Risks in the payroll process include financial reporting problems, such as
understatement of payroll and employee benefit-related liabilities or misclassification of labor costs between cost of goods sold (COGS) and selling, general and administrative (SG&A) expenses. Operational efficiency can be compromised by paying phantom or terminated employees (usually the result of collusion) and by using incorrect wage and salary rates. Regulatory compliance is compromised through violation of federal and state wage and hour laws or violation of Internal Revenue Service (IRS) regulations related to employees versus independent contractors.