Chapter 20 Week 6

Audit of The Payroll

and Personnel Cycle
Putri Nabilah
 Today’s Agenda :

LO 1
Identify the accounts and LO 3
transactions in the payroll
and personnel cycle. Understand IC and design
and perform TOC and STOT
for the payroll and
LO 2 personnel cycle.
Describe the business
functions and the related
documents and records in LO 4
the payroll and personnel
cycle. Design and perform SAP and
TODB for accounts in the
payroll and personnel cycle.
 1
Identify the accounts and transactions in the payroll and
personnel cycle.
01 Accounts and Transactions in The
Payroll and Personnel Cycle

The payroll and personnel cycle involves the employment

What does it involved? and payment of all employees.

The main differences between the payroll and

Why it’s unique? personnel cycle and other cycles include:
● There is only one class of transactions for
payroll.
● Transactions are generally far more
significant than related balance sheet
accounts.
● Internal controls over payroll are effective
for almost all companies, even small ones.
01
 2
Describe the business functions and the related
documents and records in the payroll and personnel
cycle.
02 Business Functions

Controller

Human
Payroll
Resources Or Treasure
(Accounting)
Personnel
02
Human Resources

The payroll and personnel cycle :

1. Begins with hiring employees
2. Ends with paying them for the services they
performed
3. Includes payment to the government and
other institutions for withheld and accrued
taxes and benefits

Human Resources : This department is an independent source for hiring qualified

personnel and a source for verification of wage info, including deletions from payroll
and changes in wages and deductions.
● Human resource records include such data as the date of employment, personnel
investigations, rates of pay, authorized deductions (w-4), performance
evaluations, and termination of employment.
02
PAYROLL
Timekeeping and payroll preparation : These functions are important in the audit of payroll
because they directly affect payroll expense for each period.

The following documents are involved in timekeeping and payroll :

● Time Record is a document indicating the time the hourly employee
started and stopped working each day and the number of hours the
employee worked.
● Job Time Ticket is a form indicating which jobs an employee worked on
during a given time period.
● Payroll Transaction File is computer-generated file includes all payroll
transactions processed by the accounting system for a period.
● Payroll Journal or Listing is generated from the payroll transaction file
showing payroll details for each employee
● Payroll Master File record of every payroll check, including gross pay,
deductions, and net pay for each employee.
02 Payment - Treasure
Payment of Payroll : The approval and distribution of payroll must be carefully controlled to
prevent theft. To increase control, payroll disbursements are generally processed separately
from other disbursements.
● Payment of payroll may be made by check, but ore often are deposited directly into
employees bank accounts.

Payroll Bank Account Reconciliation : An imprest payroll account is a separate

payroll account in which a small balance is maintained and the exact amount
of payroll is transferred immediately before distribution of payroll.

Preparation of Payroll Tax Returns and payment of Taxes : Federal and state
laws require timely preparation and payment of payroll taxes.
 3
Understand IC and design and perform TOC and STOT for
the payroll and personnel cycle.
03 1. Overall Picture
Understanding IC for
payroll and
personnel cycle

2.
Assess planned
control risk payroll
and personnel cycle.

3.
Determine extend
TOC *PCAOB

4.
Design TOC and STOT to meet
transaction-related audit
objectives
 Payroll and Personnel Cycle
Understand Internal Control and Assess Control Risk -- Payroll and Personnel Cycle :

Internal control for payroll is normally highly structured and well

controlled. As a result, control risk is often assessed as low for this cycle.
Jupiter
Test of controls (TOC) and substantive test of transactions (STOT) in this
cycle are usually not extensive for these reasons :
1. Employees are likely to complain to management if they are
underpaid.
Saturn
2. All payroll transactions are typically uniform and uncomplicated.
3. Payroll transactions are subject to audit by federal and state
governments for income tax withholding, Social Security, and
unemployment taxes.
Mars
 Methodology for Designing TOC and STOT

Key IC for payroll and personnel cycle for assessing control risk :

● Adequate Separation of Duties : Payroll function should be kept

Jupiterof the human resources department. No Ghost EE
independent
● Proper Authorization : Human resources should authorize additions
and deletions to payroll. Approval is needed on all time cards.
● Adequate Documents and Records : What is adequate dependents on
the nature of the company’s payroll. Time card for hourly EE, piece
Saturn
rate. Prenumbered documents. Of course.
● Physical Control over Assets and Records : Access to unsigned payroll
checks should be restricted, as should access to direct deposit
information. Physical and logical.
● Independent
Mars Checks on Performance: a member of management or
other responsible employee should review payroll for obvious
misstatements.
Jupiter

Saturn

Mars
Jupiter

Saturn

Mars
Jupiter

Saturn

Mars
 Methodology for Designing TOC and STOT

Payroll Tax Forms and Payments : The auditor should review the
preparation of at least one of each type of payroll tax form during the
understandingJupiter
of internal controls phase of the audit.

Timely Payment of Payroll TAxes and Other Withholding : The auditor

should also test whether the client has fulfilled its legal obligations in
submitting payments for all withholding on a timely basis.
Saturn
Inventory and Fraudulent Payroll Considerations : If payroll affect the
valuation of inventory, the auditor often extends payroll audit procedures.
This is common for manufacturing and construction companies. Trace job
tickets. Mars
 Methodology for Designing TOC and STOT

Relationship Between Payroll and Inventory Valuation : When payroll is a

Jupiterof inventory, the improper classification of payroll can
significant portion
materially affect asset valuation for work in process and finished goods, or
construction in process. Auditors should emphasize internal control over
proper classification of payroll transactions.

SaturnConsideration :
Fraudulent Payroll
● Test for nonexistent employees.
● Test for fraudulent hours : Audit software for unusual amount
● Fraudulent expense reports : Travel and entertainment expense.
Examine receipts. I/C
Mars
 Test for nonexistent Employees

● Keep the EE on payroll after termination

● Compare names of cancelled checks with time cards
● Software : Scan checks for second endorsement
● Trace checks to HR record
● Review termination policies and procedure
● Audit software : termination of HR terminate date to payroll record
date with last paycheck.
 4
Design and perform SAP and TODB for accounts in the
payroll and personnel cycle.
 Substantive Analytical Procedures

Analytical procedures is the study of relationship/data between various

figures. Ratios, horizontal analysis, vertical analysis so on.

Looking for unusual fluctuations or relationship for further investigation.

Review Common one

Analytical procedures are performed at three stages of audit :

1. Beginning of the audit (risk assessment procedures)
2. During (optional as a substantive step) Use judgment. Extend
depends on stability of numbers.
3. End of audit (financial analytical procedures)
Substantive Analytical Procedures
Test of Detail Balances for Liability and Expense Accounts

Two major balance-related audit objectives in testing payroll liability :

1. Accruals in the trial balance are stated at the correct amounts
(Accuracy).
2. Transactions in the payroll and personnel cycle are recorded in the
proper period (Cutoff).
Liabilities = not recording is always an issue
Test of Detail Balances for Liability and Expense Accounts
The major liability accounts in the payroll and personnel cycle :
1) Amounts withheld from Employees’ Pay:
a) IF I/C proper the cutoff and straight forward
2) Accrued salaries and wages
a) Determine the company policy then recomputed
3) Accrued Commissions
a) Bit more challenging. Auditor might have to review various agreement between
company and executives. Is is based on performance or stock price? Compare prior
period to this period
4) Accrued Bonuses
a) Minutes from Board of directors meetings
5) Accrued Vacation Pay, Sick Pay, or Other Benefits
a) Review company policy then recalculate
6) Accrued Payroll Taxes
a) Examine tax form in subsequent period to determine the amount that should be
withheld
Test of Detail Balances for Liability and Expense Accounts
Analytical procedures, internal control and test of transaction play a major role in auditing the
expense account.

The major expense accounts in the payroll and personnel cycle :

1. Officers Compensations
a. Compare authorization from BOD minutes to form 10-K
b. People with authority
2. Commissions
a. If based on sale then easy to verify
3. Payroll Tax Expense
a. If analytical procedures don’t indicate a problem then good to go
4. Total Payroll
a. Compare payroll tax expense with payroll tax return and W-2. Analytical procedures and
test of control are helpful in this process
5. Contract Labor
6. IT Services
a. Compare amount with signed contract
Test of Detail Balances for Liability and Expense Accounts

Presentation and Disclosure Objective : Usually not extensive, though some complex transactions,
such as stock options and executive officer compensation plan, may require footnote disclosures.