The Evolution of HR Audits

Evolution is a process of change. In recent years we have seen a significant shift in the value gained from human resources audits and in the tools companies use to audit HR.

HR audits have grown from a simple checklist of dos and don’ts, or periodic affirmative action plans, into a comprehensive and sustainable process that is an integral part of an organisation’s internal controls, due diligence and risk management. A core activity of strategic and operational management, the HR audit draws on advanced audit products and advisory services. Increasingly, HR audits are conducted by HR, not on HR.

An overview of HR audits

The HR audit process is, or should be, an independent, objective and systematic assessment that provides assurance that: (1) compliance and governance requirements are met; (2) business and talent management objectives are achieved; (3) human resources management risks are fully identified, assessed and managed; and (4) the organisation’s human capital adds value.

Under this definition, the HR audit is more than an exercise in collecting and presenting evidence of compliance. The organisation is expected to look behind and beyond claims of sound HR practice, test its assumptions, benchmark its processes and practices, and provide the advisory services that help it achieve its aims and objectives.

External and internal forces

Many external forces and factors have shaped the demand for and scope of HR audits. First, in the global economy human capital is becoming the most important determinant of competitiveness, productivity, sustainability and profitability. An organisation’s human capital is increasingly seen as the source of innovation and the driver of business success. To be effective, HR audits must therefore be diagnostic, predictive and action-oriented.

Second, a convergence of economic, political and social factors, including corporate scandals, the financial sector’s failure to assess risk adequately and growing shareholder activism, has brought greater legal and regulatory requirements, more demands for transparency and more internal and external audit activity. Consider these factors:

1. Sarbanes-Oxley requires effective internal controls. Although the Act addresses internal financial controls specifically, the financial and organisational costs of employment claims and lawsuits can significantly affect an organisation’s bottom line, earnings and valuation, and an employment lawsuit can harm its employment brand and long-term sustainability.
2. US Securities and Exchange Commission guidelines require management to exercise “reasonable oversight”. If human capital is one of an organisation’s most important assets, and certainly one of its largest expenditures, it is reasonable to expect management to apply the same level of oversight and due diligence to it as to the management of other assets.
3. The US Federal Sentencing Guidelines require management to show it has taken reasonable steps to create a culture of compliance and to “monitor and audit” compliance activities, behaviour and results. Ethical conduct and legal compliance, including non-discriminatory employment practices, are achieved when management sets a positive “tone”. Audits, HR audits included, give senior management and boards important feedback on how effectively they are conveying that message.
4. Government agencies are acting against systemic non-compliance. The US Equal Employment Opportunity Commission (EEOC) strongly encourages employers to conduct comprehensive HR audits as a tool to ensure the absence of systemic discrimination. The Office of Federal Contract Compliance Programs (OFCCP) treats self-assessment as a “best practice”; the US Department of Labor sees wage-and-hour self-audits as a valuable compliance tool; and the Department of Homeland Security and immigration lawyers encourage employers to self-audit their I-9 forms and hiring practices.
5. Venture capitalists, investors and shareholders examine organisations’ HR management practices, processes and results, and use HR audits to assess human capital assets, surface liabilities and carry out due diligence.
6. Internal auditors and risk managers, recognising the importance of the organisation’s human capital and the risks of misaligned, mismanaged and unlawful employment practices, are taking a leading role in developing HR audit standards and in designing and conducting HR audits.

Designing and conducting HR audits

An organisation’s size, industry, financial health, commitment to being a “best place to work”, and business goals and imperatives all influence the scope and urgency of the HR audit process, yet we see common features and objectives in recent audits.

First, HR audits are increasingly complex and multidimensional. While compliance remains a core purpose, other objectives include:

• Ensuring HR management and employment practices are aligned with the organisation’s business objectives.
• Evaluating the results of the organisation’s employment processes, policies, practices and procedures.
• Calculating and measuring the value added by human resources, determining the return on human capital, and benchmarking employment policy and practice results against equal employment and diversity goals and best practices.
• Providing due diligence, including uncovering hidden liabilities and assets and identifying vulnerabilities to correct and opportunities to pursue.
• Developing HR audit procedures that become an ongoing, sustainable element of the organisation’s internal controls and risk management programme.
• Assessing and managing employment-related fraud.

Second, HR audit reports are increasingly used to communicate audit findings to a wider audience. Distribution is no longer limited to senior management, and a growing number of third parties are interested in the organisation’s human resources management. These outside stakeholders include not only shareholders, prospective investors and venture capitalists, but also government agencies, NGOs, civil rights groups, corporate governance watchdogs and plaintiffs’ lawyers.

Because HR audit findings contain private and confidential information and in many cases generate discoverable information, the consequences of non-management stakeholders reviewing them are significant and can pose a serious problem for organisations. As a result, organisations are spending more time considering the format, content and impression of their HR audit reports.

Five critical components of the HR audit process

The Employment-Labor Law Audit (ELLA), a leading HR audit tool, builds five critical components into the process. These are the components every HR audit should address:

1. Activities. The starting point of the HR audit is a review of the organisation’s activities: the tasks and actions that create or implement employment policies, practices, procedures and programmes, such as publishing an equal employment opportunity policy statement and a harassment policy, and posting required employment notices. This component is typically assessed with a “checklist approach”, ticking items off as they are completed.
2. Behaviours. Here, behaviours are the actions and conduct that positively or negatively affect how effectively the organisation’s policies, practices, procedures and programmes are applied, and that show its commitment to its stated aims. Examples include building an organisational culture that values and supports equal opportunity, diversity and compliance; visible and firm senior management support for diversity efforts; and budgeting adequate resources to meet compliance and diversity goals. Behaviours are often assessed with qualitative measures such as culture surveys and employee satisfaction surveys.
3. Risk assessment. Risk assessment identifies current and future events that could cause loss, harm or vulnerability, and management’s willingness to accept those risks. It also identifies events or conditions that create new opportunities for achieving business goals. It lets management make informed decisions on allocating human, physical and financial capital and on effective ways to eliminate, reduce, control or transfer risk. Liability risks linked to HR management and employment practices include failure to comply with employment law; lost business opportunities from failing to attract, hire and retain top talent; losses of intangible assets from turnover and the loss of key employees; ineffective staff development and succession planning; and lower profitability from failing to control labour costs.
4. Internal controls. Internal controls are the processes, tests and assessments that help ensure compliance, manage risk, detect irregularities and achieve corporate goals. HR audit activities include evaluating the effectiveness and efficiency of HR management processes, policies and procedures; the reliability and accuracy of HR management reporting; and the level of compliance with laws and regulations, industry and professional standards, codes of conduct and ethics, corporate policies and budgets.
5. Outputs. Outputs are the quantitative and qualitative measures that gauge and help evaluate the achievement of organisational aims and goals. The HR audit includes defining the metrics the organisation uses to measure corporate and individual performance; evaluating results by comparing actual outcomes with projected outcomes, budgets and internal and external standards; and describing the activities, behaviours and internal controls needed to maintain or improve future results.

The value of the HR audit model is that it lets organisations (1) evaluate current HR management and employment practices; (2) identify and diagnose systemic problems; (3) assess and predict the impact of corrective measures; (4) develop an action plan; and (5) determine the return on that action. Organisations using ELLA increase the value of their human capital, reduce their exposure to employment-related liabilities and improve their ability to achieve business goals.

This article is an adaptation of “The Evolution of HR Audits”, published on Internal Audit 360. Source: https://internalaudit360.com/the-evolution-of-hr-audits/