AUDITING CHAPTER 14 Control Substantive Tests in Personnel

AUDITING CHAPTER 14 Control & Substantive Tests in Personnel & Payroll By David N. Ricchiute GBW 8 th ed. , Ch. 14

TOPICS Nature personnel, payroll functions Controls over personnel, payroll activities Auditor’s consideration of controls Substantive tests of payroll accounts Earnings manipulation in payroll, postretirement benefits 2 GBW 8 th ed. , Ch. 14

NATURE OF PERSONNEL, PAYROLL CYCLE Resources (services) acquired in exchange for obligations to pay Obligations to employees are paid 3 GBW 8 th ed. , Ch. 14

PERSONNEL, PAYROLL DOCUMENTS Personnel records Time record Payroll register Employee earnings record 4 GBW 8 th ed. , Ch. 14

PERSONNEL RECORDS Salary or wage rates Payroll deductions Employee signatures Job classification Performance evaluation 5 GBW 8 th ed. , Ch. 14

INTERNAL CONTROL OBJECTIVES Authorization Execution Recording Access to assets Segregation of duties 6 GBW 8 th ed. , Ch. 14

AUTHORIZATION: Objective, Errors, Procedure Objective Error Procedure Employees hired according to criteria Compensation deductions according to authorization Excessive training, relocation costs; equal opportunity Clear hiring policies, procedures; updated records Adjustments authorized Increased pay, overstated labor costs 7 Excessive labor Updated listings pay costs; violation union rates, deductions; contracts; inaccurate review, approval accruals GBW 8 th ed. , Ch. 14 Clear adjustment policies, procedures

EXECUTION: Objective, Errors, Procedure Objective Error Procedure Payroll, personnel procedures authorized Misappropriated cash from paychecks for terminated, fictitious employees Personnel, payroll procedures manual Periodically verify employee assignments All payroll disbursements for recognized liability Misappropriated cash, overstated labor costs Prenumber, control time records, paychecks, adjustment forms; dual signatures 8 GBW 8 th ed. , Ch. 14

RECORDING: Objective, Errors, Procedure Objective Amounts due employees at proper amounts, time periods, classification 9 Error Procedure Payroll costs inaccurate; misstated expenses; details do not agree Document account distribution procedures; reconcile ledgers, journals; physical barriers unused documents, forms GBW 8 th ed. , Ch. 14

ACCESS: Objective, Errors, Procedure Objective Access to personnel, payroll records, forms, documents restricted to authorized personnel 10 Error Records, forms, documents misused; unauthorized labor costs GBW 8 th ed. , Ch. 14 Procedure Prenumber, control forms, documents; Segregate authorizing, executing, recording maintain listings authorized signatories

CONSIDERING INTERNAL CONTROL: Payroll Obtain understanding n n Preliminary review Document system Perform transaction walkthrough Determine whether controls are potentially reliable in assessing control risk below maximum w Test controls 11 GBW 8 th ed. , Ch. 14

TESTS OF CONTROLS: Personnel & Payroll Obtain payroll register n Verify mathematical accuracy Obtain payroll summary, labor distribution n n Verify accuracy of summaries; compare totals to payroll register Trace totals to GL & cost accounting records Select random sample employees & obtain personnel file n n n 12 Examination for completeness, authorization Compare pay rates, deductions Trace from register to employee records GBW 8 th ed. , Ch. 14

TESTS OF CONTROLS: Distribution Paychecks Obtain sample canceled payroll checks n n Trace details to payroll register Compare endorsements to signatures in file Personally distribute checks to properly identified employees 13 GBW 8 th ed. , Ch. 14

ASSESS CONTROL RISK Review system documentation Review results of controls tests Determine whether existing controls are n n Effective Can be relied upon to w Assess control risk below maximum w Assess detection risk above minimum w Restrict substantive tests of payroll 14 GBW 8 th ed. , Ch. 14

SUBSTANTIVE TESTS: Payroll Obligations, Valuation n Determine by analytical procedures, reasonableness Obligations, Valuation, Completeness n Determine reasonableness of accruals Presentation & Disclosure n 15 Review to determine classification, adequate disclosures GBW 8 th ed. , Ch. 14

ANALYTICAL PROCEDURES: Payroll & Accruals Compare ratios n n 16 Total payroll expenses & accrued expense with prior years; & adjusted for pay rate changes Direct labor to budgets, sales, prior years Commissioned sales payroll: sales X average commission rates Payroll tax expense to payroll with prior years GBW 8 th ed. , Ch. 14

MANIPULATED EARNINGS: Capitalized Costs at Safety-Kleen CEO, CFO, others capitalized payroll costs to “unrealized contingent-contract claims” to understate period expenses Board investigation reduced income for 1997 – 1999 by $534 million SEC filed suit alleging management falsely represented financial statements 17 GBW 8 th ed. , Ch. 14

POST RETIREMENT BENEFITS: Health Care Benefits based on estimates n n Off-balance sheet financing Pay-as-you-go system Management incentives to minimize for little earnings effect Auditor incentives to ensure fair presentation 18 GBW 8 th ed. , Ch. 14

AUDIT JUDGMENT Required for n n 19 Postretirement benefits other than pensions Health care obligations GBW 8 th ed. , Ch. 14