How to Conduct a Payroll Audit [+ Free Checklist]

If you need to conduct a payroll audit, these are the steps to take.

The “payroll audit procedures pdf” is a document that can be found in the “Payroll Audit Procedures” section of the “HR Resources” tab. The document is available for free and contains a checklist to help you conduct your payroll audit.

A payroll audit ensures that your payroll system is in compliance with labor, accounting, and tax requirements. Regular payroll audits also help to prevent fraud, embezzlement, and wage theft. You may use our free customisable Checklist for Payroll Audits to assist tighten your financial controls and handle possible concerns. It walks you through how to perform a payroll audit step by step.

Checklist for Payroll Audits is available for free download.

1. Establish a timeline and procedure for your payroll audit.

Consider who, what, and when you’re arranging your payroll audit, and you’ll be well on your way to success. We suggest that you do a payroll audit once a year, but if this is your first audit and you want to make sure your payroll and data controls are in good working order, you should consider completing micro audits more often (such as quarterly or even monthly).

You may use our Checklist for Payroll Audits to create a strategy for what you’ll be testing, when it should happen, and how it should be done. You may also wish to make a list of people who can help you with the audit. This will assist guarantee that the relevant team members are available when you need them, preventing the audit from being delayed or finished incorrectly.

The comments on this online form will assist you in filling out and customizing the Checklist for Payroll Audits.

To get our free editable Checklist for Payroll Audits worksheet, click the icon below.

Checklist for Payroll Audits

2. Create a strategy for spot-checking.

Instead of checking all of your workers’ data, look at the payroll data for 5% to 10% of your whole staff. You should also figure out how you’ll choose workers, payment periods, and payroll transactions at random.

3. Run Employee and Payroll Data Reports

If your company uses payroll software or a service, keep in mind that these companies usually give reports that make payroll auditing simpler. If you administer your own payroll, you’ll need to develop and maintain your own reports. Here’s a list of things you should check for payroll audits to assist you examine employee and payroll data.

Active Employees Must Be Verified

You should look at the names of the employees, their positions, and their start dates, among other things. You should also look to see whether any terminated workers are still on the payroll, as well as any employee names you’re unfamiliar with. The existence of any one suggests that there may be an issue.

You can examine the staff list yourself if you’re a small company owner since you’ll most likely know the names of all your employees. If your company is a midsized or big organization, however, you may enlist the support of your managers to verify that all of their personnel are mentioned appropriately.

If your company uses a variety of employee-related systems (such as HR, timekeeping, and payroll), you should double-check that the data in these programs is consistent. Additionally, double-check contract worker information since their payment information may be kept in your accounting software rather than your payroll system.

Verify the Hourly Rates of Employees

Pay attention to the pay rates in the employee file and the amounts on your payroll reports. If you’re using HR software, payroll software, or both, you’ll likely have reports that include the names, start dates, and pay rates of your workers. At the end of the day, you want to make sure that no one is overpaid or underpaid.

Check the Worked Pay Periods

You may compare data for a certain time period if you have both a timekeeping and payroll system (like a random pay period). You’ll need to double-check that the pay periods match up, and that data from one system (such as actual hours worked) matches what the workers were paid during that time period.

You should also ensure that workers get their pay on time. You may encounter cash flow constraints if funds are moved too early, which might affect inventory or supplier purchases. You may be in breach of labor laws if they are remitted late. Minimum pay frequency regulations control how your pay periods should flow in several jurisdictions.

Payroll laws differ from state to state. Some states will allow you to require direct deposits, while others will not. Several states prohibit the payment of wages on a monthly basis. Others demand that you pay your workers their last paycheck on the same day you fire them. When auditing your payroll, make sure that your company’s payroll procedure meets the regulations for your area and sector.

4. Compare the number of hours worked to the data on the timecard

It’s a good idea to perform a deeper dig once you’ve looked at the big picture statistics, such as workers, pay rates, and pay periods. You may review timekeeping records to confirm that workers are being paid accurately for the hours they work, including overtime for nonexempt employees. Here are some of the most important data items to look into.

Ensure that the number of hours worked by employees corresponds to the amount paid.

You may look at historical time card information and compare them to payroll data from the same time period whether you’re using paper time sheets, punch cards, or an employee time clock app. If an employee worked 35 hours between September 2 and September 9, the payroll data (i.e., on the pay stub) should reflect the same information. Make sure you’re comparing data from the same pay periods, and then make a note of any variations or inconsistencies between the two.

When a worker forgets to clock in or out, or when a bonus is paid, most payroll software will allow you to manually override electronic time cards or payroll data. Always keep track of those modifications and double-check any manual time adjustments.

Ensure that overtime hours are correctly calculated and paid.

Paying employees overtime incorrectly is a typical payroll problem that many firms face. Most states require overtime compensation to be computed at time and a half, which means that an employee is paid 1.5 times their usual rate for every hour worked above 40 in a pay period. State overtime regulations, on the other hand, differ (i.e., California requires any employee working over 12 hours per day to be paid double their regular hourly rate).

Verify that you’ve calculated and paid overtime accurately in accordance with your state’s rules. Some payroll transactions may need to be recalculated to ensure that you’ve paid out the correct amount to workers. If there are any discrepancies, you’ll need to go back and find out what’s wrong. If you pay overtime incorrectly, you risk incurring fines and penalties, as well as owing extra money in taxes.

How to Recalculate a Payroll Transaction Manually in the Event of a Payroll Audit

To begin, make a list of all of your pay runs and choose a handful that involve overtime compensation. Multiply 40 regular work hours by the normal pay rate, such as 40 x $20 regular pay rate Equals $600. Then double that by 1.5 or time and a half to get your overtime pay rate. For instance, $20 normal pay rate multiplied by 1.5 becomes $30 overtime pay rate.

Finally, increase the hours worked in excess of 40 in the pay period by the overtime pay rate, which may vary based on your state. For instance, 10 overtime hours multiplied by a $30 overtime pay rate is $300 in overtime compensation. The employee’s paycheck should indicate $900 in gross earnings ($600 regular pay + $300 overtime compensation) in this case.

Verify commissions, bonuses, and tips.

If you work in the restaurant, service, or sales sectors, you must ensure that extra payments are properly monitored and handled. Bonuses, commissions, and employee gratuities are examples of these. You should keep track of these amounts as they’re earned and paid, and double-check that the employee pay stubs match.

Check to determine whether your HR or payroll software can generate tip reports; these allow you to examine employee tip statistics, amounts, and dates paid. Instead of being labeled as regular pay, bonus distributions should be identified as such. You should also have paperwork to back up the payment in your files. Furthermore, it should be clear what the bonus is for (for example, a performance or holiday bonus) and who authorized the payment.

When it comes to commission payments, go a bit further to uncover documentation that explains how the fee was computed. To make money, you need know how many sales the staff made and which things they sold.

5. Complete a General Ledger Report

Your general ledger (GL) records all of your company’s transactions, making it a critical data source for performing successful payroll audits. You usually have cost and payable accounts for payroll. The expenditure accounts reflect what costs your company has incurred (such as payroll expense), while the payable accounts show what your company owes others (such as Social Security, Medicare, and FICA taxes).

You’ll need to double-check if the numbers in your payroll records match what’s on the books (GL). If any sums in your payroll records can’t be traced back to the GL, you’ll need to do some digging.

It’s worth noting that these records won’t show how many hours you were paid for, but rather how much you were paid. You must track the payroll transactions you want to audit throughout the whole process, from the timekeeping system through the payroll records to the general ledger. You may begin by selecting random transactions from the general ledger and comparing them to your other entries.

Verify Federal and State Tax Deductions and Payments

It’s critical to go through the taxes you’ve paid on behalf of your company, as well as the taxes you’ve withheld from your workers’ paychecks to send to the IRS.

When you’re evaluating your payroll tax general ledger accounts, double-check a few W-4 forms to be sure you’re withholding and paying the proper amounts of taxes for those workers. It’s also worth noting that whether you pay your payroll taxes quarterly or yearly, there will be a time delay between when the expenditure and obligation appear on your records and when they’re paid. Some of these transactions must be traced to verify that they are handled appropriately.

When you pay quarterly taxes, for example, the funds held from January to March should not be in the taxes due account in September. On each paycheck, the sums will be credited to your taxes payable account as credits, which will later clear as debits when you pay the IRS. There’s an issue if the sums in your tax payable accounts are gradually growing throughout the year, even after payments should have been paid at the end of the quarters.

Check the cash GL account if your payroll tax accounts don’t appear to be clearing correctly and you’re confident you’ve been paying the IRS. Dates are the most effective approach to search. Pull a receipt or other tax evidence to assist you determine all transactions that occurred on or around the day you think you paid the taxes.

Look for the payment amount in the GL account, and you should be able to view the opposite side of the transaction after you’ve found it. That might explain why your accounts aren’t clearing if the other half of the transaction doesn’t reflect your tax payable account. You’ll need to look into the charges and make some adjustments to your books. Because this is basically payroll accounting, you may need to enlist the assistance of a bookkeeper or a certified public accountant (CPA).

Check to see that non-tax deductions are in the right accounts.

Benefits, uniforms, and court-ordered judgements are all common deductions from an employee’s salary (like child support). You should check whether your payroll deductions are correctly recorded by using the same steps we recommended for tracing your payroll tax transactions—from beginning to finish. This will verify that your end-to-end payroll deductions are working correctly and if you need to look into any possible data anomalies further.

Examine the money withheld on payday and follow up to check that they were deposited to the right account for holding and then debited in the appropriate time period. 401(k) contributions and health insurance premiums, for example, may be remitted to the provider every paycheck or at the end of the month.

Check a few pay stubs to see whether the benefits premiums that your workers are accountable for are being deducted from their paychecks. Here are a few employee deductions to double-check.

• Health insurance: In addition to ensuring that health insurance deductions are taken from the proper workers’ payroll, you should ensure that they are deposited in the correct insurance payable account and that timely payments to the insurance carrier are made.
• Garnishments: Check to see whether garnishments are being recorded and if deductions are being made from workers’ paychecks. Check to see that the withheld monies are paid on schedule and from a garnishments payable account to the requesting agency.
• Check that the 401(k) employee and employer payments are remitted to the bank at the conclusion of each pay period, and that the employer contribution amounts and percentages are right.

You may wish to have different payables accounts for each vendor and kind of deduction. Businesses in states that require employers to give commuter benefits, for example, may create a separate account for this purpose. This simplifies payroll accounting and payroll audits for you.

Check to see whether the information on your payroll account matches the information on your bank account.

You may check whether there are any sums being paid out of the cash account that don’t belong by comparing bank account statements to your payroll cash GL account. You may also check to see if any workers haven’t collected their last paychecks or if a payroll amount was paid twice to the same employee. You’ll want to address these concerns.

You must cancel and reissue checks if you have dismissed workers whose unclaimed last paychecks have gone stale. To prevent a scenario like this, we suggest reaching out to these workers a few times. You must deliver their cheques to the state as unclaimed monies if you are unable to contact them.

6. Keep an eye out for any unusual transactions and make a note of them.

This is when you examine your gut and search for anything out of the ordinary. If an employee has been paid $2,600 every pay period for three months and then receives a $5,000 cheque, you should investigate. If you see a garnishment payment that appears to originate out of nowhere and you are unaware of it, look into it more.

Here are some unusual deals to keep an eye on.

• Retro Pay: This is a line item that is generally included to an employee’s paycheck when you pay them after a payroll error occurred in a previous pay period. Maybe they earned a raise but it wasn’t processed in a timely manner, or maybe they neglected to notify you that they worked six hours on Saturday. After that, the retro pay amounts are applied to their present salary. These transactions, however, should be rare.
• Back pay is required when a government agency orders you to pay someone for things from previous pay periods, such as miscalculated overtime pay, paying a worker below minimum wage, or docking an employee’s salary unlawfully. Back compensation may be imposed by the court as part of the verdict in situations of wrongful termination. If you’re often required to pay back pay, it’s a sign that your company has an HR or payroll compliance issue that has to be addressed in the future.
• Garnishments: Garnishments (such as child support) are handled differently in each state, and the IRS may also garnish a person’s salary for past taxes. You should double-check that the right amounts are deducted and paid, and that garnishment evidence is kept on file for payroll records.
• Review copies of 1099 Forms and W-9 Forms if you’re a freelancer. To avoid tax fines, you should also make sure that your company is not deducting payroll taxes on amounts paid to freelancers and that your freelancers are categorised appropriately.

7. Reconcile the Payroll and Bank Accounts

In addition to checking your GL, you should analyze the bank accounts you’ve set up to handle payroll (such as employee paychecks and direct deposit transactions) and payroll tax payments. Here are several data points to double-check.

Check to see whether the numbers are correct.

Banks sometimes make errors, such as sending paper checks when all of your workers have signed up for direct deposit, and fees or reversals on your bank account that don’t seem to be correct. Check the balances and transactions in your bank accounts utilized for payroll processing against what’s in your GL accounts to make sure the data they represent match.

Look for any checks that haven’t been cashed.

Checks that have been uncashed for a year or longer are subject to escheat laws, often known as unclaimed property laws, in your state. The employee owns the cheque amount, but how you manage it differs by state. Check your state’s rules for transferring unclaimed cash to a government agency.

Ensure that all tax payments are made correctly and on time.

Compare the due dates on your bank account to the tax agency’s due dates to see whether your tax payments are on time. Even if you use third-party payroll software or a service to handle your tax payments, you should double-check these transactions since errors do happen. You, not the payroll processor, are usually accountable for late tax payment penalties in certain situations.

Payroll Audits: Why Do You Need One?

Payroll audits may assist you in ensuring that your company’s payroll systems are accurate. It operates as a risk-avoidance strategy to save you from making expensive blunders that might harm your company’s image. Payroll audits often include examining and verifying data from a variety of software systems and applications that handle your employees’ information, such as pay rate, overtime regulations, pay type (salary vs. hourly), and employee job categorization (exempt vs nonexempt).

Auditing also aids in the detection of payroll-related fraud and inadvertent errors. A staff worker, for example, may have gone part-time but is nevertheless given a full-time pay. A employee with access to payroll and bank accounts, on the other hand, may take money from one account to pay herself more. This will almost certainly be discovered during your payroll audit.

Separate persons controlling workers, timekeeping, and payroll data is one of the best methods for preventing possible fraudulent payroll operations. HR shouldn’t be able to make payroll modifications if they can add a new employee. Instead, division of responsibilities is required to prevent the incentive for employees to steal from you. Following that, payroll audits ensure that your procedures are being followed.

Conclusion

You don’t have to wait until the end of the year to conduct a payroll audit. Pay attention to your instincts. It’s time to examine if anything doesn’t seem or feel right in your accounting system or payroll bank account. After all, it’s your money on the line and your company’s image on the line if payroll breaches go unnoticed. You can avoid being punished for late taxes or sued for unfair pay practices by conducting regular payroll audits.

A payroll audit report is a document that provides the information on the company’s payroll, including the number of employees, their hours and wages. A checklist for conducting a payroll audit can be found here: “payroll audit report deloitte“.

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