Payroll audit

It’s common for businesses to face payroll issues. An employee may not receive a promised raise, accurate tracking of overtime hours can falter, and payroll tax deposits might miss the payment deadline. To tackle these challenges proactively and prevent lasting damage, employers frequently conduct payroll audits.

What is a payroll audit?

Employers conduct payroll audits to ensure their payroll data is correct. They examine pay rates, tax withholdings, hours worked, and more. The time it takes for these reviews depends on the audit's scope and the size of the business.

Why do employers need to conduct payroll audits?

While conducting a payroll audit isn't mandatory, it plays a crucial role in ensuring accuracy. Employers who regularly audit their data can:

• Minimize errors: Payroll errors often occur, and audits reveal incorrect calculations, missed deadlines, and wrong data entries.
• Support compliance: Employment regulations continually evolve. By auditing payroll, employers can evaluate their compliance with wage and hour laws related to overtime, minimum wage, pay timing, and payroll deductions.
• Keep employees satisfied: Employees expect accurate and timely payments, which federal and state laws mandate. Conducting regular payroll audits and promptly addressing discrepancies enhances employee satisfaction and ensures compliance with relevant regulations.
• Prevent fraud: Employers can verify whether everyone entitled to a paycheque is actually receiving one and if employees have been submitting accurate timesheets. Audits also ensure that tax deposits are accurate and timely, and can help uncover fraudulent activities.

How to audit payroll

Using a payroll audit checklist can assist employers in managing the process effectively. Here’s a suggested approach:

1. Determine the frequency of payroll audits—whether to conduct them annually, quarterly, monthly, or after each pay period (with the latter being the recommended best practice).
2. Review employee records to confirm that only active employees are receiving compensation and that their pay aligns with the terms in their offer letter or any recent adjustments, such as raises.
3. Cross-check the hours worked by employees against their time and attendance records, pay rates, and total earnings.
4. Ensure the accuracy of all variable payments and standard employee compensation, including overtime, bonuses, tips, commissions, shift differentials, and reimbursements.
5. Verify that employment taxes and other payroll deductions are calculated correctly.
6. Compare payroll records with bank statements and make sure that requests for direct deposit are properly documented.
7. Keep abreast of changes in employment regulations and modify payroll processes as needed.
8. Thoroughly document the audit results, retain the information, and share it with relevant stakeholders, such as HR and finance leaders.

Primary risks for payroll

Conducting internal payroll audits enables employers to rectify mistakes, which can prevent potential audits from government agencies, penalties, and claims from employees regarding wages. Some common errors that may surface during payroll audits include:

• Employees incorrectly classified as independent contractors
• Miscalculated overtime wages
• Incorrect payroll tax payments
• Payroll processing lagging behind schedule

Payroll audit best practices

Auditing payroll for the first time can feel overwhelming, but it doesn’t have to be. The following recommendations may facilitate a smooth process:

• Reconcile payroll consistently, ideally with every payroll run. Review wage payments, deductions, tax withholdings, and deposits thoroughly.
• Keep precise records, including payroll registers, and ensure they are easily accessible.
• Consider hiring a third party to conduct the payroll audit. External auditors may identify errors that the employer might overlook.
• Divide HR responsibilities to reduce the chance of fraud. For example, one manager can oversee time tracking while another handles payroll processing.
• Ensure that employees leaving the company are correctly coded. Before removing them from the payroll system, confirm that all final wages have been disbursed and that year-end tax forms have been completed and issued.
• Use reliable payroll and HR software solutions to manage payroll, compliance, and employee information efficiently.
• If there are suspicions of fraud, consult HR or legal counsel prior to addressing the issue with the employee.

How payroll software can help employers improve audits

Auditing payroll using software is more efficient and less labour-intensive compared to manual methods. Payroll service providers, such as ADP, often provide:

• Tools for detecting errors that highlight possible inaccuracies
• A centralized database containing all employee compensation information
• Digital reports and analytical insights
• Assistance with complying with regulatory requirements

Frequently asked questions

Is auditing payroll a requirement?

While employers are not legally obligated to conduct payroll audits, it is advisable to perform them regularly to reduce the risk of costly errors, potential fraud, and compliance issues. Accurate payroll management also contributes to employee satisfaction.

How frequently should you audit your payroll?

Employers should reconcile payroll with each processing cycle and carry out a thorough audit at least once a year.

What triggers a payroll audit?

Employers should take a proactive approach to payroll audits. In the absence of such diligence, common triggers for an audit include employee complaints regarding incorrect pay and notifications from governmental bodies.

How long does a payroll audit take?

The duration of a payroll audit can range from a few minutes to several weeks. Ultimately, the number of employees and the volume of data being reviewed will dictate the time required. Employers can simplify audits by reconciling payroll frequently.

What happens if you fail a payroll audit?

If errors are identified during a payroll audit, employers must rectify them without delay.

Learn More

Are you looking to effectively navigate payroll audits? You can benefit from ADP’s payroll solutions.

Talk to us about your payroll challenges, and we’ll walk you through our solutions — including how companies like yours use them. Call 866-622-8153 or start a quote.

This guide is intended to be used as a starting point in analyzing payroll audits and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.