Payroll: Are you doing it right?

Introduction

Payroll is the heart of any business. It is the one financial function of every business which must be punctual and accurate. It is also one area which has great potential for assisting in other areas of business.

A slight delay in paying staff can trigger a range of consequences from staff discontent through to industrial action. An error in underpaying or overpaying an employee can cause problems as the employee will demand prompt correction and have a less favourable view of the company. Sometimes there are legal and practical reasons which prevent an employer recovering an overpayment.

Every industrialised nation in the world now has detailed laws on employment conditions. Although they are tending to include similar elements, there are still significant differences between nations. Overlooking a legal detail can lead to serious penalties. It can also lead to significant errors in costing if some payroll cost is overlooked.

Payroll is also an area which is vulnerable to security risks. There is opportunity for fraud, such as putting ghosts on the payroll. There is also a security risk in that the information is sensitive.

These are all good reasons to run an in-house self-assessment/audit of your payroll and payroll function. But payroll audit is not just concerned with avoiding mistakes. Payroll can be used as a powerful management tool. Employees frequently trust payroll staff more than other accounts or personnel staff. Payroll data can contain useful information about employees which may need to be shared with other departments. Payroll functions can be integrated with other functions.

Too often businesses see payroll as simply an administrative function, no more important than window cleaning.

The audit of payroll extends beyond just ensuring that payslips are properly prepared and that statutory returns are filed. The payroll audit should check that the methods for determining employee payment are the most effective, and that all elements of the payroll resources are utilised for maximum efficiency.

Structure of the Audit

A payroll audit should be structured into six steps reflecting the key considerations of the payroll auditor. They are:

Step 1    Payroll in the Organisation

Step 2    Setting up Payroll

Step 3    Supply of Information

Step 4    Resourcing Payroll

Step 5    Payroll Security

Step 6    Developing the Payroll Function

In this briefing, I'll present an outline of the questions you need to be asking at each step. For full details and a complete do-it-yourself audit framework, see The Payroll Audit, from which this article is drawn.

Step 1 - Payroll in the 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, which also gives guidance on how to prepare for and run the audit).

Audit Questions

• To whom is the payroll department answerable?
• What are the lines of communication from line managers to payroll?
• How is the authority defined for levels of information to payroll?
• How is this information recorded and filed?
• What non-payroll functions are handled by payroll?
• Are there any functions related to payroll but not handled by payroll and, if so, who does handle them?
• By what method is employees' gross pay calculated?

• For any employees paid by piece rate, what checks are in place that the piece work is properly inspected?
• How many employees are paid weekly, monthly, or at some other interval?
• By what method are the employees paid their take-home pay?
• What bonuses and commissions are payable, and to whom?
• Is the bonus and commission structure properly defined to the sales or other figure to which they relate?
• Is the bonus and commission structure linked to the objectives of the company?
• Does the employer provide any profit-related pay or performance-related pay?
• Are the criteria for any profit-related pay or performance-related pay appropriate to that employee?
• Is the system for profit-related pay or performance-related pay fair?
• Does the employer provide any shares or options?
• Does the payroll department have full details of any employee share or option schemes?
• Does payroll receive details when an employee share option is exercised?
• What fringe benefits are provided by the employer?
• Does the employer offer employees a choice of fringe benefits? If so, are the benefits properly costed?
• What analysis has been done of perceived value and tax effectiveness of benefits?
• What system exists 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 system exists for reporting payroll data for the purposes of the financial accounts?
• What analysis is made of payroll data for the purposes of management accounts? Is further analysis appropriate?

Step 2 - Setting up payroll

When reviewing how payroll is set up and administered there are four key issues that need to be examined. They are:

• the legal implications of payroll
• the employers policy on issues related to payroll
• the method of making payment to employees
• the timetable for processing the payroll.

Audit Questions:

• Is the payroll department fully conversant with the law and practices of the countries in which it operates?
• Is there a system in place for payroll to be kept up to date with developments in law and practice?
• Does the payroll department have adequate training and resourcing in basic law and practice?
• Does the employer 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

The organisation should ensure that it has a proper system for controlling the supply of information to and from the payroll department. There must be clear lines of responsibility for reporting and implementing information, and clear policies for what information is communicated and by whom.

Audit Questions

• Is there a system for authorising payroll information at appropriate levels?
• Is there a system for the proper notification of information?
• Is there a system for recording information?
• Is there an effective system by which payroll may raise queries and receive prompt replies?
• Is the payroll department protected against illegal orders?
• Is there a system for recording relevant personal details of employees, and for keeping these details up to date?
• Is there an appropriate system in place for handling staff who leave?
• Are payroll records properly kept? Is there an adequate system of folio or similar cross-references to maintain the audit trail?
• Are there clear instructions to the payroll department of when it may disclose information and to whom?
• Is the concept of overriding interest disclosure properly understood?

Step 4 - Resourcing payroll

Payroll needs the resources of:

• people
• equipment
• stationery
• regulations
• internal data

The resources of payroll must always be considered in the context of the serious problems that can arise in a business if there is even a slight delay in meeting any payroll deadline.

Audit Questions

• Does the payroll department have enough staff?
• What checks were made into the integrity of payroll staff?
• What systems exist to train and improve the staff?
• What provision is made to cover for absent payroll staff?
• What computers and other equipment do the payroll staff use?
• Is this equipment being fully used?
• Has it yet become cost-effective to upgrade the existing equipment?
• Are there adequate back-up facilities?
• Are there sufficient resources to ensure that all payroll staff can handle problems with hardware and software? Are manuals readily available? Is there a helpline? Do staff regularly try out parts of the system which are not otherwise frequently used?
• Is there an adequate stock of all payroll stationery? Is the stock more than sufficient to cover the lead time of ordering more stationery?
• Are copies of old regulations and company policy retained so that any query can be answered several years after the event?

Step 5 - Payroll security

Payroll has a particular 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.

Audit Questions

• What arrangements have been made to prevent theft of computers?
• What security arrangements exist to restrict access to the payroll office?
• What arrangements exist to take copies of payroll data? Are these arrangements adequate? Have they been tested to ensure that the payroll can be run from these copies?
• Are computer systems adequately protected against viruses, electricity surges and hacking?
• Is there a system of password control? Is it adequate? Is it taken seriously?
• Are any suspected instances of improper computer use thoroughly investigated?
• What other software security is in place? Is it adequate?
• Does the computer produce appropriate exception reports? Does anyone take any notice of these reports?
• What provisions have been made to protect against fraud? Are they adequate?
• Are the 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 unfortunately has to be there.

Payroll has the capacity to play a much more significant role in any organisation. The auditor should review the scope of payroll in providing additional resources within the organisation.

Step 1 explains the routine payroll functions in financial accounting and management accounting. It also explains how the management accounting functions can be developed to provide significant analysis of labour costs for decision-making purposes. The possible functions mentioned below provide further opportunity for payroll to be used effectively.

Audit Questions

• Is the payroll function properly utilised for personnel purposes?
• Is payroll linked to any time and attendance system or any till control system?
• Is payroll linked to any human resources management function?
• Does the payroll department provide adequate explanation and assistance to employees in understanding their payslips and answering queries?
• Is there scope for the payroll department to take on non-payroll duties?
• Is there scope to make the payroll department a profit centre?

Andrew Carey

Andrew has worked as a writer, editor, marketing consultant, publisher, team facilitator and business development adviser. He is also a practising psychotherapist. He is the author of Inside Project Red Stripe, published by Triarchy Press - the story behind The Economist's famous innovation project, and a wide ranging guide to launching a successful  innovation programme.

The full Payroll Audit is available from Cambridge Strategy Publications.