Accounting, Financial, Taxation

Payroll control is one of the biggest controlling aspect in financial and accounting field after the cash and inventory (finished good and raw material). Why? Quiet straight forward reason; payroll or wages takes the second biggest portion of the “Cost Of Goods Sold” allocated in every company (or business in general) after the inventory. So, payroll control should be one of main focus of the controlling task of any financial managers, accounting manager, controllers, and the CFOs or the business owner (in a small business). Loosing control on the payroll system would lead a company into a big risk.

Unless you know what control you should apply to the payroll system, controlling this activities (read: transaction) could be a super complicated (yet tricky) task that you can not even imagine. You should understand the nature and flow of a payroll process. I know, you may not literate with human resource filed. It is not your expertise, yes so do I, but as a financial manager or controller, you should be familiar (hence become literate) with the payroll transaction and its nature. In this post, I am going to provide you set of control that will cover nearly every aspect of payroll system, such as: basic payroll system control, computerized timekeeping controls, computerized payroll system controls, payroll self-service controls, electronic payroll payment controls, cash payroll payment controls, electronic payroll remittance controls, and outsourced payroll controls.

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 and tax calculations. A second payroll clerk will review the payroll wage and tax 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.

Remit taxes on a timely basis. The payroll manager will ensure that all payroll taxes are remitted to the appropriate government entities on a timely basis.

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.

Computerized Timekeeping Controls

Controls for computerized time clocks are used to ensure that the correct numbers of hours are recorded by the employees who actually worked the recorded hours. The controls are as follows:

Time clock controls employee hours. The computerized time clock will block out hours when employees are allowed to clock in or out.

Time clock requires overtime approval. The computerized time clock will require a supervisory approval code before an employee can record overtime hours.

Review time clock reports. The payroll clerk will review time clock exception reports for such items as missed punches, late punches, and overtime hours worked, and investigate problems as necessary.

Use biometric clocks. Biometric clocks will not allow time recording by anyone but people specifically

 Identified as being current employees. Link photo images of employees to badge scanner. An electronic camera will record the image of each employee as they enter time in the time clock, which the payroll clerk will monitor to detect buddy punching.

Review hours worked. Supervisors will regularly review time clock reports itemizing hours worked by employee, and investigate any unusual amounts.

Computerized Payroll System Controls

Controls in a computerized payroll system should incorporate many of the controls already noted for a manual system, but can be streamlined in the area of timekeeping controls. The controls are as follows:

Restrict access to the employee master file. The computer system will restrict access to the employee master file to authorized employees.

Automatic reporting of missing time cards. The computer will automatically compare the employee master file to submitted time cards, and report on employees for whom no timecard has been received.

Compare time card totals to data entry totals. A non-data entry person will compare keypunched employee time records to time cards for data entry errors, and correct any errors found.

Review payroll register for errors. The payroll staff will compare source documents to the payroll register report, and correct any errors found.

Independent review of payroll register. The payroll manager will independently print the payroll register and review it for evidence of improper payments.

Review exception reports. The payroll manager will print and review computergenerated exception reports, addressing such areas as negative deductions, as well as unusually large base pay, overtime, or hours being paid, and investigate as necessary.

Send a manual check copy to the general ledger clerk. The payroll staff will copy each manual check created and forward it to the general ledger clerk for recording in the general ledger.

Audit employee master file. The internal audit staff will periodically determine if all employees listed in the employee master file are actual employees who are currently employed, and investigate any differences.

Payroll Self-Service Controls

When payroll self-service systems are used, all related controls are automated, and center
on data entry issues and user notifications. The controls are as follows:

Limit the pre-allowed amount of pay rate changes. The self-service system will impose restrictions on the amount of pay raises that managers can grant employees, above which supervisory approval is required.

Send change verification e-mails. The self-service system will automatically send an e-mail message to the person initiating a payroll change, verifying the change made.

. The self-service system will notify the controller by e-mail if the bank account information for any employee is changed.

Reject entry of unauthorized residency states. The self-service system will reject the entry of a state of residence for which the company is not set up to record state income or unemployment tax remittances, and notify the payroll staff.

Link termination information to self-service system. The human resources system will be linked to the payroll self-service system, so that entry of termination information by the human resources staff will automatically shut down access to the payroll self-service system.

Cash Payroll Payment Controls

When employees are paid their wages in cash, strong controls are required to ensure that the correct amount of cash is received by the intended recipient. The controls are as follows:

Complete pay envelope information in ink. The payroll clerk will write employee pay information on the pay envelope in ink to avoid subsequent modification of pay amounts.

Match payroll register to pay envelopes. A second clerk will compare the payroll register to the pay amount listed on each pay envelope, investigate any differences, and initial each correct envelope.

Complete cash requirements form in ink. The payroll clerk will complete a cash requirements form (on which specific bill and coin amounts are requested) in ink to avoid subsequent modification.

Require approval of the cash requirements form. The payroll manager will review and approve each completed cash requirements form before cash is issued.

Casher retains copy of cash requirements form. The cashier will retain a copy of the cash requirements form once cash has been issued.

Count and sign for received cash. The paymaster will count cash received from the cashier and match the amount received to the cash requirements form prior to signing for receipt of the cash.

Employee signs pay receipt. Each employee being paid will count the cash received from the paymaster and match it to the pay amount listed on the pay envelope prior to signing for receipt of the cash.

Electronic Payroll Payment Controls

The primary controls over electronic payments are the proper authorization and verification of electronic payment information. The controls are as follows:

Require electronic payments. The human resources manager will enforce the use of direct deposit or payroll card payments to all employees.

Match routing and account numbers on employee check to submitted information. The payroll clerk will verify that the routing and account numbers on the check accompanying any employee request for direct deposit payment match the corresponding numbers entered in the payroll software.

Require direct deposit verification. The payroll clerk will not process a change to an employee’s direct deposit information without the employee’s signature and formal identification.

Securely store direct deposit authorization forms. The payroll clerk will store all completed direct deposit authorization forms in a locked cabinet.

Investigate multiple payments to the same bank account. The payroll manager will periodically print a computer report itemizing all bank accounts referenced multiple times in the payroll database, and investigate any payments from multiple employees to such accounts.

Electronic Payroll Remittance Controls

When payroll remittance information is provided online, there is no risk of asset loss, but there is a risk of inappropriate access to personal information, which is mitigated by the following control:

Require user verification. Employees will create user identification and password information for access to their online payroll remittance and W-2 accounts.

Outsourced Payroll Controls

When the payroll function is outsourced, the key additional controls are to verify that the supplier is indeed remitting taxes, and that paychecks are still routed through the company paymaster. These controls are shown below:

Obtain verification of tax remittances. The payroll manager will obtain receipts for all tax remittances made by the payroll supplier and match them to required remittance information.

Route incoming paychecks through a paymaster. The payroll supplier will send all employee paychecks to a paymaster rather than directly to employees; the paymaster will verify the existence of each employee prior to issuing the paychecks.

The cost components of work-in-process and inventory goods will inevitably include some labor. However, the proportion of labor in the total cost mix has dropped markedly over the years, with material and overhead costs now predominating.

Nonetheless, the costing reports the accounting staff has traditionally generated are mostly concerned with labor. Examples of these reports are those detailing overtime, comparing actual to standard labor rates or usage, and labor efficiency. By comparison, the reports concerned with the materials expense typically cover only scrap rates and purchase price variances, while many companies have no reporting for overhead costs at all. Hence, most accounting departments are misallocating their time in reporting on the smallest component of product costs.

How To Address This Issue?

The best way that addresses this problem is one of the easiest to implement—simply stop reporting on labor variances. The accounting staff will have more time to spend on reports concerning costs that make up a larger proportion of product costs. The problem with this best practice is the remarkable uproar it frequently incites, especially on the part of traditional production managers who were raised on the concept of tight control over labor costs.

Thus, the best way to implement this item is to carefully educate the production staff on the following points:

Direct Labor Is Really a Fixed Cost

In many manufacturing situations, the direct labor staff cannot be sent home the moment there is no work left to do. Instead, a company must think about retaining them since they are trained and more efficient than other people who might be brought in off the street. Accordingly, it makes a great deal of sense to guarantee regular working hours to the direct labor staff (within reason). By doing so, it becomes apparent that direct labor is not a variable cost at all and requires much less detailed investigation and reporting work for the accounting staff.

Other Reports Are More Valuable

If the accounting department only has enough resources to issue a fixed number of reports, there is a good argument for eliminating the least useful ones (labor reporting) in favor of ones involving more costs, such as materials and overhead. One can reinforce this argument by formulating trial report layouts for new reports that will replace the labor reports.

Target Costing is The Real Area Of Concern

Many studies have shown that costs are not that variable once a product design is released to the factory floor. Instead, the primary area in which costs can truly be impacted is during the product design.  A strong argument in this area, especially if combined with visits to other companies that have installed target costing, will go a long way toward convincing management on this point. If production management can be convinced that these three points are accurate, it becomes much easier to eliminate labor variance reporting, either completely or in part.

The only situation in which this best practice should not be implemented is one where labor costs still make up the majority of product costs (an increasingly rare situation) and where those costs are variable. If labor costs are highly fixed in nature, there is not much point in continuing to issue reports showing that the costs have not changed from period to period.

Many payroll departments are fully occupied with processing some kind of payroll every week, and possibly even several times in one week. The latter situation occurs when different groups of employees are paid for different time periods. For example: hourly employees may be paid every week, while salaried employees may be paid twice a month. Processing multiple payroll cycles eats up most of the valuable time of the payroll staff, leaving it with little room for cleaning up paperwork or researching improvements to its basic operations. It will become even worst when the payroll preparation (review, calculation, and disbursement) is carried out by the accounting department. We still can find many of private companies still occupy accounting dept for payroll preparation as well for the name of efficiency (which most likely be not).

Solution:

All of the various payroll cycles can be consolidated into a single, companywide payroll cycle. By doing so, the payroll staff (or accounting dept if it carried out by them) no longer has to spend extra time on additional payroll processing, nor does it have to worry about the different pay rules that may apply to each processing period—instead, everyone is treated exactly the same. To make payroll processing even more efficient, it is useful to lengthen the payroll cycles. For example: a payroll department that processes weekly payrolls must run the payroll 52 times a year, whereas one that processes monthly payrolls only does so 12 times per year, which eliminates 75 percent of the processing that the first department must handle. These changes represent an enormous reduction in the payroll-processing time the accounting staff requires.

But, any changes to the payroll cycles may be met with opposition by the company’s employees.

The primary complaint is that the employees have structured their spending habits around the timing of the old pay system, and that any change will not give them enough cash to continue those habits.

For example: employees who currently receive a paycheck every week may have a great deal of difficulty in adjusting their spending to a paycheck that only arrives once a month.

As a consequence, it is extremely likely that the payroll staff will be deluged with requests for pay advances well before the next paycheck is due for release, which will require a large amount of payroll staff time to handle.

Next solutions: 

1. You can increase pay cycles incrementally, perhaps to twice a month or once every two weeks, and also tell employees that pay advances will be granted for a limited transition period. By making these incremental changes, one can reduce the associated amount of employee discontent.
2. Review the prospective change with the rest of the management team to make sure that they are well prepared for the situation. They must buy into the need for the change, because their employees will also be impacted by the change, and they will receive complaints about it. This may requires a long lead time to implement, as well as multiple notifications to the staff about its timing and impact on them. It is also useful to go over the granting of payroll advances with the payroll staff, so that they are prepared for the likely surge in requests for advances.