A recent survey from EY found that payroll errors are plaguing American businesses of all sizes. Their survey found that each payroll error costs companies, on average, $291 to remedy—and that at least 20% of businesses are making payroll mistakes.
Payroll errors are hard to spot and can impact your bottom line, your employee satisfaction, and employee retention. The worst payroll errors can even lead to fines from the Department of Labor and state authorities. By performing a regular payroll audit, your business can avoid these penalties and keep a tight rein on payroll spending.
What is a payroll audit?
A payroll audit is a review of your business’s payroll records, processes, and dollar amounts to make sure everything is accurate. Payroll audits verify that your employees are being paid correctly, payroll taxes are calculated properly, and your organization is up-to-date with relevant payroll regulations.
Payroll audits help mitigate the risk of fraud and can uncover mistakes that lead to overspending, inaccurate tax reporting, and compliance issues. “A payroll audit ensures a company follows best practices and legal requirements. It identifies areas for improvements to increase efficiency, and reduces the risk of errors. It also guards against non-compliance in record-keeping, tax reporting, employee pay rates, and payroll,” wrote Deel.
Ideally, your small business should conduct an internal payroll audit annually. Experts also recommend going through this process after a merger or acquisition or if your business has recently scaled its workforce.
If your business has gone through a major change, it might be prudent to hire a third-party auditor to go through your payroll records. A government agency may also perform an audit if they suspect you’re noncompliant with wage and hour laws. However, your team can manage annual payroll audits by taking the following steps.
How to conduct a payroll audit
Start by gathering the following information:
- Employee payroll data.
- Payroll tax filings and tax deposits.
- Banking activity.
- Accounting records.
If your business has gone through a major change, it might be prudent to hire a third-party auditor to go through your payroll records.
A good starting point is to ensure that each employee is being compensated accurately. Compare employee time and attendance records with their reported hours worked to identify any discrepancies. Verify that each employee's total earnings align with their pay rate and the number of hours worked, taking into account any overtime or other adjustments.
Then, examine all variable payments, such as overtime, bonuses, commissions, tips, shift differentials, and reimbursements, to ensure they are calculated correctly and comply with company policies and relevant regulations. Check your payroll policies and procedures to make sure the systems you have in place are correct. Deel suggests reviewing your systems to see how your pay rates are determined, overtime is calculated, and employee benefits are administered.
[Read more: How to Choose the Right Payroll Software for Your Business]
Then, review your tax forms and payments for compliance purposes. “In particular, check your Form 941, which reports federal income tax withholdings to the IRS,” wrote QuickBooks. “Also, ensure you make all your tax deposits with the appropriate authorities within the designated time frame, such as Social Security and Medicare taxes.”
Read the latest Department of Labor laws and applicable state labor regulations to make sure everything is current. As you go through your audit process, keep meticulous records of any changes you make or errors you see.
What to look for in a payroll audit
There are a few common errors that payroll audits can help remedy. ADP recommends keeping an eye out for:
- Instances when employees are mistakenly classified as contractors.
- Nonexempt workers listed as exempt.
- Errors in calculating overtime.
- Incorrect payroll taxes.
- Delays in payroll payments.
Payroll audits can also help reduce the risk of fraud. “For example, audits can uncover things like ghost employees on the payroll or unauthorized changes to pay rates,” wrote Justworks. You can also look for things like incorrect punch cards or expenses that look suspicious.
[Read more: Decoding PEO vs. Payroll Services: A Small Business Guide]
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