HOW TO PREPARE, SURVIVE & THRIVE PAYROLL AUDITS

What Sould a Payroll Audit Include?

A complete and successful payroll audits analyzes the following information in a company’s payroll processes:

• Employee Rosters; It is a list of employees and their tasks to perform, and it can be used for various purposes, such as tracking absences or managing shifts.
• Employee Compensation and Tax deductions; overtimes, variable, and atypical payments.
• Time clock data; i.e Timesheets. These include days off, paid and unpaid leave days taken, hours worked for, etc.
• Taxes and all other deductions.
• Number of payrolls; to match with the number of paychecks under audit. i.e to match with the lookback period.
• All atypical payrolls; to include payments made for part-time, temporary, or contract-based, and casuals.
• General ledger and the bank account reconciliations; ensures that all transactions specifically involving payroll are properly recorded and supports the integrity of the general ledger and other financial statements.

HR teams should double-check whether processes adhere to updated federal, state, or local laws and make adjustments or issue corrections as necessary. For instance, update their minimum wage laws at the beginning of the year. HR leads should make sure all affected employees’ pay rates are updated appropriately.

Why Should Businesses Conduct Payroll Audits?

Conducting regular payroll audits is crucial for businesses to maintain accuracy, compliance, and trust with employees while also preventing potential financial and regulatory issues. To speed up the payroll audit process, companies are advised to leverage payroll software.

Here are some key reasons why conducting a payroll audit is important:

1. Accuracy and Compliance: A payroll audit helps verify that payroll processes, pay rates, wages, and tax withholdings are correct and compliant with employment laws.
2. Preventing Errors and Fraud: Regular audits can help identify and address errors, prevent payroll fraud, and ensure that all employees receive accurate pay.
3. Employee Satisfaction: Ensuring accurate wages through payroll audits can help keep employees satisfied and maintain their trust in the organization.
4. Financial Record Accuracy: Payroll audits help ensure accurate financial records, proper remittance of taxes, and compliance with financial regulations.
5. Identifying Opportunities for Improvement: Regularly reviewing payroll activities through audits can help identify errors, find opportunities for improvement, and streamline processes

How do you Audit Payroll Records?

Implementing an effective payroll audit is a process that many companies find tedious if they are not well-equipped with the materials needed. A business should determine the payroll audit timeframe and stakeholders, collect all necessary employee pay data, and reconcile them with timesheet records, tax payments, and financial ledgers of the business.

Below are the steps to follow for an effective payroll audit:

1. Determine your stakeholders and payroll audit timeframe.

Too understand this, a business should be in position to answer the following questions:

1. When should companies conduct the audit?

Most businesses choose to run annual payroll audits at the end of their financial year.

Startups, or businesses conducting their first payroll audit or companies in need to address problems in their payroll processes should consider quarterly or semiannual audits.

2. What is the ‘lookback’ period?

Depending on the business preference, the lookback period can be shorter or longer than one year. This then implies, by default, one year is the lookback period for many companies. The shorter the lookback period, the shorter it takes for the payroll audit to be completed and vice versa. This then reflects the cost of the audit process and.

3. Who should conduct payroll the audit?

Internal payroll audits can be conducted by the following:

• Human Resource lead,
• Human Resource Assistant,
• Payroll Masters / Managers,
• Accountant(s), and
• An Executive from the management.

External payroll audits can be conducted by:

Certified external Auditors and any combination of individuals from the Internal audits teams Audit team.
 

Note that; smaller companies may benefit from an unbiased external auditor who has no vested interest in employee salaries, benefits, or the business’s overall health. They are always objective and ready to provide insights and suggestions for improvement. On the other hand, larger businesses with dedicated payroll, finance, and HR teams may wish to run the payroll audit themselves since they have the resources and could save costs.

'
 

Generate employees and payroll reports.

Employee rosters, payroll registers, and other payroll reports covering the lookback period should be generated from the payroll records. Having the best payroll softwares like Elevate HR Africa keeps you up to date with such reports. Such reports include:

should provide all necessary information about employee pay rates, benefits, deductions, taxes, job titles, start and termination dates, other variable payments, and any atypical payments.

• Employee Rosters

This avails reports for the following:

• Active employees listed in every payroll,
• Employees terminated, placed on leave or absenteeism,
• Employees listed but not recognized by the management,

Existence of “ghost” employees is an indication of fraud. These fake employees appear on the employee roster and are getting paid but never received contract letters from the management.

• Payroll reports

Employers should check the following:

• Do the number of payrolls match the lookback period: e.g. an employer with a one year lookback period and a monthly pay period should have 12 (twelve) total payrolls.
• Are the pay periods correct?
• Are all employees paid timely and at their appropriate pay rates?
• Could any discrepancies be the result of a bonus run or other atypical payroll?
• Were any employees misclassified as independent contractors or vice versa?

Match actual payments and hours worked.

Auditors should generate timesheets or time clock data and make sure employees are paid for their actual time worked in every pay period. For example, if an employee works 50 by 4  hours in a pay period when they normally work 40 by 4 hours, auditors should investigate to understand why that is the case.

To avoid scenarios where the investigation reveals someone else clocking in on the employee’s behalf, then that calls the need to have payroll automation softwares in place. ElevateHR seals such loopholes  to stop clocking manipulations.

Next, audit teams should double check overtime hours to ensure employees are being paid correctly. Employees must be paid at their time-and-a-half (overtime) rate for any ordinary hours worked over the stipulated daily working hours and double-time (special overtime) rate for any special hours worked for in the holidays.
 

Examine variable and atypical payments.

The audit team involved should interrogate variable payments which include factors like commissions, bonuses, shift differentials, or tips. The team is supposed to check the availability of documentation in place to support these variable pay structures. These documents might be; a handbook policy or employment contract.

Payments for Paid time off (PTO) should also be well labeled and paid correctly. This includes payments like paid holiday, paid vacation, paid sick leave, paid personal time, or paid jury duty according to company policies.

Atypical payments include reimbursements, back pays, retro-pays, or contractor payments. The audit team should investigate why an employee suddenly earns more or less than they typically make in a pay period. For instance, if an employee typically receives Kes 200,000 every paycheck but suddenly starts receiving Kes 400,000, then auditors should anticipate to see a pay rate increase, variable payments, or atypical payment. If not, then this will be a payroll fraudulent act.

Accuracy of tax deductions and other deductions.

Depending on the different types of employee classification, auditors should double check the tax withholdings for all employees to ensure compliance with the laws.

For instance, a resident-primary employee should be subjected to the following kra tax bands:

Pay from (KES amount) to (KES amount) and inclusive: Tax rate = (percentage)

First  24,000 : = 10%

Next  8,333 : = 25%

Next  467,667 : = 30%

Next  300,000 : = 32.5%

Pay amount above  800,000 : = 35%

Such an employee enjoys the following:

• Allowable deductions before taxation on:
• Total Pension deductions and capped at KES 20,000
• Total mortgage deductions and capped at KES 25,000
• personal relief of KES 2,400 and insurance relief equivalent to 15% of total insurance premiums and capped at KES 5,000.

These computations are applied differently depending on the residential status, and employment type.

Other deductions:

Other than statutory compliance deductions, employees are normally subjected to other paycheck deductions which might include; Savings, Insurance policies, payday loans, payments advances, emergency loans, and so forth. Auditors should review whether these deductions were made timely and accurately. Any discrepancies reported should be investigated and addressed accordingly.

Comparing actual payroll records with the General Ledgers and the bank account statements.

When comparing payroll records with the general ledger and bank accounts, it is essential to ensure accuracy and consistency across these financial records. Payroll reconciliation is a crucial process that helps verify the accuracy of payroll transactions and maintain precise accounting records. Here's how the comparison is typically done:

Payroll Reconciliation Process

Payroll reconciliation involves verifying that the records and information supporting employees’ compensation are accurate. This process ensures that employees are paid the correct amount and on time, supporting broader financial goals and regulatory compliance.

Below are the steps involved in payroll reconciliation include:

• Checking the payroll register against supporting documentation to verify its accuracy.
• Comparing payroll records to the business's general ledger to ensure that payroll expenses in the ledger match the audit findings.
• Reconciling payroll records with bank statements to compare the amounts listed in payroll records to the actual debits from the attached bank account.

Importance of Payroll Reconciliation.

Payroll reconciliation is crucial for maintaining accurate accounting records, which are necessary for tax filing and measuring financial health.

It ensures that all transactions specifically involving payroll are properly recorded and supports the integrity of the general ledger and other financial statements, reflecting the company’s health and profitability.

Steps for Comparing Payroll Records.

When comparing payroll records with the general ledger, auditor should:

• Verify that the transactions in the general ledger match the information on the payroll register.
• Record the correct amount for each employee and ensure that each transaction was recorded in the correct ledger account.
• Confirm that all the accounts affected by a paycheck agree with the gross earnings, including payroll expenses, tax deductions, and employer liabilities or other deductions.

Employ Payroll Software.

Elevate HR Africa

To speed up the payroll audit process, companies are advised to leverage payroll software. Instead of compiling reports for the payroll audit lookback period by hand or by simple excel package, payroll software can instantly assemble all reports in just minutes:

Payroll software automates employee pay and maintains human resource records like time and attendance, which saves time for HR leaders and reduces paycheck errors.

Here are some of the key benefits of using payroll software to enhance smooth payroll audit:

• Time-saving: Payroll software can automate core payroll tasks, which would otherwise take a lot of manual work. It can store employee information, keep you up-to-date with the current tax laws, and even automatically calculate wages alongside taxes. Auditors will love to pull reports instantly.
• Transparency: Auditors appreciate transparency in the payroll process which is enhanced by Payroll softwares. Therefore, a smooth audit process.
• Reduces errors: Payroll software reduces the chances of costly errors occurring. This is always the wish for all auditors.
• Compliance: Payroll software ensures compliance with employment laws and regulations, reducing the risk of penalties and legal issues.
   

Implement a process for future payroll audits.

Businesses should make sure payroll systems are in place for future audits and write a policy outlining a regular payroll audit timeline. Consider the following questions:

• How long did the payroll audit take?
• What worked and what did not work during the payroll audit?
• Were all the personnel involved in the audit necessary?
• Was every area of the payroll audit addressed?

In addition to addressing the questions above, businesses should prepare a payroll audit checklist to improve the efficiency of future payroll audits.

For a video version of this blog, watch our recent webinar here.