A4 - Transaction Cycles

The system of internal control for PPE includes controls related to both the revenue and expenditure cycles, as well as:

• Acquisition: a special requisition form is generated for acquisitions.

  • Includes a description, reason for acquisition, amount to be charged, and probable cost. This should be approved by top management.

  • BOD should approve acquisitions of assets over a certain amount.

• Subsidiary Ledgers: detailed information concerning each assets is kept in the subsidiary ledger.

  • Includes asset’s description, identification number, location, acquisition date, cost, depreciation method, and amount of depreciation.

• Physical Security: Identification plates (serial number on the plate should be listed in the control account)

  • Physical controls to safeguard assets from theft, destruction, or unauthorized disposition

• Written depreciation policies and records

• Disposition: asset retirements documented on a sequentially numbered work order containing evidence of proper authorization and reason for retirement.

To test completeness of PPE balance for substantive testing, the auditor should:

1. Obtain a fixed asset schedule and agree total to GL

2. Obtain schedule of additions and dispositions of fixed assets and agree amounts to the fixed asset schedule

3. Select a sample of Floor-to-Sheet counts

To test valuation and allocation of PPE balance for substantive testing, the auditor should:

1. Recalculate accumulated depreciation

2. Evaluate FA for impairment by examining the entity’s document impairment analysis

To test existence of PPE balance for substantive testing, the auditor should:

1. Vouch additions to FA accounts by:

   • examining internal documents (asset requisition form)

   • examining external documents (invoice)

   • inspecting actual asset (Sheet-to-Floor)

2. Select older FA from subsidiary ledger and then locate those assets as a means of testing unrecorded retirements

To test rights and obligations of PPE balance for substantive testing, the auditor should:

1. Examining invoices, deeds, and title documents to confirm ownership

To test completeness of PPE transactions for substantive testing, the auditor should:

1. Trace a sample of FA purchase requisitions to receiving reports and the fixed asset subsidiary ledger.

2. Review the related repair and maintenance expense accounts to test for completeness of asset additions (i.e. scan for items that should have been capitalized).

To test cutoff of PPE transactions for substantive testing, the auditor should:

Review fixed asset purchases and dispositions from shortly before and after year end for recording in the proper period

To test valuation, allocation, and accuracy of PPE transactions for substantive testing, the auditor should:

1. Recalculate depreciation expense amounts

2. Gains and losses and the removal of accumulated depreciation for fixed assets or retired

To test existence of PPE transactions for substantive testing, the auditor should:

1. Vouch a sample of purchases to receiving report and vendor invoice

2. Vouch a sample of dispositions to asset retirement form and other supporting documentation

To test understandability of presentation and classification of PPE transactions for substantive testing, the auditor should:

Review lease transactions for proper classification (i.e. operating vs finance)

What are some controls involving segregation of duties that pertain to payroll?

• Authorization to employ and pay records by HR department

• Supervision: all pay base data should be approved and monitored by an employee’s immediate supervisor

• Timekeeping and cost accounting: data on which pay is based should be accumulated independent of any other function, and hourly employees should use time clocks

• Payroll check preparation: payroll department computes salary based on information received. If a service org is NOT used, this department is responsible for issuing the unsigned payroll checks that are signed by the treasurer or CFO.

  • If a check signature plate is used to sign the payroll checks, the treasurer or CFO should supervise the process.

  • There should be controls over access to blank checks and check signature plates.

• Check distribution: typically directly deposited into employees bank account

  • If paychecks are manually distributed, then payroll checks should be distributed by a person who has no other payroll function.

The employees in the payroll department should NOT have the authority to…

1. initiate changes in hours or rates

2. ability to sign checks

In evaluating the system of internal control for the payroll function, the auditor should perform the following procedures:

• Observe segregation of duties between HR (authority) and payroll distribution (custody)

• Compare personnel records for each department with the actual time cards and the employees actually working in each department

• Observe payroll distribution on an unannounced basis to ensure that all personnel being paid are actually employed by the company

• Observe the use of time clocks and investigate time cards not used

• Test general and application controls to ensure that payroll transactions are valid, properly authorized, and completely and accurately recorded

When the system of internal control over payroll is effective, the auditor typically focuses substantive procedures on…

analytical procedures and the recalculation of payroll accruals

When the system of internal control over payroll cannot be relied upon, the auditor generally performs tests related to…

completeness, existence, and rights and obligations

How can the auditor test completeness of the payroll accrual?

Performing a SURL

How can the auditor test valuation and allocation of the payroll accrual?

Recalculate any YE payroll accrual and compare the calculated amount with the reported accrual

How can the auditor test existence of the payroll accrual?

Vouch amounts from the client’s calculation of the payroll accrual to supporting documentation (such as time cards and employee files)

How can the auditor test rights and obligations of the payroll accrual?

Examine supporting documentation (employee file) to verify that the payroll accrual is an obligation of the entity

How can the auditor test completeness of payroll transactions?

Trace a sample of time cards to the payroll register

What system of internal controls should an entity have over debt?

• Authorization of new debt financing by the BOD or management

• Adequate controls over interest and principal payments and the recording of bond premium and discount amortization amounts

• Adequate documentation of all financing agreements

• Detailed records of LT debt and periodic independent verification of amounts between the ledger, details of debt, and the note holder’s records

What system of internal controls should an entity have over equity?

• All stock issuances, dividend declarations, and treasury stock purchases must be authorized by the BOD

  • Evidence should be recorded in meeting minutes

• Many large entities use a stock transfer agent (i.e. bank), who ensures that stock issuances comply with articles of incorporation, prepares stock certificates, and maintains records of shares authorized, issued, and outstanding

• If a stock transfer agent is not used, the following controls should be implemented:

  • Periodic independent reconciliation of the stock certificate book with the number of shares outstanding

  • An officer of the entity should ensure that stock transactions comply with the articles of incorporation and regulatory requirements and should maintain the stock certificate book

What functions should be segregated related to payroll and personnel?

ARC:

• Authorization (HR, supervisory staff)

• Record keeping (timekeeping, cost accounting, and payroll department)

• Custody of assets (treasurer)