The end of the month generally indicates the end of payroll; salaries are paid, and all systems are in place. However, the receipt of an unexpected payroll audit notice, along with other compliance requests, transforms the once normal process into a difficult task of collecting paperwork, records, calculations, and related explanations.
Employers often experience payroll audit notifications arriving without prior notice. Internal errors, changing regulations, complex pay structures, and increased dependence upon automated payroll software (HRMS) can result in negligible errors, creating expensive financial suggestions and destruction of the company’s reputation.
Hence, the payroll audit process has gone from reacting to a request to now a proactive, preventative measure designed to protect employers from making payroll compliance mistakes and to prevent payment errors, violations of employer intent, legislative violations, and the like. Additionally, payroll audits protect the ethical integrity of the employer as well by reducing the potential for corporate negligence or unethical business practices.
What Is a Payroll Audit?
Payroll Audit Definition: A Payroll Audit refers to a detailed examination of an organization’s payroll processing procedures, systems, documentation, and controls for the purpose of determining if the calculations of employee compensation are accurate and that all calculations are in accordance with corporate policy and current federal and state employment law. A Payroll Audit will review employees’ pay, withholdings, benefits, tax withholdings, attendance records, and compliance with all state and federal laws.
Both the Human Resources and Finance departments of an organization can perform internal payroll audits, while external auditors and governmental regulatory agencies perform external payroll audits. An External Payroll Audit focuses not only on the identification of flaws and disturbances; it also verifies that the payroll system, payroll software, and all Human Resource software are working properly and consistently.
In addition to assuring compliance with federal and state laws and validation of payroll calculations, Payroll Audits also help companies maintain the integrity of the Human Resources Management System (HRMS), Attendance Management System (AMS) and Leave Management System (LMS) and assure that they accurately reflect the actual amount of time and leave employees have taken and also accurately reflect the employees’ available leave benefits.
Why Payroll Audits Are Important for Businesses?
Payroll audits protect organisations from losing money, getting accused, and experiencing other operational problems. By reviewing company payroll records periodically, companies can detect payroll errors quickly, remain compliant with federal and state laws, and build employee confidence in their company. A strong payroll audit process improves companies’ decision-making capabilities and enhances their internal controls.
1. Maintain Legal and Statutory Compliance
Payroll audit results can help identify whether an organization is compliant with applicable laws (such as wage and hour laws), regulations (like IRS regulations), and any statutory tasks related to payroll. Payroll audits ensure that an organization’s filings, deductions, and contributions are made in accordance with both current regulations and documented policies.
Payroll audits also reduce the uncertainty of being compliant by identifying gaps as they occur, which allows for corrective actions to be taken, payroll software to be updated, and consistent application of statutory changes throughout the organization each payroll cycle.
2. Reduce Payroll Errors
Regular payroll audits can prevent payroll calculation errors related to salary, overtime, incentive, and expense payments. Audits also ensure accuracy in providing accurate gross amounts to net amounts upon an employee receiving a paycheck.
Audits of a company’s attendance, leave, and payroll data also reduce manual input, old record-keeping practices, and misconfigured payroll software-based rules and errors throughout all processing cycles due to disturbances.
3. Avoid Penalties, Fines, or Lawsuits
Through payroll audits, employers are able to detect tax miscalculations and late filing of taxes as soon as possible and can be proactive about resolving tax miscalculations and not paying interest and penalties as a result of being late in filing their taxes, which can prevent more serious matters between the employer and the government as well as prevent more extensive action with employees in the future.
With regular audits occurring, employers demonstrate due diligence and have documented evidence available in the event that they become subject to an inspection, inquiry, or any other action. This information will strengthen the employer’s overall compliance attitude and reduce its overall organizational liability as a result of the establishment of clear controls and reports.
4. Enhancing Trust Between Employees and Their Employers
Accurately calculated payroll inspires employee confidence in that they will be paid accurately, deductions will be taken accurately, and benefitswill be managed fairly, openly, and consistently every pay period, without being subjected to errors.
Regular audits also help to reduce payroll errors, improve communication, and support HR’s credibility, which is positively related to employee confidence, engagement, and retention in the long term across a variety of teams and departments.
5. Improving the Financial Accuracy of Your Business
When payroll is audited, correct compensation costs get entered into the corporate books and can therefore provide accurate records for tracking finances by category, managing budgets by department, as well as to validate the accuracy of payroll information reported in the corporate financial statements.
Using payroll as a measure of workforce costs and productivity records, payroll provides finance managers with a means to effectively make decisions regarding how to best use troubled resources and build organizational performance.
6. Improving Your Company’s Internal Control System
Through audit assessments of payroll processes and approval workflows, payroll audits identify control weaknesses that could potentially cause payroll errors, fraud, or unauthorized changes to the HRMS system.
Payroll audits provide organizations with stronger internal controls through the establishment of appropriate separation of duties and create standardized approval processes along with checks that are built into both payroll and HR software solutions.
7. Supporting Your Company As It Grows
Payroll audits help you manage the growth of your company’s employee base and expand the complexity of your organizational structures while still allowing you to remain compliant with all regulatory requirements as you experience rapid growth.
Payroll audit practices that can be automated within an HRMS environment allow a company to standardize its payroll processes, maintain compliance, and increase the level of compliance with the regulatory body, while allowing the company to scale as needed, allowing the business to continue to succeed without any interruption or loss of quality due to compliance issues.
What are the key practices for an Efficient Payroll Audit?
An effective payroll audit requires structure, consistency, and the right tools. Below is a practical payroll audit checklist every employer should follow:
1. Verify Employee Master Data
The accuracy of employee master data determines the correct calculations of payroll in relation to employee roles, salaries, and banking information. The higher level of accuracy means there will be fewer errors in payroll and compliance risk between the payroll and HRMS systems.
2. Review Salary Structures
The salary structure review determines that fixed and variable salary components are in accordance with the offer letter, policy, and pay scale. This will result in the consistent processing of payroll and eliminates possible errors.
3. Validate Attendance and Leave Data
Validating the attendance and leave data ensures that the payroll accurately reflects the appropriate number of days worked, any overtime, and absences that would be reflected through the attendance management software and leave management software.
4. Check Statutory Deductions
Reviewing all statutory deductions verifies that the tax has been calculated accurately, that contributions are deposited in a timely manner, and that we are compliant with all relevant regulations. The more accurate the statutory deductions are, the fewer penalties will occur, and the easier it will be to maintain a payroll that is ready to pass an audit.
5. Audit Overtime and Incentives
When auditing overtime and incentive payments, the audit will verify that the overtime payments and incentive payments were approved, calculated accurately, and that there is supporting documentation. An audit will prevent over-payments, under-payments, or disturbances between cycles of payroll processing.
6. Accommodate Payroll Reports
Payroll reports with accounting records and bank statements will help find errors before the next payroll period; therefore, ensuring financial accuracy and information used for reporting payroll expenses.
7. Review Access and Approvals
Reviewing the payroll system on access and approvals will strengthen internal controls by limiting unauthorized changes and providing the appropriate level of privacy for duties in the payroll system.
8. Document Findings and Actions
Documenting findings from the audit and the corrective actions provides enough documentation of what happened during the audit, establishes accountability, and improves payroll in the future.
Step-by-Step Payroll Audit Process
Managing payroll audits becomes easier when split into clear and actionable steps:
Step 1: Establish your audit objectives and scope
By defining the audit scope and objectives clearly, you help keep the audit focused and organized while also helping make sure it is compliant with appropriate legislative and business requirements:
- Define your reason for conducting the payroll audit
- Identify the period to be audited (monthly, quarterly, annually)
- Decide on which elements of payroll will be examined in the audit
- Identify what statutory compliance and legislative requirements must be reviewed
- Determine what constitutes a successful audit
- Assign responsibilities for the audit.
Step 2: Collect payroll and hr data
Accurate and complete payroll and hr data will provide an acceptable basis for the coming audit analysis and validation.
- Obtain payroll registers and payslips from the payroll system
- Download all employee master and salary information from the payroll system
- Collect all records related to attendance and leave
- Collect all statutory and compliance-related filings and reports
- Recover all accounting and bank payment records
- Ensure that the records for payroll data are complete and accurate.
Step 3: Review employee records
Through reviewing employee records, you are confirming that the employee records are consistent with employment agreements, company policies and payroll regulations.
- Verify the classification and employment status of all employees
- Cross-verify the salary structure and salary changes for all employees
- Confirm that all employees have accurate joining, exiting, and transfer dates
- Cross-verify bank account and personal details changes
- Confirm that each employee record has supporting documentation that verifies it has been processed according to HR regulations
- Identify any employee records that need to be updated or that do not have a record in the employee database.
Step 4: Review attendance and leave records
Reviewing and analyzing attendance and leave records ensures that payroll will accurately reflect all working hours and any approved time off.
- Match attendance data with payroll inputs
- Verify leave balances and approvals
- Review overtime and shift records
- Check system integration accuracy
- Identify disturbances in working hours
- Confirm compliance with attendance policies
Step 5: Verify Payroll Calculations
The fifth step in the process of verifying that you are using the correct maths to calculate your payroll is to ensure that all payroll calculations are correct, are done each pay cycle correctly, and are compliant with the law:
- Validate the gross salary calculations
- Confirm payroll deduction quantities and employee contribution amounts
- Validate all incentive, bonus, and reimbursement payments
- Recalculate the example payrolls
- Ensure that there are no configuration errors or rounding errors
- Ensure consistency in payroll processing across every pay cycle
Step 6: Assess Statutory Compliance
The sixth step in the payroll process is evaluating statutory compliance to ensure that the payroll practices of an organization meet all regulatory requirements and filing obligations.
- Evaluate the calculations for all tax deductions
- Confirm the statutory contribution amounts
- Verify the filing of chalans within the correct timeframes
- Validate all compliance reports and registers
- Ensure that all regulatory updates have been incorporated into the pay system
- Identify any documentation gaps that exist within the payroll processes
Step 7: Identify Gaps and Risks
The seventh step in the payroll process is identifying the gaps and risks in the payroll process to enable an organization to address issues proactively so as not to impact compliance or the accuracy of payroll.
- List payroll disturbances and errors
- Highlight any inefficiencies in the payroll process
- Identify any weaknesses in controls and approvals
- Identify the risks associated with noncompliance and the financial impact
- Analyze the root causes of issues and errors
- Prioritize the risks based on impact to the organization
Step 8: Implement Corrections and Improvements
The last step in the payroll process is the implementation of corrective actions to enhance payroll processes and promote ongoing improvements and audit readiness.
- Correct any payroll errors and adjustments
- Update any payroll and HRMS configuration settings
- Enhance and improve approval workflows and control processes
- Change the payroll policies, if required
- Conduct payroll and HR training for HR and payroll staff, as needed
- Establish an ongoing audit practice for payroll processing.
Common Payroll Audit Issues and How to Prevent Them
1. Employee Classification Errors
The Problem: Wrongly classifying an employee negatively impacts the accuracy of tax withholding, the calculation of tax benefits, and ultimately creates non-compliance issues as per statutory regulation.
The Fix: Clearly define the rules of an employee’s classification within your Human Resources Information System (HRIS) and periodically review your processes for classification.
2. Time & Attendance System to Payroll Systems Mismatch
The Problem: The payroll calculation of hours worked does not match the actual hours worked due to a poorly integrated time and attendance system with the payroll system.
The Fix: Create a system that automatically updates the payroll system based on information from the time and attendance and leave management systems in real-time.
3. Errors with Statutory Deductions
The Problem: The employer’s tax withholding rate may be incorrect, and the employer may not be aware of changes to tax laws and regulations and as such may be penalized for not complying.
The Fix: Maintain current statutory requirements in a payroll system and periodically validate the payroll system for compliance.
4. Manual Adjustment of Employee Payroll
The Problem: Manual overrides of employee payroll increase the risk of making mistakes in payroll calculations and inconsistency in the payment of wages.
The Fix: Pay employees through the usage of automated payroll calculations in your HRMS while restricting access to manually edit payroll through an approvals workflow.
5. No Timely and Accurate Updates on Employee Data
The Problem: The delay in updating the payroll processing of an employee’s salary increase or promotion will still show the previous salary amount.
The Fix: Use a single point of reference for all employee-related changes and ensure that information is updated promptly.
6. Absence of Sufficient Documentation and Audit Records
The Problem: The absence of documentation of payroll processes or missing audit trails reduces the ability to audit payroll processes effectively and efficiently.
The Fix: Use HR software that creates a detailed log of all payroll activities, including reports, and system-generated audit trails.
How Savvy HRMS Simplifies the Payroll Audit Process?
By providing an all-in-one solution for payroll, HR, attendance, and leave data, Savvy HRMS removes the barriers that otherwise exist between these different types of data sources and allows for accurate, up-to-date payroll calculations based on real-time data. With this capability, payroll audits are made easy.
Automated payroll software like Savvy HRMS also helps to reduce human error through the automated syncing of both attendance and leave management systems with the payroll processing system. Built-in validation helps to ensure salaries, deductions and statutory contributions remain compliant with applicable laws and regulations.
Examples of the SOPs (Standard Operating Procedures) provided by Savvy HRMS include audit-ready reports, approval workflows and detailed audit trails, which can substantially reduce the time needed to complete both internal and external payroll audits and improve the transparency of the process for both HR and finance teams.
Conclusion
While payroll audits can feel like compliance activity, they are truly a way to strategically manage risks and an excellent way to develop transparency and accuracy within the organization.
Utilizing best practices to identify potential issues and create a structured payroll audit process by utilizing checklists for payroll audits gives employers a better chance of proactively managing their payroll risk and strengthening Payroll Governance. Modern payroll audit solutions like Savvy HRMS make payroll audit processes much easier, faster, and more reliable. Integrated payroll systems, HR systems, time and attendance systems, and leave systems help businesses maintain a state of audit readiness at all times, facilitating business compliance and confidence as well as preparing for the future.
