Running payroll affects employee morale and reflects on an organization’s financial stability and reputation. And while there shouldn’t be any room for error, several things can go wrong.
You may input numbers incorrectly, forget to remove a terminated employee from your payroll, or fail to add an employee’s recent pay raise. Carrying out a payroll audit will help identify and eliminate these problems, alerting you to mishaps earlier.
In this guide, we’ll show you how to conduct a successful payroll audit and discuss a few payroll best practices to keep everything in top shape.
What Is a Payroll Audit?
Generally speaking, audits are done to confirm that dollar amounts are correct and procedures are completed correctly.
A payroll audit analyzes a company’s payroll processes to verify their relevance and ensure accuracy and compliance. The process involves looking into specific aspects like a business’s active employees, wages, pay rates, and tax withholdings.
Generally, payroll audits are internal. This means that it’s either you or someone in your business who conducts them. But we recommend getting external help, too, if possible, to get an unbiased opinion.
The Basics of Payroll Auditing
Your payroll determines how straightforward your payroll audit will be. For instance, if you have ten employees, auditing will be a relatively simple affair. But for a multi-branch enterprise with thousands of workers in different locales, including independent contractors or seasonal workers, things will be more complex and time-consuming.
Regardless of the complexity, you should try to implement and execute an efficient procedure that helps you identify and eliminate payroll-related errors. Below is an overview of the basics of payroll auditing.
Verify Employees on Your Payroll
Employee turnover and attrition happen all year round. Therefore, it’s essential to ensure that only those employees who have actually worked during that pay period receive paychecks.
Go through your payroll and review all the employees. This list should match your current employment records. If you find any employee who doesn’t work for you anymore, remove them right away.
You should also review any employees who are temporarily not working due to FMLA, maternity, adoption, paternity, or sick leave.
For independent contractors and external vendors, confirm the contract periods for every entity to make sure you pay them only the owed amount.
Check Pay Rates and Time Categories for Every Employee
Analyze the pay rates listed in your company’s existing payroll system, ensuring it’s correct for every employee for specific pay periods, including their base salary, tax deductions, withholding, overtime rates, and other applicable fees.
Additionally, promotions, bonuses, and salary increases can happen anytime throughout the year. So if any employee receives a raise or a promotion during the audit period, you should adjust their pay rate immediately to reflect the changes.
Time categories are another consideration when paying employees.
Several businesses give employees specific categories of payroll time, such as paid leave and sick leave. Your job is to label these hours correctly based on the applicable payroll time label, like vacation, bereavement leave, and sick leave. Once that’s done, verify and compare pay rates against employee attendance records.
Pay attention to overtime hours, sick leave, and vacation days when going through employee records to avoid overcompensation and underpayment.
Reconcile All Your Payroll Records
Compare your payroll records to your company’s general ledger so that every payroll expense recorded in the general ledger matches your payroll audit findings.
Reconciling payroll records with company bank statements is also important. Check whether your company‘s bank account total matches with your internal ledgers. Any change should reflect internally as well as in your bank records. We highly recommend having a separate payroll bank account to simplify bank record reconciliation.
Check Employment Tax Accuracy
Confirming accurate tax withholding and limiting is another crucial aspect of a payroll audit. This way, you won’t find yourself paying excessive fines and fees and avoid costly mistakes.
Ensure you withhold the correct amount of taxes from every employee’s wages, including Social Security, Medicare taxes, and federal income taxes. You may also have to withhold state and local income tax, so keep an eye out for that.
You should also verify the accuracy of your payroll reports, such as the IRS Form 941. All wages and tax withholding amounts listed on your payroll reports should always match their old records.
5 Tricks for Payroll Audit
Let’s take a look at how you can make payroll and payroll audits more effective.
1. Adopt Advanced Payroll Software
Doing payroll manually or using outdated payroll software tools are the most common causes for inefficiencies in payroll. So if you do either of the two, it’s high time you upgrade.
Good payroll management software will not only help you improve payroll efficiency, but it’ll also automate repetitive and monotonous processes and help you identify errors early on. Additionally, several software solutions offer excellent customer support to make running payroll even easier. It’s a win-win situation for you.
2. Practice System Transparency
You must establish a pay policy and put it in writing if you want to prevent accidental time theft, underpaid taxes, misclassification of employees, and other payroll errors.
The policy should lay out how employees are classified and how wages, salaries, promotions, and raises are calculated. How the payment process works, when changes to payroll come into effect, and how the company deals with payroll mistakes should also be mentioned. The idea here is to include every aspect to make payroll as transparent as possible.
Once done, make sure every employee has a copy of it or access to it through the employee portal.
3. Stay up to Date With the Latest Rules and Regulations
Federal and state labor regulations and IRS tax tables change from year to year. Precisely why you should ensure your knowledge of these regulations is always up to date.
The best way to do this is by downloading the latest tax tables from the IRS website. If you use payroll software, set up the settings to update automatically every year to keep you in compliance. Also, pay attention to any government regulation changes, namely, income tax withholding, child support withholding, state unemployment taxes, and different benefit calculation and taxation.
4. Make Auditing a Routine Practice
Try to carry out a payroll audit at least once a year if you want to cut down your time and money losses. This stands true for those with a computerized system, too, as even automated ones can produce errors.
You may overpay an employee because of a math error, incorrectly classify a new employee‘s tax status, or forget another’s pay raise. It’s why you must double-check all your paperwork and processes to make sure everything functions as it should be.
5. Analyze Results to Make Improvements
Take stock of your payroll audit findings by analyzing the results and making well-thought-out recommendations focused on improving current processes and developing new strategies to make payroll efficient and accurate. It’s due to this that experts encourage getting an outsourced payroll provider instead of an internal auditor.
An internal auditor may find it difficult to look objectively upon the processes since their own departments or colleagues often develop them. Contrarily, an external auditor has a more objective viewpoint and can make recommendations unimpeded by internal bias.
Nevertheless, whatever you do, make sure you fast-track your company’s payroll development, helping it achieve greater accuracy, compliance, and efficiency in a shorter timescale.
What to Do Next
While not every payroll error will cause the IRS to come knocking on your door, you should still make an active effort to ensure all your corrective actions are right and can genuinely help rectify mistakes.
Of course, the best way to avoid payroll-related errors is through a routine and thorough payroll audit. You must also be aware of the number of employees on your payroll, their pay rates, and time schedules, as well as know the ever-changing regulations, rules, and legislation.