Module 8 - Payroll/Personnel Cycle

Question 1

The overall objective of the audit of payroll/personnel cycle:

Answer 1

Evalulate whether the account balances affected by the cycle are fairly stated in accordance with applicable accounting standards

Question 2

Why do auditors often emphasize tests of controls, substantive tests of transactions, and analytical procedures in the audit of payroll?

Answer 2

1. There is only one class of transactions for payroll
2. Transactions far more significant than balance sheet accounts (BS accounts are accrued payroll liability)
3. Internal controls over payroll are highly effective for small and large companies (federal/state payroll laws)

Question 3

Use this card to gain an understanding of the accounts and their effects within the payroll cycle:

Answer 3

_{*Companies should have separate withholding account for each type of withhold}

_{**Direct Labor represents capitalisable labor}

Question 4

What are the 4 business functions associated with the Payroll Cycle?

Answer 4

1. Human resources and employment
2. Timekeeping and payroll preparation
3. Payment of payroll
4. Prep of payroll tax returns and payment of taxes

Question 5

The human resources of a company provides these documents/records:

• explain these records

Answer 5

Human resource records: Date of employment, rates of pay, authorized deductions, performance evals, termination rec.

Deduction authorization forms: Form for authorized payroll deductions; income taxes, 401(k), health insurance, etc..

Rate authorization forms: Authorizes rate of pay; labor contracts and authorization of management/directors

Question 6

What is the purpose of business records produced for the timekeeping and payroll prep business function?

What should is the auditor’s objective in review of these records?

Answer 6

Directly affect payroll expense for each period

Auditor should check for adequate controls that prevent misstatements in 4 activities:

• Prepare time records by employees
• Summarize and calculate gross pay, deductions, and net pay
• Payment of payroll
• Prepare payroll records

Question 7

What documents/records can be reviewed for this business function: Timekeeping and payroll prep

• explain these records

Answer 7

• Time record
• Job Time ticket
• Payroll transaction file
• Payroll journal
• Payroll master file

Question 8

Describe these records and their general purpose:

• Time Record
• Job Time ticket

Answer 8

Time record: Indicates time employee started/stopped working each day (not applicable to salaried)

Job Time ticket: If employees work on diff jobs/departments, indicates time spent on each job (allocate capitalisable labor)

Question 9

Describe these records and their general purpose:

• Payroll transaction file
• Payroll journal

Answer 9

Payroll transaction file: Contains all payroll transaction info for a given period

Payroll journal: Summarizes transaction info by employee to be sent to general ledger

Question 10

Describe these records and their general purpose:

Payroll Master file

Answer 10

Computer file for recording payroll transaction for each employee and maintaining total employee wages paid

• tells bank what to pay employees
• used to make selections for testing

Question 11

What records are included in this business activity:

Payment of payroll

Answer 11

Payroll check/automated payroll: Displays net amounts paid to employees

Payroll bank account reconcilation: Independent bank reconcilation for cash accounts, including payroll, that searches for errors/fraud

Question 12

What records are included in this business activity:

Preparation of payroll tax returns and Payment of taxes

Answer 12

W-2 Form: Form sent to each employee that summarizes employee’s earning for calendar year, income tax, and FICA

Payroll Tax Returns: Prepared from payroll master file; submitted to state/local/federal gov. to show payments of withheld taxes and employer’s tax

Question 13

Use this card to understand the methodology for

desiging tests of controls

and

substantive tests of transactions

Answer 13

Question 14

The main risks associated with the Payroll and Personnel cycle that the auditor should be aware of when designing and performing tests:

Answer 14

Overpayment to employees

and

Unauthorized payments

Question 15

The key principles/risks to prevent overpayment to employees and unauthorized payments include:

Answer 15

• Employees are only paid for work done
• Salaries/wages only paid for valid employees
• Hours worked are authorized/approved
• Hourly wage rates are correct and calculated correct
• Payroll transactions are correctly recorded in accounting records
• Payroll deductions are correct and paid to appropriate parties

Question 16

Phase 1 - Understand Internal controls

Some questions auditors may ask the client to better understand internal controls:

Answer 16

• Can employees be paid for work not done?
• Can wages be paid to fictitious employees?
• Can unauthorized wages be paid?
• Can errors occur in payroll calculation?
  
  • If so, will they be discovered in timely manner?

Question 17

Phase 1 - Understand internal controls - Payroll

What features would the auditor expect of a client with strong internal controls?

Answer 17

• Adequate separation of duties
• Proper authorization
• Adequate documents/records
• Physical control over assets and records
• Independent checks of payroll calculations
• Comparison of budget to actual payroll expense
• Review of SOC reports for 3rd party service providors

Question 18

How can a company maintain adequate separation of duties for the payroll cycle?

Answer 18

• Key payroll functions (adding/deleting employees) should be limited to HR department
• Payroll processing should be separate from issuance of payroll disbusements

Question 19

How can a company maintain:

• Proper authorization
• Adequate documents and records

Answer 19

Proper authorization

• Only HR should add/drop employees and change pay rates and deductions
• Hours worked/overtime (timecards) should be authorized by employee’s supervisor

Adequate documents and records

• Job tickets/Time records for hourly employees
• Personnel records

Question 20

How can a company ensure physical control over assets and records?

Answer 20

Proper physical controls over assets:

• Access to unsigned payroll checks should be restricted
• Payroll distributed by someone independent of payroll functions
• Time cards and HR records should be restricted from employees

Question 21

Describe these payroll controls:

Surprise payroll payoff

Answer 21

Company randomly requires employees to pick up payroll checks

• Ensures a timely check of valid employees (no checks to fictitious employees)

Question 22

Describe these payroll controls:

Comparison of budget to actual payroll expenses

Answer 22

Payroll cycle has very consistent expenses

• Would not expect huge deviations in expenses from the budget

Question 23

Describe these payroll controls:

Review of SOC reports

Answer 23

• If the client relies on a 3rd party to maintain payroll services, the auditor cannot perform audit of 3rd party
• 3rd party hires own auditor to tests controls they provide as 3rd party service
• Auditor hired by 3rd party issues SOC report; we may rely on controls if SOC report is clean

Question 24

Use this card to understand:

The methodology for designing tests of balances for the payroll cycle

Answer 24

Question 25

Explain the effectiveness of analytical procedures within the payroll cycle:

Answer 25

Because payroll is relatively consistent and predictable, analytical procedures are highly effective and provide the majority of evidence

• Majority of evidence is provided by controls and analytics

Question 26

What are some analytical procedures to gather evidence of:

• Misstatement of payroll expense accounts
• Misstatement of direct labor/inventory

Answer 26

Misstatement of payroll expense:

Compare payroll expense account balances with previous years

Misstatement of direct labor/inventory

Compare direct labor as % of sales with previous years

Question 27

What are some analytical procedures to gather evidence of:

• Misstatement of commision expense
• Misstatement of payroll tax expense

Answer 27

Misstatement of commision expense

Compare commission expense as % of sales with prior years

Misstatement of payroll tax expense

• Compare payroll tax expense as % of salaries and wages with prior years
• Compare accrued payroll tax accounts with prior years

Question 28

What are the two major balance related audit objectives auditors should be concerned with testing in the payroll cycle?

Answer 28

1. Accuracy: Accruals in the balance are stated at correct amounts
2. Cutoff: Transactions of payroll are recorded in proper period

_{Note: Balance related tests <u>not as significant</u> as other tests due to accruals not as significant}

Question 29

What are some procedures for testing the details of account balances of the payroll cycle?

Answer 29

• Compare wages paid to recalculation amounts (wage rate * time card record)
• Compare salaries per payroll records to HR records
• Attempt to login in to payroll and change records
• Recompute withholdings and agree to HR records
• Reconcile payroll master file to accounting records to bank statement
• Test for terminated/fictitious employees

Question 30

What is performed during the test for terminated/fictitious employees?

Answer 30

• Compare termination date in termination file to last paycheck
• Select from payroll master file and review HR records
• Select from termination list and ensure no payments made to anyone on list