Accounting and tax audit of payroll operations

Payroll audit provides the owner and accountant with confidence in the compliance of company accounting with labor and tax legislation.

All business operations must be confirmed by a large number of personnel and accounting primary documents. These documents must contain identical information and, if the company's payroll process is not automated, very often some inconsistencies lead to errors and the risk of fines. The most common penalties faced by many companies (the amounts of penalties are specified as of 1.10.2022):

• payment of wages in an amount less than the minimum - a fine of UAH 13,400;
• payment of wages ignoring taxes (unified social tax, personal income tax, military tax) - UAH 67,000 for the first violation and UAH 201,000 for the repeated violation during 2 years;
• breach of terms for payment of wages - UAH 20,100.

To reduce the risk of errors, we recommend that companies consider:

• express audits of accounting and reporting before submitting reports to regulatory authorities;
• automation of accounting (in full or separate processes).

Using the example of our client's case, we will describe all stages of payroll audit, and what business owner's problems it solves.

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What is the procedure for auditing payroll operations?

We were contacted by one of our clients, the owner of a cosmetology medical center, with a request to perform a payroll audit. We needed to perform this audit because the accountant responsible for this area was planning to resign.

The express audit was conducted in accordance with the following plan:

1) Checking the availability and accuracy of personnel documents.

2) Checking payroll transactions:

• Correctness of payroll accrual (in accordance with personnel documents);
• Correctness of payroll tax accrual and withholding.

3) Checking remuneration transactions (bonuses to employees):

• correctness of documentary evidence of bonus payments;
• correctness of bonus accrual;
• correctness of bonuses tax calculation and withholding.

4) Correctness of the reflection of remuneration in the expenses of the company.

5) Verification of the correctness of the social package compensation:

• correctness of documenting the social package compensation;
• correctness of reflection of expenses on the social package;
• correctness of accrual of additional benefits.

The main task of this audit was to confirm the accuracy of this section of accounting, and the transfer of "clean" files to a new accountant. In the case of deviations - prompt elimination of them by the previous accountant and charging him with the amount of losses that the company incurs in the event of fines.

Let's focus on each block of audit in more detail.

Our client's company provides medical practice and cosmetic procedures. The company has its own staff of specialists - doctors and a commercial department. Employees of the medical center work in accordance with the approved schedule, employees of the commercial department - according to the office schedule (5 days a week, 8 working hours).

The company policy allows employees to take advantage of the social package in the form of a gift for 1 free treatment center per month and a permanent 50% discount on the purchase of cosmetic products.

Step 1: Checking the availability and accuracy of personnel documents

We checked the staff schedule of all documents on the hiring / dismissal of employees (applications and orders), timesheets.

In the course of the audit, we found a discrepancy between the actual work schedules and the timesheets. In fact, the medical center works 7 days a week, while according to the timesheets, all employees of the medical center (not only the commercial department) worked according to a 5-day schedule.

This work model was adopted in the company to simplify the work of the accountant in the process of calculating wages. But this method is unacceptable, because:

• The medical center has a terminal and cash register, according to which any supervisory authority can easily obtain information about the work of the center on the day off;
• The medical center's schedule is available on its signboard and website.

Audit results:

• The discrepancy between the documented work schedule and the actual work schedule, which may equate to underpayment of wages;
• The absence of a provision and order on the working conditions on a day off;
• the timesheet includes an employee working under a civil-law contract (which is prohibited by law and equates to the employment relationship between the employee and the company).

Step 2: Checking payroll operations

We made a comparative calculation of salaries and accrued taxes for each of the employees (based on the available timesheets). During the audit, no deviations in the correctness of the calculations were revealed.

The company also has 2 part-time employees who do not have the medical center as their main place of work. The income of these employees is less than the minimum wage. No supporting evidence of the main place of work was provided.

Audit results:

• failure to confirm the main place of work of part-time employees may lead to additional accrual of unified social tax.

Step 3: Checking remuneration operations (bonuses to employees)

The company has a system and regulations on bonuses, according to which there are:

• monthly bonuses based on KPIs;
• annual bonuses (13th salary);
• one-time annual bonus for top management.

There are no comments on the first two types of premiums. All transactions were carried out in accordance with legal requirements and internal regulations of the company.

A one-time annual bonus for top managers inside the company is called a "dividend", but in essence it is an additional reward for achieving annual financial results and is subject to taxation in accordance with the general rules of payroll taxation.

When reflecting such a transaction in the accounting, the accountant did not check that the recipients of this bonus (dividends) are not the founders of the company, and carried out taxation at 5% personal income tax instead of 18%.

Audit results:

• the name of the annual bonus in internal documents does not correspond to its actual nature;
• failure to accrue and pay personal income tax in full (13%).

Step 4: Proper recording of remuneration in the company's expenses

Salaries of the medical center's employees are the cost of services provided and should be included in the production cost, which is formed in the balance sheet item "Work-in-progress".

Salaries of the commercial department are commercial expenses and should be included in selling expenses.

Salaries of administrative personnel (managers) make up administrative expenses.

At the medical center, salaries of both the commercial department and the medical center staff are reflected in sales expenses, which is a violation of the provisions of accounting standards and leads to a distortion of the cost price of services sold.

Audit results: Incorrect recording of payroll expenses of the medical center's employees.

Step 5: Checking social security compensation

As we said earlier, the company's social package includes:

• 1 free medical center procedure (per month);
• 50% discount on the purchase of beauty products.

Primary documents confirming the purchase price of beauty products confirmed that the sale at a 50% discount does not result in a sale below cost. In this case, the employee pays for the products, which avoids the accrual of additional benefits.

What can not be said about the first type of social package - a procedure as a gift. By providing a free service to your employees, you provide them with an additional benefit in kind, since:

• we can trace who used the procedure/received the service;
• we know the cost of the service.

The company did not conduct an official accrual of additional benefits for employees, which could lead to the risk of fines in the case of not conforming to the fiscal authorities the cost of writing off materials for the procedure and the employee's job at the time of their implementation.

Audit results: absence of accrual of taxes on the social package, but the availability of information about the social package both on the company website (in the section Jobs) and in internal policies.

The results of express-audit show that the revealed deviations to a greater extent testify to the need to bring these internal policies in compliance with the rules of labor and tax legislation.

Our specialists offered recommendations on how to correct the identified deviations:

1. Development of internal rules that record the use of different work schedules for the company's subdivisions.
2. Development of timesheets and keeping them in accordance with the actual working hours of employees. Correct incorrect (old) timesheets to match the actual work schedules of the medical center's employees.
3. Additional control (automation at the software level) over the documentation of part-time employees and those working under civil-law contracts.
4. Development of a policy of remuneration payments to employees and shareholders.
5. Setting up the correctness of reflection of payroll costs (setting up the accounting system).
6. Social package: to develop a mechanism for obtaining information about services and the mechanism of automatic accrual of taxes on them (automation of accounting).

The business owner accepted our recommendations and expressed interest in the automation process. We helped the owner not only to identify current deviations in their accounting, but also to automate the processes to prevent them in the future. 

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What are the documents required from the company to conduct internal audits?

To conduct internal audits, you will need (but not limited to):

• Personnel documents (staff schedule; timesheets; orders for hiring / dismissal / leave / sick leave of employees; orders for bonuses; orders to change salaries; other internal documents);
• Vacation accounting documents (vacation schedule, vacation reserve, applications to the Social Security Service for sick leave, minutes and other internal documents);
• Reporting (Tax calculation of completeness and timeliness of payment of personal income tax, military tax and unified social tax);
• Internal policies and regulations related to labor remuneration.

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How does the owner benefit from auditing payroll operations?

The absence of an audit in the company increases the risk of fines during inspections by regulatory authorities.

The owner's main benefits:

• analysis of the company's financial activities allows the owner to be confident in the absence of malicious acts on the part of employees;
• method of insuring the accountant before submitting statements - detection of mechanical errors;
• confirmation of the correctness of the company's accounting to the shareholders and regulatory authorities.

The payroll audit includes:

• verification of accounting compliance with labor legislation;
• verification of compliance of accounting with tax legislation;
• verification of correct accrual of wages, vacations, sick leave and other payments related to labor remuneration;
• verification of correct accrual, withholding of taxes and fees and their payment to the budget;
• verification of correctness of reflection of remuneration in the company's expenses;
• verification of legitimacy of labor relations with employees.

Find out the cost of auditing accounting processes here.

Please see the cost of Robotic Process Automation (RPA) for accounting here.