Payroll Audit Checklist & How to Run It

A payroll audit is among the most integral processes that assure accuracy and ensure compliance in the payroll system of an organization. It consists of reviewing payroll audit procedures, payroll records, and controls to uncover errors in payments and fraud. Auditing payroll process on a regular basis helps an organization avoid expensive mistakes, prevent the loss of employee trust, and maintain legal requirements.

What is a Payroll Audit?

A payroll audit examines the payroll process of a given organization to establish whether employees are paid properly and if the operation is in full compliance with all prevailing laws and regulations. Some of the aspects of concern include employee records, timekeeping, wages, benefits, deductions, and tax filings.

This procedure ensures that all discrepancies, errors, and possible fraud in payroll management are properly identified. Different steps are followed in the typical payroll audit program in order to ensure a comprehensive evaluation of each payroll component.

Why Audit Payroll?

Payroll auditing is very essential for many reasons, including the following:

Ensuring Accuracy: Ensuring that employees receive the correct pay for the job done with all entitled benefits.
Complying with Laws: Ensures compliance with minimum wage, overtime wages, and taxes according to local, state, and federal labor laws. That is usually referred to as the payroll compliance audit.
Fraud Prevention: Identifies any evidence of payroll fraud or unauthorized changes in payroll data.
Improves Efficiency: Assists in streamlining the payroll process and eliminates unnecessary steps or duplication of effort.
Builds Trust: Avails transparency and trust between employers and employees about the payments.

Types of Payroll Audits

There are many types of payroll audits. Each focuses on various aspects of payroll management:

Internal Payroll Audit: Conducted by the internal staff of an organization, usually the human resources or finance departments. It is usually done periodically to ensure sustained payroll accuracy. An internal payroll audit checklist helps ensure that everything that needs to be covered is there.
External Payroll Audit: This is done by an outside auditor or some third-party firm to provide a non-biased view of the payroll. It is usually requested by the stakeholders or some regulatory body.
Compliance Audit: This is an audit where only compliance with the labor laws and tax regulations of the organization is targeted.
Operational Audit: This type of audit helps evaluate the overall process of payroll which involves technology, systems, and procedures followed to perform the tasks.

Steps to Conduct a Payroll Audit

In conducting the payroll audit, there is a need for a structured approach. A checklist in the payroll audit serves as an assurance that all aspects are properly addressed:

Audit Preparation: Clearly outline the scope and objectives of the audit. Select the type of audit to be conducted and identify what documents and records will be checked.
Collection of Payroll Data: Prepare all payroll data, such as records of employees, timesheets, pay slips, tax forms, benefits availed of, and any other payroll data related to this.
Employee Data: Verify that employee information is updated correctly. Name, address, social security number, etc., are some of the personal data to be validated.
Timekeeping Records Review: Review timekeeping records and analyze whether the employees are paid rightly for the hours worked, overtime hours, or while on sick leave or vacation.
Wages and Salaries Verification: Wages and salaries must be rightly paid according to the different employment contracts, minimum wage, and overtime requirements.
Analyze Deductions and Benefits: Confirm all the deductions for things such as taxes, health insurance, retirement plans, and other fringe benefits for their accuracy and conformance with laws and regulations.
Payroll Taxes: Payroll taxes should be appropriately computed and withheld; taxes are to be reported or deposited as required with relevant agencies.
Payroll Controls: The internal controls over payroll processing also need analysis to identify weaknesses or opportunities for any improvement.
Future Errors & Discrepancies in Records: Highlight all errors, discrepancies, and inconsistencies noted within the audit.
Payroll Audit Report: Present a detailed payroll audit report about findings, issues noted, and recommendations for changes.
Corrective Actions: It includes an action plan to be used for identifying and correcting identified issues.

Payroll Audit Checklist

To ensure that your organization’s payroll audit is effective, we have put together an Excel template for a payroll audit checklist. The template below is based on the payroll audit process highlighted to help you stay on track with the following:

Task	Done	Not Applicable	Note
Review Employee Data
Ensure payroll data matches the information the employee received
Make sure everyone being paid is an active employee
Verify employee classifications (exempt vs. non-exempt, full-time vs. part-time, etc.)
Review hours worked and paid
Verify hours worked against timesheets
Check for discrepancies between scheduled and reported hours
Check variable payments and different types of Compensation
Check overtime pay, bonuses, commissions, and piece-rate information
Make sure tipped employees report their actual earnings
Check vacation pay and/or shift differentials
Verify compliance with minimum wage laws
Examine and document typical payroll transactions
Look at signing bonuses, relocation pay, back pay, previous corrections, and reimbursements
Review payroll advances and loans and their repayment terms
Liaise with the payment department, if needed
Check tax withholdings and deposits
Check if your withholding amounts are correct
Check if you are paying the right income taxes
Be mindful of changing laws and regulations
Watch out for different tax withholdings for office and remote employees

Below is an elaborate payroll audit checklist that you can always adapt to suit your organization’s needs:

Internal Payroll Audit Checklist

Employee Data Review
Validate payroll information against data provided to employees.
Ensure all employees on payroll status are currently working.
Validate classification of employees, such as exempt or non-exempt, full-time or part-time.

Hours Worked-Paid Reconciliation

Hours worked need to be tested against timesheets.
The variance between scheduled versus actual hours worked should be identified.

Variable Payments-Compensation Types Check

Validate overtime pay, bonuses, commissions, and piece-rate payments.
Ensure that tipped employees report their actual earnings.
Validate vacation pay and shift differentials.
Determine whether laws governing minimum wage have been complied with.

Account for and Document Unusual Payroll Transactions

Validate signing bonuses, relocation payments, back pay, prior corrections, and reimbursements.
Determine payroll advances or loans and the repayment terms.
Coordinate with the finance department where applicable.

Tax Withholdings and Deposits Check

Verification of the correctness of withholdings
Verification for correct income tax payments
Notices of changing laws and regulations
Additional variations in tax withholdings for office staff and work-from-home staff.
Confirm that all payments regarding social security, Medicare, and unemployment taxes are being made.

Payroll Reconciliation

Bank statements reconciled with payroll records
Documentation for all changes to direct deposit.
Reconcile payroll liability accounts.

Consideration of Payroll Regulations

Comply with regulations in each state in which the company operates.
Comply with Wage and Hour Laws which includes Fair Labor Standards Act, state laws, etc.

Reporting of Findings

Prepare a payroll audit report.
Provide the report to key personnel on staff.
Record keeping of audits.

Opportunities for Improvement

Identify a list of potential payroll process improvements.
Use technology and automation when it’s available to reduce errors and increase efficiency.
Evaluate the efficiency of payroll software and systems.

Improvement Implementation Planning

Create an action plan regarding the implementation of improvements.
Propose a timeline and budget and seek stakeholder approval of it.
Prioritize improvements and implement them accordingly.
Plan periodic follow-up audits to ensure continued improvement.

Some Common Payroll Audit Issues

Some of the usual issues found during payroll audits include:

Inaccurate Employee Classification: One way to definitely invite non-compliance with the labor laws is the misclassification of employees as exempt or non-exempt.
Incorrect Timekeeping: A tendency is observed where wrong times are kept to either overpay or underpay.
Unreported Benefits: This kind of audit issue arises when benefits are not correctly reported. This might complicate the scenario and lead to some tax issues.
Improper Deductions: Mistakes made while calculating various deductions for taxes or benefits can lead to severe compliance issues.
Lack of Documentation: Partial or incomplete records bring complications to the audit process and raise red flags with regulators.

Payroll Audit Best Practices

One needs to take care of the following pointers to ensure that they follow best practices while auditing payroll:

Regular Auditing: You need to audit payroll regularly to guarantee that it processes with the highest level of coherence.
Use Payroll Software: You also need to implement robust payroll software so it can digitize your calculation work and lessen the risk associated with any discrepancies.
Accurate Record-Keeping: You will have to keep full and accurate records of all payroll transactions and employee information.
Law Updated: You must study labor laws and regulations regularly to stay updated.
Train Employees: Impart training in payroll processing to the concerned employees for minimal errors and increased efficiency.
Segregate Duties: Separate duties related to payroll preparation, approval, and payment to prevent any type of fraud.

Benefits of Regular Payroll Audits

Cost Savings: Errors found earlier, provide an avenue to evade huge fines and overpayments.
Improved Compliance: Regular audits will ensure compliance with labor laws and tax regulations.
Enhanced Accuracy: Audits discover mistakes and discrepancies, hence enhancing payroll accuracy.
Fraud Prevention: Auditing regularly prevents fraudulent activities due to oversight and accountability.
Improved Employee Relations: Helps employees get paid correctly and builds trust in the organization.

Challenges in Conducting Payroll Audits

Time-Consuming: Audits can be very labor-intensive, especially when dealing with large organizations that have several employees.
Data Complexity: Maintaining and analyzing a large volume of payroll data is extremely difficult.
Constant Regulatory Changes: Changes in labor laws and tax regulations are happening and shifting so frequently that it’s hard to stay updated.
Employees’ Reluctance: Workers also refuse to give information owing to threats of scrutiny or layoffs.

How to Overcome Payroll Audit Challenges

Use Technology: There is technological assistance through payroll software by means of using the technology for collecting and analyzing the data.
Hire Experts: Third-party auditors or payroll specialists can be hired to do the audit. 
Set a Clear Procedure: Establish practices and instructions to make audits easy.
Employee Communication: Inform employees about the process and purpose of the audit in order to gain their cooperation.

Conclusion

Payroll audits ensure accuracy, compliance, and efficiency within payroll management. This can be achieved by periodic audits through an efficient payroll auditing program. This will help an organization find and make changes, prevent fraud, and gain employee trust. Also, best practices like the use of technology, record-keeping accuracy, and an all-inclusive internal payroll audit checklist are going to help overcome or reduce challenges in a payroll audit. Regular auditing protects an organization from potential risks associated with finances besides creating a workplace environment that is transparent for all.