Audit of the Payroll and Personnel Cycle Chapter

Learning Objective 1 Identify the accounts and transactions in the payroll and personnel cycle.

Accounts in the Payroll and Personnel Cycle The overall objective in the audit of

Accounts in the Payroll and Personnel Cycle Cash in Bank Payment for salaries Accrued

Accounts in the Payroll and Personnel Cycle Cash in Bank Payment for salaries Withheld

Accounts in the Payroll and Personnel Cycle In most systems the accrued wages and

Learning Objective 2 Describe the business functions and the related documents and records in

Business Functions in the Cycle and Related Documents and Records The payroll and personnel

Personnel and Employment Personnel records Deduction authorization form Rate authorization form © 2006 Prentice

Timekeeping and Payroll Preparation Time Card Job Time Ticket Payroll Transaction File Payroll Journal

Payroll Master File A payroll master file is used for recording each payroll transaction

Payment of Payroll check Payroll bank account reconciliation © 2006 Prentice Hall Business Publishing,

Preparation of Payroll Tax Returns and Payment of Taxes W-2 Form Payroll tax returns

Learning Objective 3 Understand internal control and design and perform tests of controls and

Methodology for Designing Controls and Substantive Tests Understand internal control – payroll and personnel.

Understand Internal Control – Payroll and Personnel Cycle • • • Adequate separation of

Payroll Tax Forms and Payments Preparation of payroll tax forms Payment of the payroll

Inventory and Fraudulent Payroll Considerations Relationship between payroll and inventory valuation Tests for nonexistent

Methodology for Designing Tests of Balances for Payroll Liabilities Phase I Identify client business

Methodology for Designing Tests of Balances for Payroll Liabilities Phase II Design and perform

Methodology for Designing Tests of Balances for Payroll Liabilities Phase III Design and perform

Learning Objective 4 Design and perform analytical procedures for the payroll and personnel cycle.

Analytical Procedures for the Payroll and Personnel Cycle Analytical procedure Possible misstatement Compare payroll

Analytical Procedures for the Payroll and Personnel Cycle Analytical procedure Possible misstatement Compare commission

Learning Objective 5 Design and perform tests of details of balances for accounts in

Two Major Balance-related Audit Objectives Accruals in the trial balance are stated at the

Tests of Details of Balances for Liability Accounts Amounts withheld from employees’ pay Ø

Tests of Details of Balances for Expense Accounts Officers’ compensation Ø Commissions Ø Payroll

Types of Audit Tests for the Payroll and Personnel Cycle Payroll Liabilities Cash in

End of Chapter 18 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18

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Accounts 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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 3

Accounts in the Payroll and Personnel Cycle Cash in Bank Payment for salaries Accrued Wages, Salaries, Bonuses, and Commissions Payment Beginning balance Direct Labor Earned wages, salaries, etc. Ending balance Payment for payroll taxes Withheld Income Taxes and Other Deductions Payment Beginning balance Payroll withholding Ending balance © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 4

Accounts in the Payroll and Personnel Cycle Cash in Bank Payment for salaries Withheld Income Taxes and Other Deductions Payment Beginning balance Payroll withholding Ending balance Payment for payroll taxes Payroll Tax Expense Accrued Payroll Tax Expense Payment Beginning balance Payroll tax expense Ending balance © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 5

Accounts in the Payroll and Personnel Cycle In most systems the accrued wages and salaries account is used only at the end of an accounting period. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 6

Learning Objective 2 Describe the business functions and the related documents and records in the payroll and personnel cycle. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 7

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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 8

Timekeeping and Payroll Preparation Time Card Job Time Ticket Payroll Transaction File Payroll Journal Timekeeping and Payroll Preparation © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 10

Payroll Master File A payroll master file is used for recording each payroll transaction for each employee and maintaining total employee wages paid for the year to date. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 11

Learning Objective 3 Understand internal control and design and perform tests of controls and substantive tests of transactions for the payroll and personnel cycle. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 14

Methodology for Designing Controls and Substantive Tests Understand internal control – payroll and personnel. Assess planned control risk – payroll and personnel. Determine extent of testing controls. Design tests of controls and substantive tests of transactions for payroll and personnel to meet transactionrelated audit objectives. Audit Items procedures to select Sample size © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Timing 18 - 15

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 © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 16

Payroll Tax Forms and Payments Preparation of payroll tax forms Payment of the payroll taxes withheld and other withholdings on a timely basis © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 17

Inventory and Fraudulent Payroll Considerations Relationship between payroll and inventory valuation Tests for nonexistent payroll © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 18

Methodology for Designing Tests of Balances for Payroll Liabilities Phase I 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. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 19

Methodology for Designing Tests of Balances for Payroll Liabilities Phase II Design and perform tests of controls and substantive tests of transactions for the payroll and personnel cycle. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 20

Methodology for Designing Tests of Balances for Payroll Liabilities Phase III Design and perform analytical procedures for the payroll and personnel cycle. Design tests of details of payroll accounts balances to satisfy balance-related audit objectives. Audit Sample procedures size Items to select © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Timing 18 - 21

Analytical Procedures for the Payroll and Personnel Cycle Analytical procedure Possible misstatement Compare payroll expense account balances with previous years. Misstatement of payroll expense accounts. Compare direct labor as a percentage of sales with previous years. Misstatement of direct labor and inventory. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 23

Analytical Procedures for the Payroll and Personnel Cycle Analytical procedure Possible misstatement Compare commission expense as a percentage of sales with previous years. Misstatement of commission expense and commission liability. Compare payroll tax expense as a percentage of salaries and wages with previous years. Misstatement of payroll tax expense and payroll tax liability. Compare accrued payroll tax accounts with previous years. Misstatement of accrued payroll taxes and expense. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 24

Learning Objective 5 Design and perform tests of details of balances for accounts in the payroll and personnel cycle. © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 25

Two Major Balance-related Audit Objectives Accruals in the trial balance are stated at the correct amounts (accuracy). Transactions in the payroll and personnel cycle are recorded in the proper period (cutoff). © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 26

Tests of Details of Balances for Liability Accounts Amounts withheld from employees’ pay Ø Accrued salaries and wages Ø Accrued commissions Ø Accrued bonuses Ø Accrued vacation pay, sick pay, or other benefits Ø Accrued payroll taxes Ø © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 27

Tests of Details of Balances for Expense Accounts Officers’ compensation Ø Commissions Ø Payroll tax expense Ø Total payroll Ø Contract labor Ø © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 28

Types of Audit Tests for the Payroll and Personnel Cycle Payroll Liabilities Cash in Bank Direct Labor and Payroll Expenses Payments Expenses Audited by TOC, STOT, and AP Ending balance Audited by AP and TDB TOC + STOT + AP + TDB = Sufficient competent evidence per GAAS © 2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 29