When it comes to processing payroll, most companies are on autopilot. But due to the pandemic-induced high employee turnover rate, now is a particularly good time to revisit payroll controls. The increased turnover rate has led to a large volume of changes to payroll information, including employee terminations, furloughs, possible rehires, and non-routine compensation types like hazard pay and paid time-off for vaccinations.
Some companies assume that involving a third party in the process takes away any risk. But oftentimes, several easily-adopted procedures are frequently overlooked by third parties and if these small errors are not detected, they may compound other weaknesses in the process, resulting in more egregious abuse over time. Thankfully, by implementing a few key strategies, creating a strong control environment is easier than one may think.
Segregation of Duties
The first step to ensuring an effective process is to appoint three different individuals with defined responsibilities for initiating, processing, and approving payroll. Even when a third-party payroll company is utilized, it remains important to define who is responsible for approving rates, communicating changes with the payroll company, and performing the detailed review. Of these, perhaps the most vital step is the detailed review, which should be completed both prior to the payroll submission, and again after the payroll is processed, ensuring the approved data matches the final payments. For smaller companies with limited personnel, this is achieved through a detailed review by the business owner or senior management.
Review and Analyze Payroll Data
Conducting periodic reviews of the underlying payroll data to secured personnel files is a crucial best practice for accountability and accuracy. This task should be performed randomly throughout the year and by someone independent from the payroll process who has no authority to initiate or approve payroll on a routine basis. The process should be extremely thorough and seek irregularities including, but not limited to the following:
- Always check the first and last check number for each approved payroll to identify any missing or duplicated check numbers, or any that have been written between payroll periods.
- Beware of fictitious employees and review the employee payroll database for any duplicates or gaps in the employee number sequence. Fake employees are sometimes added to a different number sequence.
- Look for duplications of employee addresses or bank account numbers used for direct deposit.
- Inspect for employees that do not have any tax or social security withholdings.
Another important step to perform regularly is a timely review and a thorough analysis of labor hours, as well as expenses compared to budgets. Ideally, this information should be budgeted in enough detail to detect irregularities, often by department or class, in order to properly predict and analyze trends throughout the year. Too often, this process is circumvented by only looking for high level variances, without developing detailed expectations that can properly identify inconsistencies. For instance, fictitious employees tend to show up during periods when they aren’t likely to be detected, often when there are many payroll changes. When a company has a rapid period of employee changeover, it’s critical to make sure that a terminated employee’s payroll information has not been assigned to a different account number rather than removing the payroll information from the authorized payroll listing.
Reporting and Approving Changes
By providing a record and approval process for all changes to the payroll system, a tracking log can quickly be generated every pay period. These reports detail any changes from the prior pay run and can identify unauthorized changes to the master file, including employee name and address changes, pay rate changes, non-recurring changes to hours worked within established parameters, and even the addition of ghost employees to the master payroll system. The task should be performed by someone outside of payroll to verify the changes processed each payroll period agree to the changes documented and authorized in the employee personnel files. It’s also a good practice to send payroll payment reports to department heads to spot payment irregularities and approve time on a regular basis.
Access and Security
Don’t forget other roles in the payroll process, including ones that have access to the employee personnel files and the stock of physical payroll checks. While the distribution of physical checks is less common today, payroll checks are often maintained for non-routine payments as well as expense reimbursement. Manual check stock should be locked and secured, and when possible, should be hand delivered to employees. Also consider setting up a separate payroll account which is funded for the exact amount of each payroll period. This ensures alterations of checks are detected quickly, as the additional funds are not available in the account.
Finally, as with any accounting process, log each employee’s access to the payroll system and define the authorized parameters based upon their defined role to initiate, review, or approve payroll. Far too often, passwords are generic to the numerous employees who access the system, and user controls aren’t properly set up to limit access.