Compensation is the money employers pay employees for their services. Payroll, wages, salaries, remuneration, etc., are the terms used for compensation. Payroll and wages are the major expenses of any business entity. If the employees of a company are not well paid or not paid on time, it affects the overall satisfaction of the employees as well.
Payroll management is very important for any business entity as the HR department and management will be able to pay the employees on time and accurately. Proper payroll management is also necessary to improve the business entity’s regulatory compliance and employee management. Inefficient payroll management will lead to errors in data, and wage claims and penalties can be the extreme side of the mismanagement.
Regularly inspecting and auditing the payroll aspect will ensure that everything is well-managed and in good shape. Therefore, the business entities might hire an independent auditor to perform payroll audits to ensure compliance and check the company’s internal controls regarding payroll.
In this article, we will talk about all the audit objectives, procedures, assertions, and everything you need to know about payroll audits. So let’s get into it.
What Is Payroll Audit?
A payroll audit can be defined as the review and analysis of the company’s payroll processes. The payroll audit can be part of a company’s independent audit at the end of the accounting period or part of an interim or individual audit for a business entity. The payroll audit might be conducted manually or a software-assisted audit by using the company’s payroll software.
Objectives Of Payroll Audit
The main objective of any audit is to ensure proper procedures are followed for recording and recognizing different transactions. The other objectives of an audit can include checking the accuracy of the financial statements and transactions and ensuring that the business entity’s internal control procedures are efficiently working.
Similarly, a payroll audit’s objectives are the same as any other kind of audit. However, if we talk about the specific objectives related to payroll management, here are the main objectives for conducting an independent payroll audit by a third-party auditor:
Accuracy Of Payroll Transactions And Accounts
The first objective of a payroll audit is to check and ensure the accuracy of all payroll-related accounts and transactions. The auditor will assess the payroll accounts and statements and run the relevant tests and procedures to identify any deficiencies leading to inaccurate payroll accounts.
Compliance With Laws And Accounting Standards
Payroll is an operating expense for the business entity. The company will follow the generally accepted accounting procedures and accounting standards, but the additional aspect of payroll is employment and tax law compliance. Therefore, one of the main objectives of a payroll audit is to check if the business entity is complying with the country’s employment and tax laws regarding employees. The audit will identify any gaps in employment and tax laws compliance at the managerial level.
Accurate Data Of Employees
Yet another objective of the payroll audit is to examine the compensation-related data of all employees. The independent auditor works in the interest of all stakeholders of payroll. It means that he will identify any errors or misstatements in the employees’ payslips, tax documents, etc., to provide accurate data.
Detection Of Frauds
Finally, the payroll audit will focus on identifying inherent errors, intentional misstatements, or on a wider scale, any fraud undergoing regarding the company’s payroll management.
Risks Associated With Payroll Audit
There are certain risks associated with any account of the financial statements. Similarly, any department or business entity’s internal control deficiencies can further complicate the risks.
Therefore, when the auditor takes on the audit engagement, he has to assess and understand the risks associated with the certain account. When it comes to payroll, the risk involved in the account is higher, and auditors must assess it accordingly when planning the audit.
Risk of Material Misstatement
The risk of material misstatement can be assessed by the inherent risk associated with payroll management and the control risk of a business entity. The risk of material statement implies that the payroll figures are not accurate or correctly recorded.
The weaker internal control combined with the inherent risk of inaccurate reporting of payroll figures increases the risk of material misstatement in the financial statements. The risk of material misstatement is usually higher for payroll due to the tendency of tweaking payroll figures easily.
Detection Risk
Detection risk is also a material misstatement arising from inconsistencies in the financial statements. When an auditor takes on the audit engagement to review and examine payroll accounts, there is a risk that he might not be able to detect the inconsistencies in the payroll figures. The detection risk for payroll is also high in bigger organizations.
Control Risks and Deficiencies
Besides the primary risks associated with payroll audit, there are certain deficiencies in the control procedures that the auditor must take note of when taking on the audit engagement. The most common control deficiencies in payroll are as follows:
- Improper segregation of duties includes one person performing more than one task. For instance, one person approves payroll payments, enters time and salary rates, issues payroll checks, etc.
- There might be no review and approval process for time logging and payroll issuance
- No surprise audits of payrolls
- There are no appropriate procedures for maintaining employee records
Assertions Of Payroll Audit
An audit assertion is the statement of the management about the accuracy and correctness of the figures posted in the financial statements. The auditors have to obtain the evidence to verify the audit assertions for any account of the financial statements.
The audit assertions for payroll are as follows:
Existence
The assertion of existence implies that the auditor must ensure that the payroll expenses recorded in the financial statements are actually incurred during the accounting period they relate to. The audit tests and procedures should be designed to detect any inconsistency related to the existence of the payroll.
Cutoff
The cutoff assertion for audit implies that the payroll expenses recorded in a current financial year should only be the one that has been incurred during the current accounting period. The cutoff assertion relates to the internal control process of expense recognition as per proper cutoff criteria.
Occurrence
Occurrence assertion of payroll audit means that the business entity should not report any irrelevant expenses in the account of payroll expenses. Only payroll expenses should be reported in the financial statements that the relevant human resources of the business entity can verify.
Accuracy
Accuracy assertion of payroll audit relates to the arithmetical accuracy of the payroll figures reported in the financial statements of the business entity.
Disclosure And Presentation
Any business entity’s payroll expenses are expansive, and the disclosure assertion relates to the description of each type of expense recorded for the payroll account.
Audit Procedures For Payroll
Here are the audit procedures that an auditor might undergo when performing a payroll audit for any business entity
Tests of Control
Tests of controls are focused on inspecting and examining the efficiency of the internal controls of the business entity. The business entity having an efficient will require less rigorous tests of details in the audit plan. However, the auditor will plan the substantive procedures and tests of details based on the tests of controls run for any business entity.
The tests of controls that might be suitable for payroll audit are as follows:
Walk Through Test
Walk-through tests refer to the audit procedure run by the auditor to check the reliability of an entity’s accounting system. A walk-through test gauges the accounting system by testing a financial transaction from the first point to the final deposition. The walk-through test for payroll might include the following questions:
- Does the business entity have a dedicated payroll bank account?
- What is the frequency of payroll processing or the normal payroll period of the company?
- The hiring and firing authority of the company
- The paperwork and documentation when hiring or terminating an employee
- Who is responsible for monitoring compliance with labor laws and payroll regulations
- Who is responsible for payroll processing?
- Do highly-paid employees get their salaries after multiple approvals?
- Who is the signing authority for electronic checks or physical checks?
- And a lot more similar questions can be asked in the walk-through test.
- Are surprise payroll audit practices in the business entity?
- Does any outsourcing company look after the payroll services of the business entity in question?
Review Of Master File For Evidence
The auditor might decide to review and examine the master file containing the data about the employees and their wages. You must independently review the amendments made in the master file to identify any misstatement or fictitious entry.
Signatures Evidence From Payroll
Yet another test of control to ensure that the overtime paid to employees or wages are paid to the right employee, the auditor should review the forms of authorized signatures. It will help to ensure the effectiveness of the internal controls and that the right person has access to the right resources.
Attend The Wages PayOut
The auditor might attend wages payout during an interim audit to ensure the occurrence assertion. It will ensure that a valid employee is paid for his work.
Substantive Procedures
The substantive procedures in payroll audit can be the following:
- The auditor might perform the following tests to examine existence assertion: an examination of payroll slips, payroll bank accounts, random sampling of monthly paychecks, and random interviews from the staff to ensure that only valid employees received the remuneration.
- To ensure the occurrence assertion, substantive testing can include reviewing calculations of payroll expenses and tracing them back to the figures recorded in the financial statements. Further tests of details or fraud-related audit procedures might be planned depending on the outcome of the test.
- The accuracy of the payroll accounts and figures can be tested by designing substantive tests involving recalculation of the payroll figures for the current and previous years.
The auditor might decide to adopt further fraud-related audit procedures if they get enough evidence that there has been intentional material misstatement in payroll accounts by the staff or management of the client.