How to Create a Payroll Audit

Photo of author
Written By Nidhi Sharma

Lorem ipsum dolor sit amet consectetur pulvinar ligula augue . 

Internal payroll audits can help you avoid external ones. Here are the steps to perform them.
It was difficult to calculate your employees' wages before the advent of payroll software. This meant that each employee had to do their calculations meticulously.

To avoid any problems down the line, these calculations needed to be accurate. Although payroll software has made this easier, payroll audits are still necessary to avoid human error.

What is a Payroll Audit?

A payroll audit involves reviewing the payroll software and processes of your company to verify that they are correct. A payroll audit will confirm that your company is paying the correct salaries to your employees and managing your payroll withholding. Also, you will verify that benefits-related deductions have been properly taken from employees' paychecks.

Most payroll audits are performed internally rather than at the request of the IRS. However, IRS audits do occur. Regular internal audits may help you avoid being subject to an IRS audit. If an internal auditor finds errors, you can correct them by making additional tax or wage payments.

How to do a Payroll Audit

Although payroll audits can seem daunting, once you get started, you'll soon see how simple they are. Here are the steps to perform them.

1. Check all Employees on Your Payroll.

Take a look at your entire payroll. Ask yourself the following questions: Is anyone missing? Are they missing? Are you unable to recognize a name?

Check the payment history of any employees on your payroll that shouldn't be there. Most likely, you forgot to delete the employee from your payroll software. You may have to contact the former employee to resolve the matter and get the money back.

If you find a name on your payroll you don't know, it is a serious problem. An in-depth investigation is required to identify the source of this problem. You could lose money that you owe no one if you don't do this.

2. Take a Look at All of Your Numbers.

Verify that you have recorded the correct wages by checking each employee's pay rate. The information might not be correct if you have given a raise to a staff member or changed them from an hourly worker to a salary. Adjust the amount to reflect correct wages, pay back any owed pay, and then go on to the next set.

Once you have verified wages, take a look at the hours each employee worked in each pay period. If the numbers are consistent with what you recall as the employee's work schedule, then you're good to go. If you don't see the hours the employee worked, it could be a problem.

While it is one thing to offer vacation days as paid time off, it can be quite another if the employee provides inaccurate timesheets.

Next, take a look at the total hours worked and their pay. The employee's total salary should be equal to the sum of their wages and hours worked. The total hours of an employee should equal the sum of all hours worked per paycheck. These conditions will ensure that your numbers are accurate.

Your numbers may be off in another area: employees classified exempt or nonexempt. You should ensure that overtime compensation has been paid to employees who are not exempted from overtime pay under the Fair Labor Standards Act (FLSA). Adjust your payroll records to reflect this and pay the back pay.

3. Take Vacation Time Into Consideration

Paid time off (PTO), can be represented as days worked in your payroll software. Sometimes, it is easy to distinguish vacation time from actual hours worked. Some payroll software allows employees the ability to mark certain hours as PTO days. Your payroll software will know to subtract these vacation days from your employee's total hours.

The employee is responsible for operating within the honor system when using a PTO tracking system. The employee has the final say on whether or not they record their vacation days as such. They can also choose to keep their regular paid days. Your business will suffer if they run out of vacation days.

After reviewing PTO, you should review all days off for your employees to make sure they are properly labeled. Separate them for unpaid vacation, paid vacation, personal days off, sick leave, parental or grief leave. These three categories can be either paid or unpaid.

4. Check Out Other Payment Records.

You can also record employee payments in your payroll system. Your ledger and your bank account also reflect payroll disbursement. All three areas should have the same numbers. You will need to dig into your records if you discover discrepancies.

After identifying the cause of the discrepancy you can rectify it. This should fix any errors in the way you pay your employees. It leaves one final area of payroll open to analysis.

5. Analyze Tax Reports.

You must withhold income, Medicare, and Social Security taxes when you pay employees. This task should be handled by your payroll software and you will need timestamped records. It's a good idea to verify mathematically, by hand, that you have withheld the correct amount for each tax type. You should do the same for any local or state taxes you pay to your employees.

Auditing Payroll is a Requirement?

Although auditing payroll is not a requirement, most payroll experts recommend that internal audits be done. Internal audits, as we've already mentioned, can help you avoid trouble. Internal audits also keep you and your employees happy so that they receive accurate wages. These are only two reasons to conduct payroll audits.

Payroll Audits Have Many Benefits

Small business owners will reap the benefits of regular payroll audits. These are just a few of the many benefits of regular payroll audits.

Fewer Compliance Errors

Payroll audits could reveal that you are not deducting enough income tax from your employee's paychecks. This information will allow you to correct any mistakes and prevent the IRS from identifying a lack of compliance. The IRS can punish you if it finds a problem. Worse, the IRS may conduct its audit which is costly, time-consuming, and stressful.

Happier Employees

Let's suppose you give your employee a raise but forgot to add it to your payroll software. This will cause the employee to be underpaid until you correct it. Most likely, the employee will be aware of the mistake and come to you. Although you will correct the error immediately, your employee may not be happy.

This could have been avoided if you did a payroll audit. You will likely find out that you did not add the raise to your payroll software. Then, update your software immediately and make retroactive payments.

It will be possible to approach your employee and explain the error, apologize, and assure them that they will receive their back pay. Your employee will feel more secure if you take this proactive approach.

Easier Fraud Identification

While trusting your employees is a great way to create a better work environment, a coworker can submit timesheets that don't reflect their actual hours. This fraud can be identified by a payroll audit. You may notice fraud if you have a payroll system that shows an employee working a certain amount of hours but not showing a higher number.

You might have forgotten their hours or they may have filled out the wrong timesheet. Employees who commit fraud often confess to it when confronted.

Former Employees May be Fired Earlier

Payroll audits can help you recover data from former employees that could be taking up unnecessary storage space in your payroll system. Regular audits help you identify employees that are still in your payroll system, even if they're not being paid.

Before you delete an ex-employee, consider the tax implications. You may need to issue tax forms to employees in the future. Make sure you don't delete them from your payroll system. Also, ensure that you have paid all outstanding wages. You can remove an employee from your system without having to reinstate them.

How Often Should Your Payroll be Audited?

A payroll audit should be conducted at least once a year. There are many benefits to performing a payroll audit more often. A good practice is to audit your payroll at least twice a year, but quarterly is better. You will spend less time correcting errors if you catch them sooner.

Leave a Comment