ch16 70 360

Chapter 16: Audit of the
Payroll and Personnel

Cycle
16-1
Copyright © 2007 Pearson Education Canada
Chapter 16 objectives
 Explain the importance of the payroll and
personnel cycle
 Describe the functions and records in this cycle
 List typical audit tests of controls by assertion
 Identify misstatements that payroll analytical
review could detect
 Discuss the audit of liability accounts in this
cycle
16-2
Payroll and personnel cycle
 Importance of this cycle:
– Salaries, wages and employee benefits are a
major expense in most organizations
– Labour is an important component in the
valuation of inventory in manufacturing and
construction companies
– Large amounts of company resources can be
wasted through inefficiency or stolen through
fraud
16-3
Payroll and personnel functions
(Table 16-1)
 Personnel hiring and evaluation
 Master file changes (semi-permanent
information)
 Timekeeping and payroll preparation
 Payment of payroll
 Employee withholdings and benefit
remittances
16-4
Methodology for designing tests of controls
for the payroll and personnel cycle
16-5
Practice problem 16-15 (p. 493)
 Identify controls that
could prevent
misstatements
 Identify audit tests
that could help detect
misstatements
16-6
Payroll tests of control by assertion
Transaction- Key internal Common test of

related audit control control
objective
Occurrence: Only employees Examine printouts
Recorded payroll existing in the of rejected
payments are for computer data files transactions, or
work actually are accepted when determine whether
performed by they are entered. invalid entries are
existing employees rejected at point of
entry.
16-7
objective
Completeness: Payroll cheques Account for a

Existing payroll are sequence of
transactions are prenumbered payroll cheques,
recorded. and accounted or conduct
for. sequence gap
tests.
16-8

objective
Accuracy: Authorization of Compare pay rates
Recorded payroll wage rate, salary, with union
transactions are for or commission contract, approval
the amount of time rate. by board of
actually worked directors, or other
and at the proper source.
pay rate.
16-9

objective
Classification: Adequate chart Review chart of

Payroll of accounts. accounts.
transactions are
properly
classified.
16-10

objective
Timing: Payroll Procedures require Compare date of
transactions are recording recorded cheque
recorded on the transactions as (or automatic
correct dates. soon as possible withdrawal) in the
after the payroll is payroll journal
paid. with the date on
cancelled cheques
or time records.
16-11
Transaction-related Key internal Common test of
audit objective control control
Posting and Comparison of Test clerical
summarization: payroll master accuracy by
Payroll transactions file with payroll footing the payroll
are properly general ledger journal and tracing
included in the totals. postings to general
payroll master file ledger and the
and transactions payroll master file.
files; they are
properly
summarized.
16-12
Relationship between payroll and
inventory valuation
 Improper account classification of payroll
can significantly affect asset valuation for
accounts such as work in process, finished
goods or construction in process, for
example:
– Overstatement of overheads
– Incorrect allocation of labour to direct costs
16-13
Tests for nonexistent payroll
 Audit procedures for payroll are extended
when internal controls are inadequate
 “Nonexistent” employees could arise in
two ways:
– Employees who are no longer working for the
company
– Fictitious employees
16-14
Examples of testing for employees who
no longer work for the company
 Comparison of cancelled cheque data to source
documents such as authorized time cards
 Review of cheque endorsements for unusual
signatures (e.g. a company name or absence of a
signature)
 The above tests are not practical for clients with
direct deposit payments: instead, the auditor
could use generalized audit software to compare
bank account numbers on deposits (e.g. looking
for duplicates)
16-15
Methodology for designing tests of
details of balances for payroll
liabilities
16-16
Payroll liabilities – materiality
considerations
 Most organizations have a large number of
transactions involving payroll, often
involving large amounts
 However, balance sheet accounts
(liabilities) are normally insignificant,
except for amounts charged to inventory
16-17
Payroll liabilities – inherent risk
considerations
 Inherent risk of fraud exists because most
transactions involve cash
 Occurrence objective is often considered most
important
 For manufacturing companies with significant
labour component to inventory, need to consider
potential for misclassification between payroll
and inventory categories
16-18
Payroll liabilities – control risk
considerations
 Internal controls for payroll transactions
and withholdings are normally good
 Many companies use outside service
centres for processing payroll: need to
consider controls at these locations
16-19
 Identification of
expectations with
respect to analytical
review
 Audit procedures by
audit assertion
16-20
Analytical procedures (Table 16-3)
Analytical procedure Possible misstatement

detected in
Compare payroll Payroll expense accounts
expense account balance
with previous years
(adjusted for pay rate
increases and increases
in volume)
16-21
(cont’d)
detected
Compare direct labour as Direct labour
a percentage of sales
with previous years
Compare commission Commission expense
expense as a percentage
of sales with previous
years
16-22
(cont’d)
detected
Compare payroll benefits Payroll benefits expense
expense as a percentage and payroll benefits
of salaries and wages liability
with previous years
Compare accrued payroll Accrued payroll benefits
benefits accounts with and payroll benefits
previous years expense
16-23
Tests of detail for amounts withheld
from employees’ pay
 Compare the balance with the payroll
journal, the withholding remittance form of
the subsequent period, and the subsequent
period cash disbursement
 If internal controls are operating
effectively, this addresses cutoff and
accuracy
16-24
Tests of detail for accrued salaries
and wages
 Correct cutoff and valuation depends on
company policies (should be followed
consistently from year to year)
 Test for cutoff and valuation by evaluating
the reasonableness of the method and then
recalculating the client’s accrual
16-25
Tests of detail for accrued
commissions
 Accrual may be difficult to verify because there
may be different types of agreements with
salespeople and other commissioned employees
 Determine the nature of the commission
agreement and then test the calculations based on
the agreement
 Compare the method of accruing to prior years
16-26
Tests of detail for accrued bonuses
 Exclusion of year end accrued bonuses

may be highly material
 Compare the amount to authorizations in
the minutes of the board of directors
16-27
Tests of detail for accrued vacation
pay, sick pay, or other benefits
 Determine the policy, or procedures used
in the prior year, or legal requirements
(such as for pension and unemployment
insurance)
 Recalculate the recorded amounts in
accordance with the method required
16-28
 Audit procedures for a
complex vacation pay
accrual
 Use of generalized
audit software to
assist with the process
16-29
Tests of detail for expense accounts
 Normally, little additional testing of the

income statement accounts is done beyond
the analytical procedures, tests of controls,
or related tests of liabilities
16-30

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Chapter 16: Audit of the

Payroll and Personnel

Transaction- Key internal Common test of

Completeness: Payroll cheques Account for a

Transaction- Key internal Common test of

Transaction- Key internal Common test of

Classification: Adequate chart Review chart of

Transaction- Key internal Common test of

Analytical procedure Possible misstatement

 Exclusion of year end accrued bonuses

 Normally, little additional testing of the

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