How to conduct a payroll audit: a complete checklist

Can small business owners do their own payroll audit?

Yes, small business owners can conduct their own payroll audits. Hiring an external auditor can be expensive, but running an internal audit can help save money. Owners are usually familiar with their payroll systems and can easily identify discrepancies or issues.

Still, there may be specific situations where hiring an external auditor is advisable. Some cases include complex operations (such as multi-location businesses), a high need for regulatory compliance, and credibility for investors and business loans.

Essential components of a payroll audit

Conducting a payroll audit involves several key components. Here’s what you need to focus on during an audit:

Employee records

Reviewing employee records includes verifying personal information such as names, addresses, and contact details to ensure they are up-to-date. It’s important to check each employee’s classification, whether full-time, part-time, or casual, and confirm that the pay rates listed match the agreed-upon amounts in their employment contracts.

Attendance and leaves

Auditing attendance and leave records ensures that employees are getting paid correctly. This involves comparing reported hours worked against submitted timesheets for accuracy. It’s important to verify that leaves taken, such as sick and annual leave, are accurately recorded and that balances reflect each employee’s entitlement.

Tax compliance

Tax compliance is a critical component of a payroll audit. You’ll need to check that the correct amount of income tax is withheld from paychecks and verify that superannuation contributions are made correctly and on time. All necessary tax forms and reports must be submitted accurately and by their deadlines.

Benefits and deductions

Auditing benefits and tax deductions ensure that all employee entitlements are managed properly. This includes confirming that any salary sacrifices and employer-sponsored benefits, such as health insurance, are correctly administered and deducted from pay.

Record-keeping

Employers must ensure that all payroll records are retained for the required period, generally seven years, in Australia. This retention period is crucial for compliance with tax laws and employment regulations. Keeping payroll files organised allows for easy access to information during an audit, making the process more efficient.

How to do a payroll audit: a complete checklist

Conducting a payroll audit involves multiple procedures to ensure accuracy and compliance. Read on below for everything that should be part of your payroll audit checklist.

1. Review employee records

Start your payroll audit by looking at employee records. Check that all personal information is correct and up-to-date. Make sure each employee’s job status—whether they are full-time, part-time, or casual—is recorded correctly. These factors impact their pay and benefits entitlement. 

Confirm that the pay rates match what is written in their employment contracts. If you find any mistakes, fix them right away.

2. Examine timesheets and wages

Next, examine the timesheets and wages carefully. Compare the hours that employees say they worked on their timesheets with the wages they were paid. Make sure they are getting paid correctly for the hours they worked. Investigate any differences and correct them as soon as possible. Note any changes you need to make to address the procedural errors that caused the errors.

3. Track variable payment and compensation

After checking wages, look at variable payments and compensation. Factors like bonuses, commissions, and overtime pay can be a breeding ground for discrepancies. Make sure these payments are calculated correctly according to your company’s rules. If you find any errors in these payments, make the necessary adjustments and keep a record of what you changed.

4. Inspect corrections in payroll transactions

Now, check any corrections made in payroll transactions. Look at changes to payroll records, like updates to pay rates or fixes for previous mistakes. Ensure that all corrections are properly documented so you know why they were made. Any unjustified corrections should be flagged to the right team members.

5. Audit tax withholdings and superannuation

Next, check tax withholdings and superannuation contributions. Verify that the right amount of income tax is taken out of each employee’s paycheck according to Australian tax laws. Also, make sure all eligible employees make superannuation contributions correctly and on time. If you spot any tax withholdings or contributions mistakes, fix them immediately to avoid penalties.

6. Reconcile payroll with your bank activity

Once you’ve completed the previous steps, reconcile your payroll records with your bank activity. Compare your payroll records against bank statements to ensure that all employee payments match what is recorded in your payroll system.

7. Create a report with findings and actions

Finally, create a report summarising what you found during the audit and suggest actions to fix any problems. Write down any issues you discovered and outline a clear plan for correcting them. This report will be helpful for improving your payroll processes in the future. Share this report with relevant people so everyone knows about the findings and what needs to be done.