How to Avoid A DOL Payroll Audit

©2016 The Payroll Advisor1

How to Conduct an Internal Audit to Avoid an External

OnePresented on Wednesday, October 19, 2016

2©2016 The Payroll Advisor

Housekeeping

©2016 The Payroll Advisor

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Our Focus For Today

Learn the best practices for payroll departments to avoid audits

How to beat them at their own game: strategies to conduct your own internal audit

Auditing for internal fraud: what to look out for including phantom employees and reverse deductions

Auditing for Wage and Hour law compliance on both the federal and state level

Auditing for tax law compliance on both the state and federal level

How to get management to buy into the idea of an “internal audit”

What to do if a compliance issue does arise during an internal audit

When to conduct the internal audit

New areas of audits on the horizon

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About the Speaker


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Vicki M. Lambert, CPP, is President and

Academic Director of The Payroll

Advisor™, a firm specializing in payroll

education and training. The company’s

website www.thepayrolladvisor.com offers

a subscription payroll news service which

keeps payroll professionals up-to-date on

the latest rules and regulations.

http://www.thepayrolladvisor.com/

Strategies to Conduct Internal Compliance Audits

Not a quick project but a department wide project

Allow months to a year to conduct

Any task payroll does is subject to audit

Conduct the audit on an aspect by aspect basis to allow a starting and stopping point along the way

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Setting Up…


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This makes it easier to complete each phase of the audit

Can handle other projects, and then return to the next phase

Speed is not the concern for this audit but accuracy

Must conduct the same kind of thorough audit of all the payroll procedures as an external auditor would do—You are the IRS Agent!

Setting Up…


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When to start the audit is a tough call

Best time is beginning of a new year—March is fine

Employees are less likely to notice/question the changes that may occur

Forms W-2 are easy to adjust

Entire department can be verified in same calendar year

Strategies…

The audit can be conducted with the full knowledge of the payroll staff

Not a secret audit to find fraud or to “catch” someone doing something wrong

Purpose is to find areas that are out of compliance and fix them before ever facing an external audit

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Strategies…

Payroll staff can be useful in this endeavor

Staff can audit each other and manager

No one working on the focus of audit does the audit for that task

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Strategies…

Don’t confuse this type of audit with accounting firm audits or other “internal audits”

Those are looking for compliance with general accounting practices or principles

Audit both policy and practice

Your policy may be in compliance but your actual practice may not be

Never assume your company policy is in compliance as demonstrated by the First Ohio Banc case.

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First Ohio Banc Example

March 2007 company paid $307,702 in back wages to 298 employees for minimum wage violations. Company policy required loan officers to be paid commissions on a twice-monthly basis and receive no pay if they had not closed loans during a pay period. DOL disallowed this policy.

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Getting Management to Buy In

Upper management must buy in at the start

May run into the “we’ve never had a problem yet” mentality

SOX is helpful if it applies

Use case history to convince management

Example CVS Pharmacy case

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CVS Pharmacy Case

December 2006 CVS Pharmacy Inc. was assessed civil penalties and required to pay back wags to 51 employees most for improper editing of time cards by store managers. The penalties were $11,220. The back wages were $38,151. The back wages would have to be paid in an internal audit but not the PENALTIES.

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Setting Up the Internal Audit

There are two points that are critical for the payroll manager to complete before beginning any internal audit

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First Point…

The person conducting the audit should know all the laws, rules and regulations concerning the topic being audited:

These should be put in writing and include both federal and state regulations

This should not be done from memory but from primary sources such as the DOL/IRS website

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First Point…

Secondary sources (such as payroll manuals) can also be used if the source is comprehensive including source cites

This can be done prior to each audit for each topic or the entire audit book can be compiled prior to starting the audit

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Including…

The company policy for each topic should also be included

Many times the federal or state requirements are exceeded by company policy

Employees can sue if company policy is not followed even if the federal and state requirements are, so they should be included in the audit as well

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Second Point

A comprehensive list of all payroll tasks to be audited should be completed, in writing, either prior to beginning the audit or as you go along:

This gives a “playlist” of the tasks to be accomplished and what lies ahead

Helps with assembling the law book discussed in the previous bullet

Also assists in compiling the time frame and work schedule for the audit

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What to Cover

Comprehensive sample list in the handout but should include:

All facets of paying employees that are covered by the Department of Labor

All taxation and reporting facets

Don’t forget the state equivalents

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Spreadsheet

The topics are in written form to know what to look for. On your spreadsheet you would list each individual area as a topic or subtopic. Example for Regular rate of pay could be listed as:

Topic: Regular Rate of Pay

Subtopic: Bonuses

Commissions

Shift Differential

Each topic and then subtopic would be audited.

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Setting up the Spreadsheet

Many ways the spreadsheet can be organized on Excel:

Have a separate sheet for each topic

Excellent for small payrolls with limited auditing

Use a separate file for each topic and use a separate sheet for each item

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Setting up the Word Spreadsheet

Can also set up on Word using a table style

What works best for your department

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Exempt Employee Example for DOL Audit

Payroll doesn’t make the decision—most cases

Payroll must apply the rules for exempt employees

Audit to ensure that exempt employees are paid correctly

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Exempt Employee Example for DOL Audit

Are deductions from exempt employee’s pay for vacation, sick or other leaves done correctly?

Are exempt employees paid on a “salary basis”?

Are deductions done to exempt employee’s salary?

If so…are they done correctly?

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Before Beginning…

Create template for conducting the audit for each task

Create report template for audit findings for each task

Create compliance problem template

Create general template of final audit report for department

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How to Conduct It

Written, formal report for each procedures or policy reviewed

This report the basis for new controls if needed

Not a quick scan

Set up spread sheets and review forms

Compare the regulations to the actual practice and then to policy

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Conducting the DOL Audit

Include all facets of payroll subject to FLSA or state equivalents

Auditing all facets not just your own—remember CVS case dealt with store managers

Violations can occur anywhere

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Conducting DOL…

Pay special attention to payroll calculations and your department’s understanding of how they are conducted

Audit each employee not the department as a whole—it only takes one employee who fails to understand…

One area that definitely requires scrutiny is “regular rate of pay”.

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Regular Rate of Pay

Does the company have any factors that would affect the regular rate of pay such as bonuses, commissions, or shift differential?

Do the state and federal regulations match or must payroll allow for a higher state requirement?

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Regular Rate of Pay

Can regular rate of pay be calculated by the payroll system?

This question is not a quick answer

Most payroll systems do not have the capability to calculate regular rate of pay especially if it crosses over to more than one payroll

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Regular Rate of Pay

If the regular rate of pay cannot be calculated by the computer system, are manual spreadsheets being used?

If manual spreadsheets are used to calculate regular rate of pay, are they being done correctly?

Are retroactive pay raises being included when calculating regular rate of pay for back overtime due?

Does A/P pay bonuses?

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Regular Rate of Pay

Does the payroll staff understand the rules concerning regular rate of pay?

Are they applying them to the payroll processing?

This is critical

The company policy and the procedure manuals may state the calculation correctly but the staff does not follow through because they do not understand the concept is a compliance problem

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Regular Rate of Pay

Does the company policy meet or exceed the federal and state requirements for regular rate of pay?

Example: do you include sick, vacation or holiday as hours worked?

Does the payroll staff understand the policy?

If the employee works more than one job with more than one rate are weighted averages used?

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Auditing For Regular Rate of Pay

Use your primary source as a starting point

DOL has a overtime calculator that can be used to test your calculations

http://www.dol.gov/elaws/otcalculator.htm

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http://www.dol.gov/elaws/otcalculator.htm

Auditing For Regular Rate of Pay

Better to look to secondary sources for the actual understanding of the calculations in this case

Make sure you understand what “premium pay” is and how it is calculated

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Sample Steps for Regular Rate of Pay Audit

Determine how the regular rate of pay is currently being calculated on your payroll using three example employees with different types of payments such as shift differential, bonus payment and commissions

Use the DOL calculator to see how the DOL would perform the same calculations for the same employees

Compare the two outcomes

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Overtime Calculator


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Explains the rules of overtime and then demonstrates how to calculate using your own information

Let’s you calculate how the DOL would calculate overtime but without the auditor sitting in your office by completing a series of questions

Let’s do an example to see how it works…


Continue…


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From this point on you will answer the questionsrelated to the employee such as: Are you a government employer or is this a tipped employee

The advisor will give your information as to what you will need to continue to the next screen based on the answers to the last screen

You will input day of the week the workweek starts on, hours worked, hourly rate, bonus information, type of payroll period etc.

When you finally hit submit…

The Results


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The website will show you the results of the calculations—exactly what the employee’s gross wages should be

It will explain each step of the calculation and then show the calculations

The advisor will also explain the rules it used to determine the calculations

We entered a weekly employee who is paid $10.00 per hour and received a $100 bonus this week for completing a project on time and on budget

The Results


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Here is the first set of calculations

The Results


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Here is the remaining calculations:

How Did You Do?


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We compare our employee’s gross wages with what the DOL Overtime Calculator results

If they match within 2 or 3 cents we have a good system for handling overtime

If they don’t match within 2 or 3 cents we have a problem

Increase the audit scope if unsure

Other Areas of Concern for DOL

Lunches docked but not taken

Overtime for semi-monthly payroll periods

Weighted averages used for overtime payment when employee works at more than one rate per week

Off the clock work

And of course…independent Contractors!

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State Side…

Now look at the same areas for the states where employees are performing work

Anything unique such as CA OT?

Are meal and rest periods mandatory?

Are you handling travel pay correctly?

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State Side…

Check for non-federal laws such as: Postings

Paystubs

Notices

On-call pay

Show up pay

Split shift pay

other state related items

Check for pay frequencies and lag times

Are you paying the higher standard?

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Auditing for IRS Tax Compliance

All facets of taxation including all payments made through the payroll and through accounts payable and offered through human resources---Everything!

Don’t forget the state and local taxes

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Example Area of Audit—Prizes and Awards

Does the company offer rewards for performance? Taxation audit should include such items as:

Length of service awards

Safety awards

Employee referral programs

Employee of the day/week/month/quarter or year

Performance bonuses

Prizes

Any payment to employees through A/P

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What to Do If Noncompliance Issue Is Found

Set up procedures in advance to report to management any noncompliance issues that are discovered.

Deal with each one as they arise after the completion of the audit for that procedure

Keep written records to show corrections to procedures or to show why they were not corrected

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Auditing for Internal Fraud

Payroll fraud is defined as “anything that uses payroll to take money from the company in a deceptive or illegal manner”.

Can take many forms

Phantom employees

Deduction reversals

Fraudulent additions to time cards

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Phantom Employees

A fake or phantom employee is “hired” and set up in the payroll system. This phantom employee is then paid normally, no excess hours or overtime to make the employee stand out on an edit report

Usually the payroll staff member works with a supervisor of another department. This allows a time record to be submitted that would pass auditing

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Phantom Employees

Once the phantom employee is set up it is almost impossible to detect and can go on for years

Especially true in large companies where one extra employee in a large department would go undetected

Best method for finding phantom employees or to make sure there are none on the system is to conduct a headcount of employees to payroll checks

This is called a phantom employee check

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Phantom Employees Check

Team of employees not related to the payroll department pass out the paychecks in person to each employee

The employee must show identification before receiving the paycheck

This confirms that the employee whose name is on the payroll check is available in person

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Phantom Employee Check

Phantom employee checks cannot be announced in advance

Must be done in secret

Direct deposits are cancelled for this phantom employee audit

Phantom employee is frequently set up as a salaried employee with payments that follow automatically

This is particularly true in the case of electronic payments into bank accounts where a check does not need to be collected

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Phantom Employee Audit

No one can pick up someone else’s check—even the supervisor

All unclaimed checks on payday are retained in payroll and must be picked up in payroll

Account for sick or vacation employees

If the check is never picked up or suddenly the employee “quits” this is the sign of a problem

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Signs of Fraud

Remember what my accounting professor once said “If you are going to embezzle or steal, do it once, do it big and get out of town”.

Not everyone follows my accounting professor’s advice

Little bits over time is the norm—no one thinks they will get caught

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Pay Raise Input Fraud

If payroll inputs pay raises or has access to input on this master screen, all pay raises should be compared to the actual paperwork

Better fraud prevention: someone other than payroll inputs pay raises perhaps Human Resources

Someone other than HR verifies pay raises such as payroll

3rd party such as controller is best

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Reverse or Refund Deduction Fraud

Reversing a deduction is a rare input

Any reverse deductions should always be verified immediately by someone other than the one who did the input

Refunds of deductions are rare as well

All refunds of over deductions should be verified by a third party and fully documented including the complete “proof” i.e. payroll records that it actually occurred

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Garnishments

Garnishment checks should be processed as a third party check directly from the payroll system if possible

If accounts payable checks are used, then proof of a deduction from the payroll should accompany each check request

Harder to do for child support nowadays but if sending child support via EFT will prevent fraud

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Tax Refunds

Tax Refunds Or Adjustments: The payroll department should never refund taxes to employees. Whenever this is done an audit should be conducted.

Especially watch for state and local tax refunds—less harder to spot

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Other Fraud Methods

Anything out of the normal usual current dollars times current hours should be reviewed by someone other than the person who input it

It must be KNOWN that you are keeping watch!

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Preventing Fraud

One of the best ways is to make sure that the duties in the payroll department are properly distributed among the staff so that a separation exists for all check producing or input to checks tasks

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Implementing Internal Controls

Have internal controls in place for every single payroll process no matter how small

If you can find a way around the process so can someone else

Every process has to have a break somewhere for a review by a 2nd party

Example: input timecards and process paychecks on a normal payroll run—where is the break? Where is the audit?

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The following are some of the control features that should

be in place when running a payroll:

Auditing procedures prior to input

Auditing procedures to verify input

Reconciliation of the payroll

Error correction controls

Manual checks, void checks and check stock controls

Procedures for the proper distribution of payroll checks and unclaimed checks

Audit trail requirements

Controls on distribution of payroll information and reports

System documentation

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Best Practice for Protecting Data

Two questions to ask of staff members:

1. Do you need access to do your job or want access to do your job?

2. Do you have access as a requirement of your job or as a promotion or reward

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New Areas for Potential Audits

IRS is looking at fringe benefits for executives such as personal use of housing or vehicles and club memberships

Independent contractor misclassification is the big area of audits right now both federal and state


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Are There Any Questions?


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How Can Ascentis Help Me?

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Ascentis products have a number of automated features that help make your own internal audits easier.

• Weighted average overtime calculations in Ascentis Timekeeper

• Multiple internal audit reports for employee data, payroll processes, and company setup to know who did what and when

• User security settings to restrict access to data changes or certain payroll processes

• Third party system for garnishment and other external vendor payments automatically linked to paycheck deductions

• Ability to determine for any third party vendor whether they will be paid via check or EFT

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Documents

How to Avoid A DOL Payroll Audit