Tests of Control in the Transaction Cycles - Payroll, Production, Inventory Warehousing, Financing, and Investing

Flashcards testing knowledge of tests of control, internal documentation, departmental duties, and risk assessments for the payroll, production, inventory warehousing, financing, and investing transaction cycles.

What are the major categories of transaction cycles in an organization?

1. Revenue and collection/receipt
2. Expenditure and disbursement (Acquisitions, Disbursement, Payroll, Production, Inventory warehousing)
3. Financing
4. Investing

What types of compensation transactions are included in the payroll cycle?

Salaries of personnel, wage earners (factory workers), salespersons' commissions, executive bonuses, payroll taxes, pensions, profit-sharing plans, and other employee fringe benefits.

What are the primary errors or irregularities that auditors look for in the payroll cycle?

A padded payroll and the misappropriation of unclaimed paychecks.

What is a time card (Daily Time Record / DTR) and what is its audit significance?

A record for each employee indicating total daily hours worked during a pay period (often recorded via a time clock). Its audit significance is providing evidence about the validity of hours worked that an employee is paid for.

What is a deduction authorization form and which deductions require one?

A form signed by employees authorizing voluntary withholdings, such as loan payments. Mandatory deductions (SSS/GSIS, Pag-ibig, Philhealth, and withholding tax) do not require authorization forms because they are legally required.

What is BIR Form No. 2316 and what is its audit significance?

The Certificate of Compensation Payment/Tax Withheld prepared annually for each employee reporting gross earnings, income taxes withheld, and mandatory deductions. Its audit significance is confirming that taxes withheld were reported to taxing authorities.

What is a labor ticket (time ticket or time sheet) and what is its audit significance?

A prenumbered form recording time spent on a specific job by an individual worker in the production plant. Its audit significance is recording the specific activity of a laborer in the production plant.

What is a labor ticket summary?

A form that summarizes all daily labor tickets by job or process to record total labor used in production on any given day.

What is BIR Form No. 1601-C and what is its audit significance?

The Monthly Remittance Return of Income Taxes Withheld on Compensation filed with the BIR. Its audit significance is providing evidence that amounts withheld have been remitted to appropriate tax authorities.

What audit significance do HR records (e.g., 201 files, pay rate change authorizations) serve in the payroll cycle?

They provide evidence that employees actually exist and that pay rates or rate changes are properly authorized.

What is the difference between a Payroll Register and an Employee Earnings Record?

A Payroll Register lists each payroll check along with gross pay, withholdings, and net pay for each pay period. An Employee Earnings Record tracks check numbers, gross pay, deductions, net pay, and cumulative YTD totals for an individual employee.

What is a labor distribution journal?

A report in which salaries and wages are allocated to specific accounts based on account codes (e.g., direct labor, indirect labor, or specific departments).

What key internal controls should be present in the User Department for payroll?

Monitoring and approving daily time records (via biometrics/access devices in computerized systems) and requiring department head approval for any time card exceptions.

How does the HR Department prevent terminated employees from receiving compensation?

By immediately notifying the payroll department of terminated or retired employees to prevent their inclusion in subsequent payroll calculations.

Why must the Payroll Department be segregated from HR, Treasury, and User Departments?

To maintain proper segregation of duties, preventing payroll staff from initiating personnel changes, handling physical cash/checks, or approving work hours.

What key internal control procedures should the Treasury Department / Cashier enforce regarding payroll?

Maintain a separate exclusive payroll bank account, conduct surprise paycheck distributions by an employee independent of payroll/user departments to detect fictitious employees, and redeposit unclaimed paychecks back into the bank.

How can auditors test internal controls over the Existence or Occurrence assertion in payroll?

Observe procedures followed by the personnel department, examine written approvals for selected payrolls, observe segregation of duties in check distribution, and verify supervisor approvals on time cards.

How is the Completeness assertion tested for payroll transactions?

Observe whether bank reconciliations for prenumbered payroll checks are routinely prepared by an independent employee who is not involved in payroll activities.

How is the Valuation or Allocation assertion tested for payroll?

Examine the payroll register for signature verification of calculations, and inspect worksheets comparing independent control totals of hours worked against recorded hours paid.

What is the primary misstatement resulting from inadequate separation of duties among timekeeping, personnel, production, payroll accounting, and check distribution?

Payroll padding.

What activities are involved in the Production Cycle?

The conversion of raw materials into finished goods, including production planning, inventory level control, and managing manufacturing process activities.

What is a production order (or production work order) and what is its audit significance?

A prenumbered form issued to instruct production personnel to produce a specific quantity of a product. Its audit significance is recording approval for manufacturing activities.

What is a bill of materials and what is its audit significance?

A document listing raw material components required to produce a product. Its audit significance is establishing the exact components required to produce a given item.

What is a materials requisition form and what is its audit significance?

A prenumbered form prepared by production personnel to request and authorize the issuance of raw materials from the warehouse. Its audit significance is recording approval to transfer materials into production.

What is a materials requisition summary?

A form summarizing materials requisitioned by job or process over a period, providing the basis for assigning material costs to specific accounts.

What is a cost accumulation report (or job cost sheet)?

A document that accompanies goods through production to record direct materials, direct labor, and applied overhead costs as they are incurred.

What is a completed production report and what is its audit significance?

A report summarizing costs for control purposes and allocating costs between completed goods and work in process. Its audit significance is providing a basis for inventory valuation.

How are custody, authorization, and recording responsibilities divided in the Production Cycle?

Custody of raw materials and labor forms is held by the production department; Authorization for runs rests with the production department via production orders; Recording is handled by cost accounting, which submits summaries to general accounting.

How is Existence or Occurrence verified for production transactions?

Inspect materials requisitions signed by both the releaser (warehouse custodian) and recipient (production worker), and examine labor tickets bearing signatures indicating work performed.

How is Completeness tested in the Production Cycle?

Account for the numerical sequence of prenumbered production orders and materials requisitions, and observe whether labor ticket time is reconciled to time cards.

What misstatement can result from a lack of periodic physical inventory test counts?

Undetected inventory shrinkage or unrecorded inventory errors.

What are the two main transactions in inventory warehousing?

1. Receipt of goods by the storeroom
2. Issuance of goods to production

How does an entity demonstrate controls over Rights and Obligations in inventory warehousing?

By ensuring that goods received on consignment are clearly labeled and physically separated from entity-owned goods.

What controls support the Completeness assertion in inventory warehousing?

Prenumbering receiving reports and materials requisitions, requiring inventory clerks to sign receiving reports upon counting goods, and restricting physical access to inventory.

Why do auditors rely more on substantive testing for the Financing and Investing cycles?

Because these cycles typically involve a small number of transactions, but each transaction involves a materially significant dollar amount.

Who holds authorization authority and custody for unissued debt and equity certificates?

Authorization must come from the Board of Directors. Custody is maintained by an appropriate internal officer (such as the Corporate Secretary) or an independent external custodian.

What internal control prevents duplicate payments when debt or equity securities are retired?

Canceling the retired security certificate through perforation (punching holes) and keeping supporting records for the audit trail.

What is 'dual control' (or dual custody) in the Investing Cycle?

A procedure requiring at least two high-ranking officers (such as the President, Treasurer, CEO, COO, CFO, or Chairman of the Board) to be present when accessing investment certificates.

Which departments are responsible for recording investment transactions in the general journal and maintaining the subsidiary ledger?

General Accounting records investment transactions in the general journal, while the Treasury Department maintains the investment subsidiary ledger.