How to Conduct a Pay Audit, and Why It Matters

December 22, 2021・7 mins read
How to Conduct a Pay Audit, and Why It Matters

Employees expect fair compensation for the work they put in. However, the gender pay gap continues to persist, with women earning 82 cents for each dollar a man makes. Unequal pay goes beyond gender, extending to race, color, national origin, age, religion, disability, and other protected classes. To promote fair compensation, federal, state, and local governments have enacted equal pay laws. You can ensure legal compliance and employee satisfaction by conducting a pay audit.

What is a pay audit?

Pay audits are vital to achieving pay equity.

A pay audit is a process that lets you verify employees' wages/salaries and identify any pay disparities. Pay audits are vital to achieving pay equity, ensuring employees are paid equally for performing the same or similar work. In addition, a pay audit:

  • Allows you to verify other factors influencing pay, such as employees' credentials, level of experience, length of service, and job performance
  • Helps determine whether pay compression exists between managers/supervisors and their employees
  • Reveals whether pay disparities are limited to certain areas, such as a specific department, pay range, or employee age group
  • Helps determine whether the pay gaps are due to legitimate, nondiscriminatory reasons. This can be things like a seniority system, merit system, or a system that measures earnings based on quantity or production quality.

Why should you conduct a pay audit?

Pay audits matter because they enable fair compensation — which is critical to:

  • Attracting the best people
  • Decreasing turnover
  • Increasing employee efficiency, creativity, and productivity
  • Improving organizational commitment

Pay audits also help you comply with:

  • Federal equal pay and pay discrimination laws. These include the Equal Pay Act (EPA), Title VII of the Civil Rights Act of 1964, the Lilly Ledbetter Fair Pay Act, the Americans with Disabilities Act (ADA), and other laws enforced by the Equal Employment Opportunity Commission (EEOC).
  • State and local pay equity laws. Many states and local governments have pay equity laws prohibiting pay discrimination and requiring equal pay for equal work. Also, more and more states are enacting salary history bans and pay transparency.
  • Other laws relating to pay. These include the Fair Labor Standards Act (FLSA) and state and local wage and hour laws.
  • EEO-1 pay data reporting. Private sector employers with 100 or more employees must submit workforce demographics data to the EEOC. In addition, a few states are requiring or considering their own EEO reporting requirements.

Importantly, pay audits let you correct pay disparities that do not have a legitimate business reason. Without the pay audit, you might not know the gap exists until it's too late. By promptly conducting the audit and making the correction, you can avoid employee wage-and-hour complaints or lawsuits.

Without pay audits, you may not realize that pay disparities exist within your organization, until it's too late.

Pay audits can also serve as a litigation defense tool by demonstrating that no pay disparities exist or by providing legitimate reasons for the discrepancies.

Tips for conducting a pay audit

Develop goals for the audit

These goals should cover long-term and short-term audit initiatives, such as:

  • Verifying each employee's pay
  • Identifying pay disparities
  • Detecting the root cause of pay disparities
  • Uncovering trends/patterns in pay disparities
  • Correcting pay disparities
  • Adjusting the systems and procedures causing pay disparities

Select the key players

At the very least, pay audits should involve the payroll and human resources teams. Both departments should work together to ensure accurate pay data collection, including timekeeping, payroll, and performance management records. Other key players:

  • Finance team. This is essential because pay data is intricately linked to the company's financial statements.
  • Company leadership. This is necessary to help determine:
    • The scope of the audit
    • How much time should be spent on the audit
    • Remediation efforts for resolving problems uncovered during the audit
    • Budget parameters for the audit and remediation efforts
  • Legal counsel. This is especially crucial if:
    • Your compensation structure is complex
    • You're not sure what grounds to cover during the audit
    • Your company may be sued for pay inequity

Examine your compensation strategy

How your employees are paid comes down to your compensation strategy. The results of the pay audit will dictate whether you need to modify the strategy. According to TriNet's People Operations Guide to Compensation, a strong compensation strategy has the following 3 elements:

  1. Your compensation philosophy, meaning your company's stance on pay. Your philosophy also provides a framework for establishing equal pay and competitive compensation packages.
  2. What you want to achieve. This can help you figure out what skills your employees need and how to prioritize different hiring forms. It can also help you design incentive programs for driving productivity.
  3. Your budget. This helps you make realistic hiring decisions, including how many people and what experience level you can afford to hire. Your budget also keeps you on track when you're making decisions about raises, promotions, and pay adjustments.

Collect the necessary employee data

This includes:

  • Pay ranges
  • Individual pay rates
  • Hours of work
  • Offer letters
  • Credentials (e.g., education)
  • Job titles
  • Role descriptions
  • Job classifications
  • Length of service
  • Performance evaluations (e.g., raises and promotions)
  • Employee demographics (e.g., race, gender, and age)

All data relevant to employees' pay should be collected and considered.

Evaluate your pay practices

This is a wide-ranging process, and the details vary by employer. For an idea of steps to take during the evaluation, you can review the 10-step equal pay self-audit guide developed by the United States Department of Labor Women's Bureau. The guide recommends that you:

  1. Conduct a recruitment self-audit
  2. Evaluate your compensation system for internal equity
  3. Evaluate your compensation system for industry competitiveness
  4. Conduct a new job evaluation system if needed
  5. Examine your compensation system and compare job grades or scores
  6. Review data for new hires (including men, women, and minorities)
  7. Assess opportunities for employees to win commissions and bonuses
  8. Assess how raises are awarded
  9. Evaluate employee training, development, and promotion opportunities
  10. Implement changes where needed, maintain equity, and share your success

Also, pay close attention to how you're administering employees' wages. Pay disparities can easily happen if you're doing payroll manually instead of through an automated system.

Fixing pay disparities

Pay disparities can usually be fixed by adjusting pay by no more than 5%.

You may need to adjust your compensation philosophy, strategy, and/or practices based on the audit results. For example, if you find pay disparities, you can correct them by increasing pay equity. Usually, these increases do not exceed 5%. According to WorldatWork, "A typical organization treats between 1 percent to 5 percent of their employees with a pay equity increase with on average a 5 percent increase, implying that total impact on payroll typically ranges between 0.1 to 0.3 percent of total base salaries." Note that pay equity increases are typically done as pay adjustments. These are simply changes in the employee's base salary or hourly rate. In most cases, they cannot be administered via back pay. As stated by Harvard Business Review, "Unless driven by litigation, back pay is not typically part of the equation — pay adjustments are made on a go-forward basis."

Avoiding pay disparities

You need a rock-solid compensation system and consistent policies and procedures to prevent pay disparities. To learn how to build your compensation structure, see TriNet's People Operations Guide to Compensation.

This communication is for informational purposes only; it is not legal, tax or accounting advice; and is not an offer to sell, buy or procure insurance.

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