Payroll is at the heart of any business. It is the one financial function of any business that must be punctual and accurate. It also has enormous potential for assisting in other areas of the business.
Even a small delay in paying staff can trigger a range of consequences from staff discontent through to full-scale industrial action. An underpayment or overpayment to an employee can cause problems as the employee will demand prompt correction and have a negative view of the company. Sometimes there are legal and practical reasons which prevent you from recovering an overpayment.
Every industrialised nation now has detailed laws on employment conditions. Although they tend to include similar elements, there are still significant differences. Overlooking a legal detail can bring serious penalties. It can also lead to significant errors in costing if some payroll costs are overlooked.
Payroll is also obviously vulnerable to security risks. There is opportunity for fraud, including putting ghosts on the payroll. There is also a security risk as the information is sensitive.
These are all very good reasons for you to run an in-house self-assessment/audit of your payroll and payroll function. But a payroll audit is not just concerned with avoiding mistakes. Payroll can also be used as a powerful management tool. Employees often trust payroll staff more than other accounts or personnel staff. Payroll data can also contain useful information about employees which may need to be shared with other departments. Finally, payroll functions can be integrated with other functions.
Too often businesses see payroll as no more than an administrative function, no more important than window cleaning.
The audit of payroll extends beyond ensuring that payslips are properly prepared and statutory returns are filed. The payroll audit should check that the most effective methods of determining employee payment are used, and that all elements of the payroll resources are used for maximum efficiency.
Structure of the Audit
A payroll audit should follow these six steps reflecting the key considerations of the payroll auditor. They are:
Step 1 Payroll in your Organisation
Step 2 Setting up the Payroll
Step 3 Supply of Information
Step 4 Resourcing the Payroll Function
Step 5 Payroll Security
Step 6 Developing the Payroll Function
In this briefing, I’ll give you an outline of the questions you need to ask at each step. For more details and a complete do-it-yourself payroll audit structure, see The Payroll Audit, from which this article is taken.
Step 1 – Payroll in your organisation
The process of auditing payroll begins by examining the functions that payroll performs in the organisation. Having defined the functions carefully, you then need to carefully examine the different payment methods that are to apply to employees including issues such as commissions and bonuses, share options and fringe benefits. At the same time, you also need to be satisfied that the systems for setting and increasing pay are effective. Finally, in this step, ensure that the correct payroll data is brought into the financial and management accounts of the organisation in order that effective decisions can be made about the resourcing of the organisation.
There are certain basic questions you must ask. For each step, these questions are summarised below (they’re explained in detail in the full Payroll Audit [see resource box at the end of this article], which also gives guidance on how to prepare for and run the audit).
- Who is the payroll department answerable to?
- What are the lines of communication from line managers to the payroll function?
- How is authority defined for levels of information to payroll?
- How is this information recorded and then filed?
- What non-payroll functions are also handled by payroll?
- Are there any functions related to payroll that are not handled by payroll and, if so, who does handle them?
- How is employees’ gross pay calculated?
- For employees paid by piece rate, what checks are in place that the work is properly inspected?
- How many employees are paid weekly, monthly, or at other intervals?
- How are employees paid their take-home pay?
- What bonuses and commissions are payable? To whom?
- Is the bonus and commission structure properly allocated to the sales or other figure to which they relate?
- Is the bonus and commission structure linked to the objectives of the organization?
- Do you provide any profit-related pay or performance-related pay?
- Are the criteria for any profit- or performance-related pay appropriate to that employee?
- Is the system for profit- or performance-related pay fair?
- Do you provide any shares or options?
- Does the payroll department have full details of employee share or option schemes?
- Does the payroll function receive details when an employee share option is exercised?
- What fringe benefits do you provide?
- Do you offer employees a choice of fringe benefits? If so, are the benefits properly costed?
- What analysis have you done of perceived value and tax effectiveness of benefits?
- What systems exist for ensuring that payroll is notified of the provision, or any change in provision, of a fringe benefit?
- How are pay rates set?
- How are pay rates reviewed?
- What systems exist for reporting payroll data for the purposes of the financial accounts?
- What analysis do you make of payroll data for the purposes of management accounts? Is further analysis appropriate?
Step 2 – Setting up the payroll
When reviewing how payroll is set up and administered there are 4 key issues that must be examined. They are:
- the legal implications of payroll
- your policy on issues related to payroll
- the way you make payment to employees
- the timetable for processing the payroll.
- Is the payroll department fully familiar with the law and practices of the countries in which it operates?
- Is there a system for payroll to be kept up to date with developments in law and practice?
- Does payroll have adequate training and resourcing in basic law and practice?
- Do you have a comprehensive policy in all areas affecting payroll?
- Has the payment method been properly set up?
- Is there a payroll timetable?
Step 3 – Supply of information
You should ensure that you have a proper system for controlling the supply of information to and from the payroll function. There must be clear lines of responsibility for reporting and implementing information, as well as clear policies for what information is communicated and by whom.
- Are there systems for authorising payroll information at appropriate levels?
- Are there systems for the proper notification of information?
- Are there systems for recording information?
- Are there systems by which payroll may raise queries and receive prompt replies?
- Is the payroll function protected against illegal orders?
- Are there systems for recording relevant personal details of employees, and for keeping these details up to date?
- Are there systems in place for handling staff who leave?
- Are payroll records properly kept? Are there systems of folio or similar cross-references to maintain the audit trail?
- Are there clear instructions to the payroll function of when it may disclose information and to whom?
- Is the idea of overriding interest disclosure properly understood?
Step 4 – Resourcing the payroll function
Payroll needs the resources of:
- internal data
The resources of the payroll function must always be considered in the context of the serious problems that can arise in an organization if there is even a slight delay in meeting any payroll deadline.
- Does the payroll function have enough staff?
- What checks are made into the integrity of payroll staff?
- What system exists to train and improve the staff?
- What provision is made to cover absent payroll staff?
- What computers and equipment do the payroll staff use?
- Is this equipment fully used?
- Has it become cost-effective to upgrade the existing equipment?
- Are there adequate back-up facilities?
- Are there enough resources to ensure that all payroll staff can handle problems with hardware and software? Are manuals available? Is there a helpline? Do staff regularly try out parts of the system which are not frequently used?
- Is there an adequate stock of payroll stationery? Is the stock enough to cover the lead time of ordering more stationery?
- Are copies of old regulations and company policy retained so any query can be answered several years after the event?
Step 5 – Payroll security
Payroll has a need for security above that which prevails in an organisation generally. The particular problems of security relate to:
- protecting data from loss
- protection against fraud and error
- security for cash.
These are considered separately.
- What arrangements exist to prevent theft of computers?
- What security arrangements exist to restrict access to the payroll office?
- What arrangements exist to make copies of payroll data? Are these arrangements adequate? Have they been tested to ensure the payroll can be run from these copies?
- Are computer systems adequately protected against viruses, electricity surges and hacking?
- Is there an adequate system of password control? Is it taken seriously?
- Are suspected instances of improper computer use thoroughly investigated?
- What software security is in place? Is it adequate?
- Does the computer system produce appropriate exception reports? Does anyone take notice of these reports?
- What provisions exist to protect against fraud? Are they adequate?
- Are arrangements for handling cash adequate?
Step 6 – Developing the payroll function
Payroll should be seen as more than a dead overhead, or an overhead burden which just has to be there.
Payroll can play a much more significant role in any organization. You should review the scope of payroll in providing additional resources within your organization.
Step 1 explained the routine payroll functions in financial accounting and management accounting. It also explained how the management accounting functions can be developed to provide analysis of labor costs for decision-making purposes. The possible functions mentioned below provide more opportunities for payroll to be used effectively.
- Is the payroll function properly used for personnel purposes?
- Is payroll linked to your time and attendance system or any till control system?
- Is payroll linked to any HR management function?
- Does the payroll department provide explanation and assistance to employees in understanding their payslips and answering questions?
- Is there scope for the payroll function to take on non-payroll duties?
- Is there any scope to make the payroll department a profit centre?