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10 39 (Objective 10 5)
Anthony, CPA, prepared the flowchart (p. 330) which portrays the raw materials
purchasing function of one of Anthonys clients, Medium-Sized Manufacturing Company,
from the preparation of initial documents through the vouching of invoices for payment
in accounts payable. Assume that all documents are prenumbered.
Required
Identify the deficiencies in internal control that can be determined from the flowchart.
Use the metodology discussed in this chapter. Include internal control deficiencies
resulting from activities performed or not performed.*
Answer

Accuracy
Purchase requisitions and purchase orders are not compared in the stores
department. Although purchase orders are attached to purchase requisitions in the
stores department, there is no indication that any comparison is made of the two
documents. Prior to attaching the purchase order to the purchase requisition the
requisitioner's functions should include a check that:
a.
b.
c.
d.

Prices are reasonable;

The quality of the materials ordered is acceptable;
Delivery dates are in accordance with company needs;
All pertinent data on the purchase order and purchase requisition (e.g.,
quantities, specifications, delivery dates, etc.) are in agreement.

Because the requisitioner will be charged for the materials ordered, the
requisitioner is the logical person to perform these steps.
1. The purchase office does not review the invoice prior to processing approval.
The purchase office should review the vendor's invoice for overall accuracy
and completeness, verifying quantity, prices, specifications, terms, dates, etc.,
and if the invoice is in agreement with the purchase order, receiving report,
and purchase requisition, the purchase office should clearly indicate on the
invoice that it is approved for payment processing. The approved invoice
should be sent to the accounts payable department.
2. The copy of the purchase order sent to the receiving room generally should
not show quantities ordered, thus forcing the department to count goods
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received. In addition to counting the merchandise received from the vendor,
the receiving department personnel should examine the condition and quality
of the merchandise upon receipt.
3. There is no indication of control over dollar amounts on vouchers. Accounts
payable personnel should prepare and maintain control sheets on the dollar
amounts of vouchers.
Such sheets should be sent to departments posting transactions to the general
ledger and master files.
Note: Classification, timing, and posting and summarization are not applicable.
Recording in journals is not included in the flowcharts.

MULTIPLE CHOICE QUESTIONS FROM CPA EXAMINATIONS

20 - 17 (Objective 20-3)
The following questions concern internal controls in the payroll and personnel cycle.
Choose the best response.

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a. A factory foreman at Steblecki Corporation discharged an hourly worker but did
not notify the human resources department. The foreman then forged the
workers signature on time cards and work tickets and, when giving out the
checks, diverted the payroll checks drawn from the discharged worker to his own
use. The most effective procedure for preventing this activity is to
(1) require written authorization for all employees added to or removed from the
payroll.
(2) have a paymaster who has no other payroll responsibility distribute the
payroll checks.
(3) have someone other than persons who prepare or distribute the payroll obtain
custody of unclaimed payroll checks.
(4) from time to time, rotate persons distributing the payroll.
b. An auditor found that employee time records in one department are not properly
approved by the supervisor. Which of the following could result?
(1) Duplicate paychecks might be issued.
(2) The wrong hourly rate could be used to calculate gross pay.
(3) Employees might be paid for hours they did not work.
(4) Payroll checks might not be distributed to the appropriate employees.
c. The purpose of segregating the duties of hiring personnel and distributing payroll
checks is to separate the
(1) human resource function from the controllership function.
(2) administrative controls from the internal accounting controls.
(3) authorization of transactions from the custody of related assets.
(4) operational responsibility from the record-keeping responsibility.

20 - 18 (Objective 20-3)
The following questions concern audit testing of the payroll and personnel cycle.
Choose the best response.
a. When control risk is assessed as low for assertions related to payroll, substantive
tests of payroll balances most likely would be limited to applying analytical
procedures and
(1) observing the distribution of payroll checks.
(2) footing and crossfooting the payroll register.
(3) inspecting payroll tax returns.
(4) recalculating payroll accruals.
b. A common audit procedure in the audit of payroll transactions involves tracing
selected

items

from

the

payroll

journal

to

employee

time

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cards that have been approved by supervisory personnel. This procedure is
designed

to

provide

evidence

in

support

of

the

audit

proposition

that
(1) only proper employees worked and their pay was correctly computed.
(2) jobs on which employees worked were charged with the appropriate labor
cost.
(3) internal controls over payroll disbursements are operating effectively.
(4) all employees worked the number of hours for which their pay was
computed.
c. In performing tests concerning the granting of stock options, an auditor should
(1) confirm the transaction with the Secretary of State in the state of
incorporation.
(2) verify the existence of option holders in the entitys payroll records or stock
ledgers.
(3) determine that sufficient treasury stock is available to cover any new stock
issued.
(4) trace the authorization for the transaction to a vote of the board of directors.

DISCUSSION QUESTIONS AND PROBLEMS

20 - 19 (Objectives 20-2, 20-3)
Items 1 through 8 are selected questions typically found in internal control questionnaires
used by auditors to obtain an understanding of internal control in the payroll and
personnel cycle. In using the questionnaire for a client, a yes response to a question
indicates a possible internal control, whereas a no indicates a potential deficiency.
1. Does an appropriate official authorize initial rates of pay and any subsequent
changes in rates?
2. Are formal records such as time cards used for keeping time?
3. Is approval by a department head or foreman required for all time cards before
they are submitted for payment?
4. Does anyone verify pay rates, overtime hours, and computations of gross payroll
before payroll checks are prepared?

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5. Does an adequate means exist for identifying jobs or products, such as work
orders, job numbers, or some similar identification provided to employees to
ensure proper coding of time records?
6. Is the issuance of payments to employees independent of timekeeping?
7. Are employees required to show identification to receive paychecks?
8. Are written notices required documenting reasons for termination?
Required
a. For each of the questions, state the transaction-related audit objective(s) being
fulfilled if the control is in effect.
b. For each control, list a test of control to test its effectiveness.
c. For each of the questions, identify the nature of the potential financial
misstatement(s) if the control is not in effect.
d. For each of the potential misstatements in part c, list a substantive audit
procedure for determining whether a material misstatement exists

Answer

No
1

Transaction-Related
Audit Objective
Recorded
payroll
transactions are stated
at the proper pay rates
(accuracy)
Hours worked are
correctly
recorded
(accuracy)
Recorded
payroll
payments are for
work
actually
performed by existing
employees
Recorded
payroll
transactions are for
proper
rate
and
amount (accuracy)

Test of Control

Potential
Substantive audit
Misstatement
procedure
Examine
Employees
are Compare
rates
in
authorizations in paid the wrong payroll journal or
personnel files.
rate
listing to rates in
personnel files.
Examine
time Incorrect
Randomly
sample
cards and observe recording of time workers and trace to
preparation
time cards for hours
worked
Examine
time Incorrect
times Analyze
payroll
cards for approval are
used
in records of a sample of
computing
employees
for
employees pay
reasonableness
Examine payroll Employees pay is Recompute employees
journal or listing miscalculated
pay, compare pay rates
for indication of
to personnel files, and
internal
hours worked to time
verification
cards

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5

Time records are

properly classified by
job (classification)
Recorded
payroll
checks are for work
performed by existing
employees
(occurrence)
Payments are made to
actual
employees
(occurence)

Recorded
transactions
(occurrence)

Examine system
of
identifying
jobs by number
Observe
and
discuss
payroll
system
with
employees

Direct labor is
charged to wrong
jobs
Payroll payments
are
made
to
nonexitent
employees

Trace entries from job

summaries to time
cards, job cards, etc
Trace payroll payments
to
employees
to
determine if employee
exists

Observe
payments
discuss
employees

Payroll payments Examine

cancelled
and are
made
to checks
for
with wrong employees endorsements,
and
compare to personnel
file
payroll Examine
Employees
are Compare termination
exist personnel files for improperly
dates from personnel
termination
terminated
and files to date of last
notices
payment
paycheck
continues

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