1 Chapter 11 production and payroll cycle including audit of inventory valuation and capital assets

2 production

3 1.Production cycle typical activities (1)production planning(inventory planning). (2)produce goods and services. (3)cost accounting(cost accounting allocations, unit cost determinations, physical cost calculations). (4)determine cost of goods sold. Authorization custody recordingkeeping periodic reconciliation

4 Production planning Inventory planning Receive goods and services Produce goods and services (physical quantity) Cost accounting Determine cost of goods sold Start here Reconciliation (analysis) Authorization Cost of goods sold Amortization schedule Sales forecast Acquisition cycle Purchase labour, materials, and overhead Inventory Payroll cycle Pay wages Orders Deliveries Revenue and collection cycle Deliver to customers (valuation) Periodic physical count Production cost analysis Quality control test reports Production orders Production reports Accounts/Records Inventory Cost of goods sold Amortization Inventory plan Production plan Sales forecast custody recordkeeping

5 (1)Authorization Sales forecast production planning (inventory planning to production orders) Material, labour,timing Production orders Managers(s,p) Sign off the approval

6 Production reportQuality control test report Finished goods Inventory record files A A

7 (2)custody MOVING inventory (materials into finished goods) Supervisors and workers Production order Quality control test Good cost accounting and analysis Completion of Production

8 (3)recordkeeping Cost accounting department Production order, record of material and labour used Separation (inventory custodian, payroll department) Overhead Depreciation amortization Cost-per-unit standard cost variances Cost of goods sold

9 (4)periodic reconciliation ACTUAL asset and liability TO RECORDED account A.Physical count of inventory, perpetual inventory records B. vendors`s monthly statement, recorded accounts payable C.product Cost, prior experience or standard cost lower-of-cost-or-market

10 Production planning Inventory planning Receive goods and services Produce goods and services (physical quantity) Cost accounting Determine cost of goods sold Start here Reconciliation (analysis) Authorization Cost of goods sold Amortization schedule Sales forecast Acquisition cycle Purchase labour, materials, and overhead Inventory Payroll cycle Pay wages Orders Deliveries Revenue and collection cycle Deliver to customers (valuation) Periodic physical count Production cost analysis Quality control test reports Production orders Production reports Accounts/Records Inventory Cost of goods sold Amortization Inventory plan Production plan Sales forecast custody recordkeeping

11 2.audit evidence in management reports Amortization schedule 462 Sales forecast Production plans and reports

12 3.control risk assessment Account balance (1)general control considerations (2)internal control questionnaire (3)production management--jit (4)detail test of controls audit procedures (5)direction of the test of controls procedures (6) summary:control risk assessment

13 Account balance Inventory: raw materials work in process finished goods cost of goods sold: amortization: amortization expense accumulated amortization

14 (1)general control considerations A.Segregation of responsibility B.Detail control checking procedures

15 (1)general control considerations Segregation of responsibility authorization (pro,inv planning) Custody cost accounting reconciliation

16 Segregation of responsibility A.authorization (production and inventory planning). Custody, recording, reconciliation B. Custody of inventory (raw materials, work in process, finished goods).authorize, purchase, cost accounting recordkeeping, prepare cost analyses (reconciliation)

17 Segregation of responsibility C.cost accounting (recording) Authorization, Custody But prepare various analyses and Reconciliation combination of 2 or more

18 Detail control checking procedures A.Production orders (a list of materials and the quantity, approved by planner) B. materials requisitions( compared with the list, signed by production operator and storeskeeper)

19 Detail control checking procedures C.labour time record ON JOBS (signed by production supervisor; the cost accounting department should reconcile these cost amounts with the labour report from the payroll department)

20 Detail control checking procedures D.production report(signed by production supervisor and finished goods inventory custodian, to cost accounting) computer (manual signatures and paper production orders, be imbedded in computer-controlled systems)

21 (2)internal control questionnaire appendix 11A-1

22 (3)production management--jit Just-in-time manufacturing implemented in many companies appendix 11B

23 (4)detail test of controls audit procedures Exhibit 10-2 detail test of control procedure: A. 样本总体 (population) B. 取证方法（ action) action: vouching, tracing, observing, scanning, recalculating Exhibit 11-2

24 (5)direction of the test of controls procedures Exhibit 11-3 Exhibit 11-4 Exhibit 11-5 why?

25 Production planning department Cost accounting Production orders Bill of materials Manpower needs Issue slips Material used report Production cost report Labour reports Production cost reports Sample Authorized 5-a 5-b 5-c 5-d Trace Match

26 ProductionCost accounting Materials requisitions and bills of materials Issue slips, Materials used reports Production cost reports Labour reports Overhead analysis General ledger (inventory) Same sample Sample recalculate 2-a 2-c 2-e 2-e,f 2-b 2-d Vouch materials Compare materials Vouch overhead Compare labour Vouch labour

27 (6) summary:control risk assessment CONTROL RISK IS LOW CONTROL RISK IS high

28 3.audit cases: substantive audit procedures Casette 11.1 unbundled before its time

29 problem Production “sold” as finished goods before actual unit completion. Understated inventory overstated cost of goods sold overstated revenue overstated income

30 Method Western corporation assembled and sold computer system A system Production order Hardware equipment software contract After finished installation pay the price for the entire package

31 Unbundled hardware Unbilled contract revenue Sales revenue cost of goods sold software Accounts receivable A billing statement Other Revenue, cost Work-in-process inventory account

32 Paper trail Customer orders contracts Hardware and software production orders Production cost accumulation work-in-process inventory record production report production cost report

33 Amount Overstatement 3 years 12%,15%,19% of Income before taxes

34 Audit approach Objective occurrence of cost completeness of recorded inventory

35 control 1.production planning department approval of orders as a total unit. 2.cross-referenced, Can see them as same order unit

36 Test of controls production orders vouched to the underlying customer orders and contracts, validity, proper period. Enquiry the standard procedures for the time of revenue and cost of goods sold recognition.

37 Audit of balance A.dual purpose test B.points: the dollar amounts accounts accumulated as cost of contracts and proper cutoff for recording the cost. C.red flag:unbilled contract revenue.

38 Discovery summary audit firm Purchasing complete software packages from other developers.

39 Break:5 minutes

40 4.Part 2:payroll cycle Activities Personnel hiring/firing Payroll accounting Compensation determination Supervision attendance and work Cash distribution Payroll distribution

41 Acquisition and payment cycle Cash disbursement (reconciliation) Cash disbursemte nt Start here ere Personnel hiring/firing Compensation determination Authorization Custody Payroll distributio n Recordkeepin g Payroll accounting Supervisionl, affendance, and work Payroll cheques Production cycle Cost accounting Labour cost analyses Payroll register Year- to-date Earning s records Timekeepin g records Government tax reports Personnel files Employees’ T-4 forms Employment application Termination notice Union contract Other approval Deduction authorizations Employee benefits Accounts/Records Wages expense and accrual Payroll tax expense and liability Pension expense and liability Accrued employee benefits Expensea and Liability Cash disbursements

42 (1)Separate people or department Personnel and labour relation---hiring/firing supervision--approval of work time timekeeping and cost accounting payroll accounting payroll distribution

43 (2)authorization Personnel or labour department Add new employees to payroll delete terminated employee obtain authorization for deduction transmit authority for pay rate changes to payroll department. SUPERVISOR Approve all pay base data (hours, job number, absence, time off allowed).

44 (3)custody Paycheques,cash, electronic transfer codes payroll distribution function: control the delivery of pay to employees, not be returned to persons involved in other-fun. timekeeping function: supervisors access to time cards or time sheets. the timekeeping devices, the employee.

45 (4)recordkeeping Prepare individual paycheques, pay envelopes. Year-to-date earnings records tax reports payroll tax returns federal T-4 summary. Authorization and custody //prepare the payroll

46 (5)Periodic reconciliation Payroll bank account,bank statement Comparing “real payroll” to recorded wages. Sent supervisor a copy of the payroll register, showing the employees paid under the authority and responsibility. Reapprove the payroll after it is completed. Notice whether any persons not approved. Payroll report, the labour records used.

47 (6)Employees on fixed salary The system is simplified even nonexistent.

48 5.audit evidence in management reports and file Personnel files timekeeping records payroll register labour cost analysis governmental and tax reports year-to-date earnings records employee T-4 reports.

49 6.control risk assessment THE MAJOR RISKS PAYING fictitious “employees” overpaying for time or production incorrect accounting for costs and expenses.

50 6.control risk assessment (1)general control considerations (2)computer-based payroll (3)internal control questionnaire (4)detail test of control audit procedures (5)direction of the test of controls procedures (6)computerized payroll processing (7)summary:control risk assessment

51 (1)general control considerations Segregation of responsibility authorization Custody cost accounting reconciliation

52 Segregation of responsibility A.authorization//payroll preparation, paycheque distribution, reconciliation. B. payroll preparation// authorization, payroll cheques C.recordkeeping// // authorization,distribute pay.

53 Detail control checking procedures (1)periodic comparison of the payroll register to the personnel department files to check hiring and terminated employees not deleted. (2)periodic rechecking of wage rate and deduction authorizations

54 Detail control checking procedures (3) reconciliation of time and production paid to cost accounting calculations (4) reconciliation of YTD earning records with tax returns (5)payroll bank account reconciliation.

55 (2)computer-based payroll Various paper records and approval signatures may not exist. they may all be imbedded in computerized. 嵌入 chapter 19

56 (3)internal control questionnaire Appendix 11A-2

57 (4)detail test of control audit procedures A. 样本总体 (population) B. 取证方法（ action) action: vouching, tracing, observing, scanning, recalculating Exhibit 11-7

58 (5)direction of the test of controls procedures 2 directions:completeness, validity understand why? E11-9 E11-8

59 Personnel filesPayroll department Authorization files Payroll registers Sample Review, trace to authorization A-1-a A-1-b A-1-c B-1-a Sample Vouch rates, deductions or Trace rates, deductions

60 (6)computerized payroll processing Reference files dynamic files the test of controls procedures

61 (7)summary:control risk assessment Control risk is low or high

62 Casstte 11.3 time card forgeries M hospital Nurse jane Leasing agency Time card shift supervisor bills paid work

63 method Agency time card showed approval signatures of a county nursing shift supervisor. The shift supervisor had been terminated. 1-2 days, 40-hour work week. Claim payroll hours on the false time card.

64 Paper trail (1)ward shift logs. (2)personnel records( the own nurses, supervisors, and other employees).

65 amount 24 e.h × $22/h=$ weeks, $7900 friends, $24000

66 Audit approach Objective valid employees actual time worked authorized pay rate

67 control Authorization: contract for nursing time,rate ward shift log supervisors approve time card. Agency billings( contract, time card) prepare paycheques.

68 Test of control weakness Nobody compared the card shift logs to time card. Nobody examined the supervisory signatures for their validity. Auditor Enquiry about error-checking procedures, follow.

69 Audit of balance (1)Vouch rates billed to the contract. (2)vouch time claimed to the ward shift logs (3)compare handwriting example to the approval signatures on the time cards. (4)using personnel records to determine the supervisors were actually employed. (5)using the work attendance records to determine the supervisors were on duty.

70 discovery (1)Had not signed in on the ward shift logs. (2) supervisors were not employed at the time. (3) signatures were not written by the supervisors. $32,900 WAS REFUNDED.

71 Auditing assignments(13) 1. prepare chapter 下列各题，每人自我练习，不交。 11.3, 11.4, 11.10, 11.17,11.21,11.22, 下列各题，每人均做，书面完成, 提交。 , 11.61,11.63, 11.64, 小组完成案例 :11.2, 11.4