20-1
Chapter 20
Audit of the Payroll and
Personnel Cycle
Concept Checks
P. 666
1. Transactions for the payroll and personnel cycle are generally far more
represent amounts associated with the last pay period, while payroll related
2. The human resources department provides an independent source for the
hiring and firing of personnel and the verification of wage information,
including changes in wages and deductions. The primary role of the
P. 675
are:
1. Examine time card for indication of approval to ensure that payroll
performed by existing employees (occurrence).
2. Account for a sequence of payroll checks to ensure existing payroll
payments are recorded. The purpose of this test is to determine
payroll transactions are properly classified. (Classification)
5. Observe when recording takes place to ensure that payroll
transactions are recorded on a timely basis. (Timing)
20-2
Concept Check, P. 675 (continued)
2. An auditor should perform audit tests primarily designed to uncover fraud in
the payroll and personnel cycle when he or she has determined that internal
Review Questions
Cash Direct labor
Inventory Salary expense
Construction in progress Commission expense
overstated. Similarly, if the indirect labor cost of individual employees is charged
to specific jobs or processes, the valuation of inventory is affected if labor is
year and indicates his or her gross pay, income taxes withheld, and FICA
withheld for the year. In serving as a summary of the employee’s earnings
record, the W–2 form conveniently provides information necessary for the
employee to fill out his or her income tax returns.
compensation taxes.
20-3
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20–4 An imprest payroll account is a separate payroll bank account in which
a constant balance, either zero or small, is maintained. When a payroll is paid,
the exact amount of the net payroll is transferred by check or electronic funds
transfer from the general account to the imprest account. The purpose and
advantage of an imprest payroll account is that it limits the company’s exposure
to payroll fraud by limiting the amount that may be misappropriated.
20–5 Where the primary objective is to detect fraud, the auditor will examine
the following supporting documents and records:
1. Cancelled payroll checks for employee name, authorized signature,
recurring second endorsements.
2. Payroll journal or listing, tracing transactions to the personnel files
the payroll period.
3. Payroll journal or listing and individual payroll records, selecting
terminated employees to determine whether each terminated
subsequent payroll period.
signs for his or her check.
5. Time cards, testing them for reasonableness or observing whether
they are being punched by the proper employees.
20–6 The auditor should be concerned with whether the human resources
department is following the proper hiring and termination procedures. An
obvious reason for this would be to ensure that there are adequate safeguards
against hiring and retaining incompetent and untrustworthy people. The
ramifications of hiring such people can range from simple inefficiency and
waste to outright fraud or theft. More importantly, though, it is necessary for the
20–7 To trace a random sample of prenumbered time cards to the related
payroll payments in the payroll register and compare the hours worked to the
hours paid is to test if payroll payments have been recorded (completeness)
and if those employees who worked are being paid for their time actually
20-4
20–7 (continued)
(occurrence). This test, in effect, attempts to discover nonexistent employees or
20–8 The percentage of total audit time in the cycle devoted to performing
tests of controls and substantive tests of transactions is usually far greater in
the payroll and personnel cycle than for the sales and collection cycle because
year–end balances in payroll–related accounts are often immaterial. Also, there
consuming tasks.
20–9 Audit procedures that are primarily for the detection of fraud in the payroll
and personnel cycle include:
1. Examine cancelled payroll checks for employee name, authorized
employees were actually employed during the period.
3. Select several terminated employees from payroll records to
determine whether each former employee received his or her
termination pay in accordance with company policy and to determine
that the employee’s pay was discontinued on the date of termination.
result, which will necessitate extensive investigation.
20–10 The auditor can use audit software for tests of controls in the payroll
cycle by accounting for the numerical sequence of payroll checks or other
documents, testing for proper approval of time records if the client uses an
general ledger, or summarize payroll by job or by category.
20-5
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20–11 Types of authorizations in the payroll and personnel cycle are:
1. Deduction authorization, without which the wrong amount (or no
deduction) may be deducted from the employee’s paycheck.
2. Rate authorizations, without which the employee may be getting
paid at the wrong rate.
3. Time card authorization, without which the employee may be getting
paid for the wrong quantity of hours worked.
4. Payroll check authorization, without which unauthorized funds may
be paid out.
6. Authorization to hire a new employee, without which nonexistent
or unqualified personnel may be added to the payroll.
following objectives:
1. Time card hours agree with payroll computations.
2. Overtime hours are approved.
3. Foreman approves all time cards.
5. Gross pay calculation is verified.
6. Exemptions taken agree with W–4.
7. Income tax, other deductions, and net pay calculations are verified.
8. Authorizations are available for voluntary withholdings and
miscellaneous deductions.
9. Paycheck endorsement is same as signature on W–4 form.
The frequency of control deviations or monetary errors must be estimated
prior to performing the tests. This estimate together with the acceptable risk of
overreliance (ARO) and the tolerable exception rate will enable the auditor to
20–13 In auditing payroll withholding and payroll tax expense, the emphasis
should normally be on evaluating the adequacy of the payroll tax return preparation
procedures rather than the payroll tax liability, because a major reason for
misstatements in the liability account is incorrect preparation of the returns in
20-6
20–14 Several analytical procedures for the payroll and personnel cycle and
misstatements that might be indicated by significant fluctuations are as follows:
SUBSTANTIVE ANALYTICAL
PROCEDURE
MISSTATEMENT TYPES
1. Comparison of payroll expense
accounts to amounts in prior years.
Cutoff misstatements or improper
amounts recorded in a period.
2. Direct labor divided by sales compared
to industry standards in prior years.
Cutoff misstatements or amounts
charged to improper payroll
accounts.
3. Commission expense divided by sales
compared to industry standards, prior
years, or sales agreements.
Failure to record commission on
sales, or recording the improper
commission amount.
4. Payroll tax expense divided by salaries
and wages compared to prior year
balances adjusted for changes in the
tax rate and not including officers’
salaries.
Failure to record payroll taxes or
recording of the improper amount.
5. Comparison of accrued payroll and
payroll tax accounts to prior years.
Failure to record payroll accruals or
recording improper amounts at the
end of a period.
6. The percentage of labor included in
work in process and finished goods
inventories compared to prior years.
Use of improper labor standards, or
classification misstatements.
7. Analysis of direct labor variances.
Use of improper labor standards, or
classification misstatements.
20–15 It is common to verify total officers’ compensation even when the tests
of controls and substantive tests of transactions results in payroll are excellent
because the salaries and bonuses of officers must be included in filings with the
SEC and IRS (e.g., the Form 10–K Report, proxy, and the federal income tax
Multiple Choice Questions From CPA Examinations
20–16 a. (2) b. (2) c. (3)
20–17 a. (4) b. (4) c. (4)
Multiple Choice Questions From Becker CPA Exam Review
20–18 a. (1) b. (3) c. (3)
Discussion Questions and Problems
20–19
a.
TRANSACTION–
RELATED AUDIT
OBJECTIVE
b.
TEST OF
CONTROL
c.
POTENTIAL
MISSTATEMENT
1. Recorded payroll
transactions are
stated at the
proper pay rates
(accuracy).
Examine
authorizations in
personnel files.
Employees are
paid the wrong
rate.
2. Hours worked are
correctly recorded
(accuracy).
Examine time
cards and
observe
preparation.
Incorrect recording
of time.
3. Recorded payroll
payments are for
work actually
performed by
existing
employees
(occurrence).
Examine time
cards for
approval.
Incorrect times are
used in
computing
employees’ pay.
4. Time records are
properly classified
by job
(classification).
Examine system
of identifying
jobs by number.
Direct labor is
charged to wrong
jobs.
5. Recorded payroll
checks are for
work performed by
existing
employees
(occurrence).
Observe and
discuss payroll
system with
employees.
Payroll payments
are made to
nonexistent
employees.
20-8
20–19 (continued)
a.
TRANSACTION–
RELATED AUDIT
OBJECTIVE
b.
TEST OF
CONTROL
c.
POTENTIAL
MISSTATEMENT
6. Payments are
made to actual
employees
(occurrence).
Observe
payments and
discuss with
employees.
Payments are made
to wrong
employees.
7. Recorded payroll
transactions exist
(occurrence).
Examine
personnel files
for termination
notices.
Employees are
improperly
terminated and
payment
continues.
8. Existing payroll
transactions are
recorded
(completeness).
Discuss with
employees and
observe
reconciliation.
Bank reconciliation
may be misstated
to conceal a
diversion of cash or
a misclassification
of payroll
transactions.
20–20
a.
TYPE OF TEST
b.
TRANSACTION–RELATED AUDIT OBJECTIVE(S)
1. Substantive test
of transactions
To determine if monthly payroll costs have been correctly
allocated (accuracy).
2. Test of control
To determine if recorded payroll transactions are for work
actually performed by existing employees (occurrence).
3. Substantive test
of transactions
To determine if employees are paid for the hours they have
worked (accuracy).
4. Substantive test
of transactions
To determine if payments are made to actual employees
(occurrence).
5. Substantive test
of transactions
To determine if the appropriate person is paid and amount and
time are correct (accuracy and timing).
6. Substantive test
of transactions
To determine if the correct job is charged for labor and if the
amount is recorded correctly for each job (classification and
accuracy).
7. Test of control
To determine if all payroll checks are recorded (completeness).
20-9
20–21
a.
RECOMMENDED CONTROL
b.
SUBSTANTIVE AUDIT PROCEDURE
1. Approval of time cards by foreman and
observation of use of time clock by the
foreman.
Observe employees punching in—only
one card per employee—to see whether
any employee punches two cards
(normally not an effective or practical
audit procedure).
2. Paychecks distributed by someone
other than the foreman.
Perform payroll payoff, requiring identification
from all employees prior to payment.
3. Pay employees only for time charged
to jobs. Reconcile payroll expense to
amounts charged to jobs.
Compare total hours worked from payroll
journal or listing to total hours worked as
recorded on job cost tickets.
4. Internal verification of classification.
Trace labor distribution to supporting job
input forms.
5. Payroll checks not returned to payroll
clerk after signing.
Perform payoff as described in 2 above.
6. Internal verification of calculations and
amounts.
Recompute federal withholding taxes and
trace to employee earnings record.
7. Payroll checks are prenumbered and
accounted for. Use an imprest bank
account where the amount to be
deposited is taken from the payroll
journal or listing.
Reconcile the disbursements in the payroll
journal or listing to the disbursements on
the payroll bank statement.
20–10
20–22
a.
TYPE OF TEST
b.
TRANSACTION–RELATED
AUDIT OBJECTIVE(S)
1.
(4) TDB
N/A
2.
(4) TDB
N/A
3.
(3) Substantive
analytical procedure
N/A
4.
(1) Test of control;
(2) STOT
Occurrence and accuracy
5.
(1) Test of control
Accuracy
6.
(1) Test of control
Accuracy
7.
(1) Test of control
Completeness
8.
(4) TDB
N/A
9.
(3) Substantive
analytical procedure
N/A
10.
(2) STOT
Occurrence, timing, and accuracy
PROCEDURE
PERFORMED
a.
ADDITIONAL PROCEDURES
b.
AUDIT OBJECTIVE
1.
Consider changes in client circumstances
that might suggest fluctuations in accrual
balances, such as increase in number of
employees.
Completeness
2.
Examine payroll tax form filed in subsequent
period to verify amount of payroll tax accrual.
Accuracy,
completeness
3.
Compare the bonus formula with prior years.
For a sample of salespersons, recompute
the accrued bonus based on the formula as
stated in the contract.
Trace amount of accrual to cash
disbursements in subsequent period.
Completeness
Accuracy
Accuracy,
completeness
4.
Review company policy for computing and
recording vacation pay accrual.
For a sample of employees, recompute
accrued vacation pay based on company
policy.
Accuracy
Accuracy