How to Spot Audit Your Payroll System

The possibility of payroll fraud occurring is always a concern for a business. But an even greater concern for organizations should be remaining in compliance with all applicable laws and regulations.

“Fraud is an important issue but compliance is even more so,” says Jim Medlock, director of education and training for the American Payroll Association (APA). “An organization is more likely to be found out of compliance and penalized as a result than it is to experience fraud.”

Alleviating risks, preventing mistakes

Medlock advises businesses to conduct periodic spot audits of the payroll process to guard against the risks — and possible legal and financial consequences of noncompliance. Regular audits can confirm payroll accuracy and identify and correct problems, ensuring businesses remain in compliance with all state and local requirements, as well as federal regulations, such as those issued by the Internal Revenue Service (IRS) and the U.S. Department of Labor.

Common pitfalls for companies include failing to calculate overtime pay correctly, including the employee’s regular rate of pay, especially if a worker also receives additional wage payments in the form of shift differentials, commissions or bonuses.

Auditing your payroll process isn’t overly complicated, according to Medlock. Even the smallest businesses usually have automated payroll systems that have the capability to produce reports on demand.

These reports allow employers to verify various aspects of payroll, such as whether mandatory deductions are being made and whether pretax deductions are handled properly. In addition, the IRS provides tools that give employers the ability to verify that withholding amounts and various tax payments are being reported and paid to the proper agencies.

The value of regular payroll system audits

Medlock recommends auditing the payroll system every pay period. In addition, payrolls should be balanced and reconciled every pay period, as well as on a quarterly and annual basis. By reconciling your payroll system in a timely manner, problems can be identified and corrected sooner rather than later, reducing the potential for penalties.

A payroll audit is best performed by skilled payroll professionals who are charged with ensuring payroll accuracy. Even if a company outsources its payroll function to a service provider, Medlock cautions this doesn’t remove the company from bearing responsibility for payroll accuracy.

“You can outsource the responsibility, but not the accountability,” he says. “It always comes back to your organization.”

He cites a case where a company’s payroll service provider failed to pay taxes to state authorities, but the company was still held responsible for the problem, as well as any back taxes and penalties. Medlock notes that service providers rely on calculations and other information supplied by the employer, so employers must ensure they provide accurate inputs to the payroll process.

Ensuring accuracy

In addition to auditing your payroll system automatically, Medlock suggests taking the following steps to ensure payroll accuracy:

Segregate duties. The likelihood of payroll fraud occurring can be reduced by not allowing one employee to be responsible for multiple aspects of payroll.

For instance, reconciliation shouldn’t be performed by the same person who issues paychecks; otherwise, you have the same individual validating his or her own work. The more you can divide duties among employees, the more you’ll have a system of checks and balances.

Stay informed. Payroll and tax issues are always changing, and the professionals best equipped to manage ever-evolving changes are those who engage in continuous learning.

Companies can help their staff enhance their skills by encouraging involvement in organizations such as the APA. Managers also should support ongoing education, including training opportunities and professional certifications, such as the Fundamental Payroll Certification (FPC) and Certified Payroll Professional (CPP) designations.