Chapter 12 Audit

What is the auditor’s main concern in the human resource process?

Payroll transactions once an employee has been hired.

What do operating departments initiate?

Personnel changes.

What payroll information is approved by the supervisor?

Time sheets.

What does the Human Resource Department review?

Payroll master file changes.

How are reviewed payroll master file changes stored?

Filed by date. 

What information goes into payroll processing?

Payroll master file changes and time sheets.

What does the payroll processing program produce?

• Payroll checks or direct deposit

• payroll register

• payroll master file changes report

• error report.

What does the payroll reporting program produce?

• General ledger information

• periodic payroll reports

• various tax reports and forms

What happens when payroll processing produces an error report?

Error correction is made and input back into the system.

What two types of transactions are typically processed through the human resource management process?

1. Payments to employees for services rendered.

2. Accrual and payment of payroll-related liabilities arising from employees’ services

What accounts can be affected by payroll transactions?

Cash, inventory, various payroll-related liability and expense accounts.

What accounts can be affected by accrued payroll liability transactions?

Cash and various accruals, such as payroll taxes and pension costs. 

What documents and records are used in the human resource management process?

•Personnel records

•T-4, TD1

•Time care / time sheet

•Payroll check / direct deposit

•Payroll register

•Payroll master file

What is the Human Resources function?

Authorization of hiring, firing, salaries, and payroll deductions.

What is the Supervision function?

Review and approval of employees’ attendance and time information and monitoring employee scheduling, productivity, and payroll.

What is the Timekeeping function?

Processing employees’ attendance and time information and coding account distribution.

What is the Payroll Processing function?

• Computing gross pay, deductions, and net pay

• recording and summarizing payments

• verifying account distribution.

What is the Disbursement function?

Payment of employees’ compensation and benefits.

What is the General Ledger function?

Proper accumulation, classification, and summarization of payroll in the general ledger

Who initiates wage or salary changes?

Operating or supporting departments.

Who initiates employee hiring or firing?

Operating or supporting departments.

Who approves wage or salary changes?

Human Resources.

Who updates personnel records?

Human Resources.

Who updates payroll records?

Human Resources.

Who approves time sheets and job classification?

Operating or supporting departments.

Who reviews time data and payroll distribution?

Timekeeping.

Who prepares payroll?

Payroll and IT.

Who prepares and signs payroll checks?

IT

Who distributes payroll checks?

Treasurer.

Who updates the general ledger for payroll activity?

IT.

Who compares monthly departmental payroll expense to budget?

Operating or supporting departments.

Who calculates and records payroll taxes?

Payroll

What should the auditor consider when assessing inherent risk for payroll?

• Economic conditions affecting payroll costs

• supply of skilled workers

• frequency of employee turnover

• existing labor contracts

What is the inherent risk associated with non-officers generally considered?

Low.

Why may inherent risk associated with company officers not be considered low?

Because of their ability to take advantage of their high position.

What are the three steps shown for control risk assessment of the human resource management process?

• Understand and document the human resource management process based on a reliance strategy.

• Set and document control risk for the human resource management process.

• Plan and perform tests of controls on payroll transactions.

What does the auditor want assurance about for the occurrence of payroll transactions?

That payments for payroll-related services are made to valid employees for time actually worked.

What must controls prevent regarding fictitious employees?

Payments being made to fictitious employees.

What must happen to payments once an employee is terminated?

Payments to the employee must be stopped.

What payroll areas must the entity have controls over?

• Hiring and terminating employees

• setting pay rates

• making withholdings

• awarding benefits

• issuing payroll checks.

What is the auditor’s main concern regarding the accuracy of payroll transactions?

That the employee’s gross pay and payroll deductions are determined correctly. 

What can happen if payroll expense is charged to the wrong accounts?

The financial statements may be misstated.

What can happen if payroll expense is not properly classified between direct and indirect labor?

Inventory and cost of goods sold may not be valued properly.

What tests of controls can provide assurance for the presentation assertion?

Tests around management’s use of a chart of accounts, proper codes for recording payroll transactions, and the financial reporting process

Matthews Corporation changed from paper time sheets to an IT payroll system where employees use magnetic cards. What effect does this change have?

A. A generalized computer audit program must be used
B. Without paper time sheets, part of the audit trail is altered
C. The potential for payroll-related fraud is diminished
D. Transactions must be processed in batches

C. The potential for payroll-related fraud is diminished

What happens if tests of controls support the planned level of control risk?

The auditor conducts substantive procedures of payroll-related accounts at the assessed level.

What happens if tests of controls do NOT support the planned level of control risk?

The nature and extent of substantive testing are increased.

What current-year payroll information can the auditor compare with prior years?

Payroll expense accounts.

What payroll costs can be compared with prior years and industry data?

Payroll costs as a percentage of sales.

What labor information can be compared with industry data?

Labor utilization rates and statistics.

What payroll expenses can be compared?

Budgeted payroll expenses with actual payroll expenses.

How can sales commissions be estimated?

Using formulas and recorded sales.

What can be compared when auditing payroll-related accrual accounts?

Current and prior years’ balances in payroll-related accounts.

What can the auditor test regarding accrual balances?

Their reasonableness. 

How can the auditor test OCCURRENCE of payroll transactions?

Trace a sample of payroll checks to the master employee list to verify validity.

How can the auditor test COMPLETENESS of payroll transactions?

Trace a sample of time sheets to the payroll register.

How can the auditor test ACCURACY of payroll transactions?

Recompute the mathematical accuracy of a sample of payroll checks.

What can CAATs or audit data analytics test for payroll accuracy?

The logic of computer programs for proper calculation of gross pay, deductions, and net pay and identification of unusual items.

How can the auditor test CUTOFF of payroll transactions?

Trace a sample of time sheets before and after period end

How can the auditor test CLASSIFICATION of payroll transactions?

Examine a sample of payroll checks for proper classification into expense accounts.

How can the auditor test PRESENTATION of payroll transactions?

Review the disclosure checklist and related disclosures for relevance and completeness. 

How is EXISTENCE tested for payroll-related accruals?

Vouch selected amounts from account schedules for accruals to supporting documents.

How are RIGHTS AND OBLIGATIONS tested for payroll-related accruals?

Review supporting documentation to determine that the entity is legally obligated to pay the liability.

How are ACCURACY, VALUATION, AND ALLOCATION tested?

Obtain an account analysis schedule for accrued payroll liabilities, foot schedules and agree the total to the general ledger, and compare amounts accrued with supporting documentation.

What expense accounts can payroll transactions affect?

• Direct and indirect manufacturing expense

• salaries

• commissions

• payroll tax expenses

If internal control is reliable, does the auditor need detailed tests of all payroll expense accounts?

no

When is additional testing of payroll expense accounts necessary?

When control weaknesses exist. 

What payroll-related liabilities can an entity incur?

Payroll taxes withheld, medical and life insurance premiums; pension; and other miscellaneous deductions.

How can supporting documentation for payroll accruals provide cutoff evidence?

It provides evidence about the proper period for recording the expense or liability. 

How can the auditor verify the existence, accuracy, and valuation of an accrued payroll liability?

Trace amounts included on the account analysis working paper to supporting documentation

What should the auditor know in order to determine whether payroll-tax accruals are complete?

The normal payroll-related taxes paid by the entity.

What payroll taxes are specifically mentioned?

CPP and EI.

What can the auditor conclude if likely misstatement is LESS than tolerable misstatement?

The auditor may accept the accounts as fairly presented.

What must the auditor conclude if likely misstatement is GREATER than tolerable misstatement?

The accounts are not fairly presented.