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9 Steps to Conducting a Payroll Audit and Why You Should

Each year, during the week following Labor Day, American businesses celebrate National Payroll Week. As an extension of the Labor Day sentiment, National Payroll Week celebrates the significance of “an honest day’s work for an honest day’s pay.” For business owners, the week is a helpful reminder to revisit payroll processes with an audit, ensuring everything is running smoothly.

For many businesses, payroll is a mostly automated process without much active oversight. Audits are your chance to review your books and look for any inconsistencies. In other words, regular audits help ensure that each and every payroll cycle has been conducted correctly.  

To conduct an audit of your own, here are nine steps to follow.

1. Determine the Timeframe and Process

The first step in your audit focuses on establishing the process. Before you begin, take a moment to think about how often you’ll conduct your audits, which team members need to be involved, and any other details that might affect your process. The key is to have an easily replicable plan before you start, so you can follow your standard parameters moving forward. When in doubt, see the rest of the list below!

2. Run a Report for Employee and Payroll Data

Most payroll providers offer numerous reports to help you make sense of your data. If you’re managing payroll yourself, you’ll need to break payroll data down by employee. Run aggregate totals for information like gross payroll expenses, withheld taxes, and net check amounts. 

3. Verify Active Employees, Pay Rates, and Pay Periods

As you dive into your data, pay special attention to employee names, pay rates, and pay periods. For employee names, you’ll want to look for employees whose names you don’t recognize or who have previously been removed from the payroll. Then, for each employee, double-check that pay rates are accurate. Finally, ensure your established pay periods align with the payments themselves.

4. Compare Hours Worked Against Timecard Data

Next, you’ll want to dig a little deeper into hourly data. Watch out for incorrect overtime payments and payroll hours that don’t align with punch card or timesheet hours. Your timekeeping data sources should perfectly match your payroll data sources—if not, something is up. 

5. Look For and Document Any Atypical Transactions

This step is your opportunity to spot-check various components of your payroll process to look for abnormalities. For example, if one employee typically reports 20 hours of work in a pay period and suddenly reports 50 hours, you’ll want to look into that outcome in more detail. The same goes for much higher (or lower) paychecks than usual. If you find any atypical transactions, explore related data to assess the validity. Not all abnormalities are errors, but they should always be examined. 

6. Verify Tips, Bonuses, and Commissions

Tips, bonuses, and commissions introduce a new layer of complexity into the payroll process, and as such, they’re commonly mismanaged. If your employees have these additional compensation avenues, verify commission rates and sales, double-check bonuses and their approvals, and cross-reference staff tips. 

7. Run a General Ledger

Now that most of your payroll process has been analyzed, it’s time to run a general ledger report to cross-reference numbers with your accounting department. The totals for accounts like wage expense and Social Security should perfectly align between payroll and accounting. If discrepancies exist, dig deeper with your accounting team to learn why. 

8. Verify Federal and State Tax Payments and Deductions

Another complexity in the payroll process involves paying taxes on behalf of your business and withholding from employee paychecks. To audit this part of the process, pick a few W-4 forms randomly and verify that the withholding and tax data matches your payroll records. 

There are two quarterly tax filings employers can cross reference to double-check business tax payments:

1. the quarterly 941 forms for your federal tax liabilities 

2. your quarterly state tax and wage report (the form name varies by state).

By editing these quarterly, employers can avoid costly fines for incorrect payments.

9. Verify PTO Balances

Finally, look at PTO balances for employees to look for outliers. Double-check PTO for employees with exceptionally high PTO balances, checking for the possibility that recent PTO wasn’t deducted correctly. Also, take note of employees with negative or zero PTO time, ensuring that each employee is accruing their time off at the correct rate.

When you’ve made it through this nine-step checklist, there’s only one thing left to do: celebrate the completion of your audit! With your audit complete, you can confidently process payroll, knowing everything is running as it should. Audits can be a heavy lift for any business, especially towards the end of the year. Contact us for payroll support and administration to avoid costly payroll errors down the road.

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