Auditing bonus and incentive payments

Auditing bonus and incentive payments means testing three different things depending on the scheme: statutory bonus against the Payment of Bonus Act's eligibility and computation rules, discretionary bonus and incentive schemes against the approval evidence and performance criteria the entity itself set, and the year-end accrual against whether the obligation existed and was measurable as of the balance sheet date. The three schemes carry different risks and should not be tested with one blended procedure.

Statutory bonus: Payment of Bonus Act basics

The Payment of Bonus Act applies to certain classes of establishments and requires bonus to be paid to eligible employees within a band set by the Act — a minimum bonus payable even in a loss year, subject to conditions, and a maximum linked to allocable surplus, both expressed with a wage ceiling for eligibility that has been revised by amendment over time. Confirm the current eligibility ceiling and the minimum/maximum bonus percentages from the Act as it stands for the year under audit rather than carrying forward a figure used in a previous engagement.

1. 01Confirm which employees are eligible for statutory bonus based on the wage ceiling and the minimum qualifying period of serviceAn employee above the eligibility ceiling who still received a 'bonus' payment is receiving a discretionary payment, not a statutory one, and should be tested under that lens instead.
2. 02Recompute the statutory bonus for a sample of eligible employees against their bonus-qualifying salaryThe salary base used for bonus computation under the Act is typically narrower than gross salary — confirm the entity applied the correct base rather than the full gross.
3. 03Check the percentage applied falls within the minimum and maximum band, and matches the entity's own stated policyAn entity paying a flat percentage every year regardless of profitability should be able to explain how that percentage was arrived at and reconciled to allocable surplus where the Act requires that computation.
4. 04Confirm the bonus was paid within the time limit prescribed by the ActA delay beyond the prescribed period is a compliance breach independent of whether the amount itself was correct.

Provision versus actual payment

Many entities provide for bonus and incentives at year end based on an estimate and true it up when the actual payment is finalized, often months later. The audit needs to look at both sides: whether the provision at the prior year end was a reasonable estimate of what was eventually paid, and whether the current year's provision follows the same basis.

Discretionary incentive schemes: approval evidence

Discretionary incentive and commission schemes carry a different risk profile from statutory bonus, because there is no external statute defining eligibility or computation — the entity's own policy document is the only benchmark, and the audit's job is to confirm that benchmark was actually followed.

• Obtain the incentive scheme document or policy approved for the period, and confirm it was approved before the period it governs began — a scheme approved retrospectively after performance is already known is a red flag on its own.
• For a sample of employees who received an incentive, trace the payment back to the performance metric the scheme specifies — sales achieved, targets met, project milestones — and to the underlying data supporting that metric.
• Check for payments made outside the documented scheme altogether, approved as one-off discretionary payments, and confirm each carries its own approval at an appropriate level of authority.
• Where incentives are a material part of total compensation for sales or leadership roles, consider whether the scheme design creates pressure to misstate revenue or other metrics the incentive is tied to, and whether that risk needs to be factored into other audit areas.

Accrual cut-off at year end

Whether a bonus or incentive obligation existed as of the balance sheet date depends on whether the underlying performance period had ended and the amount was reasonably estimable — the accrual question is really a recognition question, not a payroll question, even though the number sits inside the payroll audit section.

1. 01Identify the performance period each scheme covers and whether it aligns with the financial yearA scheme running April to March aligns cleanly; a scheme running on a calendar year or a rolling twelve-month window needs its own apportionment, and the apportionment basis should be checked rather than assumed to be straight-line.
2. 02Confirm whether the obligation was approved before or after the year endA board or management approval dated after the balance sheet date, for a scheme that was genuinely discretionary with no prior commitment, can mean the obligation did not exist as of the year end and should not be accrued — this needs a judgement call documented in the file, not a default assumption either way.
3. 03Check payments made shortly after year end against the prior-year provisionA subsequent payment that significantly exceeds the provision, with no corresponding adjustment recorded as an adjusting subsequent event, points to either an estimation failure or a cut-off error worth pursuing.