Overview of the Outsourced Payroll Process

Outsourcing the payroll processing function shifts a number of key payroll processing tasks to a supplier, resulting in a significant drop in the payroll department's workload, its required level of expertise in operating computer software, and in the risk that payroll taxes will not be remitted to the government in a timely manner. For these and other reasons, outsourcing payroll is an extremely popular option, especially for smaller businesses that do not have much in-house payroll expertise on hand.

The basic process flow for an outsourced payroll function is shown in Exhibit 1.2. Note that the key items in the exhibit are the tasks that are not shown because they have been taken over by the payroll supplier. These tasks include processing the payroll transactions, printing payroll reports and paychecks, and making tax deposits and reports to the government on behalf of the company. By outsourcing these activities, the payroll staff is required only to compile and verify incoming data about hours worked, load it into the supplier's payroll system, and verify that the results are accurate.

The process tasks noted in the exhibit can be streamlined by taking several additional steps. First, use a computerized timekeeping system that will prevent unauthorized overtime and automatically issue reports that highlight hours that were not logged in by employees, thereby eliminating two steps from the data collection part of the process. Second, some payroll suppliers sell computerized timekeeping systems that link directly into their systems, so there is no need to manually load this information into the supplier's system (or call it in to a data entry person). Third, a company can pay the supplier to create customized summary-level reports that can be used as the foundation for journal entries, which eliminates additional work. Finally, some suppliers now issue payroll reports on compact disc (CD), which nearly eliminates the filing chore. By taking advantage of these additional outsourcing features, the payroll process can become a very efficient system.

Controls over the outsourced payroll process are fewer than required for other systems, because there is no need to control the check stock or signature plates, which are handled by the supplier. Consequently, the primary controls tend to be at the beginning and end of the process. As shown in the boxes with bold lettering in Exhibit 1.3, there should be an approval process for overtime hours worked, as well as for negative deductions. A negative deduction is essentially a payment to an employee; if used repeatedly, even incrementally small amounts could add up to a significant pay increase for an employee. For larger companies with many employees, you should also compare the addresses on the employee paychecks to see if a "fake employee" has been added to the system, with the check being mailed to a current employee's address to be cashed by that person. You can also issue a list of the names of people receiving paychecks to the department supervisors to see if any fake names or the names of departed employees crop up. Finally, you can also spot fake employees by handing out checks directly to employees after they show some form of identification. Not all of these controls are necessary, but you should select those that make the most sense for a company's specific circumstances.