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Payroll’s impact in the accounting cycle

accountingpaycycleFrom an accounting perspective, payroll is straightforward — or at least that is what some accountants and auditors think!

On the surface, payroll accounting does not appear complex or require detailed application of advanced accounting principles and theories. Accounting guidance relating to the payroll expense is relatively straight forward, with most of it not going beyond basic accounting principles.

However, contrast this perceived simplicity with the sheer dollar impact of payroll-related accounting transactions, the volume of payroll-related regulatory requirements and the variety of uses for payroll information, and you get a completely different picture.

Payroll processes are therefore an integral part of the accounting cycle. In both large and small organizations, internal controls surrounding payroll are crucial. The risk of payroll not being reported properly makes it significant.

Accurate inputs and outputs make the difference

Whether reported as a separate account, or combined with other transactions and reported in various lines of the profit and loss statement, payroll costs are typically the biggest expense item for many organizations (70% on average). In addition to being reported in the financial statements, information coming from payroll is used in other ways for costing and business analysis. That is why accuracy of payroll information is so important. While the flow of payroll information is relatively easy to control in small organizations, the risk significantly increases with the size and complexity of the operation.

Regardless of the organization’s size, input and output controls are imperative in every payroll process. In smaller organizations, payroll inputs and outputs are hourly or daily inputs and other payroll data that are entered by employees and/or a supervisor or payroll administrator using manual or automated time and attendance systems. Payroll expenses are booked to the general ledger (GL) via journal entries or data interfaces. Accountants or controllers can verify the accuracy of inputs and outputs in the process fairly easily, but they must be able to rely on internal controls.

Internal control risks may be greater in larger organizations because payroll inputs can be entered by different personnel, some of whom may be unfamiliar with the accounting impact of those entries. It may be difficult for an employee on the shop floor entering hours into the time and attendance system to understand that their entry will impact more than their paycheque, but also creates an accounting transaction that may potentially drive product cost and pricing decisions during an analysis exercise. Similarly, a benefits specialist may not always realize that the amount they are updating in the payroll system actually creates an accounting liability subject to various reporting and disclosure rules.

Reliable interfaces drive accuracy and compliance

Particularly in large organizations, both payroll inputs and outputs can enter the accounting system through complicated interfaces that make the transaction flows difficult to follow. In such cases, the inputs and outputs results must be carefully balanced using IT or business
process controls. For example, in the case of outbound payroll interfaces being posted to the GL, controls should exist to confirm that all payroll transactions included in the register and impacting accounting records are correctly accumulated by the interface and that its content
is accurately posted to the GL. As obvious as it sounds, this can be quite a challenge in large organizations and the results of inaccurate interfaces can have significant accounting consequences.

When you include internal, external and government audits and take into account the fact that every employee is acting as an auditor over their own pay statements and direct deposits, payroll is the most audited area of every business. This extensive review also makes payroll
data one of the most accurate an organization can have. So remember, the next time you feel a bit unappreciated, think about the big impact of payroll transactions on the accounting processes of your organization. It should brighten your day…and your accountant’s as well.

by Magdalena Szczupak, CPA, CMA

Magdalena Szczupak is the Manager of Finance for the Canadian Payroll Association. She has more than 20 years of experience in accounting, corporate reporting, stock compensation accounting, payroll and process design.

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