Internal Controls in the Payroll Department

The overall goal of an internal controls program is to prevent someone from subverting the pay/withholding/depositing/reporting process. In other words—committing fraud. If the IRS suspects fraud, all the statutes of limitations go out the window, and it can go back into your records for as long as it wants. And that will be a problem, if you’ve destroyed your old records. We think internal controls over payroll data is a prudent idea, and, more important, so does the IRS.

Checks and balances

A basic internal control is separation of duties, so a single person doesn’t control inflows and outflows.

Examples: The person who has access to a company’s check signature plates doesn’t also have check-signing authority; the person who completes tax returns, including 941s, doesn’t sign them; the person who is responsible for tax filings doesn’t receive tax deficiency notices.

Here are some other key steps you can take to ensure that your internal controls are robust:

  • Cross-check tax data. This prevents errors and this level of coordination will help with tax auditors. Best practices: All returns—Forms 1120, 941, 940, W-2 and W-3—are cross-checked against each other before filing
  • Ensure accountability, authorization and approval of payroll entries. Best practices: Periodically review and update signature authorizations; obtain preapproval for changes made to employees’ time sheets; review attendance records to determine whether they’re accurate and conform to company policy; and reconcile ledgers monthly to double-check that recorded transactions are accurate
  • Protect employee resources. Store paychecks and pay statements in a safe location and restrict access to personnel records to employees on a need-to-know basis. Best practices: Request proof of identity prior to distributing payroll; notify employees of unclaimed checks; return unclaimed checks to Payroll; and secure private and sensitive information
  • Establish working relationships with Accounts Payable and Benefits. Close cooperation will allow Payroll to be brought into the decision-making process early. Best practices: Bring Payroll into hiring decisions when an offer letter is prepared, so that policies and state laws aren’t violated. Examples: Requiring a new hire to enroll in direct deposit or a paycard program, when state law mandates voluntary participation; whether sign-on bonuses or other taxable payments, in addition to salary, will be made to the new hire. And if Payroll is left out in the cold? Intervene as soon as possible and point out payroll-related considerations as soon as you hear a rumble
  • Review and reconcile monthly. Monthly reconciliation ensures that you’re paying the right employees at the correct rates. Best practices: Review and audit monthly payroll costing reports; spot variances by comparing actual payroll costs to estimated costs; and reconcile operating ledgers monthly to ensure accuracy and timeliness of expenses.