The Importance of Payroll Audit and How to Prepare for It

Payroll audit is crucial for every business because payroll mistakes can have fatal consequences. By preparing and executing payroll audits, you can protect your business from costly mistakes. 

As a business function that all companies must undertake to pay employees, payroll is very crucial. It needs to be accurate and on time. While many companies use payroll software to ensure a smooth and systematic payroll process, it’s still necessary to do internal checking or payroll audits. This process will reveal any issues that occur in the company’s payroll process and can avoid the severe consequences of payroll inaccuracy. In this article, you will find out what a payroll audit is, the benefits of conducting one, and how to prepare for it.

What is Payroll Audit

A payroll audit is a thorough examination of a company’s payroll process. Generally, there are two types of payroll audits: internal payroll audits and external payroll audits. The difference lies in who conducts the audit. An internal payroll audit is carried out by the company’s internal staff, like the HR department or payroll specialist, while an external payroll audit is conducted by third-party firms or government agencies, such as the IRS.

The main purpose of a payroll audit is to make sure all the payroll processing is done correctly and accurately. It aims to maintain transparency in the entire payroll process, preventing any potential fraud. Furthermore, it’s also to ensure the organization’s compliance with employment laws and regulations related to payroll like minimum wage, overtime fees, and taxes.

Why Payroll Audit is Important

On average, the payroll accuracy rate for companies stands at 80.15%, according to a December 2022 report by EY. Each error can cost a company approximately $291 to rectify, both directly and indirectly. Given the significant amount of money to mend the error, it will be a great disadvantage for the company if it happens repeatedly. Auditing payroll periodically can help prevent the escalation of payroll errors.

Typically, payroll audits are conducted once a year. However, it is advisable to conduct more frequent audits depending on the size of your company. It’s always better to catch the errors sooner, so you’ll have enough time to make corrections.

Besides all these, here are some more reasons why conducting a payroll audit is necessary for every company.

Ensure Compliance

Even though payroll software has a high streamlining capability, there’s still a chance of compliance errors. Mistakes such as inaccurate tax calculations, misclassification of employees, or fringe benefit miscalculations can happen easily. When it happens, it often results in fines. Conducting payroll audits helps identify and rectify such issues. 

Streamline Employee Data

There are a lot of cases of payroll errors where former employees’ data accidentally remains in the system, so they are still included in every payday. Additionally, these kinds of data take up storage in your system. Auditing your payroll periodically will help streamline employee data and records, assisting in increasing accuracy such as making payments only to active employees. 

Increase Record-Keeping Accuracy

Besides updating compliance and employee data, a payroll audit is also useful for keeping records of the company’s business processes. It helps maintain overall business operations in order and facilitates the detection of malpractices like fraud or corruption. Sometimes, fraud can come from within the organization, for example, employees submitting time sheets for hours they didn’t work.

How to Prepare for a Payroll Audit

Payroll audits can be conducted by various parties, depending on the company’s needs and policies. Small companies usually hire unbiased outside auditors, while bigger companies often have in-house payroll teams and HR teams that are capable of performing the audit for their own company. 

For business owners and leaders, you can consider the size and complexity of your company to determine which method is more suitable. As an alternative, you can also prepare and do the payroll audit independently. If you want to try, check out this checklist from Deluxe to help you get started.

Verify Your Employee

Make sure employees listed on your payroll are active employees. Even though this seems unnecessary, it’s still important to guard against the possibility of “ghost employees” and the fraud schemes that come with it. Use this opportunity to confirm the correct classification of your employees. Also, verify that their pay rates and hours are accurately recorded in your system. 

Review Payroll Tax Submissions

Different regions have varying payroll tax policies that employers must adhere to. Verify that your company complies with local regulations. If your company employs remote workers overseas, ensure compliance with each region's specific regulations.

Search for Inconsistencies in the General Ledger Report

In general, auditors use the general ledger as the primary source of information, including for payroll audits. The general ledger records every financial activity chronologically. So you can check if there’s something that doesn’t adhere to the primary source. You can then track it down in the individual journal entries and make corrections. 

Reconcile Your Bank Statements

Nowadays, many employers pay their employees via online banking. Regardless of the payment method used, it’s important to examine every transaction. Ensure that each check issued to employees is cleared for the intended amount. The numbers from payroll records, bank statements, and the ledger should match.

Assess Your Current Payroll System

Lastly, it’s also important to evaluate your current payroll system. With the world’s rapid growth and ever-changing laws, you need to always be prepared to make the necessary adjustments. Ensure that your payroll system makes your job easier, not the other way around. 

Conclusion

In the end, a payroll audit is essential for maintaining an accurate and transparent payroll process. Without regular payroll audits, companies risk facing financial penalties and even reputational damage from a single issue or error. After each audit session, you should establish a regular audit schedule to sustain ongoing compliance and proactively identify issues before they escalate.



Next Read: Payroll and Human Resources: The Benefit of Integrating and Streamlining Functions