Audit of the Payroll and Personnel Cycle Chapter

Audit of the Payroll and Personnel Cycle Chapter 17 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 1

Learning Objective 1 Identify the accounts and transactions in the payroll and personnel cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 2

Accounts and Transactions in the Payroll and Personnel Cycle The overall objective in the audit of the payroll and personnel cycle is to evaluate whether the account balances affected by the cycle are fairly stated in accordance with generally accepted accounting principles. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 3

Accounts and Transactions in the Payroll and Personnel Cycle Cash in Bank Payment for salaries Payment for payroll taxes Accrued Wages, Salaries, Bonuses, and Commissions Payment Beginning balance Direct Labor Earned wages, salaries, etc. Ending balance Withheld Income Taxes and Other Deductions Payment Beginning balance Payroll withholding Ending balance © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 4

Accounts and Transactions in the Payroll and Personnel Cycle Cash in Bank Payment for salaries Payment for payroll taxes Payroll Tax Expense Withheld Income Taxes and Other Deductions Payment Beginning balance Payroll withholding Ending balance Accrued Payroll Tax Expense Payment Beginning balance Payroll tax expense Ending balance © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 5

Accounts and Transactions in the Payroll and Personnel Cycle Separate operating accounts for payroll also normally include officers’ salaries and bonuses, office salaries, sales salaries and commissions, and indirect manufacturing labor. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 6

Accounts and Transactions in the Payroll and Personnel Cycle These accounts have the same relationship to accrued wages and withheld taxes and other deductions that is shown for direct labor. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 7

Learning Objective 2 Describe the business functions and the related documents and records in the payroll and personnel cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 8

Business Functions in the Cycle and Related Documents and Records The payroll and personnel cycle begins with the hiring of personnel and ends with payment to the employees for the services performed and to the government and other institutions for the withheld and accrued payroll taxes and benefits. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 9

Personnel and Employment Personnel records Deduction authorization form Rate authorization form © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 10

Timekeeping and Payroll Preparation Time Card Job Time Ticket Payroll Transaction File Payroll Journal Payroll Master File © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 11

Payment of Payroll check Payroll bank account reconciliation © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 12

Preparation of Payroll Tax Returns and Payment of Taxes W-2 Form Payroll Tax Returns © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 13

Learning Objective 3 Understand internal control and design and perform tests of controls and substantive tests of transactions for the payroll and personnel cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 14

Methodology for Designing Tests of Balances – Accounts Receivable Understand internal control – payroll and personnel. Assess planned control risk – payroll and personnel. Evaluate cost-benefit of testing controls. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 15

Methodology for Designing Tests of Balances – Accounts Receivable Design tests of details of controls and substantive tests of transactions for payroll and personnel to meet transaction-related audit objectives. Audit procedures Sample size Items to select Timing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 16

Understand Internal Control – Payroll and Personnel Cycle • • • Adequate separation of duties Proper authorization Adequate documents and records Physical control over assets and records Independent checks on performance © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 17

Payroll Tax Forms and Payments Preparation of payroll tax forms Payment of the payroll taxes withheld and other withholdings on a timely basis © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 18

Inventory and Fraudulent Payroll Considerations Relationship between payroll and inventory valuation Tests for nonexistent payroll © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 19

Methodology for Designing Tests of Balances – Accounts Receivable Identify client business risks affecting payroll liability accounts. Set tolerable misstatement and assess inherent risk for payroll liability accounts. Assess control risk for the payroll and personnel cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 20

Methodology for Designing Tests of Balances – Accounts Receivable Design and perform tests of controls and substantive tests of transactions for the payroll and personnel cycle. Design and perform analytical procedures for the payroll and personnel cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 21

Methodology for Designing Tests of Balances – Accounts Receivable Design tests of details of payroll accounts balances to satisfy balance-related audit objectives. Audit procedures Sample size Items to select Timing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 22

Learning Objective 4 Design and perform analytical procedures for the payroll and personnel cycle. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 23

Analytical Procedures for the Payroll and Personnel Cycle Analytical Procedure Possible Misstatement Compare payroll expense account balance with previous years. Compare direct labor as a percentage of sales with previous years. Compare commission expense as a percentage of sales with previous years. Misstatement of payroll expense accounts Misstatement of direct labor and inventory Misstatement of commission expense and commission liability © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 24

Analytical Procedures for the Payroll and Personnel Cycle Analytical Procedure Possible Misstatement Compare payroll tax expense Misstatement of payroll as a percentage of salaries and tax expense and payroll wages with previous years. tax liability Compare accrued payroll tax Misstatement of accrued accounts with previous years. payroll taxes and payroll tax expense © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 25

Learning Objective 5 Design and perform tests of details of balances for accounts in the payroll and personnel cycles. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 26

Tests of Details of Balances for Liability Accounts Amounts withheld from employees’ pay Accrued salaries and wages Accrued commissions Accrued bonuses Accrued vacation pay, sick pay, or other benefits Accrued payroll taxes © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 27

Tests of Details of Balances for Expense Accounts Officers’ compensation Commissions Payroll tax expense Total payroll Contract labor © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 28

Types of Audit Tests for the Payroll and Personnel Cycle Cash in Bank Payroll Liabilities Direct Labor and Payroll Expenses Payments Expenses Audited by TOC, STOT, and AP Ending balance Audited by AP and TDP TOC + STOT + AP + TDP = Sufficient competent evidence per GAAS © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 29

End of Chapter 17 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 30