% of the revenue and it’s processing could probably be the most important duties of an employer. It presents plenty of challenges for the payroll professionals. As, small mistakes can result in pretty dire consequences including but not limited to affecting attrition, reputation, legal actions and profitability. The most common mistakes include

  1. Non-removal of terminated employees
  2. Incorrect working hours clocked in
  3. Manual data feeding and calculation errors
  4. Payroll fraud
  5. Outdated employment laws
  6. Incompatible systems that bleed money
  7. Tight deadline for inputs, owing to long processing time

The reasons resulting in such mistakes could be human errors, dishonest employees, faulty systems and non-updation of employment laws. 

To identify these compliance problems in a multi-layered and complex payroll processing a frequent analysis of an organization’s payroll-related processes also known as payroll audit is really vital.  

Top reasons to conduct a payroll audit:

Payroll audit helps you better navigate through HR processes and helps strategize payroll as  well as other budgets. Interestingly, a payroll audit is mandatory for business loans and hence may come handy to you in times of need. It ensures accuracy in the accounts and can translate 

Majorly following are the the reasons payroll audit is absolutely necessary

  • Verification of information in the payroll system: Since Employee pay and the pay distribution are a continuously changing information and humans are responsible for the updation of information. The probability of manual errors is high and a payroll audit helps in rectifying these errors.
  • Compliance to Changing Employment laws: A payroll audit will identify non-compliant practices especially while managing a global payroll, keeping up with the ever-changing regulatory laws of each country. 
  • Reconciliation of payroll to bank accounts: It checks whether the payroll expenses in the business ledger match the payroll audit findings. A payroll audit also compares the money specified in payroll records to the money withdrawn from the account. 
  • Verifies employee status, tax withholdings and remittance: The discrepancies in employee statuses – leave, promotion, new joinees, raises and allowances can be pointed out in this regard. Reviewing tax withholdings helps in finding solutions in case this has been overlooked during remittance of taxes and ensures timely payments.

The checklist 

The following steps can be used with some changes specific to your organization as no two audits look the same but the broad high level process is similar. The major theme is to justify the reasons for audit. You can start with AI/ML based assessment tools for automated anomaly detection before moving on to a rigorous process.

Identify Active employees on the payroll

First step is to verify that only the employees that worked for you in the specified period are listed on the payroll. Generally, in bigger organizations some former employees don’t get removed from the payroll due to an oversight during the termination of the employee or an employee might have been left to be onboarded during joining the organization. In some cases it might uncover payroll frauds where fake employees could be added to the payroll. You may need to dig deeper in such situations and weed out such scenarios which could lead to payroll frauds to avoid scrutiny in the future.  

Verify pay rates

Next step is to verify the pay rates of all the employees to ensure that every employee is being paid the correct amount which is updated in accordance with the pay hikes and salary reductions along with any promotions and also ensure that such changes are reflected from the correct dates. Also, check for typos like adding an extra zero or it being left off to the salary payments.

Verify the pay with time and attendance records

Compare the pay rate with the hours worked from the attendance systems to calculate the total pay for the period that should have been disbursed and compare that with the actual payments. Also, check for paid leaves and overtime along with the eligibility. During overtime calculations Review anything a manager may have overlooked that could result in overtime hours exceeding the payroll budget. 

Check independent contractors and vendor payments

If the company employs a contingent workforce or relies on independent contractors and vendors, you need to confirm the status of the contracts for the pay period to ensure payment for services you’re not using. Also, Check the relationship and classification of the vendors and ensure they are rightly classified.

 Reconcile your payroll

Compare your reconcile payroll to other records to verify your totals match. Closely examine the records in case of any discrepancy to find the root of the problem.

Compare your payroll records to your business’s general ledger. The payroll expenses in your general ledger should match your payroll audit findings.

Next, you need to reconcile your payroll records with your bank statements. Compare the amounts listed in your payroll records to what was withdrawn from your account. Consider having a separate payroll account to make bank reconciliation easier.

Confirm tax withholdings

Another critical payroll audit procedure step is to verify the accuracy of your employment taxes.

Make sure you withheld the correct amount of taxes from each employee’s wages. You must withhold income tax as per the tax regime preferred by the employee, Professional or state taxes if any and GST in case of insurance.

Compare bank statements with internal records

Compare the bank statements with the internal ledgers to ensure that the balances align and if all the checks issued are cleared or there is a need for any action.

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