1. Chapter 12 Auditing the Human Resource Management Process McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved

2. Human Resources/Payroll  Major expense  Strong controls  Often outsourced

3. 12-3 Overview of the Human Resource Management Process The human resource process starts with the establishment of sound policies for hiring, training, evaluating, counseling, promoting, compensating, and taking remedial actions for employees. The main concern of the auditor involves payroll transactions once an employee has been hired. LO# 1

4. 12-4 Flowchart for EarthWear Clothiers Operating Human Resource Departments Payroll Initiates personnel changes Payroll master file changes Reviews master file change report Review By date Payroll master file changes Time cards Approved by supervisor   Time cards Input Error corrections From IT To IT LO# 1

5. 12-5 Payroll transactions  Employee performs a job  Employee records the time  Approval by supervisor

6. 12-6 Flowchart for EarthWear Clothiers Payroll Departments IT Payroll master file Error report Payroll processing Payroll checks Payroll register Error corrections Payroll register Review by date Payroll master file changes report Payroll reporting General ledger Periodic payroll reports Tax reports and forms LO# 1

7. 12-7 Two types of transactions are typically processed through the human resource management process: 1.Payments to employees for services rendered. 2.Accrual and payment of payroll-related liabilities arising from employees’ services, including liabilities for Social Security and unemployment taxes. LO# 2 Types of Transactions and Financial Statement Accounts Affected

8. 12-8 LO# 2 Types of Transactions and Financial Statement Accounts Affected

9. 12-9 Types of Documents and Records LO# 3

10. 12-10 Major Functions of HR  Record production and other types of costs  Ensure that payroll costs are for legitimate activities  Accrue liabilities for salaries, wages, etc.

11. 12-11 The Major Functions LO# 4

12. 12-12 Segregation of Duties LO# 5

13. 12-13 Segregation of Duties No one person should control all phases of a transaction

14. 12-14 Inherent Risk Assessment In assessing inherent risk the auditor may want to consider the effect of economic conditions on payroll costs, the supply of skilled workers, and the frequency of employee turnover. The auditor should be familiar with any existing labor contracts and the impact of regulation on the company. The inherent risk associated with non-officers of the company is generally considered low. The inherent risk associated with officers of the company may not be considered low because of the ability to take advantage of their high position. LO# 6

15. 12-15 Risk Assessment Procedures

16. 12-16 Control Risk Assessment Understand and document the human resource management process based on a reliance approach. Set and document the control risk for the human resource management process. Plan and perform tests of controls on payroll transactions. LO# 7

17. 12-17 Tests of Controls ( Transactions) Tests of Controls Risk Assessment Procedures Test of Controls

18. 12-18 Control Activities and Test of Controls – Payroll Transactions Occurrence of Payroll Transactions The auditor want assurance that payments for payroll- related services are being made to valid employees for time actually worked. Controls must be in place to ensure that no payments are made to fictitious employees and payments to valid employees are stopped once the employee is terminated. LO# 8

19. 12-19 Control Activities, Cont’d  External payroll servicer  SAS #70 report

20. 12-20 Control Activities and Test of Controls – Payroll Transactions Authorization of Payroll Transactions The client must have controls for hiring and terminating employees, setting pay rates, making withholdings, awarding benefits, and issuing payroll checks. LO# 8

21. 12-21 Control Activities and Test of Controls – Payroll Transactions Accuracy of Payroll Transactions The auditor’s main concern is that the employee’s gross pay and payroll deductions are determined correctly. LO# 8

22. 12-22 Control Activities and Test of Controls – Payroll Transactions Classification of Payroll Transactions If payroll expense is charged to the wrong accounts, the financial statement may be misstated. If payroll expense is not properly classified between direct and indirect labor, inventory and cost of goods sold may not be valued properly. LO# 8

23. 12-23 Relating the Assessed Level of Control Risk to Substantive Procedures If the results of the tests of controls for the payroll system support the planned level of control risk, the auditor conducts substantive procedures of payroll- related accounts at the assessed level. If the tests do not support the level of control risk, the nature and extent of substantive testing will be increased. LO# 9

24. 12-24 Substantive Analytical Procedures Tests of Controls Risk Assessment Procedures Substantive Analytical Procedures

25. 12-25 Auditing Payroll-Related Accounts Substantive Analytical Procedures LO# 10

26. 12-26 Tests of Details Substantive Tests of Details Substantive Analytical Procedures Tests of Controls Risk Assessment Procedures Substantive Test of Details

27. 12-27 Tests of Detail of Transactions, Account Balances, and Disclosures LO# 11 & 12

28. 12-28 Tests of Detail of Transactions, Account Balances, and Disclosures LO# 11 & 12

29. 12-29 Tests of Detail of Transactions, Account Balances, and Disclosures LO# 11 & 12

30. 12-30 Payroll Expense Accounts Payroll transactions affect many expense accounts, including direct and indirect manufacturing expense, general and administrative salaries, sales salaries, commissions, and payroll tax expenses. If the entity’s internal control is reliable, the auditor does not need to conduct detailed tests of all these payroll expense accounts. Additional testing is necessary only when control weaknesses exist. LO# 11 & 12

31. 12-31 Accrued Payroll Liabilities The entity incurs a number of liabilities including payroll taxes withheld (federal and state income and FICA), medical and life insurance premiums, pension, and other miscellaneous deductions. Accrued wages and salaries Accrued payroll taxes Accrued commissions Accrued bonuses Accrued benefits (vacation & sick pay) LO# 11 & 12

32. 12-32 Accrued Payroll Liabilities Cutoff An examination of supporting documentation for the accruals provides evidence on the proper period for recording the expense or liability. LO# 11 & 12

33. 12-33 Accrued Payroll Liabilities Existence and Valuation To verify the existence and valuation of an accrued payroll liability, the auditor can trace the amounts included on the account analysis working paper to supporting documentation such as payroll tax reports. LO# 11 & 12

34. 12-34 Accrued Payroll Liabilities Completeness The auditor must be aware of the normal payroll- related taxes that are paid by the entity and therefore should be able to determine if accruals have been made for payroll taxes such as Social Security taxes and unemployment insurance. LO# 11 & 12

35. 12-35 Accrued Payroll Liabilities Presentation and Disclosure Completeness Assertion LO# 11 & 12

36. 12-36 Evaluating the Audit Findings – Payroll-Related Accounts If the likely misstatement is less than the tolerable misstatement, the auditor may accept the accounts as fairly presented. If the misstatement is greater than the tolerable misstatement, the auditor may conclude that the accounts are not fairly presented. LO# 13

37. 12-37 Questions?

38. 12-38 End of Chapter 12