Module 8 - Payroll/Personnel Cycle Flashcards
The overall objective of the audit of payroll/personnel cycle:
Evalulate whether the account balances affected by the cycle are fairly stated in accordance with applicable accounting standards
Why do auditors often emphasize tests of controls, substantive tests of transactions, and analytical procedures in the audit of payroll?
- There is only one class of transactions for payroll
- Transactions far more significant than balance sheet accounts (BS accounts are accrued payroll liability)
- Internal controls over payroll are highly effective for small and large companies (federal/state payroll laws)
Use this card to gain an understanding of the accounts and their effects within the payroll cycle:
*Companies should have separate withholding account for each type of withhold
**Direct Labor represents capitalisable labor
What are the 4 business functions associated with the Payroll Cycle?
- Human resources and employment
- Timekeeping and payroll preparation
- Payment of payroll
- Prep of payroll tax returns and payment of taxes
The human resources of a company provides these documents/records:
- explain these records
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
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?
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
What documents/records can be reviewed for this business function: Timekeeping and payroll prep
- explain these records
- Time record
- Job Time ticket
- Payroll transaction file
- Payroll journal
- Payroll master file
Describe these records and their general purpose:
- Time Record
- Job Time ticket
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)
Describe these records and their general purpose:
- Payroll transaction file
- Payroll journal
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
Describe these records and their general purpose:
Payroll Master file
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
What records are included in this business activity:
Payment of payroll
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
What records are included in this business activity:
Preparation of payroll tax returns and Payment of taxes
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
Use this card to understand the methodology for
desiging tests of controls
and
substantive tests of transactions
The main risks associated with the Payroll and Personnel cycle that the auditor should be aware of when designing and performing tests:
Overpayment to employees
and
Unauthorized payments
The key principles/risks to prevent overpayment to employees and unauthorized payments include:
- 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
Phase 1 - Understand Internal controls
Some questions auditors may ask the client to better understand internal controls:
- 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?
Phase 1 - Understand internal controls - Payroll
What features would the auditor expect of a client with strong internal controls?
- 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
How can a company maintain adequate separation of duties for the payroll cycle?
- Key payroll functions (adding/deleting employees) should be limited to HR department
- Payroll processing should be separate from issuance of payroll disbusements
How can a company maintain:
- Proper authorization
- Adequate documents and records
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
How can a company ensure physical control over assets and records?
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
Describe these payroll controls:
Surprise payroll payoff
Company randomly requires employees to pick up payroll checks
- Ensures a timely check of valid employees (no checks to fictitious employees)
Describe these payroll controls:
Comparison of budget to actual payroll expenses
Payroll cycle has very consistent expenses
- Would not expect huge deviations in expenses from the budget
Describe these payroll controls:
Review of SOC reports
- 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
Use this card to understand:
The methodology for designing tests of balances for the payroll cycle
Explain the effectiveness of analytical procedures within the payroll cycle:
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
What are some analytical procedures to gather evidence of:
- Misstatement of payroll expense accounts
- Misstatement of direct labor/inventory
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
What are some analytical procedures to gather evidence of:
- Misstatement of commision expense
- Misstatement of payroll tax expense
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
What are the two major balance related audit objectives auditors should be concerned with testing in the payroll cycle?
- Accuracy: Accruals in the balance are stated at correct amounts
- 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
What are some procedures for testing the details of account balances of the payroll cycle?
- 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
What is performed during the test for terminated/fictitious employees?
- 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
