What is a payroll audit

Payroll audit refers to the process of reviewing a company’s payroll system and records to ensure employees are being paid correctly and the company is complying with relevant laws and regulations. 

Comprehensive payroll audits include reviewing payroll tax filings, employee classification, overtime calculations, benefits administration, and other payroll-related processes. Whether you own a big or small business, the human resources team should insist on a regular payroll audit within scheduled time frames.

Why conduct a payroll audit?

A payroll audit ensures a company follows best practices and legal requirements, identifies areas for improvements to increase efficiency, and reduces the risk of errors or non-compliance in record-keeping, tax reporting, employee pay rates, and payroll.

An auditor may examine payroll records, employment contracts, tax returns, and other relevant documentation during a payroll audit to identify discrepancies or potential issues. Whether you pursue external audits conducted by a registered CPA or internal payroll audits, an audit report offers great insights.

Benefits of a payroll audit

Conducting an effective payroll audit can provide a company with a range of benefits, including the following.

Ensure compliance with legal and regulatory requirements

A payroll audit ensures compliance with legal and regulatory requirements by thoroughly reviewing a company’s payroll system to identify areas of noncompliance. The audit examines payroll practices and procedures to ensure they align with applicable employment laws and regulations, such as minimum wage, overtime, tax laws, and benefits administration. 

Identify potential errors or discrepancies in payroll calculations

A payroll audit identifies potential errors in payroll calculations by examining a company’s payroll system and records in detail. Close analysis helps to improve the accuracy and reliability of a company’s payroll system.

Reducing the risk of legal or financial penalties

By detecting and correcting inaccuracies, a payroll audit helps to mitigate the risk of legal or financial penalties, such as fines or legal action, which can be costly for the company and add to payroll expenses. A payroll audit also improves the accuracy and reliability of the payroll system, reduces the risk of fraud or other irregularities, and assures stakeholders that the company is operating ethically and transparently.

Improving overall accuracy and efficiency of payroll processes

The audit may identify opportunities to automate certain processes, streamline workflows, or implement new payroll software that helps reduce the risk of errors and make regular payroll audits less time-consuming. 

Payroll audit checklist

Several steps are required to conduct a payroll audit and ensure a company’s payroll system is accurate, reliable, and compliant with applicable laws and regulations.

Review payroll processes and procedures

One of the essential steps in a payroll audit is to review the company’s payroll processes and procedures. This step involves examining the policies and procedures governing payroll activities, such as how pay rates are determined, how overtime is calculated, and how employee benefits are administered. 

Reviewing payroll processes and procedures aims to identify discrepancies or inconsistencies that may lead to inaccuracies or non-compliance with relevant laws and regulations.

Examination of payroll records

When examining payroll records, auditors review employee files, timesheets, pay stubs, bank statements, and tax filings to ensure all information is accurate and up-to-date for the current pay period. Tax forms and tax payments are examined alongside the number of active employees to ensure payroll compliance.

Identifying payroll errors or discrepancies enables the auditor to recommend corrective actions that ensure employees are paid accurately and in compliance with legal requirements.

Verification of employment data and payments

Verifying employment data and payments involves confirming the employee’s name, social security number, and employment status, as well as other details such as eligibility for overtime pay, the correct amount of tax withholdings, and income tax.

The auditor will also verify that all payments, including salaries, wages, bonuses, and benefits, are accurately calculated and appropriately authorized. This step is key to identifying discrepancies or irregularities, such as fraudulent activities or unauthorized payments, and recommending precautionary measures to prevent similar issues from occurring in the future.

Identification of errors and discrepancies

At this stage, payroll reports are cross-checked with the general ledger. Common errors include incorrect pay rates, overtime calculations, and benefit deductions. By identifying errors, auditors can suggest alternative actions. 

Being proactive about identifying errors helps to reduce the risk of legal and financial consequences for the company.

Recommendations for improvements

All of the above steps help an auditor make recommendations for future payroll audit procedures. Suggestions may include improving policies and procedures, implementing new software or technology, or providing additional training to employees responsible for payroll processing. 

By recommending improvements, auditors can help the company to increase efficiency, reduce the risk of errors and noncompliance, and enhance the accuracy and reliability of the payroll system.