1. Audit of the Payroll and Personnel Cycle
Chapter 20

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

3. 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.

4. Accounts in the Payroll and Personnel Cycle
Accrued Wages, Salaries,
Bonuses, and Commissions
Direct
Labor
Payment
Beginning
balance
Cash in Bank
Payment for
salaries
Earned wages,
salaries, etc.
Payment for
payroll taxes
Ending balance
Withheld Income Taxes
and Other Deductions
Payment
Beginning
balance
Payroll
withholding
Ending balance

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.

6. Learning Objective 2
Describe the business functions and the related documents and records in the payroll and personnel cycle.

7. Business Functions in the Cycle and Related Documents and Records
The payroll and personnel cycle….
Begins
Personnel
Hiring
Ends
Payments

8. Personnel and Employment
Personnel records
Deduction authorization form
Rate authorization form
Personnel records include such data as the date of employment, personnel investigations, rates of pay, authorized deductions, performance evaluations and termination of employment.
This form is used to authorize payroll deductions including the number of exemptions for withholding income taxes.
The rate form is used to authorize the rate of pay.

9. Timekeeping and Payroll Preparation
Time Card
Job Time Ticket
Payroll Transaction File
Payroll Journal
Timekeeping and
Payroll Preparation
Adequate controls are necessary to prevent misstatements in the following activities:
Prepare time records by employee
Summarize and calculate gross pay
Payment of payroll
Prepare payroll records

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.
The payroll master file is a computer file used for recording payroll transactions for each employee and maintaining total employee wages paid for the year.

11. Payment of Payroll Payroll check Payroll bank account reconciliation
Payments may be made by check but are usually deposited directly into an employee’s individual bank account.

12. Preparation of Payroll Tax Returns and Payment of Taxes
W-2 Form
Payroll tax returns
The W-2 form is sent to each employee and summarizes the employee's earning for the calendar year.
The payroll tax returns are forms submitted to local state and federal units of government to show payment of withheld taxes and the employer’s tax.

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.

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
transaction-related audit
objectives
Internal control for payroll is normally highly structured and well-controlled to manage cash disbursed to minimize employee complaints and dissatisfaction to minimize payroll fraud.
Tests of controls and substantive tests of transactions are the most important means of verifying account balances in the payroll and personnel cycle.
These tests are emphasized because of the lack of independent third party evidence.
Audit procedures
Sample size
Items to select
Timing

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
Segregation of duties is necessary in the payroll cycle to prevent overpayments and payments to nonexistent employees.
Only the human resources department should be authorized to add and delete employees from the payroll or change pay rates and deductions.
The appropriate documents and records depend on the nature of the payroll system. Time records are necessary for hourly employees but not for salaried employees.
Access to unsigned payroll checks should be restricted.
Payroll computations should be independently verified including comparison of batch totals to summary reports.

16. Payroll Tax Forms and Payments
Preparation of payroll tax forms
Timely payment of the payroll taxes
withheld and other withholdings
As part of understanding internal control, the auditor should review the preparation of at least one of each type of payroll tax form that the client files.

17. Inventory and Fraudulent Payroll Considerations
Relationship between payroll
and inventory valuation
Tests for nonexistent employees
When labor is a material part of the inventory valuation, auditors should emphasize testing internal controls over proper classification of payroll transactions.
Consistency from period to period is essential for classification.

18. Methodology for Designing Tests of Balances for Payroll Liabilities
Identify client business
risks affecting
payroll liability accounts
Phase I
Set tolerable misstatement
and assess inherent risk
for payroll liability accounts
Phase I
Significant business risks affecting payroll are unlikely for most companies. However, risks may exist for complex compensation arrangements including bonus and stock option plans and other deferred compensation arrangements.
Inherent risk is typically low for all balance related audit objectives.
Assess control risk for the
payroll and personnel cycle
Phase I

19. Methodology for Designing Tests of Balances for Payroll Liabilities
Design and perform
tests of controls and
substantive tests
of transactions
for the payroll and
personnel cycle
Phase II
Tests of accrued payroll expenses are ordinarily straightforward if internal controls are operating effectively.

20. Methodology for Designing Tests of Balances for Payroll Liabilities
Design and perform
analytical procedures
for the payroll and
personnel cycle
Phase III
Design tests of
details of payroll
accounts balances
to satisfy
balance-related
audit objectives
Audit procedures
Phase III
Two major balance-related audit objectives in testing payroll liabilities are:
1. Accruals in the trial balance are stated at the correct amounts ( accuracy)
2. Transactions in the payroll and personnel cycle are recorded in the proper period.
Sample size
Items to select
Timing

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

22. Analytical Procedures for the Payroll and Personnel Cycle
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

23. Analytical Procedures for the Payroll and Personnel Cycle
Possible misstatement
Compare commission
expense as a % of
sales with previous years
Misstatement of
commission expense
and commission liability
Compare payroll tax
expense as a % of salaries
and wages with prior year
Misstatement of payroll
tax expense and payroll
tax liability
Compare accrued payroll
tax accounts with prior year
Misstatement of accrued
payroll taxes and expense

24. Learning Objective 5
Design and perform tests of details of balances for accounts in the payroll and personnel cycle.

25. Two Major Balance-related Audit Objectives
1. Accruals in the trial balance
are stated at the correct
amounts (accuracy).
2. Transactions in the payroll and
personnel cycle are recorded
in the proper period (cutoff).

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
Discuss how the auditor might test the above accrued payroll related accounts.

27. Tests of Details of Balances for Expense Accounts
Officers’ compensation
Commissions
Payroll tax expense
Total payroll
Contract labor

28. Presentation and Disclosure Objectives
Required disclosures are not extensive
Some complex transactions require
footnote disclosure

29. 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
Audited by
TOC, STOT, and AP
Ending
balance
Ending
balance
Audited by AP and TDB
TOC + STOT + AP + TDB
= Sufficient appropriate evidence per GAAS

30. End of Chapter 20