The surprising cost of getting payroll wrong

Podcast transcript

Therese Raft

Welcome to Navigating the New Normal – Grant Thornton’s podcast exploring trends in business and the marketplace.

I’m Therese Raft and today I am joined by Alex Bell, Partner and National Head of Forensic Consulting at Grant Thornton. Today we’re talking about payroll. Now payroll errors were front and centre 18 months ago and continue to raise headlines today.

Welcome Alex!

Alex Bell

Thanks, Therese.

Therese Raft

Now Alex take us back a few years to when payroll assurance was pretty big news. How did so many big organisations get it so very wrong?

Alex Bell

Well, I think there are two main types of issues that happened. One I would call the deliberate underpayments and the second I would call more inadvertent – and let me just explain those a little bit. So deliberate, by deliberate I mean miss-recording of hours and not paying people their proper Award rates or shift penalties. And these are the ones we probably read about in the press at the start and led to the sort of wage theft headlines that were used, which I don't really think is reflective of majority of cases. And that's because the second lot are more, what I call inadvertent. Now, it's important to say – I'm not saying companies are blameless – but what I mean is it's not something they set out to do. And in these cases, maybe they didn't realise that a specific Award applied to certain employees and then had to go back and apply that Award or they got caught up in the complexity. And I think, you know, we're still hearing about it because there is an increased focus from regulators and employees are also more aware of their rights.

Therese Raft

Now I understand that annual salaries are one of the regular causes of people being underpaid. Now everyone has an annual salary. So a lot of people might not understand how this is a trigger point. Can you explain this a little bit more?

Alex Bell

Yeah, you're correct. It's been a big headache for companies. And in general, people who have paid an annual salary are paid a much higher rate than the ward. And so most companies thought that they were easily covering the award requirements. But often those pay rates for annual salaries are based on just a standard hourly week, say like a 38 hourly week. But if you've got somebody who's working 50 to 60 hours a week regularly, what you'll find is that the more hours – and the hours – those hours will naturally attract the penalties under the Awards, like over time penalties. You'll find that the Award kind of catches up to the annual salary. And really, until very recently, salaries haven't increased much in the last 10 years compared to the award rates. So where once there was a large headroom between the annual salary and the award, that gap’s slowly got smaller and in fact overtaken the annual salary. There are also other factors of pay, like bonuses, which are not always able to be used when assessing the award entitlements. So, you know, somebody might have actually been paid more in dollar terms than the award, but part of that pay can't be considered. So, so technically, they've been underpaid the award entitlements. And as you can see there, that there's a number of issues that arise. One is that it's quite complex. And the other is that it's quite a dynamic environment. People often set and forget their payroll systems, but Awards and legal interpretations change over time. So if you don't keep up with that, you can easily fall foul of these kinds of issues.

Therese Raft

So just as a point of interest, I'm curious how many people in Australia are actually on an Award? So what's the proportion of the population that are being caught up in this as an issue?

Alex Bell

I don't have their precise numbers, but a large proportion of Australia's working population are covered by some kind of Award. Whether that's the Retail Award, Hospitality Award, specific agreements called Enterprise Agreements that an employer might develop. So there's a huge amount of people covered by them.

Therese Raft

So clearly not insignificant. Now in that case though, if it's such a big issue, what do companies need to be doing?

Alex Bell

Well, the first thing you need to do is to understand that it's a dynamic environment and make sure that they do regular – we would suggest annual reviews of the payroll, and for example reviewing these annual salaries against the Award. And in fact from March last year, it's now a requirement for about 18 Awards that employers reconcile employees annual wages every 12 months to the Award. And Fair Work has said that they're going to include additional Awards in the future, particularly the Hospitality and Restaurant and Health Services Awards. But there's no time frame right now.

The other thing we suggest is to make sure they're collecting the right data. So one of the hardest aspects we found when we're doing recalculations for clients is where the data doesn't exist. For example, they haven't tracked the hours that people have worked. And this means when you're doing a recalculation, you're going away from the strict facts, which is the position we like to be in. And then you have to start making assumptions like estimating overtime hours somebody has made. And this makes it harder to perform a calculation and may lead to questions down the track. So if you can collect the data to start with that makes people in a much better position.

And overall you really need the right people, processes and technology – and that way you can ensure that you’re set up to succeed and identify any changes you need to make on a timely basis.

Therese Raft

And you mentioned making assumptions estimating overtime. Not only does that sound like it would be harder to get the calculations right, but also opens you up to error.

Alex Bell

Absolutely. And it's very hard to estimate exactly what an employee might have done. And we've seen people take say a period of six months or trying to estimate based on, you know, what they did the previous period or what they did the same time the previous year. And obviously once you get away from those strict facts and into these assumptions, it's much easier for somebody to question your assumption and then say that you haven't got it right. And, you know, in all these situations where you're looking back, it's really important to make sure you get it right, you know, the first time. Because the last situation you want to be in is making payments to people and then later down the track realising that it's not quite right

Therese Raft

Alex, the compliance sounds incredibly difficult. But I do think there are some announcements by the Government last year on the streamlining Awards, so that clearly highlights that they recognise that complexity. And of course, that's going to mean changes to the existing systems, doesn't it?

Alex Bell

Yeah, it does. And back in May 2020 Scott Morrison announced there was going to be a working group formed on Awards simplification. And certainly my experience of working with the Awards over the last few years is that I would definitely agree that's a great idea – that they are extremely complex – and this unfortunately is still being worked on. So we haven't got an answer as yet. But it's interesting recently that industry bodies are also getting involved. Just a few days ago, the Restaurant and Catering Industrial, which is an industry body representing about nearly 50,000 cafes, restaurants and catering businesses, apply to Fair Work seeking a simplified classification structure and payments of simplified allowances. So it's good that a variety of people are getting involved and at least trying to suggest some solutions.

Therese Raft

So there's clearly a lot happening in the background. Does that mean that this as an issue is all fixed now?

Alex Bell

No, unfortunately not. You know, the simplest way of answering that is that we're still talking to clients about undertaking this review process and new issues are coming to light. I also think that these are probably the more proactive companies or companies who’ve had a specific question raised to them. And I guess someone organisations are still operating with a bit of a head in the sand approach, assuming that it can't affect them. So if you're a director or in senior management our strong advice is to make sure that somebody has looked at this issue because many people have been caught out somewhere.

The other part of why it's not fixed is that it actually can take several years between identifying an issue and a final resolution. Now, that's probably not great news to our audience or people who think that there is an issue. But it's very important in these complex calculations that the whole process is done to make sure the calculations are right and then you've got to go and pay back the employees and then there may be regulatory issues and ongoing monitoring. So it can take several years from start to finish. So it's not unexpected that we're still having people announce that there are underpayments.

Therese Raft

That's amazing that it could potentially take years to get from the very beginning of the process to the end. And I can absolutely see that there would be a temptation to put this off or to not look at it right now. But what are the consequences of getting it wrong now, particularly with so much media scrutiny in the past? Surely there would be very little to no sympathy for employers being caught out now.

Alex Bell

Yeah, I agree that there is little sympathy for people underpaying staff, but you do have to realise that companies that are still announcing this may have already been working on it for some time and the, the actual underpayments may have been several years ago. So it's not like they're still underpaying people.

Obviously there's a risk to brand, potential employee retention issues, there's the cost of repaying employees and potential fines. Because this issue has been around for a while, I would say anecdotally, the PR effect seems to be lower than it might have been a couple of years ago. But it's still a great risk for our clients. And in terms of sanctions, it was interesting that in December last year there was the Fair Work Bill that introduced a new criminal offense for underpayment where there had been dishonest and systematic wage underpayments. And that was quite serious with fines of over $1 million dollars and the potential of up to four years in prison. This passed the House of Representatives but didn't get through the Senate. But you can see that depending on how the Government goes, that this issue, I reckon will come back in future years.

Therese Raft

That's so interesting that you're talking about how that's moving and clearly people are at the crux of it. And there’s underpayments and the sanctions, there's that kind of a day to day running. But there's also an additional and perhaps surprising cost of getting this wrong, isn't there?

Alex Bell

Yeah, and that's where somebody is buying or selling a business. And we've seen this in a lot of transactions. What happens is the value of a business in most transactions is valued on profit – and a multiple of that profit. So, you know, you say you've earnt $2 million dollars of profit and they'll pay five times that profit until you get a $10 million dollar transaction price.

What we've found is people who have got underpayments, they bought a business and discovered that there are underpayments in that business. And that means that not only have you got reduced profits going forward, but you've also overpaid for that business and that overpayment’s a multiple of the single year underpayment.

That sounds probably a bit technical. So let me just explain that: To say you've got… you bought a business and you've discovered an underpayment of $200,000 in the last year. What that means is going forward, your profits will be $200,000 less each year because you've now got to pay those additional amounts. But it also means, say you paid five times earnings when you bought the business, you've actually paid five times that $200,000. So you've paid $1 million dollars more than you should have paid for the business.

Therese Raft

Well, that sounds like getting it wrong can have a long term impact on the value of your business.

Alex Bell

Absolutely. These multiple effects we've seen in a number of transactions. Some people have tried to get insurance around these, you can get warranty and indemnity insurance, but we understand from the market that these payroll issues are now not being covered by recent policies, but warranty and indemnity insurance. Mostly because these issues can come out and as I said, can cause it could cause a huge effect.

Therese Raft

Interesting. So yet another reason to check your payroll assurance. If we look forward a little bit, clearly job security is high on the agenda for many people – even though our economy is going quite well. So do you anticipate that payroll issues will not only just continue, but will they make more of a resurgence, become more to the forefront of media and our attention again?

Alex Bell

I think this will be an ongoing issue, not least because as I've said, it takes so long to understand and rectify the issues. And I think this issue has been bubbling away underneath the surface whilst we've been distracted with COVID. People are still reviewing their systems and finding issues and fixing them. So, you know, maybe the headlines aren't quite as often, but it's still going to be a relevant and important issue.

Therese Raft

I've also been reading a little bit about the massive market for payroll automation software. And in fact, the Government is also talking about investing in RegTech to help support businesses to comply. Is this the way of the future for payroll and business?

Alex Bell

Yeah, I definitely think technology can help here as it's really, you know, an application of rules. The Awards are very complex and you can easily have 30 or more factors to incorporate. So obviously when you're calculating someone's pay, having a technology solution will definitely help. However, you know, I think from our…we know from our day to day lives technology isn't the solution to everything on its own. You need the right people and processes to make sure it's implemented correctly. And I noticed Scott Morrison last year announced the Digital Business Plan, which was an $800 million program, including over $11 million dollars to help the regulatory technology sector. And this is to provide grant funding to develop innovative solutions to help government policy and challenges from that. I believe that applications close, we're recording in the beginning of June, the applications close on 17 June, so if they're listening before, then there's a short time to apply for those grants. So hopefully from that we might see some more solutions come about.

Therese Raft

There is clearly so much happening in the back end that most of us don't see. However, with what, 12.6 million people employed in Australia, payroll and payroll assurance is clearly an issue that impacts on everyone. Do you have any advice for businesses that may be concerned about their own systems or not entirely sure about how to check their own systems in this very complex environment?

Alex Bell

Yes, there are a number of easy things that companies can do. It might be from a simple health check on the payroll system. So payroll systems have different codes which are called pay codes that tell it how much to pay. A simple review is to make sure that these pay codes exist for all the requirements of the Awards that affect you. So do you have an overtime pay code that's at the right rate? Do you have pay codes that allow you to pay first aid allowance? And if you don't have that, and the Award means that you are supposed to pay people those allowances, it's an easy way of identifying an issue. You could also do a health check around the data that your time recording systems are collecting and the next stage would be to do a sample review of employees who you think are at risk. We talked earlier about the annual salary review, but you could also review specific employees to identify if there is an issue – we would normally do that for a couple of pay periods. And finally, make sure that payroll review is part of your ongoing business processes. As we said, it is quite dynamic, interpretations and Awards change and they're very complex. So you've got to make sure that this is something that is part of your ongoing work and not just a single review that you then forget about.

Therese Raft

Alex. Thank you so much for your time.

Alex Bell

Thank you.

Therese Raft

Can people track you down on LinkedIn, phone or email if they would like to talk more about what's next from payroll or their own business circumstances?

Alex Bell

Absolutely. You can find me on LinkedIn or my details are on our website. I'm fascinated by solving complex problems and trying to work out what's happened for companies. So, always happy to have a conversation with people.

Therese Raft

Fantastic. If you liked this podcast and would like to hear more, you can find and subscribe to Grant Thornton Australia on Apple Podcasts or Spotify.