The payroll dysfunction has been one of the chief casualties of the pandemic. As per the surveys, the number of companies with a payroll accuracy of greater than 90% decreased from the pre-COVID figure of 52% to 27% in the first six months post the pandemic.
Not surprisingly, 82% of the organizations found the consequences of the pandemic ‘very challenging.’
In this context, payroll audit procedures are now a priority for organizations looking to build a resilient payroll function and minimize compliance risk.
Learn why payroll compliance is critical for your enterprise and know a payroll audit's objectives, steps, and benefits.
Payroll Compliance
Payroll compliance refers to the legal and tax frameworks enterprises must adhere to while disbursing employees’ payroll compensation benefits.
The payroll tax frameworks in India govern the calculation and deduction of tax at source (TDS) and professional tax (PT) based on an employee salary structure.
The chief payroll statutory regulations in India include the Minimum Wages Act, Employee Provident Fund (EPF) regulations, Employees’ State Insurance Corporation (ESIC), pension schemes (EPS), and the Gratuity Act.
Why is Payroll Compliance Critical?
Payroll Compliance is critical because it-
- guarantees that employees are paid reasonably, fairly, and promptly for their efforts
- ensures the company does not suffer punitive penalties or interest payments due to non-compliance
- mitigates the risk of litigation from employees or trade unions
- adds to the company’s overall compliance and the employer’s brand reputation
Payroll Audit
A payroll audit is a forensic review of the payroll records of a specified period. It examines the business processes, payroll systems, and calculation methods used to ensure records are appropriate, accurate, and comply with all relevant laws.
As per the Deloitte Global Payroll Benchmarking survey 2020, 24% of the 750 organizations surveyed indicated that their payroll staff spends maximum time on payroll reconciliation and audits. It indicates how payroll auditing is a critical part of the payroll function for most organizations.
Internal payroll audits are conducted regularly within the organization appointed by the management. External payroll audits are conducted annually by independent third-party auditors appointed by the shareholders or owners of the company.
Main Payroll Audit Objectives
1. Ensure Accuracy
Errors in the calculation may go unnoticed by the payroll team, outsourcing partners, and employees whose payout is incorrect. The foremost objective of a payroll audit is to ensure that all payroll components are correctly calculated.
During the audit, computations for a workforce sample are double-checked. Also, calculation formulae and rules configured in the payroll application are reviewed. To ensure everything is accurate, approval processes and the supporting documentation that drive the payroll calculations are also checked.
2. Confirm Completeness
During a payroll audit, it is verified if the salary and benefit components have been processed for all employees and paid out entirely within the specified pay periods.
Besides the monthly salary payout components (full-time employees, part-time employees, and contract workers), checks off-cycle payments such as expense reimbursements, insurance payouts, termination settlements, and employee loan payments are also reviewed. Outstanding amounts, if any, and their reasons in the audit report are mentioned to confirm completeness.
3. Detect Payroll Fraud
Fraudulent payroll transactions pose a risk across organizations of all sizes. Team members of the payroll team or outsourcing partners may be involved in these, making it much more challenging to unearth frauds than inadvertent payroll errors.
One of the objectives of the payroll audit is to ensure occurrence and existence, which means that auditors ascertain that the payouts recorded in the payroll application have actually taken place and paid only to genuine employees of the company.
4. Ensure Payroll Compliance
A payroll audit ensures compliance with various tax laws and local labour regulations. During the audit, tax deductions are verified and ensured if they were deposited with the appropriate government authorities within specified timelines.
It is also checked if the contributions to various labour schemes such as Employee Provident Fund (EPF) and pension schemes are in order. Additionally, it is ensured that the payroll process complies with all mandatory steps like supervisory approvals of payouts, providing employees with payslips, and storing payout records securely.
5. Enable Appropriate Payroll Accounting
Payroll expenses are a part of the annual Profit and Loss (P&L) statements presented by organizations to their shareholders and tax authorities.
During payroll audit, it is ensured that an accurate and fair representation of the payroll figures is present. Any outstanding amounts are disclosed in the audit with detailed explanations and recommended remedial action.
Benefits of Conducting A Payroll Audit
Besides the compliance requirements for conducting payroll audits, they also result in tangible business benefits that boost your organizational bottom line.
1. Improved Employee Satisfaction
Payroll is a crucial component of the overall employee value proposition (EVP) you promise to your employees.
Employees expect error-free and timely salary payouts. They also expect a hassle-free tax return filing experience facilitated by correct tax forms provided by the employer. Payroll audits ensure accurate salary processing, resulting in higher employee satisfaction and retention.
2. Payroll Risk Mitigation
Regular payroll audits help you identify opportunities for improving your payroll processes and systems on an ongoing basis. They enable systemic workflows for regularly updating employee master lists and configuring the latest tax laws into the payroll software.
They also ensure payroll data is stored securely for specific periods per regulatory requirements. These improvements decrease the risk of errors and non-compliance in your payroll process over time.
3. Fraud Deterrence
Regular audits coupled with stringent punishments for fraud perpetrators in payroll result in deterrence. Payroll audits also help you identify red flags and design intelligent system alerts that proactively warn you about possible fraud.
Also, external audit of financial statements is the most pervasive anti-fraud control in the Indian subcontinent, with 91% of organizations using it.
HR Payroll Audit Checklist
1. Set the Timeframe for the Audit
The first step is to fix the timeframe for the payroll data to be audited.
Generally, companies conduct external audits annually for a timeframe comprising one financial year. However, internal audits can be performed quarterly or half-yearly basis the bandwidth available with the payroll team and the maturity of the payroll process.
2. Create an Audit Plan
The audit plan must list the various teams that contribute to the audit. These include members from the HR, payroll, finance, and IT teams and any third-party service providers involved in payroll processing.
The audit plan must also list the payroll reports and documents to be examined. You must ensure these are ready and available before the audit starts.
The audit plan also details the payroll processes and software applications that must be reviewed for compliance. It must specify the sample selection strategy to ensure enough records get reviewed for accuracy.
3. Verify Employee Master List
You must verify the list of all employees that have received payouts during the audit timeframe. This list must include the employee IDs, names, designations, salary account details, start dates, tax category, and end dates if terminated.
Employee master list must be consistent across HR, payroll, and accounting software, ensuring that only active employees have received payouts. It must be verified that every employee is categorized correctly as per the tax rules, for example, as a contractor, full-time employee, or part-time employee.
4. Verify Pay Rates and Duration Worked
During the audit, you must check the pay rates applied to each employee’s payroll calculation. For permanent employees, the latest CTC structure becomes the basis for payroll calculation. For contractors or hourly wage employees, the hourly or monthly pay rates as per the contract apply for checking the computations.
The number of hours worked or days worked for each employee to arrive at the gross pay figures must be verified with reports generated from the attendance, timekeeping, and leave management systems or physical time cards to confirm the duration worked for each employee.
5. Check the Variable and Non-Regular Salary Components
You must run reports from the performance management system to get performance pay data and check if the variable component payouts have been processed accurately as per this data.
Verify if the full and final settlement amounts are included with the gratuity and leave encashment components for the cases in which employees have quit the organization during the audit timeframe. Another element to be checked for accuracy and compliance is the overtime pay for eligible employees.
6. Verify Tax Deductions and Deposits
Verify if the payroll team has deducted the TDS due on each component of the salary structure in adherence to income tax laws. Review investment proofs, rent receipts, loan certificates, and other supporting documents submitted by employees for claiming tax exemptions.
Also, verify that the latest tax rates were applied while computing the net payouts. Check the tax deposit receipts to verify that the TDS and professional tax amounts deducted from employee payouts have been deposited with the tax authorities within specified deadlines.
7. Reconcile Payroll Data with General Ledger (GL) Reports and Bank Statements
The GL report shows every transaction occurring in your company under the appropriate heads. The amounts debited for salary payouts must match the transactions recorded in the GL expense accounts.
Amounts owed to employees under various social security and insurance schemes must match those recorded in the payable accounts in the GL. The audit must also reconcile the payout records with actual transactions recorded in the bank account statements. Verify that the bank accounts to which the payouts were transferred match those in the employee master list.
8. Document Observations Concerning Non-Typical Transactions
You must note, query, and detail any transaction that seems out of the norm. The audit must review all off-cycle payout transactions like underpayment or overpayment corrections, retroactive payments, and ad-hoc bonuses or rewards. The recommended investigation and corrective action must also be documented if any errors are uncovered.
Final Words
As per the 2021 EY Global payroll survey, 30% of organizations feel that the top payroll compliance challenge lies in keeping pace with regulatory changes because of the new working ways introduced during the pandemic.
Payroll audits are a powerful tool for identifying areas of improvement in your enterprise processes and systems. So, your organization can seamlessly process payroll despite challenges such as a growing gig workforce, remote employees in different tax regions, and flexible work timings.
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