Basic Payroll System Control

Controls are required for nearly every aspect of the basic payroll system,
covering hours to be paid, deductions, pay rates, tax remittances, and pay
distributions. The controls are as follows:
 Verify time card receipt – The payroll staff will match received time cards
against the current employer list and investigate all missing time cards.
 Obtain approval for hours worked – The payroll staff will obtain the written
approval of supervisors for hours worked by their direct reports, including
overtime hours.
 Obtain approval of pay rate changes – The payroll staff will obtain the
written approval of a high-level manager on the standard pay change form for all
changes in pay rates.
 Obtain approval of negative deductions – The payroll manager will
approve all negative payroll deductions.
 Obtain approval of payroll advances – An employee’s immediate
supervisor and the controller will approve any request for a payroll advance.
 Review wage calculations. A second payroll clerk will review the payroll
wage calculations for errors, and adjust any errors found.
 Match payroll register to authorizing documents. A second payroll clerk
will compare the payroll register to authorizing deduction forms, pay requests,
change forms, and so on to ensure that all components of the payroll were
properly authorized.
 Issue checks directly to recipients. The paymaster will require a photo
identification before issuing paychecks to employees, and require recipients to
sign for checks received.
 Retain unclaimed paychecks. The paymaster will retain an employee’s
check in a secure location until the employee is personally available to receive it.
 Segregate the paymaster function. The paymaster will not have
responsibility for any other payroll activities.
 Review un-cashed payroll checks. The paymaster will follow up with
employees regarding un-cashed paychecks.
 Review tax remittances. A second payroll clerk will review the amount of tax
remittances and the completeness of accompanying remittance documents prior
to the remittances being delivered to the government.
 Review outstanding advances. The payroll staff will regularly review the
repayment status of all outstanding pay advances.
 Limit access to completed change authorization forms. The payroll clerk
will store signed payroll change authorization forms in a secure location to
reduce the risk of subsequent document modification.
 Issue paycheck list to department managers. The paymaster will issue a
list of paychecks distributed to the department managers, with instructions to
search the list for ghost employees.
 Reconcile the payroll bank account. The controller will reconcile the payroll
bank account and investigate any variances.
  Audit pay deductions. The internal audit staff will periodically compare
deduction authorizations to the actual deductions being taken from employee
pay, and investigate any variances.
 Audit no-deduction paychecks. The internal audit staff will periodically
search for paychecks having no deductions, and determine if these are being
written for ghost employees.
 Audit employee addresses. The internal audit staff will periodically search for
matching employee addresses on multiple paychecks, and determine if multiple
instances of the same address are caused by employees fraudulently paying
themselves through ghost employees.
 Compare tax forms to pay documentation. The internal audit staff will
periodically match year-end employee tax forms to employee pay change
authorizations and termination documentation, and investigate any variances.
 Compare payroll payments to human resources files. The internal audit
staff will periodically verify that human resources files exist for all employees
being paid, and investigate any missing files.
 Review paychecks for double endorsements. The internal audit staff will
periodically review a selection of paychecks for double endorsements, indicating
the possible use of ghost employees.
 Compare the payroll salary budget to actual expenditures. The internal
audit staff will match the expected payroll as outlined in the budget to actual
payments, and investigate any differences.

PAYROLL PROCESSING SYSTEM

The processing of payroll can produce errors in several places, which calls for a detailed
process flow that also incorporates several controls. This procedure can be used to ensure that
payroll is handled consistently on a repetitive basis. The actual process flow may vary
somewhat from the steps noted below, since there may be differences related to the use of
manual, computerized, or outsourced payroll processing solutions. The most likely version of
the procedure, including responsibilities and basic controls, follows:

1. Update employee master file. The payroll clerk will probably receive notification of a number
of changes to employee information that impact the processing of payroll, such as withholding
exemptions and pay rate changes. If so, update the employee master file in the payroll software
with these changes.

2. Set pay period. Verify that the payroll module is set for the correct pay period.
3. Enter time worked. Enter the amount of regular and overtime hours worked by each employee in
the payroll system. If the company manually calculates payroll, then this step and the next step
are not needed. If the company uses computerized time clocks to assemble its timekeeping
information, then the information may be ported directly into the payroll software.

4. Enter manual payments. Enter the amounts of any manual paychecks that have not yet been
recorded in the payroll system. These may be pay adjustments from previous periods, or
payments related to the initial hiring or the termination of employees.

5. Calculate termination pay. Manually calculate the amount payable to any employee who has
left the company, including their unused vacation time and severance pay. This usually only
involves those employees who have left the company voluntarily, since forcible terminations
require near-immediate payments that usually fall outside of the normal payroll processing
period.

6. Alter deductions. Enter any changes to the standard deductions from employee pay, such as for
medical insurance, garnishments, and charitable contributions.

7. Calculate pay. Have the software process all pay calculations for the period. If the company
manually calculates pay, then use the tax tables provided by the federal and state governments
to determine the proper amount of tax withholdings.

8. Review reports. If payroll calculations are either outsourced or use payroll software, print the
following reports and review the underlying transactions for errors. Process payroll again until
these issues have been corrected.

o Negative deductions report (can indicate a data entry error or fraud)

o Negative taxes report (can indicate a data entry error or fraud)

o Preliminary payroll register (the key document used to locate errors)

o Sorted list of wages paid (focus on excessively high or low wage amounts to spot potentially
inaccurate hours worked or wage rates)

o Trend line of payroll expense by department (can indicate wages being charged to the wrong
department)

9. Issue payments. Once the analysis of reports indicate no further errors, process payments to
employees.
10. Issue management reports (optional). Issue payroll reports to management that are related to the
payroll just completed. Examples of such reports are a trend line of overtime by employee and a
trend line of compensation expenses by department.

11. Back up data. Once the payroll has been completed, back up the data related to it. If payroll
processing is outsourced, this is handled by the supplier. If in-house software is being used,
archive the data. If a manual system is used, put the payroll register in locked storage.

12. Lock down the period. Lock down the payroll period in the payroll module for the period just
completed, to prevent unauthorized changes. This is essentially the same as Step 2; by locking
down the payroll period, we are essentially shifting forward to the next payroll period.

13. Deposit taxes. Deposit payroll taxes and verify their transmission to the government. If the
company has outsourced its payroll processing, this step is handled by the supplier.

14. Store timecards. File the time cards near the payroll department. It is quite possible that
employees will question their pay, in which case the most recent time cards should be easily
accessible for review. After a month or two, the time cards can be shifted to longer -term
storage.

15. Investigate errors. If there are payroll processing problems, be assured that employees will find
them! Investigate all transaction errors encountered, and initiate changes to mitigate their
continued occurrence. This may involve the alteration of procedures or the imposition of new
controls.