Department of Industrial Relations (dir) Payroll Process

DEPARTMENT OF INDUSTRIAL RELATIONS Audit Report PAYROLL AUDIT March 1, 2016, through February 28, 2019 BETTY T. YEE California State Controller December 2020 BETTY T. YEE California State Controller December 10, 2020 Katrina S. Hagen, Director Department of Industrial Relations 455 Golden Gate Avenue San Francisco, CA 94102 Dear Ms. Hagen: The State Controller’s Office audited the Department of Industrial Relations’ (DIR) payroll process and transactions for the period of March 1, 2016, through February 28, 2019. DIR management is responsible for maintaining a system of internal control over the payroll process within its organization, and for ensuring compliance with various requirements under state laws and regulations regarding payroll and payroll-related expenditures. Our audit determined that DIR did not maintain adequate and effective internal controls over its payroll process. DIR lacked adequate segregation of duties and compensating controls over payroll transactions, resulting in improper regular, overtime, and separation lump-sum payments. DIR also granted inappropriate keying access to the State’s payroll system. In addition, DIR did not implement controls to limit the accumulation of vacation and annual leave credits, resulting in liability for excessive balances. DIR also did not promptly collect salary advances from its employees. If you have any questions, please contact Andrew Finlayson, Chief, State Agency Audits Bureau, by telephone at (916) 324-6310, or by email at afinlayson@sco.ca.gov. Sincerely, Original signed by JIM L. SPANO, CPA Chief, Division of Audits JLS/as Katrina S. Hagen, Director -2- December 10, 2020 cc: Andrew Collada, Chief, Division of Administration Department of Industrial Relations David Botelho, Acting Chief Human Resources Office Department of Industrial Relations Derek Eslao, Personnel Supervisor II Human Resources Office Department of Industrial Relations Jennifer Simunich, Personnel Supervisor II Human Resources Office Department of Industrial Relations Brendan Murphy, Chief, Administrative Services Division California Department of Human Resources Jil Barraza, Chief, Personnel and Payroll Services Division State Controller’s Office Department of Industrial Relations Payroll Audit Contents Audit Report Summary ............................................................................................................................ 1 Background ........................................................................................................................ 1 Objectives, Scope, and Methodology ............................................................................... 2 Conclusion .......................................................................................................................... 3 Follow-up on Prior Audit Findings .................................................................................. 4 Views of Responsible Officials .......................................................................................... 4 Restricted Use .................................................................................................................... 4 Schedule—Summary of Audit Results ................................................................................. 5 Findings and Recommendations ........................................................................................... 6 Appendix—Audit Sampling Methodology Attachment—Department of Industrial Relations’ Response to Draft Audit Report Department of Industrial Relations Payroll Audit Audit Report Summary The State Controller’s Office (SCO) audited the Department of Industrial Relations’ (DIR) payroll process and transactions for the period of March 1, 2016, through February 28, 2019. DIR management is responsible for maintaining a system of internal control over the payroll process within its organization, and for ensuring compliance with various requirements under state laws and regulations regarding payroll and payroll-related expenditures. We completed our audit fieldwork on September 15, 2020. Our audit determined that DIR did not:  Maintain adequate and effective internal controls over its payroll process. DIR lacked adequate segregation of duties and compensating controls over payroll transactions, resulting in improper regular, overtime, and separation lump-sum payments. DIR also granted inappropriate keying access to the State’s payroll system;  Implement controls to limit the accumulation of vacation and annual leave credits, resulting in liability for excessive balances; and  Promptly collect salary advances from its employees. Background In 1979, the State of California adopted collective bargaining for state employees. This created a significant workload increase for the SCO’s Personnel and Payroll Services Division (PPSD), as PPSD was the State’s centralized payroll processing center for all payroll related-transactions. PPSD decentralized the processing of payroll, allowing state agencies and departments to process their own payroll-related transactions. Periodic audits of the decentralized payroll processing at state agencies and departments ceased due to the budget constraints in the late 1980s. In 2013, the California State Legislature reinstated these payroll audits to gain assurance that state agencies and departments maintain adequate internal control over the payroll function, provide proper oversight of their decentralized payroll processing, and comply with various state laws and regulations regarding payroll processing and related transactions. Audit Authority Authority for this audit is provided by California Government Code (GC) section 12476, which states: The Controller may audit the uniform state pay roll system, the State Pay Roll Revolving Fund, and related records of state agencies within the uniform state pay roll system, in such manner as the Controller may determine. In addition, GC section 12410 stipulates that: The Controller shall superintend the fiscal concerns of the state. The Controller shall audit all claims against the state, and may audit the disbursement of any state money, for correctness, legality, and for sufficient provisions of law for payment. -1- Department of Industrial Relations Payroll Audit Objectives, Scope, We performed this audit to determine whether DIR: and Methodology  Maintained adequate and effective internal controls over its payroll process;  Processed payroll and payroll-related disbursements and leave balances accurately and in accordance with collective bargaining agreements and state laws, regulations, policies, and procedures; and  Administered salary advances in accordance with collective bargaining agreements and state laws, regulations, policies, and procedures. The audit covered the period from March 1, 2016, through February 28, 2019. The audit population consisted of payroll transactions totaling $661,344,713, as quantified in the Schedule. To achieve our audit objectives, we:  Reviewed state and DIR policies and procedures related to the payroll process to understand DIR’s methodology for processing various payroll and payroll-related transactions;  Interviewed the DIR payroll personnel to understand DIR’s methodology for processing various payroll and payroll-related transactions, determine the employees’ level of knowledge and ability relating to payroll transaction processing, and gain an understanding of existing internal control over the payroll process and systems;  Selected transactions recorded in the State’s payroll database using statistical sampling, as outlined in the Appendix, and targeted selection based on risk factors and other relevant criteria;  Analyzed and tested the selected transactions and reviewed relevant files and records to determine the accuracy of payroll and payroll- related payments, accuracy of leave transactions, adequacy and effectiveness of internal control over the payroll process, and compliance with collective bargaining agreements and state laws, regulations, policies, and procedures; and  Reviewed salary advances to determine whether DIR administered and recorded them in accordance with collective bargaining agreements and state laws, regulations, policies, and procedures. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. -2- Department of Industrial Relations Payroll Audit Conclusion Our audit determined that DIR:  Did not maintain adequate and effective internal controls over its payroll process.1 We found the following deficiencies in internal control over the payroll process that we consider to be material weaknesses: o Inadequate segregation of duties and a lack of compensating controls over payroll transactions (see Finding 1); o Inappropriate keying access to the State’s payroll system (see Finding 2); o Failure to implement controls to ensure that DIR adhered to the requirements of collective bargaining agreements and state regulations to limit the accumulation of vacation and annual leave credits, resulting in liability for excessive balances (see Finding 3); o Inadequate controls to ensure that payments for regular pay were adjusted properly for absences, and supported with adequate documentation, resulting in overpayments and questioned payments (see Finding 4); o Inadequate controls to ensure that overtime payments were approved and calculated correctly, resulting in improper payments (see Finding 5); o Inadequate controls to ensure that separation lump-sum payments were calculated correctly and paid in a timely manner, resulting in improper and late payments (see Finding 6);  Did not process payroll and payroll-related disbursements and leave balances accurately and in accordance with collective bargaining agreements and state laws, regulations, policies, and procedures. We found the following instances of noncompliance with the requirements 1 In planning and performing our audit of compliance, we considered DIR’s internal control over compliance with collective bargaining agreements and state laws, regulations, policies, and procedures to determine the auditing procedures that were appropriate under the circumstances for the purpose of providing a conclusion on compliance, and to test and report on internal control over compliance. Our consideration of internal control over compliance was for the limited purpose described in the first paragraph of this footnote; it was not designed to identify all deficiencies in internal control over compliance that might be material weaknesses or significant deficiencies. As discussed in this section, we identified certain deficiencies in internal control over compliance that we consider to be material weaknesses. A deficiency in internal control over compliance exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, noncompliance with provisions of laws, regulations, or contracts on a timely basis. Control deficiencies, either individually or in combination with other control deficiencies, may be evaluated as significant deficiencies or material weaknesses. A material weakness in internal control over compliance is a deficiency, or combination of deficiencies, in internal control over compliance, such that there is a reasonable possibility that material noncompliance with provisions of laws, regulations, or contracts will not be prevented, or detected and corrected, on a timely basis. A significant deficiency over compliance is a deficiency, or a combination of deficiencies, in internal control over compliance with provisions of laws, regulations, or contracts that is less severe than a material weakness, yet important enough to merit attention from those charged with governance. -3- Department of Industrial Relations Payroll Audit of collective bargaining agreements and state laws, regulations, policies, and procedures: o Excessive vacation and annual leave balances with a value of at least $8,868,422 as of February 28, 2019 (see Finding 3). Although a new directive from California Department of Human Resources (CalHR) that became effective October 20, 2020, does not affect the dollar value of this finding, we are disclosing this directive because it affects our recommendation. CalHR has directed departments to immediately suspend policies that require leave balances be reduced below the limit, and that require employees to implement leave-reduction plans. This suspension will be in effect until the 2020 Personal Leave Program (2020 PLP) ends, or July 1, 2022, whichever is sooner; o Overpayments and questioned payments made for regular pay (see Finding 4); improper payments made for overtime pay (see Finding 5); and improper and late payments made for separation lump-sum pay (see Finding 6), costing an estimated net total of $24,298,151; and  Did not administer salary advances in accordance with collective bargaining agreements and state laws, regulations, policies, and procedures. Eighteen salary advances, totaling $60,683, remained outstanding as of February 28, 2019, due to DIR’s noncompliance with the State’s collection policies and procedures (see Finding 7). Follow-up on There were no prior payroll audits and, consequently, no prior audit Prior Audit findings. Findings Views of We issued a draft audit report on November 2, 2020. Katrina S. Hagen, Director responded by letter dated November 12, 2020 (Attachment), Responsible agreeing with the audit results, and indicating that DIR has taken steps to Officials correct the noted deficiencies. This final audit report includes DIR’s response. Restricted Use This audit report is solely for the information and use of DIR and the SCO; it is not intended to be and should not be used by anyone other than these specified parties. This restriction is not intended to limit distribution of this audit report, which is a matter of public record and is available on the SCO website at www.sco.ca.gov. Original signed by JIM L. SPANO, CPA Chief, Division of Audits December 10, 2020 -4- Department of Industrial Relations Payroll Audit Schedule— Summary of Audit Results March 1, 2016, through February 28, 2019 Net Total Number of Number of Dollar Amount Dollar Amount Method of Units of Dollar Amount Selections Selection of Selections of Known and Finding Audit Area Tested Selection Population of Population Examined Unit Examined Likely Issues Number Segregation of duties N/A N/A N/A N/A N/A N/A N/A 1 System access Targeted 5 8 N/A 5 8 Employee N/A N/A 2 Excess vacation and annual leave Statistical 4 12 $ 8,868,422 105 Employee $ 2 ,151,767 $ 8 ,868,422 3 Regular pay Statistical 1 00,284 6 36,344,043 1 05 Transaction 690,077 2 4,285,681 4 Overtime pay Statistical 3 ,488 3,010,813 1 05 Transaction 8 3,705 3,460 5 Separation lump-sum pay Statistical 5 50 9,318,863 105 Employee 2,069,180 9,010 6 Salary advance Targeted 19 69,946 1 9 Transaction 6 9,946 6 0,683 7 Leave buy-back Statistical 1,098 3,732,626 105 Transaction 352,724 - $ 661,344,713 $ 5 ,417,399 $ 33,227,256 -5- Department of Industrial Relations Payroll Audit Findings and Recommendations FINDING 1— DIR lacked adequate segregation of duties within its payroll transactions unit to ensure that only valid and authorized payroll transactions were Inadequate processed. DIR also failed to implement other controls to compensate for segregation of this risk. duties and lack of compensating GC sections 13400 through 13407 require state agencies to establish and controls over maintain internal controls, including proper segregation of duties and an payroll effective system of internal review. Adequate segregation of duties transactions reduces the likelihood that fraud or error will remain undetected by providing for separate processing by different individuals at various stages of a transaction and for independent reviews of the work performed. Our audit found that DIR payroll transactions unit staff performed conflicting duties. Staff members performed multiple steps in processing payroll transactions, including entering data into the State’s payroll system; auditing employee timesheets; reconciling payroll, including reconciling system output to source documentation; reporting payroll exceptions; and processing adjustments. For example, staff members keyed in regular and overtime pay, and reconciled the master payroll, overtime, and other supplemental warrants. DIR failed to demonstrate that it had implemented compensating controls to mitigate the risks associated with such a deficiency. We found no indication that these functions were subjected to periodic supervisory review. The lack of adequate segregation of duties and compensating controls has a pervasive effect on the DIR payroll process, and impairs the effectiveness of other controls by rendering their design ineffective or by keeping them from operating effectively. These control deficiencies, in combination with other deficiencies discussed in Findings 2 through 7, represent a material weakness in internal control over the payroll process such that there is a reasonable possibility that a material noncompliance with provisions of laws, regulations, or contracts will not be prevented, or detected and corrected, on a timely basis. Good internal control practices require that the following functional duties be performed by different work units, or at minimum, by different employees within the same unit:  Recording transactions – This duty refers to the record-keeping function, which is accomplished by entering data into a computer system.  Authorization to execute – This duty belongs to individuals with authority and responsibility to initiate and execute transactions.  Periodic review and reconciliation of actual payments to recorded amounts – This duty refers to making comparisons of information at regular intervals and taking action to resolve differences. -6- Department of Industrial Relations Payroll Audit Recommendation We recommend that DIR:  Separate conflicting payroll function duties to the greatest extent possible. Adequate segregation of duties will provide a stronger system of internal control whereby the functions of each employee are subject to the review of another. If it is not possible to segregate payroll functions fully and appropriately, DIR should implement compensating controls. For example, if the payroll transactions unit staff member responsible for recordkeeping also performs a reconciliation process, then the supervisor should perform and document a detailed review of the reconciliation to provide additional control over the assignment of conflicting functions. Compensating controls may also include dual authorization requirements and documented reviews of payroll system input and output; and  Develop formal procedures for performing and documenting compensating controls. DIR lacked adequate controls to ensure that only appropriate staff had FINDING 2— keying access to the State’s payroll system. DIR inappropriately allowed Inappropriate 18 employees keying access to the State’s payroll system. If not mitigated, keying access to the this control deficiency leaves payroll data at risk of misuse, abuse, and State’s payroll unauthorized use. system The SCO maintains the State’s payroll system. The system is decentralized, thereby allowing employees of state agencies to access it. PPSD has established a Decentralized Security Program Manual that all state agencies are required to follow in order to access the payroll system. The program’s objectives are to secure and protect the confidentiality and integrity of payroll data against misuse, abuse, and unauthorized use. We examined the records of 58 DIR employees who had keying access to the State’s payroll system at various times between March 2016 and February 2019. Of the 58 employees, 18 had inappropriate keying access to the State’s payroll system. Specifically, DIR did not immediately remove or modify keying access after the employees’ separation from state service, transfer to another agency, or change in classification. A Personnel Supervisor II separated from DIR on May 31, 2017. DIR did not request to remove the employee’s access until September 22, 2017 (114 days later). The Decentralized Security Program Manual states, in part: The PPSD system contains sensitive and confidential information. Access is restricted to persons with an authorized, legal, and legitimate business requirement to complete their duties. . . . Currently, PIMS, HIST, KEYM, PIP, LAS, MPC and/or ACAS applications are restricted to Personnel Specialists or Personnel Technician classifications because their need is by definition a function -7- Department of Industrial Relations Payroll Audit of their specific job duties and any change in those duties requires a reevaluation of the need for access. If the employee’s duties change, such that the need for access no longer exists, the access privilege MUST be removed or deleted immediately by a request submitted by the department/campus. . . . A request to grant access to an individual in a classification other than in the Personnel Specialist/Payroll Technician series to access PIMS, HIST, KEYM, PIP, LAS, MPC and/or ACAS requires a written justification from the Authorizing Manager. The justification must describe the individual's specific job duties requiring the need to access system information (i.e., PIMS = Employment History, HIST=Payroll History, LAS=Leave Accounting System, etc.) as well as level of access to that application, in order to perform their regular daily duties. Manager classifications will be granted inquiry access only. To prevent unauthorized use by a transferred, terminated or resigned employee's user ID, the Security Monitor must IMMEDIATELY submit all pages of the PSD125A to delete the user’s system access. Using an old user ID increases the chances of a security breach which is a serious security violation. Sharing a user ID is strictly prohibited and a serious violation. Recommendation We recommend that DIR:  Update keying access to the State’s payroll system immediately after employees leave DIR, transfer to another unit, or change classifications; and  Periodically review access to the system to verify that access complies with the Decentralized Security Program Manual. DIR failed to implement controls to ensure that it adhered to the FINDING 3— requirements of collective bargaining agreements and state regulations to Inadequate limit the accumulation of vacation and annual leave credits. This controls over deficiency resulted in liability for excessive leave balances with a value of vacation and at least $8,868,422, consisting of $2,151,767 based on actual transactions annual leave examined (“known”), and $6,716,655 based on the results of statistical balances, sampling (“likely”). We expect the liability to increase if DIR does not resulting in take action to address the excessive vacation and annual leave balances. liability for excessive Collective bargaining agreements and state regulations limit the amount balances of vacation and annual leave that most state employees may accumulate to no more than 80 days (640 hours). The limit on leave balances helps state agencies to manage leave balances and control the State’s liability for accrued leave credits. State agencies may allow employees to carry a higher leave balance only under limited circumstances. For example, an employee may not be able to reduce accrued vacation or annual leave hours below the limit due to business needs. When an employee’s leave accumulation exceeds or is projected to exceed the limit, state agencies should work with the employee to develop a written plan to reduce leave balances below the applicable limit. -8- Department of Industrial Relations Payroll Audit Our examination of DIR’s leave accounting records determined that DIR had 2,677 employees with unused vacation or annual leave credits at February 28, 2019. Of the 2,677 employees, 412 exceeded the limit set by collective bargaining agreements and state regulations. For example, one employee had an accumulated balance of 2,576 hours in annual leave, or 1,936 hours beyond the 640-hour limit. Collectively, the 412 employees accumulated 164,698 hours of excess vacation and annual leave, with a value of at least $8,868,422 as of February 28, 2019. This estimated liability does not adjust for salary rate increases and additional leave credits.2 Accordingly, we expect that the amount needed to pay for this liability will be higher. For example, a DIR employee separated from state service with 2,226 hours of leave credits, including 1,506 hours of vacation. After adjusting for additional leave credits, the employee was paid for 2,558 hours, or 15% more. Of the 412 employees, we randomly selected a statistical sample (as described in the Appendix) of 105 employees with excess vacation and leave balances valued at $2,151,767, for further examination. We determined that DIR could not demonstrate that it had complied with collective bargaining agreements and state regulations when allowing the 105 employees to maintain excess vacation or annual leave balances. We also determined that DIR did not have plans in place during the audit period to reduce the employees’ leave balances below the limit. As we used a statistical sampling method to select the employees with excess vacation and annual leave that we examined, we projected the value of likely excess vacation and annual leave balances to be $6,716,655. Therefore, the known and likely value of excess vacation and annual leave balances totaled $8,868,422. The following table summarizes the results of our statistical sampling: Known excess vacation and annual leave balances $ 2,151,767 Divide by: Sample 2,151,767 Error rate for projection (differences due to rounding) 100.00% Population that was statistically sampled 8,868,422 Multiply by: Error rate for projection 100.00% Known and likely excess vacation and annual leave balances (differences due to rounding) 8,868,422 Less: Known excess vacation and annual leave balances 2,151,767 Likely excess vacation and annual leave balances $ 6,716,655 _____________ * Amounts in this table are rounded to the nearest dollar. If DIR does not take action to reduce the excessive leave balances, the liability for accrued vacation and annual leave will likely increase because most employees will receive salary increases or use other non- compensable leave credits instead of vacation or annual leave, thus 2 Most state employees receive pay rate increases every year pursuant to state laws and/or collective bargaining agreements until they reach the top of their pay scale, or promote into a higher-paying position. In addition, when an employee’s accumulated leave balances upon separation are calculated for lump-sum pay, the employee is credited with additional leave credits equal to the amount that the employee would have earned had the employee taken time off and not separated from state service. -9- Department of Industrial Relations Payroll Audit increasing their vacation or annual leave balances. The state agency responsible for paying these leave balances may face a cash flow problem if a significant number of employees with excessive vacation or annual leave balances separate from state service. Normally, state agencies are not budgeted to make these separation lump-sum payments. However, the State’s current practice dictates that the state agency that last employed an employee pays for that employee’s separation lump-sum payment, regardless of where the employee accrued the leave balance. Although a new directive from CalHR that became effective October 20, 2020 does not affect the dollar value of this finding, we are disclosing this directive because it affects our recommendation. CalHR has directed departments to immediately suspend policies that require leave balances be reduced below the limit, and that require employees to implement leave-reduction plans. This suspension will be in effect until the 2020 PLP ends, or July 1, 2022, whichever is sooner. Recommendation We recommend that, after the 2020 PLP ends, or July 1, 2022, whichever is sooner, DIR:  Implement controls, including existing policies and procedures, to ensure that its employees’ vacation and annual leave balances are maintained within levels allowed by collective bargaining agreements and state regulations;  Conduct ongoing monitoring of controls to ensure that they are implemented and operating effectively; and  Participate in leave buy-back programs if the State offers such programs and funds are available. DIR lacked adequate segregation of duties within its payroll transactions FINDING 4— unit, as noted in Finding 1, and lacked adequate controls over the Inadequate processing of regular pay. We identified a total of $24,285,681 in controls over overpayments and questioned payments for regular pay, consisting of regular pay, $2,935 in known overpayments and $23,401 in known questioned resulting in payments, and $2,704,030 in likely overpayments and $21,555,315 in overpayments and likely questioned payments. If not mitigated, these control deficiencies questioned leave DIR at risk of making additional improper payments for regular pay. payments CIollective bargaining agreements, and state laws and policies, contain spnecific clauses regarding regular pay. Payroll records show that DIR praocessed 100,284 regular pay transactions, totaling $636,344,043, bedtween March 2016 and February 2019. Of the 100,284 regular pay traensactions, we randomly selected a statistical sample (as described in the Aqppendix) of 105 transactions, totaling $690,077. Of the 105 transactions, siux were overpaid by $2,935. a Wte also questioned five transactions, totaling $23,401, because DIR could noet provide the employees’ timesheets to support that the payments were vaclid and authorized. Although the State’s payroll system makes all coomputations and prepares the “negative” payrolls, timesheets are still n t -10- r o l Department of Industrial Relations Payroll Audit required to substantiate the hours worked for regular pay.3 Without a timesheet, there is no record of hours worked and supervisory review or approval. Therefore, we could not determine the validity and authorization of payment for these regular pay transactions. As a result, we questioned these payments. The known overpayments and known questioned payments represent a total of $26,336. As we used a statistical sampling method to select the regular pay transactions examined, we projected the amount of likely overpayments to be $2,704,030. We could also estimate that there may have been additional missing timesheets associated with regular pay, totaling $21,555,315. As timesheets are required documents to authorize pay, we would also question these regular pay transactions. The likely overpayments and likely questioned payments represent a total of $24,259,345. Therefore, the known and likely overpayments and questioned payments totaled $24,285,681, consisting of $2,706,965 in overpayments and $21,578,716 in questioned payments. The following table summarizes the results of our statistical sampling: Known overpayments and questioned payments $ 26,336 Divide by: Sample 690,077 Error rate for projection (differences due to rounding) 3.82% Population that was statistically sampled 636,344,043 Multiply by: Error rate for projection 3.82% Known and likely overpayments and questioned payments (differences due to rounding) 24,285,681 Less: Known overpayments and questioned payments 26,336 Likely overpayments and questioned payments $ 24,259,345 _____________ * Amounts in this table are rounded to the nearest dollar. The known overpayments occurred because payroll transactions unit staff members failed to reduce, or incorrectly recorded reductions in, leave balances for absences in the leave accounting system. DIR also lacked adequate supervisory review to ensure accurate processing of regular pay. GC sections 13400 through 13407 require state agencies to establish and maintain internal controls, including a system of policies and procedures adequate to ensure compliance with applicable laws and other requirements, and an effective system of internal review. Recommendation We recommend that DIR:  Conduct a review of payments for regular pay made during the past three years to ensure that the payments complied with collective bargaining agreements and state laws and policies; and 3 According to SCO’s Payroll Procedures Manual, “These are referred to as ‘negative’ payrolls because attendance reports have not been submitted and no working payrolls have been cleared with agencies/campuses when the payrolls are prepared. This payroll writing operation is performed for the majority of state employees during the period from the cutoff day in each pay period to the 27th and 28th of the month.” -11- Department of Industrial Relations Payroll Audit  Recover the overpayment made to employee through an agreed-upon collection method in accordance with GC section 19838. We further recommend that, to prevent improper payments for regular pay from recurring, DIR:  Establish adequate internal controls to ensure that payments are accurate and comply with collective bargaining agreements and state laws and policies;  Provide adequate oversight to ensure that payroll transactions unit staff process only valid and authorized payments that comply with collective bargaining agreements and state laws and policies; and  Maintain supporting documentation for payments pursuant to retention policies. DIR lacked adequate segregation of duties within its payroll transactions FINDING 5— unit, as noted in Finding 1, and lacked adequate controls over the Inadequate processing of overtime pay. We identified a net total of $3,460 in improper controls over overtime payments, consisting of $606 in known overpayments and overtime pay, $510 in known underpayments, and $21,179 in likely overpayments and resulting in $17,815 in likely underpayments. If not mitigated, these control improper deficiencies leave DIR at risk of making additional improper overtime payments payments. Collective bargaining agreements, and state laws and policies, contain specific clauses regarding overtime pay. Payroll records show that DIR processed 3,488 overtime pay transactions, totaling $3,010,813, between March 2016 and February 2019. Of the 3,488 overtime pay transactions, we randomly selected a statistical sample (as described in the Appendix) of 105 transactions, totaling $83,705. Of the 105 transactions, six were overpaid by approximately $606 and eight were underpaid by approximately $510. These payments resulted in a net total of $96 in improper payments. As we used a statistical sampling method to select the overtime pay transactions examined, we projected the amount of likely overpayments to be $21,179 and likely underpayments to be $17,815. These payments resulted in a net total of $3,364 in likely improper payments. Therefore, the known and likely improper payments totaled a net of approximately $3,460, consisting of $21,785 in overpayments and $18,325 in underpayments. -12- Department of Industrial Relations Payroll Audit The following table summarizes the results of our statistical sampling: Known improper payments, net $ 96 Divide by: Sample 83,705 Error rate for projection (differences due to rounding) 0.11% Population that was statistically sampled 3,010,813 Multiply by: Error rate for projection 0.11% Known and likely improper payments, net (differences due to rounding) 3,460 Less: Known improper payments, net 96 Likely improper payments, net $ 3,364 _____________ * Amounts in this table are rounded to the nearest dollar. The known improper payments occurred because payroll transactions unit staff members miscalculated overtime hours worked, and paid for overtime hours claimed that lacked the required management approval. Furthermore, DIR lacked adequate supervisory review to ensure accurate processing of overtime pay. GC sections 13400 through 13407 require state agencies to establish and maintain internal controls, including a system of policies and procedures adequate to ensure compliance with applicable laws and other requirements, and an effective system of internal review. Recommendation We recommend that DIR:  Conduct a review of overtime payments made during the past three years to ensure that the payments complied with collective bargaining agreements and state laws and policies; and  Recover overpayments made to employees through an agreed-upon collection method in accordance with GC section 19838, and properly compensate those employees who were underpaid. We further recommend that, to prevent improper overtime payments from recurring, DIR:  Establish adequate internal controls to ensure that payments are accurate and comply with collective bargaining agreements and state laws and policies; and  Provide adequate oversight to ensure that payroll transactions unit staff process only valid and authorized payments that comply with collective bargaining agreements and state laws and policies. DIR lacked adequate segregation of duties within its payroll transactions FINDING 6— unit, as noted in Finding 1, and lacked adequate controls over the Inadequate processing of employee separation lump-sum pay. We identified a net total controls over of $9,010 in improper separation lump-sum payments, consisting of separation lump- $6,552 in known overpayments and $4,551 in known underpayments, and sum pay, resulting $22,954 in likely overpayments and $15,945 in likely underpayments. We in improper and also found that DIR did not make separation lump-sum payments to late payments 32 employees in a timely manner. If not mitigated, these control -13- Department of Industrial Relations Payroll Audit deficiencies leave DIR at risk of making additional improper and late separation lump-sum payments, noncompliance with agreements and laws, and liability for late payments. GC section 19839 allows lump-sum payment for accrued eligible leave credits when an employee separates from state employment. Collective bargaining agreements include similar provisions regarding separation lump-sum pay. Payroll records show that DIR processed separation lump-sum payments, totaling $9,318,863, for 550 employees between March 2016 and February 2019. Of the 550 employees, we randomly selected a statistical sample (as described in the Appendix) of 105 employees who received separation lump-sum pay, totaling $2,069,180. Of the 105 employees, five were overpaid by approximately $6,552 and eight were underpaid by approximately $4,551. These payments resulted in a net total of $2,001 in improper payments. As we used a statistical sampling method to select the employees whose separation lump-sum payments were examined, we projected the amount of likely overpayments to be $22,954 and likely underpayments to be $15,945. These payments resulted in a net total of $7,009 in improper payments. Therefore, the known and likely net improper payments totaled approximately $9,010, consisting of $29,506 in overpayments and $20,496 in underpayments. The following table summarizes the results of our statistical sampling: Known improper payments, net $ 2,001 Divide by: Sample 2,069,180 Error rate for projection (differences due to rounding) 0.10% Population that was statistically sampled 9,318,863 Multiply by: Error rate for projection 0.10% Known and likely improper payments, net (differences due to rounding) 9,010 Less: Known improper payments, net 2,001 Likely improper payments, net $ 7,009 _____________ * Amounts in this table are rounded to the nearest dollar. Of the 105 employees whose separation lump-sum payments we examined, 32 were not paid in a timely manner, in violation of collective bargaining agreements and state laws as summarized in CalHR’s Human Resources Manual, section 1703. The known improper payments were made because payroll transactions unit staff members miscalculated leave balances paid for separation lump- sum pay. DIR also lacked adequate supervisory review to ensure accurate and timely processing of separation lump-sum pay. GC sections 13400 through 13407 require state agencies to establish and maintain internal controls, including an effective system of internal review. -14- Department of Industrial Relations Payroll Audit Recommendation We recommend that DIR:  Establish adequate controls to ensure accurate and timely separation lump-sum payments;  Conduct a review of separation lump-sum payments made during the past three years to ensure that the payments were accurate and in compliance with collective bargaining agreements and state law; and  Recover overpayments made to separated employees in accordance with GC section 19838 and State Administrative Manual (SAM) section 8776.6, and properly compensate those employees who were underpaid. DIR lacked adequate segregation of duties within its payroll transactions FINDING 7— unit, as noted in Finding 1, and lacked adequate controls over salary Inadequate advances to ensure that advances were recovered in accordance with state controls over law and policies. Eighteen salary advances, totaling $60,683, remained salary advances, outstanding as of February 28, 2019, due to DIR’s noncompliance with the resulting in failure State’s collection policies and procedures. The oldest unrecovered salary to recover advance was outstanding for over seven months. These control outstanding deficiencies leave DIR at risk of failing to collect further salary advances amounts if not mitigated. At February 28, 2019, DIR’s accounting records showed 19 outstanding salary advances, totaling $69,946, including 13 balances, totaling $49,552 that had been outstanding for more than 120 days. Generally, the prospect of collection diminishes as an account ages. When an agency does not initiate collection within three years from the date of overpayment, the possibility of collection is remote. GC section 19838 and SAM sections 8776 and 8776.7 describe the State’s collection policies and procedures, which require DIR to collect salary advances in a timely manner and maintain proper records of collection efforts. We examined the 19 outstanding salary advances and noted that DIR did not comply with the State’s collection policies and procedures for 18 outstanding salary advances, totaling $60,683. DIR did not send collection notices. The lack of adequate controls over salary advances reduces the likelihood of collection, increases the amount of resources expended on collection efforts, and negatively impacts cash flow. Recommendation We recommend that DIR ensure that it recovers salary advances in a timely manner, pursuant to GC section 19838 and SAM sections 8776 and 8776.7. If all reasonable collection procedures do not result in payment, DIR may request discharge from accountability of uncollectable amounts. -15- Department of Industrial Relations Payroll Audit Appendix— Audit Sampling Methodology We used attributes sampling for tests of compliance. The sample design was chosen because:  It follows the American Institute of Certified Public Accountants (AICPA) guidelines;  It allows us to achieve our objectives for tests of compliance in an efficient and effective manner; and  Audit areas included high volumes of transactions. The following table outlines our audit sampling application for all audit areas where statistical sampling was utilized: Results Expected Projected to Audit Type Population Population Sampling Sample Selection Confidence Tolerable Error Sample Intended Finding Area of Test (Unit) (Dollar) Unit Method Level Error Rate (Rate) ᵃ Size ᵇ Population Number Excess vacation and annual leave Compliance 4 12 $8,868,422 Employee Computer-generated 90% 5% 2 (1.75%) 105 Yes 3 simple random Regular pay Compliance 1 00,284 6 36,344,043 Transaction Computer-generated 90% 5% 2 (1.75%) 105 Yes 4 simple random Overtime pay Compliance 3,488 3,010,813 Transaction Computer-generated 90% 5% 2 (1.75%) 105 Yes 5 simple random Separation lump-sum pay Compliance 5 50 9,318,863 Employee Computer-generated 90% 5% 2 (1.75%) 105 Yes 6 simple random Leave buy-back Compliance 1,098 3,732,626 Transaction Computer-generated 90% 5% 1 (0.50%) 105 Yes simple random _________________ ᵃ Pursuant to the AICPA’s Audit Guide: Audit Sampling (May 1, 2017 edition), pages 131-133, the expected error is the expected number of errors planned for in the sample. It is derived by multiplying the expected error rate by the sample size. The expected number of errors in the sampling tables on pages 135-136 was rounded upward, e.g., 0.2 errors becomes 1.0 error. ᵇ For populations of fewer than 250 items, we determined the sample size using a calculator that uses a hypergeometric distribution. For populations of 250 items or more, we determined the sample size using a calculator that uses a binomial distribution. As stated in Technical Notes on the AICPA Audit Guide Audit Sampling (March 1, 2012), page 5, although the hypergeometric distribution is the exactly correct distribution to use for attributes sample sizes, the distribution becomes unwieldy for large populations unless suitable software is available. Therefore, more convenient approximations are frequently used instead. Department of Industrial Relations Payroll Audit Attachment— Department of Industrial Relations’ Response to Draft Audit Report State Controller’s Office Division of Audits Post Office Box 942850 Sacramento, CA 94250 http://www.sco.ca.gov S19-PAR-0017